With the FTSE 100 reaching new record highs this month, not many investors are considering the possibility of a stock market crash. And yet, a number of seasoned professionals are getting concerned that a massive market downturn might be on the horizon.
Strategists from Morgan Stanley are some of the latest analysts to announce that they believe current stock prices are “disconnected from reality”. While inflation is under control, the interest rate hikes by central banks also drive up the cost of capital. And since it takes time for the effects of monetary policy changes to kick in, businesses are likely to start feeling the pinch in the coming months.
As such, some bearish investors are confident that a stock market crash might materialise in 2023. So what should investors do?
Keep calm and carry on
It’s worth pointing out that there are always doomsayers predicting disaster in the investing community, even among professionals. Yet throughout history, most stock market recoveries have begun when investors thought the worse was yet to come. And those who listened to the bears missed out on some of the best buying opportunities in their lifetimes.
But let’s be conservative and assume a stock market crash will occur in 2023. What now?
While the thought of plummeting stock prices is hardly pleasant, being a long-term investor has its advantages. Providing a portfolio containing high-quality enterprises generating plenty of excess cash flow, a temporary crash in stock valuations is likely irrelevant when taking a long-term perspective.
Don’t forget the stock market has a perfect track record of recovering from even the worst financial disasters. And this recovery is driven by top-notch companies weathering the storm and capitalising on the opportunities it creates. After all, it’s not uncommon to see cash-rich firms start acquiring their weaker competitors at discounted prices and securing a far larger market share in the future.
Understanding the risks of a crash
As many investors have learned lately, volatility makes many people act irrationally with their investment portfolios. That’s why corporations unaffected by the catalysts of the volatility end up seeing their share prices take a hit.
Prudent investors wise enough to identify these companies can capitalise on the discounted valuations and set their portfolios up for long-term success. However, when emotions are running high, it’s impossible to predict how far share prices will fall, even for strong businesses.
Therefore, even if an investor buys shares in what appears to be a bargain, it may continue to plummet in the following weeks or months for seemingly no reason. That’s why diversification is paramount, as is pound-cost averaging.
With the possibility of seeing cheaper prices in the future paired with the knowledge that timing the market is a terrible idea, spreading buying activity over several months is an easy method to capitalise on cheap valuations while protecting against further declines.
