I’m preparing for a stock market correction, or even a crash

Ed Sheldon thinks a stock market correction is more likely than a crash. But he’s preparing for both scenarios by trimming winners and stockpiling cash.

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At the beginning of 2024, I was bullish on the outlook for stocks. My view was that the market would keep rising after its big gains last year. Fast forward to today, however, and I’m starting to feel a little edgy. With many stocks already up more than 20% year to date, I think a stock market ‘correction’, or even a crash, could potentially be on the cards.

The S&P 500 is ripe for a pullback

There are a few things in the market that concern me right now.

One is the S&P 500‘s move higher. Back in late October, this index was near 4,100. However, recently, it hit 5,000. That’s a massive gain in just a few months.

Markets never go up in a straight line, so a pullback wouldn’t surprise me.

If the index did experience a wobble, it would most likely hurt the UK market.

Stocks have risen fast

Another issue is the enormous gains from US technology stocks already this year.

Microsoft is a good example here. It started the year at $376. However, recently, it hit $420. For a $3trn company, that’s a big jump (+12%) in just one-and-a-half months.

And Microsoft has actually been a laggard compared to some other tech stocks. Take Nvidia, for instance. It started 2024 at $495. However, earlier this week, it hit $746 – 51% higher.

Then, there’s Arm Holdings. Believe it not, it actually makes Nvidia look like a slouch. At one stage, it was up more than 100% in 2024.

These are all big price moves. And they worry me a little. Typically, when share prices start climbing like this, it doesn’t end well.

Valuations are looking stretched

Finally, valuations are starting to concern me a little. Especially in the tech sector.

Microsoft, for example, now has a forward-looking P/E ratio of about 36, which is punchy.

I wouldn’t be surprised to see tech valuations come down. This could send ripples through the market.

What I’m doing now

Now, if the stock market was to pull back, I think a correction (a fall of 10-20%) is more likely than a crash (a fall of 20%+).

Either way though, I’ve been trimming a few winners (e.g. Nvidia) to free up cash.

I want to make sure that I have plenty of capital to deploy if markets do drop so that I can take advantage of opportunities.

I’ve also been drawing up a list of stocks to buy.

One name that’s high up on this list is Advanced Micro Devices (NASDAQ: AMD) or ‘AMD’ for short.

It’s a leading semiconductor company that’s developing high-powered artificial intelligence (AI) chips in an effort to go head to head with Nvidia in the AI chip battle. I think the company has a lot of growth potential in today’s digital world.

Now, it has had a huge run recently. Over the last year, it has doubled in price.

After this jump, its valuation is too high for me. Currently, the company has a P/E ratio of about 48.

I’d be interested in buying the stock at a lower valuation though. If the stock was to fall 15-20%, for example, I think it could be a good purchase for my portfolio.

Let’s see what happens in the weeks and months ahead…

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Edward Sheldon has positions in Microsoft and Nvidia. The Motley Fool UK has recommended Microsoft and Nvidia. 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.

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