The last time we saw a stock market correction was in March 2020, when the overall market (S&P500) dropped 35% from its most recent high. That time around it was induced by a globally devastating event, COVID-19. Which shut down businesses all over the world, increased quarantine restrictions, and saw mass effects on single companies. Which in turn nose dived 30-50% and some even more. ONLY TO recover all of those losses into 2022 and then some.
Now the question is, will we see a 2022 stock market correction, and what makes for the case for one?
Should we see one, read below why, we’re going to outline which stocks we’re looking for when it subsides.
What Happened from the 2020 Crash into 2022?
In 2020, the market closed up about 16% (SPX) and up 67% from the COVID lows. There was a lot of Federal Reserve money movement into the market and stimulus…
In 2021, the SPX closed up about 27% from the open of the year, and up 118% from the COVID lows. Which is JUST 2 years of action in the overall index. Keep in mind the average on a year-to-year basis is a 10% gain in the markets overall. Overall The market opened around 375 and it is closing APPROXIMATELY 100 POINTS HIGHER…
We’ve now had two consecutive years of drastic gains. Last year around 15% even with the large market dump, this year 30% What a ride the S&P 500 has seen. Overall the pullbacks throughout the year we’re nothing to worry about. We had 0 pullbacks that were 10% or more. We had 7 pullbacks that were 3.5% or greater and out of those only 3 of those were 5% or more. Without a real corrective pullback this year, the market has enjoyed a lot of ride to the upside. However, that hasn’t come without a price.
We have held out a strong upside channel in the market overall and can look to continue this move, a lot of the pullbacks were news-driven such as increased COVID fears and new variants. Overall the market has been propped up by the Fed’s injection of capital this year. While rates stayed stagnant, inflation fears did perk up which was another contribution of the pullbacks.
We do have the Fed to thank for this. At the end of the year we got our Santa Rally, we did adhere to seasonality for the most part, and right now we could be in for some more chop into the new year.
At the start of 2022, we had a solid market pullback from the highs, down 13% on the SPX, which is the largest down move that we have seen in over a year. Now a lot of this is due to the overall market conditions and economic conditions. However, was there a way to pick this out? YES… Take a look at stock strength
Stock Divergence Calls for Market Pullback.
We have to take into consideration what stocks have done over the last year or so. Because stocks are the deciding factors in the overall market’s movement. If the majority of stocks go up, then the market is set to go up. If the majority of stocks go down, then the market is set to go down.
For this, I look at the SPX (S&P500) & NDX (Nasdaq) then compare their movement to the stocks that are ABOVE their 200-day moving averages. With this, we would expect market convergence, where the two move together.
Take a look at the chart below from IndexIndicators. This chart represents the SPX compared to stocks above their 200day moving averages. You’ll notice that most stocks are going to sit well above their moving averages when the market starts rising. The number on the left-hand Y-axis is the percentage of stocks above their 200day. Then the price on the right Y-axis is the SPX price.
As the market rises the majority of stocks are going to sit above the average. Which we saw at the beginning of 2021 into the above midway. The summer hits and in July/August the divergence starts. On the first pullback of the year, individual names fell fairly hard. From an average of 90% of stocks above averages to 80% of stocks maintaining. Then the crossover happened on the September dip and the market didn’t look back after that. This indicated the transition of hands. Money managers looked for safety in AAPL and MSFT and abandoned all other names it would seem.
Notice on the rally from October to the end of the year. Individual names fell to about 65% above their 200-day average. Then continued throughout December with a small risk-off…Price dropped to about 40% of stocks above their 200-day average and the market was only down about 13%… With little recovery. Putting an expected value of the market at around 3800-3900 on SPX.
The Nasdaq chart below looks even wonkier, the Nasdaq diverged at the same time, but didn’t even try to find its footing after the September/October dip. That is when a lot of tech names got hammered lower. This is because of what happened in the market and the VALUATIONS of individual names. (next section)
What Did the Federal Reserve Do in 2020?
The Federal Reserve has been widely known for pretty much 1 thing these last 1-2 years. That is printing money out and injecting it into the economy. First and foremost it’s necessary to understand what the Fed did in 2020 then into 2021.
In 2020 we hit the pandemic and businesses were shut down and so was the market, not what I consider a real market crash however this is what the Fed did to help:
- Drop the Federal Funds rate to 0-0.25% seemingly instantaneously.
- Announced that forward guidance would keep the interest rates at or near 0% until there was confidence that the economy has turned a new leaf. Which saw inflation guidance above 2% and growing.
