These days it seems everybody and their uncle thinks the stock market is about to crash. I tend to take these fears with a pinch of salt because they’re often wrong – and it’s never a good idea to make decisions based on emotion.
Still, being prepared can’t hurt. And in some cases, it can turn a potential catastrophe into an opportunity.
Will the market crash?
Last week, the FTSE 100 suffered one of its sharpest dips in months, falling 3% in less than 48 hours. That’s concerning, but understanding why markets crash can help alleviate the worry.
Sometimes they’re the result of a natural disaster, like the pandemic, but more often they’re simply a healthy correction. And as history shows, they don’t last forever.
The recent rallies in the US and UK mimic similar ones that preceded corrections, so it wouldn’t be unusual for another to occur soon.
To prepare, I’ve been rebalancing into defensive shares as they tend to weather market downturns better. But I’ve also been doing something else.
Saving for a shopping spree
Are there any stocks you want to buy, but they’re just too expensive? Well, a stock market crash could be an early Christmas self-gifting opportunity.
The trick is having cash on hand to avoid selling other stocks at a loss to finance new investments. But it’s important not to dive in immediately — market dips can drag on longer than expected, and in a recession that cash may be a much-needed lifeline.
Once things have stabilised and a recovery’s in sight, then consider where opportunities lie. Not every stock will necessarily recover, so it’s still critical to carefully assess each option.
One stock I’ve got my eye on is Polar Capital Technology (LSE: PCT), a trust that invests in US tech stocks like Nvidia, Microsoft and Meta. With the US tech sector looking particularly wobbly, the trust could take quite a dip if things go south.
The £4.58 share price is by no means unaffordable, but currently looks heavily overvalued, with a price-to-earnings (P/E) ratio of 49.2. I think it has a lot of potential, but I don’t want to pay that premium — it could severely limit my future returns.
If a crash brought the P/E ratio below 20, the growth potential could be significant. However, its heavy concentration in US tech is also an ongoing risk, not to mention its reliance on the fund management team’s continued good judgment.
For now, I think they’re doing great, so I plan to buy the stock if the valuation drops.
The bottom line
In most cases, a stock market crash is nothing more than normal, cyclical behaviour. Seasoned investors not only expect them, they actually look forward to them as opportunities.
While nobody knows exactly when they will occur, it pays to keep an eye on valuation metrics. Higher-than-average P/E ratios across the board are a common precursor.
Rebalancing from high-growth stocks into defensive shares can soften volatility, while having cash on hand means you’re ready to take advantage of lower prices.
