Is the recent rebound in stocks just the start or a fake and will stocks crash in 2022?
Stocks in the tech-heavy Nasdaq were in a bear market, down 20% from last year’s high at one point in March but have rebounded. They now stand just 14% lower and signs point to higher stock prices over the next couple of weeks.
But should investors still be worried about a market crash for the rest of the year?
Tech stocks plunged 35% in the first five months of 2000 only to rebound 32% in the next three months. Investors thought they were in for another bull market and bought back into stocks. Then the market crashed 66% for the next year before finding a bottom.
Is the recent rebound in stocks a head fake? Will the stock market crash begin again and where will it take prices?
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Why are Stocks Falling?
To answer that question, we have to ask another one, Why are stocks falling? Understanding why the market crashed to start 2022 could help us understand if it will fall further.
The biggest culprit is the decade high inflation rate over the last year. Inflation as high as 8% caught the Federal Reserve off-guard and will force it to increase interest rates. That’s how the central bank fights inflation. It raises interest rates to cool down the economy and slow pressures for higher prices.
What caused stock prices to fall 20% from last year is that the market is always forward-looking. Investors look to what is expected over the next six-months to a year and decide if that will be good or bad for stocks. Investors saw record-high inflation and decided that the higher interest rates that would be coming were bad for stocks.
Of course, the invasion of Ukraine has aggravated pressures on inflation and brought more fear into the market. So far, the selloff in stocks due to Ukraine has been on worries about a wider global conflict but we could be about to see stocks crumble on inflation-related problems as well.
Will Stocks Crash in 2022?
Stocks have rebounded since mid-March, something I predicted on the YouTube channel. The idea was that investors tend to ‘sell the rumor’ or sell stocks before an expected bad event happens. In this case, investors saw higher interest rates coming and sold stocks into the beginning of the year.
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When the actual event comes, in this case when the Fed started increasing interest rates, investors tend to ‘buy the news’ or get back into stocks when they realize the event doesn’t justify the prior crash. Investors have had a collective sigh of relief that, while higher interest rates could eventually slow down the economy, it’s not likely going to happen soon and stocks are still a good deal.
All this is one of the reasons why I focus heavily on investor behavior in my investing strategy rather than just stock analysis. Investors do some really dumb things and understanding why they are doing it can help you make money while others lose it.
For the moment then, the stock market is in a good place. Stock prices are no longer as expensive as they were last year and investors are realizing the stupidity of selling in January and February.
In fact, if you look at how stocks have done during other periods of higher interest rates, it paints the picture of a good 2022 for the market. On average over the last three times the Fed raised rates; in ’99, 2004-2006, 2015-2019, stocks returned an average of 10.4% a year. That means while investors are correct that higher interest rates could mean trouble for the economy, it probably won’t be for at least a year.
That doesn’t mean all is clear though and inflation is about to get much worse. The invasion of Ukraine sent gasoline prices and grains skyrocketing and that will soon show through in consumer inflation. It could scare investors that even higher rates are coming and that will eventually mean lower economic growth. Analysts at Goldman Sachs recently updated their forecast with a 35% chance of a recession within the next year. That would send stocks crashing down another 15% to 25% so investors need to know how to invest.
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How to Invest Before a Stock Market Crash
Fortunately, interest rates have already increased to the point that bonds can offer some protection without losing your money. Starting the year with a rate on the 10-year Treasury of 1.6% meant there was nowhere to go for bond prices but down and this typical safety investment wasn’t so safe.
Now with the 10-year Treasury rate at 2.5%, bond prices have fallen and are now providing safety and cash flow. The Vanguard Long-Term Bond ETF (BLV) has fallen 15% from late last year, a huge crash in bond terms. It’s now paying a 2.9% dividend yield and shouldn’t fall much more even as interest rates rise. If the stock market crashes and interest rates come down, this could be one of the best ways to protect your money.
Investors may also want to take advantage of the rebound in stocks over the next month to sell any stocks they regret buying. I reevaluated my portfolio and found three companies that hadn’t lived up to expectations and were good candidates to sell. That has helped me build my cash back up to 20% of the portfolio, ready to buy the dip if stocks crash later in the year.
Understand, even if stocks fall in 2022 or next year, I’m not abandoning my growth stocks. Many of these have already sold off sixty- and seventy-percent from last year and are in deep value territory. I’m holding these for long-term growth investments while reevaluating the rest of my portfolio for a potential 2022 stock market crash.
Check out All the Stock Market Crash Series