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Risks To The Bullish Thesis In 2022

Authored by Lance Roberts via RealInvestmentAdvice.com,

The market outlook for 2022 remains bullish, as Wall Street veterans suggest that Fed tightening won’t hurt stocks bullish advance. From JP Morgan’s target of 5050 to BMO’s forecast of 5300 on the S&P index, {{there’s} little concern that stocks {could possibly be} lower next year.|year {there’s} little concern that stocks {could possibly be} lower next.} {

Such {is without a doubt} understandable after {greater than a} decade of advancing markets,|

Such is understandable after {greater than a} decade of advancing markets undoubtedly,} with the last 3-years seeing the market advance more than 50%. The market has weathered 20% corrections from a Fed “taper tantrum” to a 35% rout from a pandemic-driven shutdown. {{Every time} {the marketplace} rebounded quickly {because the} Fed jumped {in to the} fray providing accommodative policies.|{Every time} {the marketplace} rebounded as the Fed jumped into the fray providing accommodative policies quickly.}

Chart Courtesy of SimpleVisor

Our market outlook for 2022 is a bit more conservative than much of Wall Street. {While 2022 {could possibly be} another bullish year for stocks,|Year for stocks while 2022 {could possibly be} another bullish,} as bull markets are tough to kill, my job as a portfolio manager is to ensure our clients don’t suffer a permanent impairment to their investment capital.{

{Considering that} our client’s portfolios remain allocated toward equity risk,|{our} client’s portfolios remain allocated toward equity risk

Given,} our market outlook focuses on what could go wrong. Such seems a more pragmatic approach than just  “hoping”  things go right.

While we should always  “hope for clear skies and calm seas,”  {a captain navigates {from} the risks to his vessel.|a captain navigates from the risks to his vessel away.}

So, what are the risks in 2022 that we should steer clear of?

Market Outlook – The Risk To The Bullish Thesis

Over the last few years in particular, as valuations have become more extreme, {the consistently bullish media {continue steadily to} invent rationals for higher stock prices.|the bullish media {continue steadily to} invent rationals for higher stock prices consistently.}

  • Low interest rates justify high valuations.

  • There is no alternative (T.I.N.A.)

  • Monetary policy supports higher prices.

  • Low inflation supports higher prices

Notably, {those rationalizations appeared correct {because of the} massive flood of monetary and fiscal policy {throughout that} period.|those rationalizations appeared correct {because of the} massive flood of fiscal and monetary policy {throughout that} period.}

So, as we head into 2022, here is a shortlist of the things we are either currently hedging portfolios against or will potentially {have to} {in the foreseeable future}.

  • Economic growth slows as year-over-year comparisons become {a lot more} challenging.

  • Inflationary pressures remain more persistent than anticipated which impedes consumption and compresses {income}.

  • Rising wage and input costs reduce corporate earnings disappointing earnings growth expectations.

  • Valuations {commence to} weigh  on investor confidence.

  • Corporate profits weaken {because of} slower economic growth, reduced monetary interventions, and rising costs.

  • Consumer confidence continues to weaken as consumption is crimped by rising costs and slowing economic growth.

  • {Interest levels} rise  {which trips heavily leveraged consumers and corporations up.}

  • A credit-related event causes {market} liquidity crunch.

  • The Fed makes a “policy error”  {by tightening monetary accommodation {because the} economy slows suddenly.|by tightening monetary accommodation {because the} economy suddenly slows.}

  • A mid-term election {producing a} broad sweep by Republicans in both houses further reduce liqudity.

  • The “housing bubble 2.0” implodes.

  • Corporate stock buybacks, which  accounted for 40% of the market’s appreciation  since 2011, slow as companies {commence to} hoard cash {because the} economy slows.

  • The massive inflows into US equity markets {during the last} year slows.

  • The avalanche of M&A activity, IPO’s, and SPAC’s  of {low quality} companies results in negative outcomes.

  • Market breadth remains incredibly week, with 5-stocks supporting the major market.

