Why the Stock Market Could Fall as Much as 18% in 2022
If you are a stock investor, it’s very likely your portfolio has grown significantly over the past two years. The stock market has seen an immense move to the upside in 2020 and 2021. Now the big question: In 2022, could similar gains follow?
Technical analysis suggests that the stock market could have a rough year in 2022. One chart worth watching is the long-term chart of the S&P 500 (plotted below).
After the bottom in 2009, the stock market has been trading in an upward channel, an uptrend with persistent support and resistance. It’s been like clockwork. Stocks drop when they hit the top of the channel and jump when they touch the bottom of the channel.
Recently, the stock market reached the upper portion of the channel—the resistance level. With this, one must ask if stocks will make a move toward the lower end of the channel in 2022. In the case of the S&P 500, that would be around 3,750. That’s 18% below where the S&P 500 currently stands.
Also look at the trading volume in the S&P 500 since early 2021. It has declined by a lot as the market has moved higher. This indicates that participation in the stock market has been low. Generally speaking, you want higher trading volumes as a market goes higher.
Look back at all the times when the S&P 500 jumped to the top of the channel. Note what happened with the trading volume. As the trading volume dropped, the S&P 500 was at the top of the channel and it was met with sellers.
Chart courtesy of StockCharts.com.
Lastly on the above chart, pay close attention to the 50-quarter moving average (the blue line), which is a long-term trend indicator. There’s something interesting about the S&P 500’s moving average.
Over the past 75 years, the S&P 500 has repeatedly come back to test the 50-quarter moving average after it ran away from it. The S&P 500 dropped below the moving average in 2008 and then bounced above it in late 2011.
Over the past 10 years, the stock market has been resilient, trading above its 50-quarter moving average. If there’s selling, could the stock market make a run toward this moving average?
For the S&P 500, the 50-quarter moving is currently around 2,227. If the stock market falls to that level, it would be a 51% decline.
A 51% decline would mean there are fundamental issues with the financial world and the economy. Generally speaking, it’s a great time to buy stocks if they dip that low. The odds of this happening in 2022 are low, however.
How to Hedge if Stock Market Drops in 2022
Dear reader, there are three things an investor can do if they expect a decline in the stock market.
- Place stop-loss orders on existing positions. That way, one doesn’t give away gains if the stock market drops.
- Raise cash: Investors can do that by selling portions of existing positions or closing positions that haven’t been so fruitful. Why raise cash? When there’s panic selling, cash could be very useful; an investor could get great stocks at deep discounts.
- Consider risky investment instruments. Thanks to financial innovation, there are investment instruments that let investors profit when the stock market falls. Mind you, these instruments are risky because, once the market improves, they could lose a lot of value very quickly.