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There’s no guarantee a stock market rally will follow 2020’s stock market crash. However, the past performance of UK shares suggests it’s very likely to take place over the coming years.
As such, buying dirt-cheap UK shares now and holding them for the long term could be a sound move. It may enable an investor to make attractive capital returns as company profits and investor sentiment strengthen following a tough 2020.
A stock market rally could lift the valuations of today’s ultra-cheap UK shares. It seems likely to take place over the coming years, since every previous market downturn has been followed by a bull market that has produced new record highs. There may not necessarily be a fast-paced market rally in 2021. However, a buy-and-hold strategy could allow an investor to take part in a likely rise in the FTSE 100 and FTSE 250’s price levels.
Of course, cheap stocks could benefit the most from an appreciating stock market. They may offer the widest margins of safety at the present time. They could also be worth significantly more in a period of stronger economic growth than investors are currently pricing in.
Starting from a low base also means there’s significant scope for a major recovery. As such, focusing on undervalued shares today could be a profitable move over the long run as a likely stock market recovery unfolds.
Buying more than just cheap stocks
Clearly, there’s still uncertainty ahead that may mean a stock market rally includes significant volatility. Past bear markets have often been followed by rallies, only for them to run out of steam as investors begin to fear a double-dip recession. Indeed, the potential for tax rises in 2021 may mean company profits come under a degree of pressure in the near term.
As such, buying a diverse range of businesses can help to reduce overall risks. A diverse portfolio is less reliant on a small number of businesses for its returns. Furthermore, buying cheap stocks that have solid balance sheets and competitive advantages versus their rivals may allow an investor to benefit more fully from a long-term stock market recovery. They may be able to deliver rising profitability that allows them to justify a higher valuation in the coming years.
A buy-and-hold strategy
A likely long-term stock market rally means that a buy-and-hold strategy using dirt-cheap UK shares is a logical strategy. But some investors may seek to trade shares over a short time period. While this can lead to high profits in a short space of time in some cases, it carries significant risks.
After all, short-term stock market movements are unpredictable. As such, buying and holding today’s cheap stocks could be a less risky, and more profitable, approach in the coming years.
Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.