Get ready for a stock market correction, says the Bank of England

The UK’s central bank reckons there’s a heightened risk of a sharp stock market correction. Here’s a share I’ve got my eye on, in case that happens.

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The stock market has been chugging along nicely in 2024. The FTSE 100 has risen 6.2% since the turn of the year, while the S&P 500 has surged nearly 15%. European shares have also been doing well.

However, in its latest update on financial stability on 27 June, the Bank of England (BoE) warned that investors might be getting a bit complacent.

The prices of many assets such as shares and bonds remain high relative to historical norms, and some have continued to rise...[Investors] are placing less weight on risks, such as geopolitical developments or continued high inflation…These risks make it more likely that there could be a sharp correction in asset prices.

Bank of England Financial Stability Report, June 2024

As a reminder, a stock market correction is generally defined as a decline of at least 10% from a recent high. A crash is considered to be a drop of 20% or more.

One positive thing the report mentioned was that UK households and businesses have remained resilient despite the impact of higher interest rates. And it said the UK banking system looks strong enough to cope even if the economy worsens.

The Foolish view

Now, the BoE isn’t predicting a correction here. It’s merely highlighting the heightened risk of one due to rising asset prices and potential geopolitical developments.

Last March, the bank also flagged up the risk of a “sharp correction” due to “stretched” asset prices, but that didn’t come to pass. And most FTSE 100 stocks don’t appear overvalued to me. Quite the opposite, in fact.

Besides, stock market corrections aren’t anything to fear. They can be very lucrative times to invest because the wheat often gets sold off with the chaff.

As investing legend Warren Buffett famously advises: “Be fearful when others are greedy, and greedy when others are fearful.” That’s a powerful mindset to have as a long-term investor.

A stock I’d buy during a downturn

Right now, I’d like to add to my holding in Rolls-Royce (LSE: RR). The stock’s been on fire, rising 350% in three years as the engine-maker recovered from the turmoil of grounded flights during the pandemic.

In its key Civil Aerospace unit, engine flying hours have returned to 100% of pre-Covid levels in the first four months of 2024. They could finish the year at 110% of 2019 levels.

Meanwhile, its Defence unit, which supports over 160 armed forces around the world, is seeing lots of demand with rising military budgets. Its nuclear reactors are set to power submarines for the Australian Navy under the trilateral AUKUS defence pact.

My issue here is valuation. The stock’s currently trading at 30 times forward earnings, which suggests it’s priced to perfection. If the civil aviation industry was hit by another pandemic, say, or the outbreak of war, the company could miss its financial targets.

However, if there was indeed a sharp market correction, I’d happily double down on the stock. By 2027, the firm’s aiming to quadruple operating profit from 2022 levels to £2.5bn-£2.8bn. And it’s seeking to expand operating margins to 13-15%, up from 5.1% in 2022.

Plus, the company reckons £45bn of new programmes will come online by 2050 within its defence markets, creating a substantial long-term opportunity.

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.

Ben McPoland has positions in Rolls-Royce Plc. The Motley Fool UK has recommended Rolls-Royce Plc. 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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