Despite an increase in volatility over the past two weeks, it has been another critical year for the stock market. Until Tuesday, December 7, the reference S&P 500 (^ GSPC 0.95% ) had gained nearly 25%. To put that number into context, the widely followed index has averaged an annual total return, including dividends, of around 11% since 1980.
There is no cutting corners: it has been a good year for many large companies.
But history also shows us that stock market crashes and double-digit percentage corrections are rife. As we prepare to enter a new year, the following seven factors stand out as the biggest threats to the stock market in 2022.
1. The Federal Reserve panics over inflation
Arguably, Wall Street’s biggest concern in 2022 is how the Federal Reserve is handling rapidly rising inflation (the rising cost of goods and services).
Throughout 2021, Federal Reserve Chairman Jerome Powell has called inflation “transient.” But that terminology changed this month, with Powell acknowledging that higher prices could persist. Although some level of inflation is expected in a growing economy, the 6.2% increase in the consumer price index for all urban consumers in October marked the biggest jump in 31 year. Sustained price hikes of this magnitude will eat away at wage increases, engulf consumer and business discretionary incomes, and could halt the economic rebound from the coronavirus-induced recession.
The country’s central bank may be forced to raise its target federal funds rate, which affects interest rates, sooner than expected. The concern is that if the Fed has acted too slowly or provided too much ignition for the US economy with its historically low lending rates and bond buying program, it could be forced to raise rates by. aggressively ready. If that happened, growth stocks would be in big trouble – as would the S&P 500, which has relied on growth stocks for most of its gains over the past 12 years.
2. Political blockade
When in doubt, keep the policy out of your wallet. But every now and then, it’s impossible to ignore how stocks in Washington, DC can affect the outlook for your investments. Yet the biggest worry in 2022 isn’t the legislation that might come out of Washington. Rather, it is what is not done.
Over the coming year, lawmakers will need to tackle yet another federal funding bill by February 15. We will also be navigating through the midterm elections in early November, and politicians could be involved in another debt ceiling debate towards the end of 2022..
In recent years, the ideological divide between America’s two dominant parties, the Democrats and Republicans, has widened, and finding intermediate solutions has at times seemed impossible. With politicians focused on re-election campaigns, the lack of action in Washington could become a serious distraction on Wall Street.
3. global “variant variant”
Another fairly obvious threat to global markets is what I call the ‘variant variance’ of coronavirus disease 2019 (COVID-19).
In May, the emergence of the delta variant of the SARS-CoV-2 virus that causes COVID-19 briefly sent investors running for the hills. The same could be said about the omicron variant over the past couple of weeks. The mutability of SARS-CoV-2 suggests that we should expect new variants to emerge in the coming year.
Variance of Variants describes how, rather than having a unified approach to tackling the spread of COVID-19, we are seeing a mishmash of campaigns and restrictions on a global scale. While some countries have few restrictions, others have made the vaccine mandatory or banned non-essential stores for the unvaccinated. These unpredictable and inconsistent responses to COVID-19 variants threaten to disrupt already fragile supply chains and could seriously reduce US and global growth rates in 2022.
4. A margin debt is unwound
A fourth threat to the stock market in 2022 is leverage.
Over time, we expect the nominal amount of outstanding margin debt to increase. Margin debt describes the amount of money borrowed from brokerage firms at interest to buy or short sell securities. However, rapid increases in margin debt are much less common and have worrying implications.
Since the start of 1995, there have been only three instances where margin debt has climbed at least 60% year-over-year, according to data from the Financial Industry Regulatory Authority (FINRA). This happened shortly before the dot-com bubble burst, just months before the financial crisis, and again in 2021.
While margin can be used to amplify gains, it can also quickly multiply losses. A short-term fear-driven or sentimental event that pushes the S&P 500 lower in 2022 could lead to large margin calls that sink Wall Street.
5. A crypto collapse
Over the past two years, the cryptocurrency market has circled around the S&P 500. Since the coronavirus trough for the stock markets in March 2020, the S&P 500 has risen just over 100%, while as the overall value of digital currencies has increased further. more than 15 times, from $ 141 billion to $ 2.34 trillion.
Making money in the cryptocurrency space has been easy – maybe a little too easy. Crypto gains have, in some cases, been invested in highly volatile stocks, dynamic coins, and memes stocks, such as GameStop and AMC Entertainment. If the crypto market, which is dominated by a handful of names in terms of market capitalization, were to undergo a significant reversion, retail capital investors would have rebounded between digital currencies and volatile / momentum / meme stocks could partially dry up. or totally.
As a reminder, in November, the Federal Reserve’s “Financial Stability Report” cited the actions of retail investors in equities as a potentially destabilizing factor for the stock market. If moose hunters are crushed by crypto in the coming year, Wall Street will likely share the pain, to some extent.
6. Reversion of the growth share premium
Historically, value stocks have actually outperformed growth stocks. But since the end of the Great Recession, low lending rates and an accommodating central bank have rolled out the red carpet for growth stocks to thrive. Ultimately, we will see a kind of return to this push-pull between growth and value, and that could happen in 2022.
If the Fed raises lending rates faster than expected and keeps its promise to cut or eliminate quantitative easing, access to cheap capital will decrease for growth stocks. This likely means fewer acquisitions, as well as fast-paced companies that are more aware of where they are putting their capital to work when it comes to new projects and innovation. In other words, it probably means slower growth rates overall.
The problem, as previously stated, is that growth stocks have been the wind in the sails of the S&P 500. If growth rates slow, it becomes much more difficult for Wall Street and investors to justify paying 50 times the sales. for a cloud service company or 35 times the revenue for a cybersecurity action. Premium reversion for fast-paced companies could sack the S&P 500 and heavy tech Nasdaq composite in 2022.
7. History (it often rhymes)
Finally, history appears to be a real threat to the S&P 500’s seemingly relentless uptrend over the past 20.5 months.
Since 1950, there have been 38 double-digit declines in the S&P 500, which translates to a notable drop, on average, every 1.87 years. Likewise, there have been one or two declines of at least 10% in the 36 months following each of the last eight bear market lows, dating back to 1960. While the stock market does not strictly adhere to averages, it does. either does not follow story with a “t”, it often rhymes with story. That is, the benchmark S&P 500 repeats downward movements after certain events, although not always on schedule.
Based on the numbers above, we are apparently due to both a natural downward correction and a hiccup during the rebound from a bear market bottom. While there is no way of knowing when this drop might occur, the story is pretty clear that downward moves are a normal part of the investment cycle.
In other words, don’t be surprised if 2022 presents a larger drop than the tiny 5% “dip” the S&P 500 has faced this year.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.