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The stock market in 2022 has been one of the most volatile markets on record. The S&P 500 has seen a near 20% drop so far YTD and the Nasdaq 100 has seen almost a 30% drop YTD. Growth stocks have also taken a beating, with many down 50-80% YTD. Many people have asked, what is causing this volatility and recent bear market behavior?
There are many factors that have attributed to this recent volatility. One could look at the stock market gains throughout Covid-19 and spark the reason that the markets are just “cooling down” for the next run. While other traders, such as The Big Short’s Michael Burry, say that this downtrend is here to stay.
The Federal Reserve
The Federal Reserve System is the central banking system of the United States. It was created Dec. 23, 1913, with the enactment of the Federal Reserve Act, after a series of financial panics led to the desire for central control of the monetary system in order to alleviate financial crises.
The Federal Reserve started reducing its balance sheet June 1. This is also known as quantitative tightening, otherwise known simply as QT. During the pandemic, the Federal Reserve implemented the complete opposite, which is known as quantitative easing (QE). It uses QE in emergency situations and had solid reasoning to use QE during the 2020 stock market crash during the start of Covid-19.
Quantitative easing simply means the Federal Reserve buys long-term securities to boost the economy in bad situations. It increases the money supply and lowers long-term interest rates. It also makes it easier for banks to lend and people to borrow.
Now, quantitative tightening means selling long-term securities and raising interest rates, which is exactly what is happening right now in 2022, and causing the stock market to “sell-off.” The fed is trying to implement a soft landing here, and right now, it’s not looking that optimistic.
What about inflation?
Another big reason why the market is spiraling is inflation rates are rising year over year. Right now, the inflation rate in the U.S is around 8%, which is extremely high. Typically we want an average of 3% when it comes to inflation — clearly, we are well above that average.
Of course, many speculate the inflation rate is actually much greater than what is being reported, with things like used cars, gas, food and household goods up anywhere from 10-50%. A lot of this has to do with situations such as the war in Ukraine, supply chain issues and many other economic factors out of our control.
Rising interest rates should lower the inflationary rate as higher interest rates typically influence consumers to spend less and save more. Basically, the Federal Reserve is doing everything it can to stop inflation from getting out of control.
Another big factor to the market volatility is the current war in Ukraine. Markets don’t like the unknown, and they certainly don’t like instability, both of which are increased during these conflicts. If this war were to escalate beyond Ukraine, we would see much more volatility in the stock market.
These geopolitical issues are also a big reason why gas prices are soaring to their highest since 2008 prices. Speaking of 2008, our last massive stock market crash was during the 2008 financial crisis. The financial crisis of 2008, or the Global Financial Crisis, was a severe worldwide economic crisis that occurred in the early 21st century. It was the most serious financial crisis since the Great Depression.
Will 2022 be as bad as 2008?
This is a topic many financial experts have been debating over the past several months. Each stock market crash is different and unique, however, typically when everyone is expecting the stock market to crash, it usually doesn’t happen.
2008 was a very unique time that was the result of too many sub-prime loans being handed out to anyone who would apply for them. 2022 is the result of too much quantitative easing in 2020-2021, which led to high inflation, combined with the geopolitical issues in eastern Europe. Will the Federal Reserve be able to have a soft landing? That’s the million-dollar question in all of this.
Should I buy the dip?
Unfortunately, we can’t answer that question. However, a famous investing quote has calmed many investors down in turbulent times, “When in doubt, zoom out.” If you have a long-term investment outlook, this recent volatility shouldn’t bother you in any way. Many famous investors such as Warren Buffet are buying stocks at a faster rate than normal.
The U.S economy is actually doing quite well, which is the reason the Federal Reserve has so much confidence they can start quantitative tightening now. We’ve survived the 2008 financial crisis and the 2020 Covid-19 crash — so we will survive 2022.
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