How to invest during this pandemic

The coronavirus that started in December 2019 is a global pandemic that has killed over 100,000 people in at least 210 countries. The nature of the virus has forced countries to impose lockdowns in a bid to mitigate the spread. This lockdown has however meant that businesses are unable to operate efficiently, translating to trillions of dollars in lost revenue. This business reality is most accurately captured in the global stock and equities markets. There are lessons to be learnt from the disrupted global markets that can guide individuals and businesses on how to navigate these rough waters that have caused disruptions on a global scale.

In Nigeria, the disease has infected over 300 people so far with 10 deaths recorded. As a measure to reduce the spread, the Nigerian government has also imposed another 14-day lockdown in two of the country’s busiest cities- Lagos and Abuja. This has caused most businesses to temporarily shut down their operations while others have folded up. Examples of businesses affected in Nigeria are the sport betting companies, retailers, beauty spas & stores, hotels and leisure spots.

Due to the COVID-19, the global stock market has been disrupted and traders have panic-sold stock. As a result, the market-wide circuit-breakers that attempt to curb panic-selling on U.S. Stock Exchange, have been triggered four times in March 2020 alone. In the first quarter of 2020, the global equity market lost $24 trillion in value, which is $2 trillion more than the GDP of the United States. In the same quarter, the pandemic shaved off nearly a third of the global market capitalization of the global equities markets.

The domino effect of the pandemic across the globe has also been felt in Nigeria. Our Nigerian Stock Exchange (NSE) recorded a loss of ₦2.3 trillion in the three weeks after the first Nigerian COVID-19 case in February – an 18% drop. The spread of the virus has also triggered panic across the world and shaken the confidence of investors in the Nigerian market.

With an impending recession looming, it is imperative investors take cues from stock behaviours in past recessions when developing their investment strategies. An assessment of previous recessions would reveal useful insights.

For example, in the last nine US recessions between August 1957 and June 2009, the S&P 500 index which measures the stock performance of the top 500 largest stocks on the U.S. stock exchange had an average pre-recession, recession, and post-recession performance as shown in the chart below.
The chart below shows the average stock performance of the S&P 500 index during the recession periods.

Also, in Nigeria, a similar pattern can be seen. The global financial crisis of 2008 caused the All-Share Index (ASI) to lose significant value. “Between March 2008 and March 2009, the ASI lost a total share of 67%, while market capitalisation lost 62% of its value. However, there was a rebound as shown in the chart below. In the second quarter of 2016, Nigeria fell into a recession and this was accompanied by significant losses and bearish behaviour in the stock market. This period was followed by a recovery as the economy eased its way out of the recession. At the end of November 2016, the market had recorded a growth of 41.2%. The financial services and consumer goods sectors were most patronised sectors by value and volume turnover in the year.

The chart below shows the pre and post stock performance of Nigeria’s All Share Index during the 2008-2009 financial crisis and 2016’s economic recession.

These figures show the importance of taking advantage of economic downturns reflected in the stock market to make personal gains in the long term. In a recession, stocks dip and this presents an opportunity for investors to buy stocks that have the capability of bouncing back post-recession. Historically, investors who made buy orders for stocks during recessions stood a better chance at making significant gains once the economy bounced back.

In deciding what stocks to buy, it is important that investors watch out for indicators that provide insights on the general health and potential capabilities of companies withstanding economic recessions. A good starting point is looking at companies’ financial statements. A simple ratio analysis can help determine financial performance and capabilities. Companies with good cashflows, profits and low debt, have higher chances of surviving economic recessions. Avoid companies with a lot of debt on their balance sheet. A debt to equity ratio of more than 50% is generally considered high. Depending on the type of business, sales that come in during recessionary periods are low compared to periods of boom and economic progress. For these types of businesses, it is a challenge to cope with paying interest and loans because of the limited cash flow and could potentially go bankrupt.

It is important to note that not all stocks lose value during recessions. These stocks are called defensive stocks and they provide consistent dividends and stable earnings regardless of the state of the stock market. Companies in this sector provide necessities, therefore, the demand for their product/service will be flat irrespective of the economic cycle. Companies in the consumer staples and utilities sectors are a good example of defensive stocks. These companies have healthy margins and strong cash flows. In Nigeria for example, Dangote Cement PLC, Nestle PLC, and Newgold ETF are some of the stocks that have shown resistance in past recessions. Often their prices are regulated and allow for stable profits.

In deciding the mix of your portfolio when the market is down, trade-offs have to be made between cheap stocks that have the potential to recover and increase in value post-recession; and relatively stable stocks which are expensive but are likely to retain their value during a recession. Depending on your investment objectives, buying stocks when they are undervalued provides an opportunity for capital appreciation as these stocks recover, however it is important to note that these stocks may not pay dividends. Consequently, if you are interested in annual cash flows from dividends then defensive stocks are the way to go.