The FTSE 100 has suffered several wobbles over the past few months. Even yesterday morning, the FTSE 100 dropped 1.2% to trade below 7,000 points. A similar slump was seen last month, and is causing the index to struggle to break new highs. Below are three main risks I see of an impending FTSE 100 crash, along with what I can do to protect myself.
Inflation has been something that hasn’t been a major issue in the UK for several years. In fact, the concern during 2019 and 2020 was that inflation was actually falling too far below the 2% target level. Things have changed quickly due to the reopening of the economy earlier this year. The price level has been rising, with the latest reading in August jumping to 3.2% year-on-year.
Some argue that this move is transitory, linked to the initial bounce in economic activity. However, the stock market isn’t taking it very well. Higher inflation is likely to be followed by higher interest rates from the Bank of England. This will make it more expensive for debt-laden FTSE 100 stocks to issue new debt. And future interest repayments will be higher.
What can I do about this FTSE 100 crash risk? The least impacted stocks will likely be ones that have low debt. So when considering a stock to buy, I’d look at the debt-to-equity or debt-to-income ratios.
A China slowdown
Another FTSE 100 crash risk is China. It sounds odd to pin a risk on an entire country, but I think it’s a valid one. Recently, economic data out of China has started to slow down. Its government is also cracking down on different sectors quite hard. Finally, we’re seeing some large companies struggle, such as the property developer Evergrande.
The reason why this is an issue is because the world economy is integrated with China. Here in the UK, a lot of companies have ties with China via where their products are manufactured or materials sourced. If China struggles, this will have a negative impact on firms that have such trading ties.
To deal with this, I can be selective in the FTSE 100 stocks I buy. I can look for stocks that don’t rely on China. For example, some financial services companies and banks don’t have much exposure in this regard.
The right perspective around a FTSE 100 crash
The final FTSE 100 crash risk I see is the fear of the unknown. Simply put, investors are starting to get scared, without directly knowing what they’re scared about. To some extent, there is rationale behind this. For example, Covid-19 is under control, but could cause problems into the winter. There’s also little certainty about the state of the economy and how robust the recovery is. The UK could head back into a recession next year.
For investors, this uncertainty could spark a crash as they might want to take risk off the table and sit in cash. Ultimately, I don’t think this is the best thing to do. As a long-term investor, I feel I’m better off riding out slumps in the market rather than trying to sit in cash as I try to pick the timing of a crash.
Overall, I can take actions against these potential FTSE 100 crash risks and ultimately look for a longer-term time horizon.
jonathansmith1 and The Motley Fool UK have no position in any of the shares mentioned. 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.