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Is the stock market going to crash again?

After sharp price rises in May and early June, there is a feeling that investors are starting to worry that the stock market is going to crash again. The FTSE 100 is only marginally below where it was at the beginning of March, when the Covid-19 rout began in earnest. The speed at which markets have recovered is unprecedented, only matched by the speed at which they sold off. Few predicted such a swift recovery, myself included.

Have stock markets recovered a bit too quickly?

Sure, there seems to be some positive momentum around declining virus cases. The gradual lifting of lockdowns also gives us some comfort and hope. But I think there’s still a pretty big risk that a second wave comes along, which could potentially cause the stock market to crash again.

Beyond the risk of a second wave, there are also economic and social effects to consider. The virus-induced lockdown has pushed millions into unemployment. Ominously, there are still millions of furloughed workers, of which a high number will not have jobs to go back to. It all points to a weaker global economy. This means company earnings will be affected too. With this in mind, it makes no sense for stock markets to be anywhere near where they were before the pandemic hit.

I think that investors, as they are so prone to do, have overreacted. I think they overreacted to the virus back in March, pushing share prices down too low. And now they have overreacted the opposite way. In the short term, this is how markets react to uncertainty. It’s these kinds of extremes that give ordinary investors opportunities to beat the market in the long term, by allowing us to buy when prices are unusually low.

How I’m investing now

If the stock market does crash again, then there are a whole host of companies that I’d like to invest in. This includes companies that I missed out on buying during the depths of the last crash. At the top of that list are Mondi and Redrow, two quality yet undervalued stocks. In fact, I’m actually secretly hoping that prices do drop a bit. So I can buy more great companies at bargain prices.

For now, as well as continuing to invest in attractively priced companies, we should also be identifying stocks that we would like to own in the future. That way, if the stock market does crash again, we will be in the perfect position to quickly take advantage of the situation.

I believe prices will come down more at some point in the not too distant future, but I might be wrong. The stock market might not crash again. Share prices often bear no resemblance to reality. This is especially the case when central banks have injected so much extra liquidity into the financial system. It needs to go somewhere after all. This means we shouldn’t stop investing. But we need to be mindful of valuation, which is the key determinant of future performance.

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Thomas 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.