Since the benchmark S&P 500 (SNPINDEX: ^GSPC) bottomed out in March 2020, investors have been treated to historic gains. It took less than 17 months for the widely followed index to double from its closing low during the pandemic. Further, the S&P 500 gained 27% last year, which is well over double its average annual total return of 11%, including dividends, since 1980.
But if history has demonstrated anything, it’s that volatility, crashes, and corrections are a normal part of the investing cycle, and the price of admission to what’s arguably the greatest wealth creator on the planet. In 2022, we may well witness a stock market crash, and one of the following 10 factors could be the catalyst that causes it.
1. The spread of new COVID-19 variants
Arguably the most glaring concern for Wall Street continues to be the coronavirus and its numerous variants. The unpredictability of the spread and virulence of new COVID-19 strains means a return to normal is still potentially a ways off. With every country seemingly having its own approach to tackling the pandemic, supply chain issues and workflow disruptions could remain commonplace throughout the year.
Wall Street likes certainty, and COVID-19 has ensured that’s a practical impossibility.
2. Historically high inflation
In a growing economy, moderate levels of inflation (say 2%) are perfectly normal. A growing business should have modest pricing power. However, the 6.8% increase in the Consumer Price Index for All Urban Consumers (CPI-U) in November represented a 39-year high in the United States.
When the price for goods and services rises rapidly, businesses and consumers usually aren’t able to buy as much with their disposable income. Thus, high inflation has a tendency to slow growth, and encourages the nation’s central bank (the Federal Reserve) to tighten its monetary policy, which I’ll touch on next.
3. A hawkish Fed
A third reason the stock market could crash in 2022 is the Fed turning hawkish.
For much of the past 13 years, the nation’s central bank has promoted dovish monetary policy. In other words, it’s kept lending rates at or near historic lows, and undertaken numerous quantitative easing (QE) initiatives designed to buoy confidence in the housing market and weigh down long-term Treasury bond yields.
Beginning in 2022, the Fed is going to wind down its QE program, and will likely raise rates by 25 basis points on a couple of occasions. As access to ultra-cheap capital becomes scarcer, the expectation is that overall economic growth will slow. This is concerning because growth stocks have powered the S&P 500 higher since 2009.
4. Congressional stalemates
As a general rule, it’s best to leave politics out of your portfolio. But every once in a while, what happens on Capitol Hill needs to be closely monitored.
For example, Congress passed and President Joe Biden signed a stopgap funding bill during the first week of December to keep the federal government and its multitude of agencies running. However, this bill only provides enough funding to get through Feb. 18. America’s two major political parties, Democrats and Republicans, have shown that they’re ideologically miles apart, making it quite possible that another government shutdown looms this year.
5. Midterm elections
Once again, politics isn’t usually something investors have to worry about. However, midterm elections are set to occur in November, and the current political breakdown in Congress could have tangible implications on businesses and the stock market moving forward.
For the time being, Democrats have an extremely narrow majority in the House and Senate. Nevertheless, this didn’t help President Biden’s Build Back Better initiative pass. Democrats picking up seats in November could pave a path for Build Back Better to become law in 2023, as well as open the door to higher corporate tax rates. Meanwhile, Republicans picking up seats would almost certainly kill any chance of Biden’s framework becoming law, and would also likely take higher corporate taxation off the table.
6. China’s tech crackdown tightens
For each of the past two years, China has been a headwind for Wall Street. The second-largest economy in the world by gross domestic product entered into a trade war with the U.S. two years ago. Meanwhile, concerns were raised last year when regulators began cracking down on the nation’s biggest tech stocks.
While it’s tough to say what 2022 will have in store for the world’s No. 2 economy, there’s been no indication of regulators loosening their hold on China’s leading innovators. Weakness in key China stocks, as well as potentially negative impacts on innovation and supply chains, threaten U.S. equities.
7. A margin-induced meltdown
A seventh reason the stock market could crash in 2022 is due to rapidly rising margin debt — i.e., the amount of money being borrowed from brokerages/institutions with interest to buy or short-sell securities.
Over time, it’s not uncommon to see the nominal amount of margin debt outstanding increase. However, a rapid increase in outstanding margin debt is often bad news. As of November 2021, nearly $919 billion in margin debt was outstanding. That’s nearly double the amount of margin debt during the pandemic low less than two years ago.
Furthermore, we’ve only witnessed three instances since the beginning of 1995 where margin debt rose by at least 60% in a single year. It occurred just months before the dot-com bubble burst, immediately before the financial crisis, and in 2021.
8. A crypto crash
Over the long run, the stock market is a money machine. But in recent years, speculators have piled into the cryptocurrency market. Watching Bitcoin gain as much as 8,000,000,000% in a little over 11 years, or meme coin Shiba Inu tack on a 46,000,000% gain in 12 months, has driven a level of FOMO (fear of missing out) never before seen.
Unfortunately, the crypto market has been unable to decouple from the stock market and define its own identity. What’s more, a decent percentage of crypto investors are also putting some of their money to work in stocks. A crypto crash in 2022 would likely weigh on stocks dependent on the cryptocurrency ecosystem, as well as reduce investment capital for equities.
9. Value comes into focus
Valuation is yet another clear concern for the stock market in 2022.
Entering the year, the S&P 500’s Shiller price-to-earnings (P/E) ratio was at 40, which represents a two-decade high. The Shiller P/E examines inflation-adjusted earnings over the past 10 years. This is well over double the average Shiller P/E for the S&P 500 of 16.9, dating back more than 150 years.
Even more worrisome is what’s happened to the S&P 500 each of the previous times the Shiller P/E has surpassed 30. In those previous four instances, the benchmark index went on to lose at least 20% of its value. With the Fed tightening its focus, a rotation to value and income stocks could spell trouble.
10. History repeats
Last but not least, history repeating itself could be the catalyst that leads to a stock market crash.
Since 1960, there have been nine bear markets (i.e., declines of at least 20% in the S&P 500). Following each of the previous eight bear market bottoms, not including the coronavirus crash of 2020, the S&P 500 has undergone either one or two corrections of at least 10% in the subsequent 36 months. This is to say that rebounding from a bear market bottom is a bumpy process that doesn’t result in a straight-line bounce.
We’re now 22 months removed from the pandemic bear market bottom, and have yet to see a double-digit percentage pullback in the S&P 500. History would suggest it’s coming, and sooner rather than later.
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