Many investors have been on edge for months, with concerns that an AI bubble or a weakening labor market could lead to a recession. But now, amid political uncertainty and conflict abroad, fears about the stock market are rising.
To be clear, no one knows what the market will do in the near term. Even the best economists in the world cannot guarantee that a market crash or recession will or will not occur in the coming months.
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However, no matter what happens with the market, there is one important step that all investors should take right now.
Where you choose to invest will probably have the biggest impact on how your portfolio fares during a recession.
In times of prosperity, it is sometimes difficult to distinguish a strong investment from a weak one, because even volatile stocks can rise in price. This is especially true of companies in hyped industries, as many investors are willing to buy into a sector without considering whether the stock is a long-term investment.
A company’s health can also change over time. A once-strong organization may experience a major change in leadership, for example, and the new people in charge start making questionable business decisions. Or the industry landscape changes, and a company that once dominated the space is now struggling to keep up with its peers.
In all of these cases, weaker companies are more likely to struggle during tough economic times. Crises are the ultimate test of strength, and companies on shaky foundations can very well crash and burn if the market takes a turn for the worse.
The best way to protect your portfolio against a market crash or recession is to invest only in high-quality stocks with strong fundamentals.
While there are many factors to consider when choosing a stock, a few key signs of a strong company include:
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Healthy finances: Skimming through a company’s financial statements can give you an idea of whether it’s on solid footing. Metrics such as the price-to-earnings (P/E) ratio and the price/earnings-to-growth (PEG) ratio, for example, can help determine a company’s value and growth potential, while the debt-to-EBITDA ratio can measure its risk.
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Competitive advantage: Some companies simply have more to offer than their competitors, whether it’s lower prices, better customer service, or higher quality products. The stronger a company’s competitive advantage in its industry, the better its chances of surviving a recession.
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Industry Capacity: As times change, sometimes entire industries struggle to stay relevant. Even if a business is fundamentally sound, it may still struggle to grow if it is part of a dying industry.
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Qualified Leadership Team: Decisions of the executive team at critical moments can make or break a company’s potential. If a company is otherwise strong but its leaders consistently make questionable decisions, the stock may not be reliable during tough economic times.
