I’ve heard a lot of talk about a potential stock market bubble popping soon. Euphoria is everywhere. Wild speculation reigns. And share prices are going gangbusters while investors fling cash into unprofitable companies. Even the biggest investment banks in the world are worried.
So how should I protect my ISA today?
Those of us who were heavily invested in the last major crash in March 2020 felt an enormous amount of pain. I personally lost tens of thousands in paper profits in my ISA. But three principles saved me. I didn’t panic. I tried to learn from my mistakes. And I never made the same mistake twice.
You see, if another stock market bubble pops, it could potentially wipe out all the hard-earned gains I’ve made over the last decade. I wasn’t well set up for the last big crash. But I’ll definitely be ready this time.
Stock market bubble-up
The rise of companies like Tesla seem to me a herald of the shaky foundations on which a stock market bubble is built. And the calls for some semblance of reality are getting louder every day. Goldman Sachs sees bubbles everywhere it looks, for example. Valuations are “extremely elevated”, writes the investment banks’s US equities chief David Kostin.
Billionaire investor Seth Klarman, whom I’ve quoted many times in these pages before, said investors were now like “frogs in boiling water”. The hedge fund founder, quoted in the Financial Times, wrote that the market appeared to be acting as if all risk “has simply vanished”.
A stock market bubble is all fun and games until it isn’t any more. As a long-term value investor I know that better than most.
Personally, I’m starting to diversify my risk by spreading investments into companies with defensive qualities. To me that means companies whose products will be in demand in times both fair and foul.
These companies’ revenue and earnings stay relatively stable even in times of intense trouble. As such, they become a safe harbour for nervous investors if a stock market bubble approaches. I’m talking about sectors like pharmaceuticals, defence and consumer essential goods.
I’d still look closely at companies that appear undervalued. There’s no need to pile into expensive high P/E stocks just because I want a bit of safety. I own AIM-listed vaccine tester Open Orphan for example, and it appears a good bet to me. For my income investing I think there are few better plays than FTSE 100 giant GlaxoSmithKline. In the FTSE 250, defence player Qinetiq could be an option for me.
Secondly, I will start taking a few profits here and there from my best performing shares, like 5G provider MTI Wireless Edge or battery metals producer Sylvania Platinum. The former is up over 90% for me in the last six months, while the latter has gained over 130%.
It’s impossible for me to predict when a stock market bubble could burst. The market can remain irrational longer than any of us can stay solvent. By being conservative, I might lose out on a few percentage points of gain here and there.
But to me, there’s no harm in preparing for a pullback. Once those dominoes start to fall, the whole thing can collapse fast. I know which position I’d prefer to be in.
Right now, this ‘screaming BUY’ stock is trading at a steep discount from its IPO price, but it looks like the sky is the limit in the years ahead.
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TomRodgers owns shares of MTI Wireless Edge Ltd., Open Orphan plc, and Sylvania Platinum. The Motley Fool UK owns shares of and has recommended Tesla. The Motley Fool UK has recommended GlaxoSmithKline. 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.