Will the stock market crash in 2022?

Will the stock market crash in 2022?
Warning signs for investors as US & UK interest rates rise to fight inflation.
Dan Lane
January 24, 2022

Key points:

  • Restrictions might be relaxing but Omicron is still here and the coronavirus is still a pain in the economic recovery’s side.
  • The US stock market's valuation is close to a 20-year high and lockdown’s favourite stocks are looking toppy. US tech firms could be vulnerable in a rising interest rate environment.
  • Inflation isn’t as ‘transitory’ as central bankers first thought and investors now expect four US interest rate rises this year.
  • Oil was 2021’s best performing traditional asset class, but will commodities attract nervous investors in 2022?

US and UK stocks put in a respectable performance last year but just because 2021 ended  in positive territory doesn’t mean a stock market crash in 2022 is inevitable.

Using the gambler’s fallacy to tackle the stock market is pointless. We don’t need hunches or feelings in a world of high inflation and rising interest rates, we need prepared portfolios.

And even more than that, we need prepared investors. In pursuit of exactly that, here are some investment trends to keep in mind before we automatically assume we’re set for a stock market crash in 2022.

Threats to the stock market in 2022

Is inflation good or bad for stocks?

Inflation isn’t good for the cash in our pockets but when it comes to shares it’s a much more nuanced affair.

Rising costs aren’t good for businesses who have to decide how much they can pass onto customers without a revolt. But more broadly, whether inflation is a real headwind to stocks depends on what’s driving it and how high it is.

If it’s the result of high growth and high demand in the economy then that can be a good backdrop for shares. 

It can start to become a concern if inflation overshoots that middle ground though and, with UK inflation coming in at a 30-year high of 5.4% in the UK [1], that’s where the worry is creeping in. 

At high levels inflation can hit shares but it can also allow companies with strong pricing power to prove their worth.

Firms with loyal followings are often able to pass on increases in input costs to consumers and maintain profit margins.  

That’s becoming increasingly important as input cost pressures rise higher than they’ve been for decades. 

Investors will likely look for companies so successful in their field that they discourage anyone else even taking part. If you’re the dominant player with little competition, that can help preserve what you charge. 

The key here is to ask just how sustainable that ability is. If it’s susceptible to a drop-off in discretionary spending and purse tightening, revenues could drop.

US tech stocks have already felt the nerves of investors, with some of the pandemic’s high-flyers losing ground on the back of rate expectations.

Ultimately, that could lead to a world where the hype is stripped out of the FAANGs and co., with what’s left much closer to a genuine assessment of pure value. 

Are bonds good during inflation?

Inflation and rising interest rates are probably more associated with direct knock-on effects in the bond market.

The clue to the possible threat here is in the name; ‘fixed’ income. When the asset has a fixed rate of interest attached to it and inflation rises, that interest starts to look less attractive and there’s not really anything investors can do to change it.

The prospect of further rate rises hasn’t been lost on bond traders, who have been selling as the broader market grows confident that four US rate rises are likely in 2022.

As long as that continues, bonds are unlikely to be at the top of investors’ wishlists.

Could rising interest rates trigger a stock market crash?

Just to dollop a little sour cream on all the fiery talk of a rate-induced crash, rates have gone up before and markets (and economies) have coped.

During the most recent period of rate rises (Sept 2015 - June 2019) the US equity market rose over 60% with the tech sector more than doubling.  

The worst performing sector was energy - food for thought given it’s pretty much been the opposite recently. 

The big takeaway is that all sectors delivered positive returns.

US stocks held up pretty well during the last period of rate rises (Sept 2015 - June 2019). Source: Bloomberg.

The starting points are a little different though. With the Fed’s money printers going hell for leather over the last couple of years it's understandable that inflationary fears are front and centre of investors’ minds.  

If supply chain bottlenecks stick around, and rates are hiked faster than current expectations this would almost certainly make for choppier waters for stocks.  

But there are deflationary forces at play too. The US stock market has historically played a significant role in consumer confidence in the US.  

A sustained market fall would dent spending substantially, and possibly stall the recovery.  This will be very much on the minds of policy setters.  

At the same time, companies have invested enormous amounts in technology infrastructure over the last two years.  

