There’s been a lot of discussion and analysis regarding a potential stock market crash recently. Michael Burry – of The Big Short fame – said he thought there’s been considerable overvaluation and speculation in financial markets. Only last month, Jeremy Grantham said the US was in a ‘superbubble’!
Both of these investors are US-based. So here, I want to focus on the UK stock market in more detail. Could there be a stock market crash on the horizon?
The UK stock market
When discussing the UK stock market, it’s often in terms of the FTSE 100. This is a large-cap index of stocks listed on the London Stock Exchange. Typically, these companies have market values of at least £5bn.
The FTSE 100 is heavily biased towards sectors such as energy, financials and mining. If we’re to see a stock market crash, as measured by the FTSE 100, then these sectors would likely have to crash.
It’s not all about the large-cap stocks, though. The FTSE 250 is a UK mid-cap index of stocks that are more domestically oriented. This means the companies in the index are exposed to the UK’s economy somewhat more than the international stocks in the FTSE 100.
The FTSE 250 has underperformed of late. Over one year, the index has increased only 3% against the FTSE 100’s over 16% rise. And so far in 2022, the FTSE 250 has fallen a steep 7.5%, while the FTSE 100 is up 2%.
Does this point to an imminent stock market crash for mid-cap UK stocks?
The main risks to consider
#1 Inflation: For me, this is the biggest risk today. The Consumer Price Index rose by 5.4% in December, according to the Office for National Statistics. This is the highest reading since 1992. Inflation can have a big impact on companies’ profit margins, and therefore earnings. Consumers may also be less inclined to spend if inflation is high.
#2 Rising interest rates: This is linked to inflation. The Bank of England has started to raise interest rates as it attempts to influence and deter price rises. But in doing so, it lowers the potential for economic growth. For example, businesses are less likely to invest if the cost of a loan is more expensive. Also, the housing market might slow if mortgages rates rise.
Both of these risks are more likely to impact the FTSE 250 index due to its greater exposure to the UK economy. On the other hand, certain stocks in the FTSE 100 may benefit from rising interest rates. Companies such as HSBC and Lloyds should be more profitable if they can charge higher interest rates on loans. Meanwhile, the oil price is at a multi-year high, which boosts the profitability of Shell and BP. All of these companies are significant players in the FTSE 100 and have supported the index’s positive return so far in 2022.
Could there really be a stock market crash?
There’s always a risk of a broad stock market crash. But today, I see greater likelihood of a crash in the FTSE 250 specifically due to the prospect of rising inflation and interest rates.
I view the prospects for the FTSE 100 more favourably. Commodity prices have risen, and higher interest rates should be a near-term boost for banks’ profitability.
Nevertheless, if a stock market crash does happen, I’d look to snap up even cheaper UK shares if the businesses are still trading well.