So far, 2024 has been good for the stock market. But with investing, things are often at their most dangerous when they look the most promising.
With that in mind, I’m looking to set up my Stocks and Shares ISA now to be in a position for a potential correction. That doesn’t mean selling things I own, but it does mean being careful.
The rise of AI
Obviously, the big theme of 2024 has been the rise of artificial intelligence (AI). And the biggest beneficiary has been Nvidia, which is up 77% since the start of the year.
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The likes of Advanced Micro Devices (+49%) and Meta Platforms (+44%) have also done well. But the emergence of AI is positive for the stock market more broadly.
Businesses beyond the tech sector also stand to benefit. Integrating AI into their products and services should help reduce costs and increase margins, resulting in greater profitability.
This makes Nvidia’s success an indication of broader strength. Its customers believe integrating AI into their operations can add value and this is a positive sign for earnings in the long term.
Time for a correction?
The stock market is therefore optimistic about the outlook for earnings, driven by the rise of AI. And that means things can turn around quickly if anything goes wrong.
Even if it’s only a short-term setback, a stock market correction can occur relatively easily when share prices are high. So I think investors ought to tread carefully at the moment.
That doesn’t mean staying out of the stock market – missing out entirely is probably a bigger risk than a drop in prices. But it does mean being careful about which stocks to buy.
With my own portfolio, I’m looking to add shares in quality businesses. But figuring out what looks attractive now and what’s best left for a stock market correction is important.
Rolls-Royce
Take Rolls-Royce (LSE:RR) as an example. The stock is up 148% over the last 12 months and isn’t showing any obvious signs of slowing down.
The business stands to benefit from the rise of AI through its use of analytics in product testing and its engine health monitoring service. But I think investors should be cautious right now.
Rolls-Royce has a medium-term target of £3bn in free cash flows. With a market cap closing in on £32bn, the margin of safety for investors if the company misses its targets is narrowing.
If the firm lands a contract to build small modular reactors later this year, these targets could increase. But I’d rather wait for this to happen before including it in my calculations.
Is a correction coming?
Predicting exactly when a stock market correction will happen is close to impossible. So my approach is to make sure I’m ready for it whenever it happens.
That doesn’t mean selling out of my investments. But it means figuring out which stocks to buy right now and which are best left for a more attractive price.
In my view, Rolls-Royce has reached the stage where it now belongs in the second category. But I’m keeping a close eye on the share price in case a buying opportunity shows up soon.