Anything that improves efficiencies and lowers costs should help to offset other cost input pressures. Microsoft CEO Satya Nadella put it well, “Digital technology is a deflationary force in an inflationary economy”.

So certainly keep an eye on inflation, but we don’t think it needs to spell the end of the current bull market.

Past performance is not a reliable indicator of future returns. 

 Source: FE, as at 19 Jan 2022. Basis: bid-bid in local currency terms with income reinvested.

Is it a good time to invest in value stocks?

There’s an important element to that question: time. Investing in unloved, overlooked or unfairly punished stocks means hanging on (sometimes for ages) until the market finally admits you were right and lifts the price, if that ever actually happens at all.

That requires an incredible degree of patience, confidence and self-awareness (what if that company was ignored for a reason?) but the recent rotation from high growth stocks into the dusty old market names has investors considering the style after over a decade in the wilderness.

Ever since central bankers set interest rates on their upward trajectory and it looked like travel restrictions would ease, a lot of classic value sectors have seemed a lot perkier.

Airlines, travel firms, banks, insurers - they’ve all seen a bounce as investors have finally seen the chance for them to grind back into gear.

They’re all dependent on a sustained economic recovery though, and there have been a few false dawns recently. A similar thing happened from November 2020 to February 2021 when the vaccine rollout accelerated and the once-hated travel and financial stocks fought back.

You don’t always have to be a hardline contrarian though. Being sensitive to company valuations and not overpaying for shares is a good discipline whatever the weather.

The other cautionary note here is that investors may have already priced in the impact of an economic rebound. 

The market is a forward-looking mechanism so we should be careful not to jump on the bandwagon when it’s already half way down the street. 

In that sense, it may be useful to diversify between growth and value styles, but keep Jim Chanos in mind this year. The big name investor warned, ‘The worst thing that can happen to reopening stocks is that we reopen.’

Are UK shares undervalued?

The UK looks achingly cheap compared to other markets, particularly the US. But cheap doesn’t automatically mean good value. And no amount of cheapness will make a bad company good. 

That’s one of the reasons the UK hasn’t had the same post-March 2020 snap back as the market across the pond. It just looks a bit fuddy duddy next to the slick tech titans.

Price divided by 12-month forward consensus expected operating earnings per share. Source: I/B/E/S data by Refinitiv, yardeni.com. As at 19 Jan 2022.

That said, if the trajectory for interest rates starts to look more solid, some of the companies that suffered because of their seemingly outdated image could start to look more attractive. 

The UK market is full of the types of stocks we’ve just mentioned - banks, insurance firms and energy titans could move higher if the economy gets back to full swing in 2022. 

Ultimately, with a lot of valuations across unloved UK firms sitting below 10x earnings, this looks like a value investor’s playbook. But a key thing to be careful of this year is leaping on the pummelled businesses that were struggling long before the virus struck. 

While other firms might be feeling the pressure temporarily, the pandemic might have accelerated the overall demise of the stragglers.

Focus on which firms have the cash to last another difficult year, if that’s what 2022 turns out to be, and get a feel for how nimble management teams have been over the past few years. A steady hand is good in a crisis, and it’s even better on the road out of one.

Omicron & Covid-19 spread

“It's tough to make predictions, especially about the future”. Never has baseball-playing philosopher, Yogi Berra, been more relevant.

We just don’t know what path the pandemic will take next so it’s important we’re prepared rather than leaving it to guesswork.

That means diversifying our portfolios and acknowledging that we aren’t out of the woods. In terms of assets, we need to keep our eyes on the horizon and not get bogged down by near-term market movements. 

Indices and the companies on them will still be finding their feet after a tumultuous few years and going big on a certain strategy has the potential to introduce big waves of volatility to your portfolio.

Concentrate on the firms able to control their own destiny and those which can operate regardless of what’s happening in the wider economy. They might not always be the shares shooting the lights out but consistency rarely offers an unexpected plunge either.

Pragmatism is the name of the game this year.

Will Chinese stocks snap back in 2022?

2021 was really quite a rough year for Chinese equities. Authorities in the country decided to draw a line in the sand and make their attitudes to stock market listings known. 

That involved driving home the notion of ‘common prosperity’ and kicking off efforts to level out wealth inequality in the country. 

