Just last week, I was discussing the possibility of another stock market crash in 2020. Economic data is awful (the UK economy shrank by a record 20.4% in April) and there’s no guarantee we’ll see a ‘V-shaped’ economic recovery as many analysts first thought we would. Worryingly, most professional money managers believe that stocks are likely to fall again in the near term.
We could already be seeing the start of another crash. This week, volatility returned to global equity markets with a vengeance. For example, on Thursday, the FTSE 100 index fell a huge 4%. Meanwhile, in the US, the Dow Jones Industrial Average fell a massive 6.9% – its worst day since March.
Of course, stock market movements are notoriously difficult to predict in the short term. Next week, stocks could rally again. However, given the enormous disconnect between share prices and economic data at present, I think it’s worth thinking about portfolio protection. So, what’s the best move now?
I’m following Warren Buffett’s lead…
Well, one thing that I’ve been doing in recent months to protect my portfolio from another stock market crash is following Warren Buffett’s lead and building up my cash pile. Buffett has been stockpiling cash in a big way recently. His investment company, Berkshire Hathaway, had nearly $140bn in cash at the end of March.
Cash is a poor investment over the long term. Over time, it loses purchasing power to inflation. However, cash can play an invaluable role in your portfolio during stock market crashes as it gives you firepower to take advantage of opportunities. If you have the cash to buy stocks while share prices are low, you tend to come out of the crash in a much healthier financial position.
To build up my cash pile, I’ve eased off my stock buying in recent months as markets have soared (I was buying heavily in March) and also offloaded a few weaker holdings into the rally. As a result, I now have plenty of ammunition for another stock market crash, if we see one.
Protection from another stock market crash
Another thing I’ve been doing to protect my portfolio against another crash is positioning it so it’s more focused on two main types of stocks.
The first type I’ve focused on is rock-solid dividend stocks such as Unilever, Reckitt Benckiser and Diageo. These kinds of companies tend to be highly resilient. As a result, their share prices often fall less during stock market crashes. Unilever, for example, is only down about 2% this year. Meanwhile, the FTSE 100 is down about 20%.
The second type of stock I’ve focused on is growth stocks that look well placed to benefit in a post-Covid-19 world. Stocks I’ve been buying here include the likes of ASOS, Mastercard,and PayPal (these two should benefit as we use cash less).
Of course, these kinds of stocks are still likely to fall if we see another stock market crash. However, compared to other stocks that are highly exposed to Covid-19, such as airline and cinema operator stocks, I think they’re likely to fall less (and much less likely to go bankrupt).
Overall, I think this strategy should provide me with an element of protection if we see another crash.
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Edward Sheldon owns shares in Unilever, Diageo, Reckitt Benckiser, Mastercard, PayPal and Microsoft. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Mastercard, Microsoft, PayPal Holdings, and Unilever. The Motley Fool UK has recommended Diageo and recommends the following options: long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, and long January 2022 $75 calls on PayPal Holdings. 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.