Investors have to get treated to unprecedented gains since the benchmark S& P 500 (SNPINDEX: GSPC) bottomed out in March 2020. The widely regarded index had then doubled in less than 17 months from the pandemic’s closing low. Furthermore, the S& P 500 gained 27% last year, much exceeding its average annual total return of 11% (including dividends) since 1980.
But, as history has shown, volatility, crashes, and corrections are a natural part of the investing cycle and the price to what is perhaps the world’s biggest wealth producer. A stock market meltdown is likely to occur in 2022, and one of the following things could be the catalyst.
- The spread of new COVID-19 variants
The coronavirus and its various forms remain arguably the most pressing threat for Wall Street. Because the growth and virulence of new COVID-19 strains are unpredictable, a return to normal could take a long time. Because each country appears to be taking its approach to combating the epidemic, supply chain concerns and workflow delays may continue throughout the year.
COVID-19 has made it a practical impossibility. Wall Street likes certainty, and COVID-19 has made that impossible.
- Inflation is at an all-time high.
Moderate levels of inflation (say, 2%) are typical in a rising economy. A thriving company should be able to charge a reasonable price. However, the Consumer Price Index for All Urban Consumers (CPI-U) rose 6.8% in November, reaching a 39-year high in the United States.
Businesses and customers are frequently unable to buy as much with their disposable income when the price of goods and services grows fast. As a result, rising inflation tends to hinder growth and pushes the nation’s central bank (the Federal Reserve), which I’ll discuss next, to tighten its monetary policies.
- A hawkish Fed
The Fed’s shift to hawkishness is a third reason the stock market could tumble in 2022. The country’s central bank has favored dovish monetary policy for 13 years. In other words, it has held lending rates at or near historic lows and implemented a slew of quantitative easing (QE) programs aimed at boosting housing market confidence and lowering long-term Treasury bond yields.
- Congressional stalemates
Politics should get kept out of your portfolio as a general rule. However, what happens on Capitol Hill should be examined now and then.
To keep the federal government and its many departments working, Congress enacted, and President Joe Biden signed a stopgap financing package during the first week of December. However, this bill only covers the months of February and March. Democrats and Republicans, America’s two major political parties, have demonstrated their ideological divide, making another government shutdown a distinct possibility this year.
- Midterm elections
Politics isn’t something that investors have to be concerned about it. However, midterm elections get scheduled for November, and the current political stalemate in Congress might have long-term consequences for businesses and the stock market.
Democrats currently hold a razor-thin majority in both the House and Senate. Nonetheless, President Biden’s Build Back Better plan failed to gain traction. With Democrats taking enough seats in November, Build Back Better could become law in 2023, paving the way for higher corporation tax rates.
- China’s tech crackdown tightens
For the past two years, China has been a drag on Wall Street. The world’s second-largest economy was involved in a trade battle with the United States two years ago. Meanwhile, last year, regulators began cracking down on the country’s tech stocks, causing anxiety.
While it’s difficult to predict what the world’s No. 2 economy will look like in 2022, regulators have shown no signs of relaxing their grip on China’s leading innovators. Weakness in Chinese stocks, and possible negative implications for innovation and supply chains, pose a threat to US stocks.
- A margin-induced meltdown
The stock market could crash in 2022 for a seventh reason: rapidly expanding margin debt, which refers to the amount of money borrowed with interest from brokerages/institutions to buy or short-sell assets.
It’s not uncommon for the nominal amount of margin debt outstanding to rise over time. Fast growth in margin debt, on the other hand, is frequently news. Margin debt amounted to over $919 billion as of November 2021. That’s about double the amount of margin debt that existed during the pandemic’s low point, which was less than two years ago.
Furthermore, since the beginning of 1995, there have only been three instances in which margin debt has increased by at least 60% in a single year. It happened in 2021, a few months before the dot-com bubble crashed and right before the financial crisis.
- A cryptocurrency meltdown
A stock market is a money machine in the long run. Speculators, on the other hand, have flocked to the bitcoin market in recent years. Observing Bitcoin grow 8,000,000,000% in just over 11 years, or meme coin Shiba Inu gain 46,000,000% in just over a year, has sparked a level of FOMO (fear of missing out) never seen before.
Regrettably, the crypto market has been unable to separate itself from the stock market and establish its own identity. Furthermore, a significant portion of cryptocurrency investors is also investing in stocks. A crypto meltdown in 2022 will undoubtedly hurt stocks that rely on the cryptocurrency ecosystem, as well as equities’ investment money.
- Value comes into focus
Another evident problem for the stock market in 2022 is valuation. The Shiller price-to-earnings (P/E) ratio for the S& P 500 was 40 at the start of the year, a two-decade high. The Shiller P/E ratio looks at inflation-adjusted earnings over ten years. That is more than double the average Shiller P/E for the S& P 500, which is 16.9. The average Shiller P/E for the S& P 500 goes back more than 150 years.
What’s more concerning is what has happened to the S& P 500 each time the Shiller P/E has crossed 30. The benchmark index lost at least 20% of its value in each of the previous four incidents. With the Fed’s focus narrowing, a shift to value and income stocks could be problematic.
- History repeats
Last but not least, a stock market catastrophe could be triggered by history repeating itself.
There have been nine bear markets since 1960. (i.e., declines of at least 20 percent in the S&P 500). The S& P 500 has had one or two 10 percent corrections in the 36 months following each of the previous eight bear market bottoms, except the coronavirus crash of 2020. That suggests that recovering from the bottom of a bear market is a choppy process that does not result in a straight-line bounce.
We’ve been 22 months after the 2008 bear market bottom, and the S& P 500 has yet to witness a double-digit percentage pullback. History suggests it will happen sooner rather than later.
Crash and corrections are a regular part of the investing cycle, even if the stock market is a money machine in the long run. Any variables could cause a severe drop in the S& P 500 in 2022. For more updates, stay in touch with us. Our experts would love to assist you in the hour of need.