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Could the stock market be headed for a nuclear implosion?

The Motley Fool logo The Motley Fool 17/04/2017 Joey Frenette
question© Provided by Fool question

A majority of investors have suddenly turned bullish following Trump’s presidential election. Both Warren Buffett and Prem Watsa are bullish on the Trump administration’s policies, which are supposed to strengthen the American economy. Stocks have had their run, and many pundits believe they’re quite expensive at current levels and, going forward, returns are likely to be modest.

I think the Trump rally still has a lot of room to run, and so do many other investors, but escalating tensions in North Korea could put this rally in serious jeopardy. Nuclear war and the stock market are never a good combination, and there’s a real chance that stocks could experience a violent sell-off if the situation in North Korea escalates further.

Last week, the Americans dropped the “mother of all bombs” over Afghanistan, and this freaked out investors; the S&P 500 pulled back by a substantial amount. Then the North Korean military parade showed off its missiles, which really spooked investors around the world.

What should you do in response to this rising tension?

If the tension turns into war, then stocks could potentially fall into a bear market, but that doesn’t mean you should sell all your stocks immediately. Many bullish investors dumped their defensive stocks in favour of cyclical ones, so they could maximize their returns from cyclical upswings that were likely to happen. Defensive stocks are out of favour right now, but I think they’re going to become more popular as the average investor gets fearful at the potential for war.

These kinds of events that impact the stock market are unpredictable, and it’s always a good idea to have a balanced portfolio to prepare for the next stock market crash. It’s going to happen eventually, and trying to time when it’ll happen usually never works.

You should have a good chunk of defensive names in your portfolio such as Alimentation Couche Tard Inc.(TSX:ATD.B) and utilities such as Canadian Utilities Limited(TSX:CU), so you can play defence when the stock market takes an ugly turn. These names will still get hit, but probably not as hard as some of the more cyclical plays out there.

Nobody knows what’s going to happen regarding the North Korea situation, but one thing I do know is that the fear gauge could skyrocket further, and stocks could take a huge hit over the next few months if more bombs continue to drop. It’s important to take a step back and look at the big picture. Don’t panic. Panicking has never helped anyone, and it could cause you to make impulse decisions.

Instead, ask yourself how protected you are from a sudden decline in stock prices. Did you sell a majority of your defensive names in favour of cyclical names? If so, then you probably want to put those defensive names back in your portfolio and hang on for the next few months. Make sure you keep cash on hand because if America goes to war, stocks will plummet, and you’ll want to scoop up beaten-up shares while they’re out of favour.

Stay smart. Stay cautious. Stay Foolish.

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Fool contributor Joey Frenette owns shares of Alimentation Couche Tard Inc. Alimentation Couche Tard Inc. is a recommendation of Stock Advisor Canada.

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