- Launched the ultimate QE. The treasury purchases were off the chain, stating in 2020 that the Fed would buy at LEAST $500Bn in Treasury securities and $200 Bn in gov-guaranteed MSB over the coming months in March. While in 2021 the MAIN topic of concern that caused a lot of the volatility was “tapering assets” meaning that this purchasing will continue, however to a smaller scale.
- The lent to securities firms. Which offered low-rate loans.
- They relaunched the crisis-era MMLF (Money Market Mutual Fund Liquidity Facility). When the crash started, investors withdrew money by the boatload from prime money market funds. These outflows needed to be met because of all of the security selling.
- Repo operations: The Fed increased its repurchase agreement to funnel more money into the money markets. July 2021 the Fed established a permanent standing repo facility to backstop money markets during times of stress.
- Direct lending to banks: The Fed lowered the rate it charges to banks for loans from its discount window from 2.25% to 0.25%. 8 big banks agreed to this along with JPM and BofA.
- Temporary relaxing regulatory requirements. The Fed had encouraged large banks and community banks to dip into their regulatory capital and liquidity buffers to increase the lending during the pandemic.
- Direction lending to major corporate employers. The Fed bought new bond issues and provided loans, which the borrowers could defer interest and principal payment for a minimum of 6 months. They also purchased corporate bonds as well as ETF funds investing in grade corporate bonds.
- Created supporting loans to small and mid-sized businesses. These were the PPP loans that were closed on July 30, 2021.
These were some of the main actions taken by the Fed over the last year, and a large portion of that was the expansion of the balance sheet as well as the super low rate environment. Which caused a surge in asset prices and overinflated a lot of names that had no business being that overbought. This is what brought on the growth of overvaluations.
Take a look at the image below, this is the Fed Balance Sheet in relation to the S&P 500. There is a direct correlation between the growth of the index and the balance sheet. This is the money that was injected by the Fed. The most we have ever seen and we have hit around $8Trillion USD on the balance sheet. We are starting to slow the injection and it would seem the music may stop…
The Federal Reserve’s Monetary Policy Changes in 2021 & 2022.
In 2021, the Federal Reserve was a little less active, as we know there are a few main topics they covered or focused on in 2021. Interest rates (inflation) and tapering the asset purchase program.
Overall the Federal Reserve said that they would NOT consider increasing rates until the economy was at where they considered “good levels”. Now at the start of the year, there was A LOT of emphases put on the employment numbers as well as the monthly non-farm payroll reports. The good news was a bad news sort of market environment. In which a bad number would mean the Fed would keep printing and keeping rates low. Throughout the year that did subside, Jerome Powell himself through many pressers said that they are NOT only looking at the unemployment and employment figures but other aspects as well.
Overall throughout the year, we did not experience any rate hikes, as we neared the end of 2021, that is when a lot of the talk about rate hikes started to escalate, and the fears of inflation and overall debt loomed over the market.
Naturally, with all of this injection, the inflation fears started to increase and we have seen the effects from the CPI numbers time and time again. The only way to combat these fears is to see increased interest rates so that the money won’t be so easily injected into the economy. This has created the largest class divide in the states. Which is another topic.
So each inflation-related report that came out made for a market worry and a jolt overall seeing downside pressure. Which prompted Jerome Powell and the Fed to retire the word “Transitory” this year WOW.
We didn’t see inflation hit critical mass this year because we didn’t experience interest rate increases. The Fed is still letting inflation regulate itself in a sense. This won’t be the case in 2022, with the slow but steady rise since the beginning of the year there is the possibility inflation continues in the same trajectory.
Based on the Bureau of Labor and Statistics the rate of inflation rose throughout the whole year, aggressively at that into the last two quarters.
Which triggered the Dec15 Fed announcement to show a little more hawkishness in terms of rates in the coming year. Based on what we have seen and the economic data, the Fed dot plot has risen into the next year. The majority of the Fed voters see about 0.75-1.00% Feds funds rate in 2022. Which is a drastic increase from 0-0.25%. Overall in 2023, the average is seen at around 1.25-1.75% and continues to increase for the coming years. According to this meeting, there is the potential to raise 3 whole times in 2022. Which would move us to 0.25-0.5%, 0.5-0.75%, and finally 0.75-1.00%.
The Fed can realistically increase rates during any meeting. However, there is the highest likelihood they will start in March. Now, this is an average figure of how many rate increases they will do. They can also increase 2X during one meeting and this can be detrimental for the market. This year it was called before Fed events, next year? The Fed is also looking for unemployment to return to 3.5% by the end of 2022. Remember the Fed’s goal is MAX employment.
