Are we heading for a second stock market crash? Will the FTSE 100 drop under the 5,000 level again, as it did at the worst point in the crash so far? I’ve already suggested three reasons why we really could be in for a second hit. But, ever the optimist, I’m still upbeat about our expectations for the rest of the year. So here’s the other side of the coin.
The Covid-19 pandemic has taken a terrible toll, and I don’t mean to play it down. But think back to those first days, when everyone was panicking and selling off their shares.
Coronavirus cases were spiking so fast it looked like it would only be a matter of weeks before NHS capacity was totally swamped. Emergency hospitals were quickly built in an impressive response, to cope with the inevitable overflow. And the phrase “flatten the curve” was all over the news. No wonder we had such a big stock market crash.
But look how it turned out. It was actually nowhere near as bad as those first predictions. NHS staff have clearly had a horrendous time, but hospital capacity did not break down. The emergency overflow hospitals were hardly used, and some weren’t even used at all.
We had some downbeat economic forecasts released last week, and they really were terrible. The International Monetary Fund (IMF) is predicting a 10.2% shrinkage for the UK economy this year. You don’t need to be an economist to know that’s bad.
But, the reaction to that dire outlook really surprised me. Over the course of the past week, the FTSE 100 has gained 7.5%. It looked like investors had already factored the expected fall into their stock valuations. Maybe the institutions had feared even worse, and they saw the IMF’s latest update as optimistic. And maybe a further stock market crash really is off the table now.
Stock market crash overreaction
My main reason for thinking we won’t see a stock market crash sending the FTSE 100 to sub-5,000 levels again is my experience of investors. Every single time there’s been a downturn, a shock, a panic, investors have initially overreacted.
It’s all about uncertainty, which investors fear possibly more than anything. And it’s only later, when the uncertainties are being resolved and we’re getting some actual numbers to look at, that the initial panic subsides.
This isn’t just an investor reaction, I think it’s based on a general human reaction to fear and uncertainty. After all, it’s better to run away from something that’s not a sabre tooth tiger than not run away from something that is.
How to handle a stock market crash
So will there or won’t there be a crash? And what should we do to prepare for either outcome? I reckon the way to deal with both possibilities is exactly the same. That’s to forget the stock market, and focus on individual companies.
Look for great companies to buy into at fair prices. Look at their debt and cash flow situations. And if they look safe from going bust, and likely to generate cash for you over the rest of your investing lifetime, buy.
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Views expressed 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.