Seasoned investors know that the next market crash is a matter of when and not if. Predicting when exactly crashes will hit remains incredibly difficult, but there are strategies and orienting principles that can put you in position to weather (and even benefit from) challenges as they emerge.
To help readers prepare for the next crash, a panel of Motely Fool contributors has weighed in with three things you should keep in mind as you navigate the stock market. Read on to see why they think that understanding these points will help you survive, and thrive, through the next crash.
Each stock market crash is different
Keith Noonan: When trouble hits, there's a natural instinct to look to history in hopes that it will show us the right way forward. Looking at what worked in the past can provide a valuable frame of reference for evaluating the present and navigating the future, but it's important to keep in mind that each stock market crash happens for different reasons and in the context of a different market environment.
For example, let's compare the last two major stock market crashes: the pandemic-driven crash of 2020 and the crash stemming from the 2008 financial crisis. The factors shaping market behavior were widely different in these two instances.
The stock market languished for years following the financial crisis, and it wasn't until 2013 that the S&P 500 index climbed above its early 2008 level. If you assumed that a similar progression would play out after last year's crash, you would have missed out on the market's rapid recovery. The S&P 500 is now up roughly 35% since the start of 2020.
Growth-dependent tech stocks often get hit hard when the market turns bearish, and investors usually flock to safer-looking alternatives that pay dividends and trade at low earnings and sales multiples. However, pandemic conditions actually created powerful tailwinds for many tech-focused companies. These seemingly risky stocks not only went on to recover faster than even high-quality value names, but many enjoyed a period of record growth and went on to set new valuation highs.
The past can teach us a lot about factors that influence the market and how things might play out, but don't expect that following yesterday's playbook will necessarily put you on track to strong performance tomorrow.
Sector-wide crashes happen all the time
Daniel Foelber: The definition of a market correction is simple enough. Technically speaking, it's when the stock market falls by 10% or more from its peak, with a bear market being an extended period of a greater than 20% decline from the peak. Similarly, a recession is defined as two consecutive quarters of negative GDP growth.
Stock market crashes and recessions affect different sectors in different ways. After the March 2020 stock market crash, the S&P 500 proceeded to rebound and finish the year up 16%, with tech, consumer discretionary, and renewables stocks doing even better. However, the energy sector suffered a brutal 37% decline in 2020, meaning it stayed in bear market territory while most of the market was roaring back to life.
This year, the script has flipped. Oil and gas stocks are crushing the broader markets but renewable energy stocks are selling off. The average stock in the Invesco Solar ETF (TAN 1.31%) is down 20% year to date. And just last week, many small-cap tech stocks suffered 10% or even 20% or higher declines.
The same dichotomies persist during recessions. Over 22 million Americans lost their jobs in the first four months of 2020. In April 2020, which was the month many consider to be the peak of the COVID-19 pandemic, the unemployment rate reached 14.8%. And while the mass exodus out of the office affected much of the country, folks who were already working remotely saw little change.
Investors can glean lessons from the volatility of different market sectors, as well as the anatomy of the COVID-19 recession. For small-cap tech investors, last week's sell-off can feel like the market is crashing before their eyes. By contrast, many oil and gas investors are just recently feeling like they are out of a bear market. Crashes are relative and can happen without warning. Therefore, it's best to keep a diversified portfolio that can handle changes in sentiment as sectors ping pong between in favor and out of favor.
Commit now to being a (smart) buyer then
James Brumley: It's easy to forget it while stocks are plummeting, but any pullback is a buying opportunity. The bigger, the better. The market's never not recovered from a correction or bear market.
Of course, you still have to stick with names that are actually poised to recover, and steer clear of the stocks that were lucky enough to temporarily catch a tailwind.
A ticker like AMC Entertainment Holdings (AMC -4.01%) comes to mind. Its short squeeze was ultimately born out of shutdowns prompted by advent of COVID-19, or more specifically, the recovery of the movie business following the easing of the pandemic -- it made for great bullish rhetoric. The thing is, the company's now overvalued by any measure you can think of using any of the company's pre-coronavirus results. A marketwide stumble could set it on a crash course.
Look for a quality name like NVIDIA (NVDA 4.28%) instead. I love the fact that its data center business is now eclipsing its gaming (and crypto mining) revenue, as the former is a much more sustainable sort of business. I'm too cheap to step in at 44 times next year's projected earnings. A move back to the $500 where it leveled off for several months late last year and early this year, however, is not only plausible, but would leave NVIDIA shares at a very attractive projected P/E around 30. (Just for the record though, I'd settle for a pullback of half that size.)
Your job is simply building a cash stash, making a watch list, and establishing an entry plan now. Waiting for a pullback to start before doing these things means you're making decisions under pressure, which is anything but ideal.