While this will inevitably continue to hit the spending power of the country’s elites, there is a huge stratum of society waiting to join the middle class - a theme playing out in China over the past few years.

These aren’t the ultra wealthy, rather they’re the well-off who will be exploring what to do with their discretionary spending. That could pave the way for a recovery in consumer stocks as well as insurers, healthcare providers and wealth management firms - all businesses that draw in the newly wealthy.

These types of stocks have had a double whammy over the past two years, with investors fleeing towards the glamorous US tech sector instead.

But seeing stocks drop and thinking they’re bound to spring back is just another take on the gambler’s fallacy - don’t fall into that trap. 

The reality is investors are still nervous over just how much influence the CCP has over the corporate world in China and will need convincing to get the indices rising again.

That means it may get worse before it gets better for investors in the country. It’s not a year to expect a sudden rocket under the economy, even with China’s recent decision to relax monetary policy even further (i.e. drop interest rates).

That might stimulate spending but foreign investors are once bitten, twice shy.

Commodities: oil, gold & real estate

Oil was one of last year’s best performing assets.

It went through the wringer though, being thrown from peak to trough as restrictions turned off the demand taps at times.

2022 presents a different backdrop though, particularly around interest rates.

Looking back through the years, commodities do tend to hold their own when the Fed tightens monetary policy. 1993-95, 2004-06 and 2015-19 are all evidence of that. But the past few years have created a different beast and commodities are still rife for disruption.

ESG pressures on legacy fossil fuel sectors continue and oil still seems to tank as soon as restrictions arise - neither of these issues are fully behind us yet.

On the other hand, if 2022 brings about a global recovery, demand for resources could rocket and outstrip supply while mines and rigs get production back online.

Covid and ESG hurdles have made it much harder to bring new projects into being though, so any rewards in the sector are likely to be shared by established producers, as long as they can flick the switch when the world needs energy.

If interest rates lag inflation in 2022, investors could opt for a diversifier like gold (that is, if they don’t go for Bitcoin like we saw last year).

Will crypto crash in 2022?

Talking of Bitcoin, 2021 was a huge year for the popularity of cryptocurrencies in general.

But, while corporations and governments the world over are coming round to the idea of the blockchain, the role of crypto is still unclear - is it an asset, a store of value, an actual currency?

Arguably the volatility of headliner Bitcoin means it’s far from offering the relative stability a traditional currency has, and anyone holding it should know how much of a rollercoaster comes as standard.

With the development of the metaverse we’re one step closer to the broad acceptance of a digital currency but there are still hurdles for the overall sector this year.

First, China’s crackdown on anything crypto was swift and unequivocal. If the world is to buy into a universal currency it will likely want the Chinese economy on board - any hope of that seems further away than ever.

Regulation will make some crypto fans reel in horror but the reality is the sector is likely to have to meet regulators half way if it is to emerge from underground status eventually. 

With that will come calls for Bitcoin and co. to showcase their ESG credentials. In a world increasingly focused on the environmental impact of everything we do, crypto will have to toe the line too.

For investors, all of this is secondary to the fact that cryptocurrencies are still hugely speculative assets to invest in. Ascribing value and determining buying and selling opportunities in the sector still includes enough guesswork to warrant a huge warning on the inherent risk involved.

If you do want to take part in crypto markets this year as part of a well-diversified portfolio, think about the ones whose tokens represent an actual use case like remittance services rather than the memecoins based on nothing but a joke.

What to do when the stock market crashes

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” That’s the view of renowned fund manager Peter Lynch.

It makes the case for not fiddling with our assets when we get nervous. If you have a portfolio of diversified, well-run companies with consistent earnings and the ability to stave off competition, why meddle anyway?

The time to prepare for any dips or corrections is long before they pop up, not while excited headlines are being written. 

And that goes for you too - make an effort to think about your behaviour. Are you likely to react emotionally to a fall in share prices? We can be our own worst enemies in times of market stress so making sure your well-diversified portfolio can handle volatility means you don’t even need to touch it.

In short, look through the drama and stick to your knitting.

In the short term there might be hysteria but in the long term companies’ share prices are guided by their ability to consistently generate solid earnings and pump that cash back into the business to make even higher rates of return. 

That can only happen over time so often the best thing to do is nothing.


[1] https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/december2021 

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