By most measures, 2021 has been a great year for investors. But like billionaire investment guru Warren Buffett, I aim to “be fearful when others are greedy, and be greedy when others are fearful”. As share prices rise, they often become more fragile and volatile. Hence, I sometimes worry about the next stock market crash. Here are five things that I’ll watch out for in 2022.
1. Stretched US stock valuations = stock market crash?
Since the low of 23 March 2020 (when it slumped to 2,191.86 points), the US S&P 500 index has skyrocketed to 4,649.23 points today. Therefore, the index has more than doubled in 21 months, soaring by 112.1%. In 35 years of investing, I’ve never seen such a powerful, one-way market. By most measures, the US stock market is strongly overvalued. So is this the calm before the storm of the next stock market crash?
2. Volatility could surge
As banker JP Morgan once replied when asked what would happen to stocks: “Prices will fluctuate”. Yet despite being year two of Covid-19, 2021 brought remarkably low volatility — for the US stock market, at least. In 2021, the biggest high-low intra-day volatility in the S&P 500 was a mere 3.3% (on 5 March). On only 14 of 245 trading days was intra-day volatility above 2% (but four of these came this month). That’s not a market I’d get too nervous about. But if volatility picks up in 2022, I’d expect more aggressive daily swings in stock prices.
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3. Chinese contagion
As the world’s workshop and growth engine, China might play a part in the next stock market crash. Chinese growth has tumbled this year, dragged down by the coronavirus and deep-rooted, possibly systemic problems. Until recently, property and construction in China accounted for 29% of economic output. But with huge property developer China Evergrande and other real-estate groups defaulting on their debts, 2022 could be tough for the Middle Kingdom. And that’s before further crackdowns by the Chinese Communist Party — following body blows to the tech, education, and property sectors.
4. Runaway inflation and rising interest rates
I was born in 1968 (Gen X and proud!), so I remember the ‘Great Inflation’ of the 1970s. I recall this decade as one of genuine hardship and poverty, as ever-rising prices ate away at modest family incomes. In 2021, after two decades of being subdued, inflation suddenly sprung to life again. In the year to end-November, UK inflation surged to 5.1%, a 10-year high. Meanwhile, over the same period, US Consumer Price Index inflation was 6.8%, a 30-year high. But if central banks jack up interest rates to quell inflation, this might trigger a stock market crash (where prices fall by 20%+).
5. Stock market crash: the next cyclical recession?
Finally, I worry about one thing that hasn’t happened for years: a cyclical recession. Before central banks and governments threw money at the problem, developed economies usually went through growth and shrinking phases. First the feast, then the famine, as boom turned to bust. However, ignoring the Covid-19 recession in spring 2020, we haven’t had a ‘proper’ recession since the global financial crisis ended in mid-2009. Will it come in 2022? Who can say?
Finally, I’m not that terrified of the next stock market crash. Indeed, buying cheap shares in the 2000-03, 2007-09, and 2020 stock market crashes made my family much richer. That’s why we’re building a war chest of cash to invest in discounted stocks in the next bear market!
