Could the Stock Market Crash 20% in 2022?

Let me tell you something you probably already knew: Stocks aren’t off to a hot start in 2022.

As 2020 Approaches, It's Time to Worry About Deflation

Source: Shutterstock

Year-to-date, the S&P 500 is already down 4%, marking its worst start to a year since 2016. And with the selling pressure seemingly accelerating every single day, the big question on Wall Street right now is whether this is a run-of-the-mill correction in a bull market or the start of something far more sinister.

It’s probably the former. But it could be the latter. And that’s why you need to “crash-proof” your portfolio right now.

But first, let’s understand what’s going on in the markets right now…

In a nutshell, it all comes down to interest rates. Put simply, stock valuations are tied to interest rates. The higher interest rates go, the lower stock valuations go and vice versa.

For decades, interest rates were relatively high because inflation was relatively high, and to that end, stock valuations were relatively low.

But in 2008, the Fed cut interest rates to zero to save the U.S. economy from collapse. What followed was 14 years of ultralow inflation that allowed ultralow interest rates to stay in place — and powered stock valuations to historically elevated levels.

In 2022, however, the story has changed. Inflation is red-hot for the first time since before 2008, meaning that the era of ultralow interest rates is — for the first time ever — threatened by runaway inflation. That’s problematic for stocks because they are still valued as if interest rates will remain lower for longer.

On fears that may not be the case, stocks have started off 2022 in a sour mood.

So… what comes next?

The way we see things, there are three potential outcomes for the stock market in 2022. They are as follows, with probabilistic weightings attached:

  • Bull Case (20% probability): The market rises 20%. In this scenario, the Fed only hikes rates once in March, after which inflation dramatically cools before their May meeting. The Fed proceeds to not hike rates for the rest of the year. Economic expansion remains vigorous against the backdrop of accommodative monetary policy, and corporate profit margins expand thanks to rapidly falling inflation pressures. In this scenario, our valuation models suggest a fair earnings multiple for the S&P 500 of 22X and 2022 earnings per share of $250. That combination implies a year-end price target for the index of 5,500.
  • Base Case (70% probability): Stocks flatline. In this scenario, the Fed hikes rates in March, after which inflation cools but not rapidly enough to scare the Fed off its hawkish course. The Fed hikes again in May. Then, inflation does start to really decelerate. The Fed pauses its rate hikes for the balance of the year. Economic expansion remains good, but corporate profit margins are dinged partially by persistent inflation in the first half of the year. In this scenario, our valuation models suggest a fair earnings multiple for the S&P 500 of 21X and 2022 earnings per share of $230. That combination implies a year-end price target for the index of 4,830.
  • Bear Case (10% probability): The market crashes 20%. In this scenario, the Fed hikes rates twice in March, but inflation remains red-hot in April and May. The Fed proceeds to hike rates three more times into the end of the year for a total of five rate hikes in 2022. The sum of those rate hikes does quell inflation but at the same time, hurts economic growth. Corporate profits margins are also dinged by stubbornly hot inflation trends and rising labor and material costs. In this scenario, our valuation models suggest a fair earnings multiple for the S&P 500 of 18X and 2022 earnings per share of $200. That combination implies a year-end price target for the index of 3,600.

All in all, then, the stock market will likely be “OK” in 2022, though investors shouldn’t expect enormous returns by investing in the index, and the risk of a market crash is as high today as it’s been since the Covid-19 pandemic emerged in early 2020.

The investment implication is that investing in the S&P 500 in 2022 is a bad investment.

The good investment? Well, that would be to invest in high-growth tech stocks.

It’s a contrarian thesis, I know, but it’s also the right thesis. The reasoning is that these stocks are in a can’t-lose situation.

Let’s say the bull case emerges. As the past decade has proven, ultralow interest rates are ultrabullish for high-multiple tech stocks. Therefore, in the event that the Fed only hikes rates once in 2022, high-growth tech stocks will fly higher between now and the end of the year.

Let’s say the base case emerges. High-growth tech stocks have already been washed out and repriced for substantially higher rates. Moderately higher rates with steady economic expansion is a hugely favorable backdrop for those stocks. High-growth tech stocks would benefit from both multiple expansion and earnings growth in the event the base case proves correct — meaning they’ll be the biggest winners on Wall Street in 2022.

Now, let’s say the bear case emerges. When the economy slows dramatically, corporate earnings growth becomes scarce. Earnings growth scarcity will force investors to congregate in stocks that still feature strong earnings growth — and those stocks are high-growth tech stocks because they don’t need a strong economy to grow quickly.

Broadly, then, the best thing you can do in 2022 is to do the exact opposite of conventional wisdom and buy the dip in the most hated corner of the market right now: hypergrowth tech stocks.

Mark my words. These stocks will, by the end of 2022, be Wall Street’s biggest winners, with many of them rattling off 100%, 200%, or even 300%-plus gains over the next 12 months.

Sound like a once-in-a-generation buying opportunity? It is. Market crashes tend to do that —  create life-changing opportunities.

Don’t let this one pass you up.

Click here, and learn how to take advantage of the gift the market is giving you in tech stocks.

On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Article printed from InvestorPlace Media,

©2022 InvestorPlace Media, LLC