Trading Strategies: buying opportunities for long-term investors

Heightened geopolitical risks have prompted elevated volatility across global stock markets over recent weeks. Investors have understandably become increasingly concerned about the prospect of a regional conflict in the Middle East and its potential effect on the world economy’s outlook.

Alongside the ongoing war in Ukraine and continued tensions between China and Taiwan, this could persuade some investors to sell shares and instead hold assets that are likely to be less impacted by any future global economic shock.

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The reality, though, is that geopolitical events are inherently unpredictable. Investors ultimately have no means of accurately determining how any ongoing geopolitical threat will play out or what its impact will be on the world economy and global stock markets. Furthermore, history shows that there are likely to be numerous risks that investors are simply unaware of at present but will almost inevitably have a significant impact on future investment performance. Indeed, such “black swan” events are part of the fabric of investing and cannot be reliably foreseen or timed.

Long-term investors should, therefore, accept that share prices will perenially experience periods of temporarily elevated volatility due to unpredictable geopolitical events. While such occurrences may sometimes prompt frustration or even worry, they also provide an opportunity to buy high-quality companies when they trade at lower prices. And with inflation set to fall and interest rate cuts still on the horizon, the long-term outlook for global economic and stock market growth remains upbeat.

A bright long-term future

Of course, inflation is proving to be far stickier than many investors expected. In the US, for example, it accelerated on an annual basis for the second month in succession during March, rising by 30 basis points to 3.5%. Although it has fallen by 80 basis points during the past two months in the UK, and by 40 basis points in the Eurozone over the same period, annual inflation remains 120 and 40 basis points above central bank targets, respectively, in both regions.

This means that policymakers are unlikely to shift to a more dovish stance in the near term, which could equate to further volatility in share prices. But with the full impact of restrictive monetary policy arguably yet to be fully felt due to the existence of time lags, inflation is still widely expected to fall to 2% in the US, Eurozone and in the UK over the coming months.

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This will ultimately provide scope for central banks to cut interest rates as they attempt to stimulate GDP growth, which should have a positive impact on the world economy’s performance. In turn, operating conditions across most sectors are likely to improve. This should translate into higher profits and upgraded market valuations for a wide range of stocks over the coming years.

A cyclical focus

Clearly, the exact timeline for this process will remain a “known unknown” until after it has taken place. Sticky inflation may persist and prompt delays to interest rate cuts, or it could now quickly evaporate and allow central banks to shift to a more dovish stance. Investors should in any case purchase high-quality companies that have the financial means to survive further economic challenges in the meantime. They should also ensure any holdings are well placed from a competitive perspective to capitalise on an eventual upturn in the world economy’s performance.

Indeed, cyclical companies that are most reliant on the world economy’s growth rate could generate the highest capital gains in the long run. Not only are their current market valuations being negatively impacted by disappointing financial performances due to weak operating conditions, their share prices are being held back by downbeat investor sentiment prompted by sticky inflation and, in recent weeks, elevated geopolitical risks.

Investors who can go against their peers and look beyond such threats are likely to be major beneficiaries in the long run. After all, history shows that the world economy’s performance ultimately improves from even its lowest ebb and rewards those investors who stick around long enough to capitalise on it.

A sound platform for growth

Mining company BHP Group Ltd (LSE:BHP) could, for example, prove to be a major beneficiary of falling inflation, declining interest rates and an improving global economic growth outlook. The company’s exposure to a wide range of commodities, notably iron ore and copper, means its financial performance and, therefore, its share price, are highly dependent on levels of economic activity.

During periods of stronger economic growth, such as those likely to be ahead as interest rate cuts are implemented, demand for commodities tends to rise. This supports their prices, since supply is unlikely to keep pace with rising demand over a limited timeframe, and equates to higher revenue for mining companies. Lower inflation would also be a welcome boost for the company. Its half-year results showed that despite a disciplined approach to cost management, unit costs rose by 5.4% versus the prior year due to inflation across all of the countries in which it operates amounting to 6.3%.

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In the meantime, BHP has a solid financial position that means it is well placed to overcome ongoing economic uncertainty. Its net gearing ratio amounted to just 28% at the time of its interim results, while net interest costs were covered nearly six times by operating profits in the first half of the current financial year. This shows that it can cope with continued sticky inflation that could delay interest rate cuts and potentially prompt further weakness in commodity prices.

Long-term growth opportunities

The company’s long-term prospects are highly appealing. It is positioned to capitalise on the world’s shift to net zero, with commodities produced by the company such as copper and iron ore used extensively in renewables infrastructure. Furthermore, the firm’s investment in potash, which is used as a fertiliser, means it is aligned with long-term global demographic changes. Indeed, the world’s population will rise from around 8 billion today to roughly 9.7 billion by 2050, according to the UN. This increase will require greater agricultural output that, in turn, means higher demand for fertiliser.

The potential combination of BHP and Anglo American (LSE:AAL), which would involve the former acquiring the latter in an all-share deal, appears to be a logical move. Anglo American has a high-quality asset base that includes future-facing commodities such as copper, iron ore and crop nutrients.

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News of a possible deal broke Thursday morning and, although a formal bid has not yet been made, BHP’s proposal values each Anglo American share at £25.08 and the whole company at about £31 billion. This equates to a price/earnings ratio of around 13, which is a relatively low level given the company’s long-term growth potential.

An attractive valuation

BHP’s latest quarterly operational review showed that copper, iron ore and energy coal production is on track to meet previous guidance for the full year. While China’s uncertain near-term economic outlook remains a risk to the firm’s short-term prospects due to it being a major importer of a wide range of commodities, the IMF still expects its economy to expand by 4.6% in 2024.

In the first half of its current financial year, BHP’s earnings per share slipped by 0.5%. The company’s share price decline of 14% year-to-date suggests that investors have priced in an uncertain near-term outlook that could prompt further earnings volatility. It now trades on a price-to-earnings ratio of just 11, with a wide margin of safety equating to a favourable risk/reward opportunity on a long-term basis that means there is scope for significant capital gains.

Given its solid financial position and exposure to a wide range of commodities that are likely to rise in price as inflation falls and interest rates are cut, BHP represents a worthwhile investment despite ongoing geopolitical risks and sticky inflation.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.