4 Reasons for a Stock Market Crash in 2022
One of the fears of being invested is waking up one day and realizing that you are down 50% in an overnight market crash. When writing this post, the stock market is bleeding, we don’t know when it will stop or if it will continue, but instead of panic, we can prepare our financials for it and take advantage of the situation.
What is a market crash?
The most important and biggest market in the world is the US market. The US dollar is the world reserve currency. That is why we always look at the US economic situation.
As a reference to define what a crash is, we have to take a look at the 500 leading US companies represented in the S&P500 index. So we could consider a crash when the value of the S&P declines rapidly by more than 30%.
An example of a market crash is what happened in March 2020 during the lockdown; the S&P fell from February 35% over the period of a month. The height of the red square below measures that decline. Each bar represents a week.
The crash happened very fast, hitting everyone that was invested. I believe that this could happen again in the next few months. so let’s take a look at the main reasons that might cause it.
4 reasons for a stock market crash in 2022
- Leverage is at an all-time high. This means that in recorded history, investors have borrowed the biggest amount of money and put it into the market. Think how would you feel if you would have borrowed from the bank and invested it. Wouldn’t you be a bit shaky and sell at the first small price decline? Below the official data.
- The size of the US market is 1.87 the size of its economy. The neutral size is considered 1 to 1. Let’s explain what it implies.
Stock prices move up because there are more investors buying than investors selling. However in a market, where almost all investors already bought their shares, who will keep buying those stocks? If new investors don’t join the market, the price cannot go up. If the price cannot go up it only can go down.
Another way to look at is by imagining a stadium full of people. Where there are twice the amount of people that are allowed. The place is packed and crowded. The tension is high, and if something would happen everyone would get out of there in a chaotic manner. - Energy prices continue rising, and inflation is at the highest in 40 years for the US. This means that the economic output of the country and its companies will be reduced. If you spend much more on gasoline or food you go less often to a restaurant or buy less stuff. If the companies earn less, their stock will be less valuable. So if the stocks are less valuable, investors will start selling them.
- The federal reserve is raising rates, and from June, it will start selling Mortgage-backed securities (MBS). This means that the interest on mortgages will rise, and once the interest is high enough, people will not be able to afford a house because the mortgage payment will become too expensive. If there are no buyers, prices will go down with the possibility of dragging down the whole stock market with it.
What to do now, so we are ready tomorrow?
We don’t know with certainty that this will happen, but just in case we can leave some cash in our brokerage account. Because when a market crash happens, all assets go down in price. Leaving good companies at a discount. So if you have some cash available you can take advantage of it. In this scenario, you might find the best companies at a 30% discount or more.
In the context of my public portfolio, I cover this situation by leaving aside 25% cash. Waiting for this to happen to take advantage of the best opportunities that might arise. I have already my stock shopping list.
Start preparing now
In a future post, I will share the list of companies that I will buy for the public stock portfolio if a crash happens. However, I want to encourage you today to make your own list now and increase your financial education as much as you can to get the best out of the situation.
A great guy that is putting out there a lot of educational content and analysis is Sven Carlin, you should check his youtube channel out.
Also, if you are interested in exploring deeper some of the points mentioned above, you can check the interviews with Michael Pento. Also, he has a weekly podcast that you can register for free for 5 weeks or pay like a 50$/year subscription.
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