4 Ways I’m Preparing for the Stock Market Bubble to Burst

Does the S&P 500‘s nearly 100% gain from last March’s low have you a little worried about a pullback? You’re not alone. Even though much of this move was a recovery from the steep sell-off sparked by the onset of the COVID-19 pandemic, much of it has also just been plain old bullishness … perhaps a little too much. Stocks are still chugging along, but at times, it feels like the only thing keeping the rally going is its momentum. That’s not good.

If you’re concerned the market bubble is going to pop soon, feel free to rip a few pages out of my personal playbook. Notice that none of them are particularly complicated moves.

1. I’m scaling out of frothier, more speculative names

I confess, some of the names I’ve picked up over the course of the past year or so aren’t exactly the sorts of stocks I fully intended to hold for the long haul. They were closer to being bets than investments, which can be fun and rewarding but not exactly safe when the market starts to unravel. As the old adage goes, the higher they fly, the farther they fall. That’s especially true when a company can’t even come close to justifying its stock price with actual fundamentals. Yes, I’m looking at you, AMC Entertainment.

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

2. I’m prioritizing cash over equities

At first glance, this seems a lot like the aforementioned move — backing off on my exposure to riskier equities. After all, if I’m selling anything, those proceeds are inherently turned into cash anyway.

To be clear, however, I’m not merely swapping out my more speculative, vulnerable names for more reliable blue chips. I’m reducing my overall exposure to the market by converting a sizable stake of my holdings to cash.

Image source: Getty Images.

It’s not always a fully understood (or even believed) facet of investing, but “safe” stocks like consumer goods names and utilities companies aren’t actually protection from a correction. Shares of consumer packaged goods giant Procter & Gamble fell nearly 24% between last year’s February high and March low when the coronavirus began to spread across the world, including within the U.S. Utility name The Southern Company fell 39% during this timeframe. Both recovered — and then some — but neither actually offered any true defense from sweeping weakness.

The point is, during market corrections, there’s really no place to hide. You’ll just have to let the long-term holdings you’re committed to take their lumps on faith they’ll bounce back. If you don’t have that faith with any particular stock, just replace it with cash until the dust settles.

3. I’m adding (a little) gold

While most stocks are going to be dragged lower by a market-wide correction, not every sort of holding is a stock. There are also bonds and commodities, which still trade independently of equities. That doesn’t preclude them from pulling back if and when the stock market does. But if they do peel back, they’re doing so independently of the broad market.

I’m not bothering with bonds right now. Interest rates are pointlessly low, and with inflation seemingly on the verge of racing out of control, bonds are little more than a coin toss at this time anyway.

Commodities, however, are a different story. If anything, they’ve become bigger movers against a rising inflation backdrop and a Federal Reserve that’s being increasingly pressured to respond. Should stocks tank, commodities — already pumped and primed — may see a swell of demand that drives prices higher. The easiest way to plug into this dynamic is with a simple pick like the SPDR Gold Trust.

4. Mostly, I’m doing nothing

Finally, and perhaps most importantly, I’m doing nothing about a possible market correction.

You read that right.

There are two schools of thought behind the decision to do nothing rather than trying to evade the impact of a correction. The first of these is the simple fact that most of my holdings really are long-haul positions I had (and have) every intention of hanging onto through bear markets. One of the greatest upsides 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 market’s next near-term reversal is just darn difficult to do … so much so that most people don’t do it very well. Indeed, the effort to time the stock market’s peaks and valleys often does more harm than good, by virtue of getting you out too soon or too late, or getting you back in too soon or too late. The market’s going to do what the market’s going to do in its own time, and it’s not going to telegraph what’s around the corner to anyone. The best way to win that game is by not playing 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.

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