Why I’d prepare for a stock market crash now

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After such a long and strong bull market, are we in for a stock market crash? That’s the question I’ve been asking myself over the past few months. And what can I do about it?

Is a stock market crash coming?

It’s not a bad time to be a tad cautious, in my opinion. For a start, looking at 70 years of US stock market history, the lowest monthly average returns were produced in September. That’s not to say that every September will produce poor returns. There are many factors involved and as long-term investors, shorter-term movements in share prices are less relevant.

That aside, US stocks have experienced a particularly long bull run. They’ve enjoyed over 12 years of relatively consistent performance. Innovative US technology companies grew significantly during this period. Smaller UK growth stocks also experienced solid returns.

Many US stocks were helped by strong economic growth combined with ultra-supportive monetary policy from the Federal Reserve. Is it time for a change of direction? Perhaps. I reckon high inflation could push the world’s largest central bank to reverse course. A surprise move could spook investors and cause the next stock market crash. Any fall in US stocks could have a knock-on effect on UK shares too.  

How to prepare?

So what should I do with my Stocks and Shares ISA to prepare? It depends on my investment time-frame. For my long-term portfolio, I’m not too concerned about a stock market crash. In fact, I see it as an opportunity to buy quality shares at cheaper prices. Like the January sales! As esteemed investor Warren Buffett said: “Be fearful when others are greedy and greedy when others are fearful.”

To take advantage of lower prices, I’d need to have some cash ready to invest. I’d also want to research the best shares to buy so that I’m fully prepared when the time comes.

That said, for the more speculative part of my portfolio, I’d possibly want to protect my starting capital by selling some of my weakest performers. A stock market crash could potentially cause significant damage to these shares. To prepare, I’d look again at the investment case and position size to ensure I’m comfortable with both.

Investing in a stock market crash

Let’s say at some point, we get a stock market crash. What should I invest in to take advantage?

I’d look for companies that Terry Smith might look for. He’s the popular founder of Fundsmith Equity, a top performing fund over the past decade. Fundsmith likes companies that demonstrate high and sustained returns on capital. They must also have a competitive advantage that’s difficult for others to replicate. Sister fund Smithson Investment Trust follows the same philosophy, but with smaller companies. UK companies that come to mind include Rightmove, Fevertree Drinks and Domino’s Pizza Group.

Market timing difficulties

Trying to ‘time’ the market can be fraught with difficulties. It’s practically impossible to do. It’s quite possible that the great bull market continues for longer than most people might imagine. If it can last 12 years, then why not 13, 14 or even 15 years?

As a long-term investor, I’d like for the sun to carry on shining on my shares. But I think it would be prudent to prepare for some rainy days too.

Harshil Patel has a position in Fundsmith Equity. The Motley Fool UK has recommended Dominos Pizza, Fevertree Drinks, and Rightmove. 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.