The FTSE 250 contains multiple mid-cap shares that tend to be more closely linked to the UK economy than the more internationally-focused FTSE 100. And so far this year, it has fallen by 16%. Could UK shares fall much further and if so, what should I buy?
Rising prices
First, let’s consider why share prices have fallen. Inflation seems to be the main culprit. Prices are rising sharply and the Bank of England indicated that inflation could reach 10% by the end of the year.
So why is that a problem? Well, higher energy bills, food prices and fuel costs all have a negative effect on our disposable income. And when we spend less elsewhere it causes economic growth to weaken. There’s now a risk of a major economic slowdown later this year.
Passive income stocks: our picks
Do you like the idea of dividend income?
The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?
If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…
Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.
What’s more, today we’re giving away one of these stock picks, absolutely free!
Could UK shares fall further?
Share prices are forward-looking and try to anticipate economic conditions several months ahead. UK shares have already taken a tumble this year, but they could still fall further.
Although not guaranteed, it’s certainly possible that a recession in the UK could last longer or be deeper than City analysts expect. There are many, uncertainties including Russia’s war in Ukraine and Covid measures in China disrupting supply chains.
If UK shares fall further, I’d see it as an opportunity to buy quality shares at a discount. I’d treat it just like the winter sales! History shows long-run stock market returns tend to be favourable.
For instance, over the past decade, the FTSE 250 produced an average return of 9% per year. That means if I invested £10,000 a decade ago, I’d currently have around £23,000.
Of course, that doesn’t mean I’ll definitely achieve the same in the coming years. But if UK shares fall further, it could raise my chances to capture a double-digit annual return. The Covid crash of March 2020 was certainly one of the opportunities. UK share prices are currently a whopping 50% higher than they were then.
Which UK shares to buy?
I could buy a UK-focused exchange-traded fund (ETF). Or with a bit of homework, I could pick and choose some quality shares that I think could perform well. To do so, I’d consider some words of wisdom from legendary investor Warren Buffett.
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” I’d add that buying a wonderful company at a wonderful price would be even better.
But what makes a great company? One attribute that high-quality companies tend to have in common is their return-on-capital-employed (ROCE). It shows how efficiently a company can turn its capital into profits.
My research suggests some examples of quality UK shares currently include Games Workshop, Greggs and Domino’s Pizza. All three are profitable, cash-generative and even offer an average dividend yield of 3%.
I’d consider buying all three shares for my Stocks and Shares ISA today. But if their share prices were to fall over the coming months, I’d be even happier to pop them in my portfolio.
