Is the Stock Market Risky in 2022?
The interest rates are rising, energy prices are soaring, inflation reached 8.5%, and the war in Ukraine is already going into its second month. While these situations are bad for the stock market, the losses of the market correction earlier this year are almost made up again.
It’s time to follow up on the status check of the stock market of last year and check the valuation metrics and macroeconomic indicators, behaviour of companies and the sentiment of investors to gauge the status of the stock market again.
1. Market Valuation
S&P 500 PE Ratio
The PE ratio shows a comparison between the earnings of a company and its current stock valuation. Earlier the average PE ratio for companies in the S&P 500 was climbing but it has now reduced to 25.59. Although this number is still on the high end, the declining PE ratio signals that companies are gradually receiving a better value for their current performance.
Shiller PE Ratio
The Shiller PE ratio, also known as CAPE, is calculated by dividing the current price of the S&P500 by its average inflation-adjusted earnings over the last decade. This ratio is more focused on whether the earning power of the market is sustainable and it has reduced from 39 in September last year to 36.37 now, which is a slight drop. A high CAPE is associated with market crashes, so it’s a meagre change in the right direction.
We’re going from 238% last August to a little below 200% now. As the Buffett Indicator compares the total US stock market valuation (Wilshire 5000 Total Market Index) to the GDP of the United States, this means economic activity is catching up with the stock market valuation.
Since the last update, we went from a strongly overvalued market to a market that is still considered overvalued. The indicator showing a falling value is positive, but stock valuations are still unattractive according to the Buffett indicator.
2. Macroeconomic indicators
Inflation and interest rates
As many countries are easing their Covid policies, demand for products and services is picking up and transportation is increasing on the road, water, and air. This contributed to a steady increase in the inflation rate, which reached 8.5% in March. Energy (mainly oil and gas) is still the biggest contributor to inflation which is reinforced by the war in Ukraine, followed by food and vehicles.
An inflation rate this high has not occurred since 1981 and the Fed acknowledged the inflation rate is getting out of hand and announced more interest rate hikes than anticipated to get inflation under control.
The US unemployment rate declined from 5.2% during the previous update to 3.6% in March. It looks like the governmental assistance plan contributed to a fast recovery of the workforce, and the unemployment rate is as low as pre-pandemic again but it established a tight labour market where a shortage of workers can result to stopping production and a wage-price spiral that results to even higher inflation.
United States National Debt
Since September last year, the US national debt has steadily increased from $28.1 to $30.4 trillion, reaching an all-time high of 137% national debt to GDP ratio. The conclusions of the study of the World Bank — suggesting that an extended debt to GDP ratio of more than 77% is adversarial to economic growth — is still applicable here.
3. US Bond Market
The 2-year and 10-year Treasury yields inverted for the second time since 2019, signalling a possible upcoming recession.
In the meanwhile, the US treasury yield curve recovered to an upward sloping figure again. However, the rate of the 10- and 30-year bonds have dropped below the 7- and 20-year bonds which is unusual. Think about lending your money for 10 years for lower compensation than lending your money for 7 years. This is an example of a so-called inverted yield curve that could signal that a recession is on the horizon.
For the last 6 recessions, an inverted yield curve had a correct prediction rate of 100%. The explanation for the phenomenon of an inverted yield curve is that investors have less faith in the short-term economy and are therefore shifting to longer-term bonds.
4. Sentiment meter
Ray Dalio analysed previous stock market bubbles and he explained that he is worried about a possible market bubble in emerging tech.
During his recent interview with Yahoo Finance, he indicated that he is, from a 1–10 scale, an 8–10 on how worried he is about inflation. Dalio furthermore said, “I think that most likely what we’re going to have is a period of stagflation.” Stagflation is a period of slow economic growth, increased joblessness and rising inflation.
Michael Burry said the market is dancing on a knife’s edge as investors are making speculative trades with borrowed money. This is not sustainable, and a crash is inevitable.
Warren Buffett is worried about overvalued stock markets, the high inflation environment we’re in, and the coming interest rate hikes the Fed announced. According to Buffett, there are risky times ahead, but he also provides timeless advice: economic and stock market downturns are temporary, such an environment can pose smart buying opportunities, and quality stocks can help volatility in your portfolio.
What Google users are searching for
It seems some of the most renowned investors find common ground in the investors’ spectrum, although the everyday investor also has something to add to the narrative.
The search terms for ‘market crash’ and ‘recession’ increase strongly just before and take off during a market crash. And looking at the current trend we have a small uptick in searches for ‘recession’, but there are no hard signs of a bearish sentiment yet.
The latest survey of the Bank of America to gauge investors’ confidence shows 71% of investors expect a weaker economy over the next 12 months and a majority of the investors expect the S&P500 to drop >10% before it will pass 5.000 points.
Conclusion: What’s Next
The burning question investors have is: what direction will the stock market go?
The PE valuation ratios are moving in the right direction and cautiously indicating better values for companies but we are not there yet. The Buffett indicator shows that the US stock market is still overvalued, as is confirmed by Buffett himself.
We can expect some turbulence in the stock market with the coming interest rate hikes in high inflation, high national debt, tight labour market environment, topped with an inverted yield curve on the bond market and a war in Europe that receives major attention and interference of third countries.
This is reflected in the sentiment of renowned investors and the common investor, as there is a small uptick in searches for market crashes and recessions. I hold my investments.