We just had the January Fed meeting, where we didn’t see a rate hike, naturally. However, we did see MANY things that we need to be aware of.
Jerome Powell, Fed chair said:
- Raising rates for every single meeting (7 left in 2022) is not out of the question.
- Inflation is still the number one mandate they need to alter by shifting monetary policy
- Quantitative tightening (reduction of the balance sheet) is potentially on the table AFTER the rate hikes.
- The first-rate hike will come in March.
- There can be a possibility that we see double rate hikes in meetings.
Stock Valuations and the Market.
Stock market valuations have been the one thing that has been evident in the market that inflation is running wild. We saw countless assets that make no real profit rip hundreds of percent in the time that the Fed was flowing money into the market.
There are a few ways to value stocks, and we’re going to go the simple route of comparing price to earnings and their respective sector (what the average holds).
For example with software, the industry average is around 32 P/E then you can compare it to CRM. That has a P/E of 43 currently (Feb08) While at its peak, when CRM was priced at 310 per share, P/E was 75.
Now big money takes this into consideration when valuing stock for a longer-term position. Now that the P/E is 75 the name is no longer attractive for investment.
The same thing happened with all of the growth names. Usually, growth names and tech are notorious for high P/E without any real profit to show for it. During the spike in 2021, a lot of growth had P/E ratios of 300-400 which was not normal, considering that they were not pulling profits, they were just doing well to grow sales overall.
This had to be regulated. It’s not just growth names overall, it’s all names/most names.
If we take a look at the top names in each of the larger sectors.
Tech: AAPL MSFT NVDA
Financials: AXP PYPL JPM
Consumer Cyclical: AMZN, TSLA, HD
Healthcare: UNH, JNJ, PFE
Communication Services: GOOGL, FB, NFLX
Take a look at the image below. We’ve added the names above into a chart that outlines the general sector. Now there are different industries in each sector so we got an average range to illustrate P/E. These are all names that are mega-caps and well known. Meaning they hold solid value. Rather than growth names. All of these names have an effect on the S&P500 as they are heavier weights in the index. Under each name is the current P/E as of Feb08 2022, below that P/E is the highest P/E reached between 2020 and 2022.
You’ll notice that after this most recent drop, whether individual names are up or down, the P/Es has cooled off a lot. Meaning either prices went down or the earnings went up. In some cases, earnings did go up but the most realistic explanation is that the prices dropped. So that means that they are in the “favorable” average investment price. So big money will start looking at these as potential investment devices. Now there could be more downside which would make names more attractive. You would ideally compare each individual name to their average P/E in periods of dipping/sustaining growth.
Our point is that during the rise of the market due to increased inflow in the market, lower rates, and constant Fed intervention. The market became overvalued and those overvaluations started in individual names. Which then pulled the market lower. There are some stocks that are still in need of a little more sales for their prices to match their earnings.
Will There Be a 2022 Stock Market Crash?
So the question is? Will there be a crash and what names look the most attractive to purchase for the long term. Now I am talking about investment vehicles that are setting up for the next 5-10 years on which I would like to compound.
But first, what are the odds we get a market crash? Maybe crash is a strong word, but a continuation to the downside?
We’re already dropped about 13% in the SPX and 18% in the NDX. While there are still outflows of money and sector rotations.
The main thing that is going to contribute to the downside is the Fed. The Fed has pumped prices so high that it caused inflation of 7% Y/Y. Then they cut rates to zero. So to mitigate this they’re going to reverse a lot of what they’ve done. So what does that mean?
- The expectation of 7 rate hikes throughout the year by countless banks like JPM, GS, BAC. Which would put us at 1.75-2.00% by the end of the year. I think they get closer to 1.50%. What this would do would increase the borrowing costs so less money would flow rapidly into the market. It would put downside pressure on assets. Each hike.
- They are tapering asset purchases set to complete in March. Last time we saw this in 2013 we saw a taper tantrum from the market. Although analysts disagree there will be a taper tantrum this time around. It’s hard to believe them.
- There is the potential for QT (Quantitative Tightening). Which is the act of unwinding the balance sheet. This reduces the assets that the Fed holds (bonds) and was a main driver for the market movement to the upside in 2020/21.
So where do we stand in the market?
On the SPY we just broke the pivotal channel to the upside. And actually held its resistance after the FB news (earnings) hit the markets. We dropped under the 200day moving average and have not been able to gain traction back to the upside.
The SPY has dropped into 420 before picking itself back up and is now wedged under 458/460. This is an ultimate target for the longs to try the upside again. There just isn’t any buying in the market. The selling has been everlasting.
