I don’t think any of us would disagree that there’s something of a disconnect between the stock market and the UK economy right now. With the market pushing all-time highs, I’d be forgiven for thinking we’re in a boom period of high growth in the UK.
Yet the reality is that we actually have high (10%+) inflation and negative GDP growth forecast for 2023. So could this mean another stock market crash is coming?
Reasons for a potential fall
One risk is that we get a crash to allow the market to more accurately reflect the state of the broader economy. A trigger for this could be weaker-than-expected earnings from FTSE 100 and FTSE 250 companies for Q1 and Q2.
If earnings disappoint, it could start to put fear in investors that the economy isn’t strong enough to support big corporates. This could start a swift downward spiral of selling shares and moving to cash.
The catalyst for a fall might not even come from anything company specific. Rather, an increasingly delicate political tightrope. Russia is clearly top of the list, with further aggression something that can’t be ruled out. But even in recent weeks, US and China tensions have worsened over the spy balloons saga. Any form of escalation between these titans could be enough to spook the stock market.
Finally, persistently high inflation could force the Bank of England to raise interest rates more than currently planned. With the rate already at 4%, if the central bank has to keep pushing it higher, the stock market could react negatively.
The other side of the coin
A strong counter argument comes when looking at the valuation of the FTSE 100. Even at 8,000 points, the price-to-earnings ratio is only 11.45. This isn’t expensive by historical standards at all. In fact, a ratio below 10 is what I use to find an undervalued stock.
If the market isn’t really overvalued, the need for a crash to reset isn’t that high. Further, if the market does start to move lower, value buyers will likely step in quickly.
I also need to appreciate that a lot of the FTSE 100 stocks are global companies. For some, revenue from the UK is a very small part of the total. This means that even if the economy undershoots in 2023, earnings might not disappoint. If Asia and the United States perform well, revenue from these areas can more than offset the UK contribution.
What I’m going to do
Based on my above thoughts, there are several ways I can still invest in coming months, despite the uncertainty. I still like to target dividend payers that can generate income, even if we see volatility in the market.
Picking a range of companies to diversify my exposure is also smart. I’m happy to invest in stocks that have revenue streams around the world, which should nullify some concern.
Finally, I can invest now without putting 100% of my free cash to work. By staggering my purchases over coming months, I take pressure off trying to time the market.
