The occasional spot of volatility aside, 2021 was a fantastic year for stocks. The S&P 500 finished the year up almost 27%, far ahead of the average total annual return since 1980 of 11%.
However, investing never comes without risk, and a significant correction or crash could be around the corner. Let’s look at the threats to the stock market in 2022.
Inflation is a critical concern for 2022. The consumer price index is forecast to be around 7% for much of the year. The knock-on effect could be significant.
Inflation is a concern for everyone, especially the Fed. Much of 2022 depends on what moves the central banks make, and if the news on January 6th is anything to go by, they plan to move aggressively against inflation. That announcement caused a sharp sell-off, and worse could follow.
Indeed, increased interest rates could be the sort of issue that causes a 20% market correction during 2022. The increases will happen; how badly they affect equities is less clear.
Of course, not everyone believes that central banks will be able to control inflation. Some argue that globalisation and the rise of China reduced labour costs, and that trend is now being reversed.
For Tech and Growth stocks, rising inflation represents some significant issues. The price of many Tech stocks relies on future earnings, and if inflation continues to increase, these distant earnings will look far less valuable.
The early January correction that followed the release of the Fed’s December minutes could be a sign of things to come.
End of Stimulus Packages
If the Fed does tackle inflation, it will spell the end of the COVID-19 stimulus. If we hit rate hikes during Q2, asset classes like equities and high yield bonds could perform well. However, depending on how much of the market recovery has been propped up by the Fed stimulus, some sectors could take a fall.
Lack of Diversification
A concentration of tech stocks was responsible for a lot of the S&P 500 growth last year. Apple, Microsoft, Nvidia, Alphabet, and Tesla have driven most of the gains since last April. When a market relies on a few big players, it’s vulnerable to changing conditions. However, 2022 is likely to see some of the equities that lag behind Growth stocks find their feet.
Regulatory changes could cause issues across several sectors. Midterm elections could see a more significant focus on drug pricing reform, which could hit Pharma. Travel could feel the effects of tightening carbon emissions regulations. At the same time, environmental and pollution laws could hurt the Energy sector.
But if one sector should be most concerned about 2022 regulations, it’s Tech. The EU’s Digital Services Act and Digital Markets Act could seriously disrupt Big Tech business models.
The S&P 500’s P/E hit 27.2 at the end of last year. It’s the highest P/E since the stock market bubble. Many analysts suggest that this is fine because profits will keep rising. However, things might not be that simple.
Operating margins are rising, and the share of sales spent on operation costs is about 40% higher than 12 years ago. If labour costs consume more profits, equities look very expensive.
New Covid Variants
Both Delta and Omicron scares have come and passed. The market could absorb both these variants; however, it’s unlikely that these will be the last form of coronavirus we hear about. A particularly bad strain could still damage and hurt already creaking supply chains.
The general consensus among financial institutions is that we are set for a steady year, albeit one without the enormous gains of 2021. For believers in the January Barometer (correct almost 85% of the time since the 1950s), the early sell-off may seem like a bad omen.
However, most of the significant threats to the stock market are familiar faces from 2021. Inflation, new coronavirus variants, and less favourable conditions for growth stocks could drag at the S&P 500. February’s federal funding bill and another debt ceiling debate could also cause issues.
However, despite the numerous threats out there, opportunities will present themselves. And according to CNBC’s Jim Cramer, everyone should keep an open mind about equities next year because the market might just keep on going up.
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Alpesh Patel OBE
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