Looking for a failure at 460, then looking for the retest of 430, 420, 408, and finally around 390-395 where we could capitulate. We are under the impression that the Fed hikes, one after another, can’t hold out the bullside in this market.
Which Stocks to Invest in During a Stock Market Crash?
Last time in 2020 it was easy, you pick your favorite name and Jerome Powell’s printer will deliver the goods.
Which stocks to buy in 2022 stock market correction. This time around, it would be wise to look for value, something that you want to hold for the next 5-10 years. With that said, here are our top 5 picks.
GOOGL is one of the favorites. This name has been growing for years and is the number one search engine conglomerate in the world. Along with having YouTube on board. GOOGL stands to be a huge pick up in 2022 should the market correct 20-25%.
GOOGL recently dropped some strong earnings to end 2021 on Feb1st, 2022. Reported $30.69 EPS vs $27.68 EST. With $75.35B in revenue vs $72.27B estimate. With their ads growing and Youtube growing, GOOGL has continued steady growth even though there have been a lot of concerns around tech into the end of 2021. They even announced a stock split 20:1. In July 2022. I would like to see GOOGL closer to $2,300 a share to start picking some up for the long term.
AAPL hit a market cap of $3T this past year, tagging just above $183 a share. Overall AAPL is a massive name that just keeps delivering, if the market goes up AAPL will too. The earnings report to end 2021 was monstrous. We watched AAPL report $123.9B in revenue vs $119B EST and $2.10 EPS vs 1.90 EST. This means that AAPL has a revenue of about $500B or HALF A TRILLION ANNUALLY!
They also addressed supply chain issues and that they were almost not too big of a burden. Mentioning they would’ve done a lot better if that wasn’t a concern. Another HUGE news event was that China’s iPhone sales are back at the 2015 numbers. Getting a large market share back.
AAPL is continuously innovating and just recently they mentioned that they were advancing in the pay space which takes over PayPal’s market share. The final thing to mention is that we’re still awaiting the AAPL car. Which is going to send AAPL into orbit. ($200+ potentially).
Should the market crash I think this is one of the top pick-ups. Starting at $150 a share and getting more at $135 a share. AAPL has split 7 times before, this could be another run to a split.
NVDA is a great name for the year and the next few. There are a plethora of reasons.
- Semiconductors/Chips are expected to do really well in 2022. With the chip shortage and all the demand is still there.
- NVDA has a huge leg up in the AI field and is going to innovate for the coming decade.
- It is a huge proponent of the tech market and has a large market cap.
NVDA earnings haven’t come out as of yet based on the publishing of this article. However, if they’re anything compared to AMD (which they usually do well). We’re going to see sparks fly during NVDA earnings.
I really like the potential in this name and as the largest semi name, it has huge potential in the future. It even split in 2021. We had already tapped one of the keys add areas at 220 during this slip. The next is 185. You’ll notice how volatile the name is, that’s because it was really heavily bought up into and after the split and on its last earnings report.
American Express (AXP)
AXP isn’t like the other names on this list. It is a credit card company, a financial name, that has done extremely well from the COVID lows and compared to its other counterparts. Visa and Mastercard. AXP is currently at all-time highs (as of Feb08 2022). AXP dipped down to 70 during COVID which was an amazing pickup and I think it can dip hard again. During COVID we dipped because spending was expected to drop a lot and the price fell 51% compared to the market dropping 35%.
To end 2021, AXP had earnings that beat hard.
$2.18 EPS vs $1.86 EXP.
$12.15B Revenue vs $11.5B EXP.
This time around I don’t think we dive that much on AXP but a few key areas that have been held are 150, 130 where I am looking to load the boat.
The final name on the list is TSLA. TSLA has been talked about a lot and has only recently started proving its valuation. Over the last 2 years. Before it was more of a hyped name that got split heavily and is not back to entertaining $1,000-$1,200 ranges.
TSLA started reporting positive earnings quarters in July 2019 and hasn’t slowed down since.
This past earnings report to end 2021:
$2.54 EPS vs $2.36 EXP.
$17.7B REV vs $17.13 EXP.
They beat earnings pretty well and have reported really good earnings per share. The call wasn’t too amazing however they did talk about innovation and looking to improve batteries, along with mitigating supply chain issues and chip shortages for batteries. No new car models in 2022, however, they’re still in the midst of large deliveries of their cyber trucks. Not to mention all of their orders are backed up due to an influx of demand.
TSLA would be a STEAL at around $700 to start then ideally $600.
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