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Why I think a stock market crash could be due and what I’m doing

Tired or stressed businessman sitting on the walkway in panic digital stock market crash financial background

A stock market crash is never fun. Unfortunately, I don’t have to look far back for the last one. In March 2020, the last time markets crashed, I admit my portfolio looked pretty terrible. Almost everything was falling in price as Covid started to spread around the world.

But here’s how I dealt with my crashing portfolio: I didn’t look at the value at all. I knew things were bad. I could see how much individual stock prices were falling. What I did do was analyse again the balance sheets of each company in my portfolio. I also reassessed their business models to determine if they could manage through lockdown. Once I did this, I didn’t sell a thing. I was content that each one of my stocks would survive the pandemic that followed.

I’m beginning to think another stock market crash could start in the US this year. Here’s my thinking.

Rising inflation is a risk

Inflation is accelerating in the UK and the US at present. These are key markets for me, and where I look for stocks to buy.

But why would inflation cause a stock market crash? Well, sticking with the direct impact of inflation, it means that consumers have lower purchasing power. This, in turn, will reduce demand for goods and services, and then impact companies’ profitability. The stock market is priced on the future expectations of profit, and if this reduces, so should share prices.

From inflation to central bank policy

Central banks like the Federal Reserve (Fed) and the Bank of England target inflation of 2%. But it’s currently way higher that this in both countries.

The main tool that central banks use to control inflation is to increase the base interest rate. This is generally negative for economic growth, and then stock market returns, but can reduce inflation.

The Fed was increasing the base rate throughout 2018. Then, in the fourth quarter that year, we saw a stock market crash. At the time the technology-based Nasdaq index fell over 20%. Technology stocks can be richly valued and higher-risk, so are most susceptible to share price falls when interest rates rise. If the Fed raises interest rates again due to high inflation, then the richly valued US market could crash.

Here’s what I’m doing

This time, I’m checking my investments to see if they have pricing power. This will be important in an economy with rising inflation, and should better protect the profits of the businesses I own. Then, if we do see a stock market crash, I’ve got a list of stocks I’d consider buying if they became cheaper.

I’m not as concerned about the UK market though. I wrote here about how I see the FTSE 100 reaching an all-time high this year. The main difference between the UK and US markets is that the UK is currently far cheaper on a forward price-to-earnings (P/E) basis. For example, the FTSE 100 is valued on a P/E ratio of 12, whereas the NASDAQ is on a multiple of 31.

So for now, I’m considering increasing my exposure to the UK market with stocks such as Aviva and Games Workshop. If I do buy US shares, I’d be sure to check each company’s valuation before buying.

The post Why I think a stock market crash could be due and what I’m doing appeared first on The Motley Fool UK.

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Dan Appleby owns shares of Games Workshop and Aviva. The Motley Fool UK has recommended Games Workshop. 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.