One of the worrying things about a stock market crash for many investors is what happens afterwards. If the market crashes and soon regains its losses, as we saw last March, a stock market crash can represent a buying opportunity. But if the market falls and stays low, it can inflict a stinging loss on one’s portfolio.
That’s what has happened in Japan in recent decades. Its stock market index still hasn’t recovered to where it was in the late 1980s. So investors who held shares then have either had the choice of selling at a loss, or hanging onto their shares for over 30 years. That imposes a high opportunity cost.
If there was a stock market crash now, would UK shares bounce back like last March – or stay at deflated prices for decades like Japan? Let’s look at both scenarios.
Quick bounce back
Last year’s crash was quite unusual because the stock market tanked and then regained a lot of lost ground almost immediately. I think that reflects the source of the crash. Rather than being the sudden release of slow-building economic pressure, it reflected panic about the unknown potential impact of the first global pandemic in generations.
If there is a stock market crash in coming months, I think it is more likely to reflect deteriorating confidence in economic prospects and fears about market overvaluation. Loose monetary policy has seen lots of spare cash sloshing around the stock markets. If policy tightens and investors start to sell, that could trigger a market correction or crash.
In those circumstances, it could take months or years for confidence to return. While the UK market is not currently as richly valued as the US market, that doesn’t mean it couldn’t also feel the impact of such a crash. So while a quick bounce back is an option, I wouldn’t expect it to happen.
A stock market crash and the long game
By the same measure, I wouldn’t expect a decades-long market weakness like we’ve seen in Japan. A key reason for the Japanese market’s slow recovery has been the unwillingness of policy makers there to let zombie companies fail. I wouldn’t expect that to happen in the UK and so would expect a quicker recovery.
That doesn’t mean that recovery would necessarily be fast, though. A stock market crash is often just one part of a wider chain of events, including for example economic downturn and tightening money availability. It can take years for investors to return and reflate asset prices to where they stood previously. Older UK investors remember bear markets that went on for years. Such markets could easily come back and ultimately there is always a risk prices may never recover.
My stock market crash strategy
What does this mean for my portfolio?
First, I generally don’t try to time the market. I focus on buying quality companies I’d be happy to hold for years. So a stock market crash could present a buying opportunity for me.
Secondly, it is why my portfolio includes dividend shares like British American Tobacco and Exxon. I don’t rely just on capital growth for my investment return. So, if there is a stock market crash, I will still hopefully receive dividend income no matter what happens to share prices in the short term.
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Christopher Ruane owns shares in British American Tobacco and Exxon. The Motley Fool UK has recommended British American Tobacco. 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.