I consider myself an optimist, but the events of the first four weeks of January have given me pause. Being positive doesn’t mean you should abandon reality. Candidly, I don’t see much reality in reading about what some people expect with capital markets in 2022. More than a few reputable people have said the bull market looks as if it will be alive and well in 2022 – and well beyond. My view is that there’s a dangerous amount of ‘optimism bias’ being exhibited and that it doesn’t always serve investors well to be optimistic.
On average, markets go down nearly every third year. Nowadays we should all be very concerned about a coming correction that I think will be huge. Let’s look at the U.S. market.
- The Cyclically Adjusted Price Earnings (CAPE) ratio for the S&P 500 was recently hovering around 40 – the second highest ever.
- The S&P 500 has finished up in 12 of the last 13 years and 17 of the last 19.
- From 2019-2021, the U.S. market more than doubled, the best run since 1997-99.
- The biggest drawdown in 2021 was a paltry -5.2%.
- Today inflation in the U.S. is over 7% – the highest in 30 years.
- Government debt levels throughout the Western world have never been higher in peacetime than they are now.
In essence, too many investors act like there is no such thing as reversion to the mean, while central bankers have somehow devised a sort of capital market alchemy where bear markets have been eradicated. This is referred to as ‘recency bias.’ Because the drawdown of early 2020 was met with a swift and successful response, people have become frighteningly overconfident.
Commentators say things like: “We continue to believe U.S. stocks are in the early stages of transitioning toward an earnings-driven, more fundamentally defined performance trajectory, especially relative to the heavily laden, momentum trading strategies that have defined much of the performance in the past few years.” I could not disagree more. I believe we are in the late stages of a long-in-the-tooth market that is rising on both accumulated momentum and misplaced confidence. Central bankers, by not raising rates in late January, merely kicked the can down the road one last time. It seems obvious that a rate hike will destroy the current recovery just as surely as it did when banks hiked in late 2018. I absolutely think there will be a painful drawdown once the hikes begin.
People are happy to partake in a roaring bull market that is almost entirely due to accommodative monetary policy, yet somehow nonetheless think the party won’t end when the easy money stops. To my mind, we’re in for the worst market since the Great Depression.
No one knows what to expect for sure. No one knows if this will happen, when this will happen, how far the drop will go, how long the drop will last, or even what will cause markets to drop in the first place. All I know is there is no evidence markets can keep climbing indefinitely. All signs point to a major downturn soon – maybe one worse than anything we have ever experienced. But you’d never know it by what many economists and pundits are saying. And that’s why it’s dangerous.
Too many people are simply not prepared for what I believe lurks just around the corner. In late January, central banks and both Canada and the U.S. signaled that rate hikes were almost certain to be implemented by their next meetings in March. The party may end at any tim