4 ways I prepare for the bursting of the stock market bubble


reare the S&P 500Worried about a decline in the near 100% gain from last March’s low? You’re not alone. While much of that decision was a pick-up from the sharp drop triggered by the onset of the COVID-19 pandemic, much of it was also just plain optimism … perhaps a few too much. The stocks continue to evolve, but sometimes it feels like the only thing that keeps the rally going is its momentum. It’s not good.

If you’re worried that the market bubble will burst soon, feel free to check out a few pages from my personal playbook. Note that none of them are particularly complicated.

1. I move away from more sparkling and more speculative names

I admit that some of the names I have chosen over the past year are not exactly the kind of stocks I intended to hold for the long term. They were closer to being bets than investing, which can be fun and rewarding but not exactly sure when the market starts to crash. As the old saying goes, the higher they fly, the more they fall. This is especially true when a company can’t even justify its share price with real fundamentals. Yes, I am looking at you, AMC Entertainment.

Most investors innately know that it is the decision to make smart money when the broad market is closer to a high than a low. Some investors, however, just need to hear someone else say it. I just did.

2. I prefer cash to stocks

At first glance, this looks a lot like the move mentioned above – pulling back on my exposure to riskier stocks. After all, if I sell anything, it gets turned into cash anyway.

To be clear, however, I’m not just trading my more speculative and vulnerable names for more reliable blue chips. I reduce my overall market exposure by converting a significant portion of my holdings into cash.

Image source: Getty Images.

It is not always a fully understood (or even raw) facet of investing, but ‘safe’ stocks like consumer goods names and utility companies are not really protection from correction. Shares of the consumer packaged goods giant Procter & Gamble fell nearly 24% from last year’s February high to March low as the coronavirus began to spread around the world, including within the name US Utility The Southern Company fell 39% during this period. Both recovered – and then some – but neither actually offered a real defense against widespread weakness.

The point is, during market corrections, there really is no place to hide. You will only have to let the long-term holdings in which you are committed take their share with the confidence that they will bounce back. If you don’t trust a particular stock, simply swap it out with cash until the dust settles.

3. I add (a little) gold

While most stocks are going to be dragged down by a market wide correction, not all types of holdings are stocks. There are also bonds and commodities, which always trade independently of stocks. That doesn’t prevent them from pulling out if and when the stock market does. But if they pull out, they do so independently of the broader market.

I’m not dealing with bonds right now. Interest rates are unnecessarily low, and with inflation seemingly on the verge of spiraling out of control, bonds are just a draw right now anyway.

Commodities, however, are another story. On the contrary, they have become more important players in a context of rising inflation and an increasingly urgent Federal Reserve to react. If stocks were to collapse, commodities – already pumped and primed – could experience increased demand that would push prices up. The easiest way to tap into this dynamic is to use a simple choice like the SPDR Gold Trust.

4. Most of all, I don’t do anything

Finally, and perhaps most importantly, I am not doing anything against a possible market correction.

You read correctly.

There are two schools of thought behind deciding to do nothing rather than try to escape the impact of a correction. The first of these is the simple fact that most of my holdings are really long positions that I had (and have) every intention of hanging onto through bear markets. One of the biggest benefits of a legitimate buy and hold approach is that you don’t even have to worry about temporary headwinds.

The other idea at work here is the fact that guessing the next short-term market reversal is just hard to do … so much so that most people don’t do it very well. This is because the effort to time the ups and downs of the stock market often does more harm than good, making you exit too early or too late, or making you come back too early or too late. The market will do what it will do in its time, and that is do not go telegraph what’s around the corner to anyone. The best way to win this game is not to play it at all.

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James brumley has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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