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Another stock market crash may be just around the corner. Here’s what I’d do now

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Back in late February, investors experienced one of the worst stock market crashes in modern history. The emergence of the coronavirus pandemic sent shockwaves through the global economy, causing a major sell-off in equity markets. Since then, many global stocks have staged a remarkable comeback. While the FTSE 100 index is still down by around 17%, some analysts fear a second stock market crash may be right around the corner. How confident can we be of this?

Inflated asset prices

The fears come as many cast doubts over the sustainability of rising share prices, especially in the US market. A steady flow of economic data paints a harrowing picture of the economic damage and long-lasting financial impact caused by the pandemic. Therefore, it hardly makes sense for the stock market to be rising.

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Early last month, investing genius Warren Buffett’s preferred stock market gauge hit a record high. The measurement divides the total value of publicly traded stocks by quarterly GDP. According to Buffett, it is “probably the single best measure of where valuations stand at any given moment”. Allegedly, the record high signals that stocks are overvalued, and a that crash could be coming.

As credible as this insight may be in relation to the US stock market, I’m not so sure of its utility with regards to UK stocks. In the depths of the sell-off, the S&P 500 and the FTSE 100 both shed similar amounts from their values, falling by 33% and 32% respectively. Since then, however, the S&P 500 has bounced back by a whopping 36%, while the FTSE 100 has only clawed back 23%. Don’t get me wrong, both bounce backs are impressive, but evidently, UK equities remain substantially lower than their pre-crash valuations.

Impact of a second wave

Countries around the world are beginning to ease various lockdown restrictions. With this comes concern about the impact it may have on the spread of the virus and thus, the economy. If the virus hasn’t been contained, we can expect the number of cases to increase. There may even be a second wave of infections. Inevitably, this will have a negative impact on businesses as they incur additional costs and battle through the looming recession.

What’s more, even if we avoid a second wave of infections, consumer spending is unlikely to return to pre-Covid-19 levels and many jobs could still be under threat. Combine this with the abysmal earnings outlook facing many companies and a second market crash may seem likely.

Investment strategy

I wouldn’t count on it though. After all, the stock market is not the economy. That said, I think it would be wise to hold at least some cash. That way, you’re primed for a second market crash where you’ll be able to pick up some bargains.

Finally, fear over tumbling share prices may be enough to put many off investing at the moment. If this applies to you, I recommend implementing a pound-cost averaging strategy. With this technique, your exposure to falling markets is reduced by investing in regular intervals so that more shares are purchased when prices are low and less when they are high. This way, regardless of a second market crash or not, you’re still investing in the stock market with the potential to realise long-term capital gains.

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Matthew Dumigan has no position in any of the shares mentioned. The Motley Fool UK has 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.

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