The old saying suggests that as investors we ought to “sell in May and go away”. The dog days of summer can be quiet times on the stock market and many investors simply prefer to head to the beach. But as traders start to return from their summer breaks, what can we expect next? Specifically, ought I to be positioning my portfolio for the possibility of a stock market crash?
How a stock market crash works
In practice, a market crash rarely results purely from a worsening economy. Typically the economic cycle deteriorates (or improves) over the course of years and developments are fairly clear. While things may get worse faster than hoped, it is unusual for an economy suddenly to do badly overnight without any clues in advance.
So a stock market crash typically requires a few things. As well as nervousness about the economy, it helps if stock prices are expensive to begin with. If they are low, there may not be much room left for them to fall before bargain hunters scoop them up, stabilising prices.
What’s going on now?
I do think stock market performance in recent months has given some cause for concern.
Some shares have been moving about a lot even in the absence of specific corporate news. Whole sectors, especially tech, have seen big drops. The return of meme shares in the form of Bed Bath & Beyond is a sign that there is frothiness in some corners of the market.
Meanwhile, the economic outlook continues to get worse. We are facing a recession and growing inflation. The pound is at its weakest in decades, which could dent profits at exporters like Victrex and Spirax-Sarco.
But there are also a couple of things I see as reasons for optimism. Although the FTSE 100 is less than 6% off its all-time high, I actually think a lot of UK shares look cheap on a valuation basis. High street banks, retailers and some other shares in my portfolio are trading on single-digit price-to-earnings ratios. Given that valuations do not look unusually stretched, there may be less room for a fall in the UK stock market than existed in the tech sector last year, for example.
On top of that, I think a lot of bad expectations are already priced into the market. We are not in the middle of an economic boom that is suddenly about to screech to a halt unexpectedly. We have lived through a tough economic period for several years already. Many investors are alert to risks such as inflation and falling consumer demand.
What will come in September?
Maybe September will see some investors coming back to the market with new energy. Or it could be the drumbeat of recession quickens and we do see a stock market crash.
In any case, my approach will be the same: to look for great companies I can buy at attractive prices.
I can already find some such bargains in today’s market. It is also time to have a shopping list of companies that could become more attractively priced in the event of any stock market crash. That way, if things do turn south, I will be ready to seize the moment and build my portfolio for the long term.