Since the COVID-19 pandemic sparked a massive stock market sell-off in late February and March, many investors have bought stocks with the expectation that they'd make nice gains when the market rebounded. Sure enough, the stock market began to rebound in late March. The major market indices have regained much of their losses. Many individual stocks are even up year to date.
But is it now time to put further buying on pause? Here are three reasons why you might not want to buy stocks right now.
1. Valuations are frothy
There's a pretty solid argument to be made that the valuations of many stocks have gotten too frothy. This argument is especially compelling considering that the global economy could be facing its biggest challenges since the Great Depression.
Consider Apple (AAPL 1.89%). Shares of the tech giant are close to their all-time highs, but its business could very well be hit hard if the U.S. enters an especially nasty recession. And the prospects of such a recession seem likely.
You might say, "But Apple is just one stock." That's true, but it runs neck-and-neck as the largest member by market cap in both the S&P 500 index and the Dow Jones Industrial Average index. As Apple goes, so goes the overall stock market to a great extent. More importantly, there are plenty of other stocks that have valuations at least as high as Apple's.
2. Q2 earnings will be worse than Q1
Many investors breathed a sigh of relief after the first-quarter earnings season. A lot of companies reported pretty good results in the quarter. But expect Q2 earnings results to be significantly worse than Q1 results.
For one thing, the impact of the COVID-19 pandemic will more heavily impact the second quarter than it impacted the first quarter. States have only recently begun to reopen after imposing stay-at-home orders. This means that at least half of the second quarter will reflect much lower overall economic activity than usual. By comparison, the first quarter included only a week or two of reduced economic activity.
Remember also that some companies benefited in the first quarter from consumers stocking up due to the coronavirus outbreak. CVS Health (CVS -1.50%) enjoyed higher prescription volumes in Q1 as people shifted to 90-day prescriptions from shorter-duration prescriptions and filled maintenance medications early. The healthcare company also saw increased front-store sales as consumers stocked up on other products. However, CVS Health won't have those tailwinds in the second quarter.
3. Another wave of outbreaks could be on the way
Perhaps the most worrisome reason to stay away from stocks now is that another wave of coronavirus outbreaks could be on the way. And it could be even worse than the first round.
Centers for Disease Control and Prevention (CDC) director Robert Redfield has expressed concern that a second wave of the COVID-19 outbreak could be more challenging to the U.S. than the first one because it could coincide with flu season. Multiple waves of outbreaks are common with pandemics. The second round of the 1918 Spanish flu pandemic was worse than the first round.
Stock markets are heavily influenced by psychological factors. If investors are worried, they're likely to sell stocks in a panic. That's what happened earlier this year. It could easily happen again. The timing of the U.S. elections could also play a factor. Some could be motivated to play up the risks of a potential second COVID-19 wave to serve their political interests.
Also, many investors appear to be banking on quick success for COVID-19 vaccines in development. Should the most promising vaccine candidates stumble in clinical testing, anxiety levels could be even higher in the fall than they are now.
Here's some good news: Most things we worry about don't end up happening. A Penn State study found that 91% of people's worries ended up being much ado about nothing. As for the remaining 9% of worries that did become reality, the outcome was better than people expected around one-third of the time.
Also, the stock market is forward-looking. Investors have largely factored in the potential for dismal Q2 results. It's no secret that another COVID-19 round could be on the way.
So should investors stay away from stocks or not? My advice is to take a long-term perspective. If you believe that a given stock's long-term prospects should enable it to grow significantly over the next five-to-10 years, don't be concerned about what might happen over the next few months.
Let's again use Apple as our example. The company's services businesses continue to grow and likely will continue to do so for years to come. Apple stands to benefit from its anticipated launches of iPhones that support high-speed 5G wireless networks. The stock might decline from its current levels this year, but it's a pretty good bet that Apple will be a lot higher 10 years from now than it is today.
I also recommend buying incrementally, perhaps once each month. You won't be able to time the market perfectly except by pure chance. Buy shares of your favorite stocks in incremental chunks over time.
But if you're still worried about the potential for another stock market downturn, you can always focus only on stocks that are likely to perform well regardless of what happens next with the COVID-19 pandemic or the global economy. I think Vertex Pharmaceuticals (VRTX 0.58%) is a good example of such a stock.
Vertex markets the only drugs that treat the underlying cause of rare genetic disease cystic fibrosis (CF). It awaits European approval of its most powerful CF drug so far, Trikafta. The company is highly profitable. It has a huge cash stockpile. Its pipeline includes several promising candidates. And the biotech stock trades at a price-to-earnings-to-growth (PEG) ratio of only 0.58, a dirt cheap valuation assuming it comes anywhere close to hitting growth targets.
The bottom line is that you might not want to buy stocks right now, but there are ways to keep investing that will enable you to win over the long run regardless of what happens next.