Share prices may have risen sharply following the recent market crash, but a second decline for indexes such as the FTSE 100 and FTSE 250 cannot be ruled out. Risks such as a continued spread of coronavirus may persist over the coming months, and could lead to declining investor sentiment.
In turn, this may lead to bargain shares that could be worth adding to your portfolio. Over time, they could recover to produce high returns that improve your long-term financial position.
A second market crash
The potential for a market crash is always present. The coronavirus pandemic is an obvious example of how investor sentiment and the economic outlook can change very quickly over a short time period. As such, the potential for declining share prices is a risk that all investors face all the time.
At present, there are a number of risks that could make the prospect of a second decline for stock prices more likely. For example, the number of coronavirus cases across the world continues to rise. This could lead to continued restrictions on people’s movements. This may lead to weaker economic growth over the coming months.
Similarly, rising tensions between the US and China ahead of the US election and other political risks, such as Brexit, may negatively impact on investor confidence. This could cause them to take a more pessimistic view of the stock market’s future. It may also cause a second market crash as they switch their focus to less-risky assets such as cash and bonds.
A market crash may prove to be a challenging event for investors in the short run. However, over the long run, such periods have historically proved to be opportunities to buy high-quality companies while they offer wide margins of safety. In other words, they allow investors to implement a strategy where they seek to buy at low prices so they can sell at higher prices further down the line.
This has been a very successful strategy in the past. And, with the recent market crash suggesting investor sentiment is very volatile at the present time, a second market crash may be very fast and very severe. This may mean it offers bargain valuations rarely seen in many of the stock market’s main sectors.
A prudent strategy
Of course, buying shares when they’re declining can be a precarious undertaking. It requires investors to buy companies that have the financial strength to survive a period of weaker sales growth. Add in those that have the strategy to improve their market position as the economy recovers.
Furthermore, diversifying across a wide range of shares can reduce your reliance on a small number of companies. This means you could capitalise on a market crash and enjoy improving returns as the economy and stock market recover.
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.