Friday, December 9, 2022

Possible directions for the stock market in 2022

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I anticipate the stock market will crash/correct and undergo a lot of short-term pain until the Fed starts printing money and becomes bearish again, which is when I’m writing this (December 2021).

Here are a few reasons why I believe that…

  • Although a huge number of high-growth firms outperformed analyst projections for their third-quarter earnings in 2021, their stock values have plummeted (10 percent to 20 percent ). For the time being, this is a solid sign that the market has already discounted the best case scenario.
  • In November 2021, the Fed began decreasing its bond purchases (also known as money printing or liquidity injection). The S&P 500 has dropped 18% to 20% every time the Fed has ended its quantitative easing (QE) program and begun tapering. This is the end of the story.
  • For the past few months, the US Dollar has been consolidating, but it has suddenly burst through its barrier. The USD is the system’s stress barometer, and a breakthrough to the upside indicates that the system is under stress. This makes sense because the Fed, by reducing bond purchases, is essentially strengthening the dollar.
  • The S&P 500 index is at all-time highs due of enormous and mega-cap names, but there has been a lot of subsequent carnage (and it’s getting worse), which is a classic sign the market has bottomed out.
  • The M2 money supply reached its peak in February 2021, coinciding with the market’s more speculative segments, such as SPACs and Cathie Wood’s ARKK.

Take a look at the chart below if you don’t believe me that central bank monetary policy is what drives financial markets…

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main qimg 6d86308f34cf7c937012e13102ee2d2b lq
  • Red Arrows =When the Fed’s balance sheet has reduced or stopped increasing.
  • Green Arrows = When the Federal Reserve declared that it will increase its quantitative easing program.

Now, because the Fed began tapering in November of 2021, I don’t believe they will halt in the near future (within the next few weeks or months) since they will lose credibility if they do.

This suggests that we will see a deflationary bust in the coming weeks and months, possibly in Q1 and Q2 of 2022, which will likely prompt them to continue with QE, prompting stocks to tear higher again.

A little more history…

The Fed has thrown a wrench in the bull market every time it has tapered, tightened, or raised rates. Fed policy has been the root of every significant market downturn. The Fed produces the boom, inflates the bubble, and then tapers and raises rates. This was true even during the 1929 stock market meltdown that precipitated the Great Depression, which occurred only after the Federal Reserve reversed the yield curve.

Now I’d like you to look at ARKK…

main qimg 205880473836f10e7a66799f73edcbe3 pjlq

Remember when Cathie Wood’s ARKK ETF (which invests in high-growth firms) doubled, earning her the title of “investor of the decade”? This kind of performance, especially for an ETF, is unheard of.

The crash/correction began in February 2021, but until November 2021, when the Fed announced tapering, the chart had been consolidating (as is normal in the early stages of a huge bubble sell-off).

The weakness and sell-off are now spreading to other sectors of the market, as the stock market begins to discount changes in liquidity conditions.

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main qimg 2aa32e1fda6d2580fef84a5a0e05685f pjlq

“Oh, but I think Google, Apple, Microsoft, and Tesla will continue to have record-breaking quarters,” some of you would remark.

Sure. While this may be true, the main issue we must ask is: What has been discounted or baked into the price of the assets in question?

For example, numerous companies’ stocks have increased 3x-5x in one year with 100% year-over-year sales growth from 2020 to 2021. This occurred mostly because investors were aware of the liquidity problems caused by the Fed’s QE program.

So, what happens when the QE cycle comes to an end and liquidity conditions shift?

The truth is that the companies whose stocks have overrun have grown to such a large market cap that it would take years for them to grow into their respective valuations. As a result, either these companies grow at a much faster rate, which is unlikely, or their stock prices will have to come down to Earth. As I have stated, this is why corporations can beat Q3 2021 projections while still seeing their stock prices plummet.

It’s no surprise that the most speculative companies (those with no revenues or cash flow to support their valuations) are destroyed first, followed by the mid-caps, and finally the more solid companies (those with revenues and cash flow to support their valuations, such as Tesla, Google, and Facebook)?

When huge hedge funds and financial institutions recognize that something is wrong and a bubble is forming, they often “hide and take shelter” in enormous and mega-cap businesses (or “liquid leaders”). As a result, they gradually shift away from more speculative names and toward “safe” and large-cap names.

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When liquidity tightens, these large-caps will eventually break…

main qimg 0b1f2b6fcf1b49cee42157aac71aff43 pjlq

Again, I must emphasize…

main qimg b2070f5e3527804635af9bec888bb31f lq

In the year 2000, when the dot-com bubble burst…

The speculative businesses with no numbers to back up their values were the first to go, followed by the mid-caps until the large-caps ultimately got their time in the meat grinder.

It’s a truth that when a bubble inflates and a parabolic surge occurs (in sectors and asset classes, not individual equities), it invariably ends in tears. Always. This is, once again, history. Liquid markets do not tend to move sideways; instead, they move up and down, constantly cycling between fear and greed.

Check out Exhibit A…

main qimg dd3181f2ea43742ef3c2f4cd8e068405 lq

Now for Exhibit B…

main qimg cc678e01ceddb9ee15061a8a05a55b02 lq

Winter in the markets, in my opinion, is here to stay until liquidity conditions improve (when the Fed steps on the gas pedal and continues on with QE).

Wishing everyone the best of luck. Personally, I’m still adding to my positions because they all have clear near-term catalysts and aren’t overvalued, but I’m doing so more cautiously because I believe the stock market’s correction/crash caused by current liquidity conditions will affect every sector, particularly the high-beta names I own, and I’d love to get my hands on some bargains!

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