{I possibly could} go on, {but you {obtain the} idea.|but you {obtain the} basic idea.}

You Can’t {OWN IT} Both Ways

While analysts on Wall Street are confident the bull market will continue uninterrupted into 2022, {you can find} {plenty of} risks to derail that market outlook. Importantly, {none {of the} independently suggest {a substantial} correction is imminent.|none {of the} suggest {a substantial} correction is imminent independently.} However, {{the chance} is {that they can} undermine the bullish |{the chance} is {they} shall undermine the bullish } “psychology”  of {the marketplace}.

The critical {element of} the “bullish thesis” has been the psychology of the “Fed put.{” {No matter|Irrespective of} valuation levels,|” of valuation levels Regardless,} deteriorating fundamentals, or simple logic, the excuse for continuing {to defend myself against} increasing {degrees of} risk was  “Don’t fight the Fed.”

However, {therein lies the irony {once we} head into 2022,|lies the irony {once we} head into 2022 therein,} {the Fed is {likely to} tighten policy {in short order}.|the Fed is {likely to} quickly tighten policy rather.} If the logic of rising prices was  “don’t fight the Fed’s liquidity,”  {the argument {now could be} to |the argument now to&nbsp is;} “fight the Fed’s tightening regime.”

As {is definitely} the case, {you can’t {own it} both ways.|you can’t {own it} both real ways.}

A Reversal Of Fortune?

As noted, the unexpected  “pandemic-driven economic shutdown”  {sent {the Federal Government|the government} and Reserve into fiscal and monetary policy overdrive.} Such {resulted in} an unimaginable influx of $5 trillion {in to the} economy, sending the  “money supply”  surging well above the long-term exponential growth trend.

{The significance} of that  “sea of liquidity” { is both {negative and positive}.| is both {positive and negative}.}  {For a while}, that liquidity supports economic growth, {the surge in retail sales into {this season},|{this season} the surge in retail sales into,} and the explosive recovery in corporate earnings. { That liquidity {can be} flowing into record corporate stock buybacks,| That liquidity is flowing into record corporate stock buybacks also,} retail investing, and a surge in private equity. { With all that liquidity around sloshing,} it is of {no real surprise} {we’ve} seen a near-record surge in the annualized rate of change of the S&P 500 index.

However, {as mentioned}, {there’s a} dark side {compared to that} liquidity.  With the Democrats struggling to pass another stimulus bill, a looming debt ceiling, and the Fed beginning to  “taper”  their bond purchases, {year liquidity will reverse next.}  As shown below, if we {go through the} annual rate of change in the S&P 500 {in comparison to} our  “{way of measuring} liquidity”  ( M2 less GDP), { it suggests stocks {could possibly be} {in big trouble} heading into next year.|year it suggests stocks {could possibly be} {in big trouble} heading into next.}

{Without} a perfect correlation, {{it really is} high enough to warrant attention.|{it really is} high to warrant attention enough.} { With global central banks {reducing} on liquidity,| With global central banks cutting on liquidity back,} {the national government providing less,} and inflationary pressures {caring for} the rest, {it really is} {worth taking into consideration} increasing risk-management practices.

Sailing In Unchartered Waters

{Time for} our  “navigation”  metaphor, {attempting to} predict {exactly what will} happen in 2022 {is really a} futile exercise. {You can find} too many variables {that may} occur {which could} change outcomes for {the higher} or worse. {As I previously discussed,}  risk management {is really a} process:

First, {the only real} certainty is {that there surely is} no certainty. Second, every decision, {as a result}, {is really a} matter of weighing probabilities. Third, despite uncertainty {we should} decide and {we should} act. {And finally}, {{we have to} judge decisions {not merely} on the results,|{we have to} judge decisions {not merely} on {the full total} results,} but on how {these were} made.

If {you can find} no absolutes, then all decisions become matters of judging {the likelihood of} different outcomes, and {the expenses} and {great things about} each. Then, on that basis, you can make a good decision .

Managing risk does not mean  “being all in cash;”  it only means navigating the risks that could cause permanent impairment to your financial plans.{year

If nothing happens and 2022 is another bullish.} Fantastic. Such will make my job very easy.

However, if an unexpected storm appears on the horizon, taking some actions to navigate safety will provide a much better outcome.

There is no value in  “going down with the ship.”

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