Global stock markets have had a great run since they crashed earlier in the year. The FTSE 100 index, for example, has risen about 25% since its March low. Meanwhile, the technology-focused NASDAQ 100 is up nearly 60%.
Could we see another stock market crash in 2020? I think it’s definitely possible. Here are three reasons why.
Valuations are high
I’m a big fan of the technology sector. It’s the sector I’m most bullish on from a 10-year point of view. However, right now, I see many parts of the sector as a little overheated.
Take US-tech giant Amazon, for example. At the moment, it trades on a forward-looking P/E ratio of 160. That’s high. Meanwhile, shares in Tesla are up about 40% in a month.
I realise the world has changed due to Covid-19. Technology is the way forward. But some recent share price movements in this sector have looked a little excessive to me.
I wouldn’t be surprised at all if we see a pullback in the US technology sector in 2020 at some point. And if that happens, UK stocks could take a hit too.
Bullish investor sentiment
While stock market valuations have looked a little stretched at times in recent years, I was never really convinced the bull market was nearing its end.
The reason? I just wasn’t seeing the kind of irrational exuberance that generally comes at the top of the market. As I explained late last year, a lot of people simply had no interest in investing in stocks, despite the fact that the market had risen for around a decade.
That has changed dramatically in the last few months. All of a sudden, everyone wants to ‘trade’ the stock market.
The attitudes of some of these new investors are a little too bullish for my liking.
For example, Dave Portnoy, the founder of Barstool Sports, recently claimed he was a better investor than Warren Buffett. “I’m better than he is. That’s a fact,” Portney said last month.
Meanwhile, another new trader recently told Bloomberg: “There’s no way I can lose. Right now, I’m feeling invincible.”
Sir John Templeton famously said: “Bull runs die on euphoria.” I can certainly feel some euphoria in the air right now.
Finally, economic conditions are woeful at the moment. Ratings agency Moody’s expects Britain’s GDP to fall 10% this year. Meanwhile, the Centre for Economics and Business Research (CEBR) says UK GDP levels won’t return to 2019 levels until 2024. I see a bit of a disconnect between some share prices and the economy.
Make these moves to protect your portfolio
Now, I don’t want to scare you out of the stock market. Stocks remain the best asset class for building long-term wealth.
However, I do think it’s worth thinking about risk management right now.
One sensible move in the current environment is to look at your portfolio and consider whether it’s fully diversified. The key is to own stocks from a wide range of sectors. That way, if one sector such as technology underperforms, you won’t suffer big losses.
Another smart move is to consider adding some ‘defensive’ stocks such as Unilever and Reckitt Benckiser to your portfolio. These could provide an element of protection if markets crash again. Defensive stocks tend to outperform during periods of stock market turbulence.
Edward Sheldon owns shares in Unilever and Reckitt Benckiser. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Amazon, Tesla, and Unilever and recommends the following options: short January 2022 $1940 calls on Amazon and long January 2022 $1920 calls on Amazon. 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.