Despite popular belief, a stock market crash is not a common event. There have only been three in the last 22 years, including the one seen in March 2020 triggered by the pandemic.
However, while the adverse business impacts of the pandemic are slowly coming to an end, fears of another stock market crash are starting to brew. Let’s take a closer look at what’s going on. And what I intend to do should the worst come to pass.
A catalyst for another stock market crash
Recently, several high-growth stocks have seen quite a bit of pullback. There are undoubtedly numerous catalysts behind this, but fears surrounding inflation seems to be at the top of investors’ minds.
The direct result of inflation is pretty apparent, prices go up, increasing the cost of living, making consumers’ lives miserable. However, businesses can often pass on the higher costs, protecting profit margins. So, why is the stock market reacting so negatively?
A small amount of inflation can stimulate economic growth. That’s why the Bank of England has an annual target of 2%. But too much, and it creates a crisis. So, to counter today’s inflation situation, central banks like the BoE are raising interest rates. And this is what seems to be creating fears of another stock market crash.
As interest rates go up, so does the cost of debt. And for businesses that were drastically impacted by the pandemic, this could be a nightmare.
After all, many started borrowing money to stay afloat last year. But higher interest payments could add a lot more pressure to cash flows. Suppose a large number of companies start defaulting on loan payments. In that case, bondholders and loan issuers alike will begin losing considerable capital. This, in turn, reduces market liquidity. Consequently, less money can be used to fund new ventures, leading to an economic slowdown that could mutate into a stock market crash.
Time to panic?
As horrifying as this sound, it’s very much a worst-case scenario, and a stock market crash is by no means guaranteed. Personally, I think a slowdown is likely given the current economic situation. But I would be surprised if it triggers the full global crisis that many investors seem to fear.
But let’s assume it does happen. Is it time to panic? No. It could be quite the opposite. Why? Because stock market crashes often present some of the best buying opportunities any investor could ask for.
Unless a company is riddled with debt and cannot withstand the pressure of rising interest rates, chances are it’s not going to be affected by the actions of central banks. Yet despite knowing this, panicking investors can often send shares of strong businesses crashing anyway. But if there’s nothing fundamentally wrong, and the firm’s growth strategy isn’t compromised, then the share price will eventually recover and may continue climbing even higher over the long term.
Sure, it will be horrible to watch my portfolio suffer large declines. But by increasing my positions in strong businesses that aren’t permanently undermined by the cause of the crash, I could be significantly better off over the long term. That’s why I’ll be looking out for bargains to take advantage of, rather than worrying about any short-term declines if the doomsayers turn out to be right.
The Motley Fool UK has no position in any of the shares mentioned. 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.
