November is likely to be the worst month for UK shares in more than a year. As I write on Tuesday, the FTSE 100 index stands at 7,078.98 points, down 0.4% today and 2.9% since Halloween. The culprit is the new omicron Covid-19 variant, news of which sent the FTSE 100 diving by 3.6% last Friday. Furthermore, the index has lost more than 320 points (-4.3%) from its 2021 peak of 7,402.68 points on 12 November. After these coronavirus-driven dips, some investors worry about a stock market crash in 2022. But should they?
Where do UK stock market crashes start?
I have witnessed — and owned stocks throughout — the October 1987, 2000-03, 2007-09, and March 2020 stock market crashes. Thus, I learnt that London market meltdowns rarely originate in the UK. In my experience, every major market correction/crash was born in the US and then leapt to the UK. Indeed, as one City saying goes, “When New York sneezes, London catches a cold”.
Hence, when I worry about the next stock market crash, I don’t fret too much over the FTSE 100. In fact, I regard the main UK index as rather cheap, both in historical and geographical terms. Instead, I look to the valuations of two major US indices: the S&P 500 and the tech-heavy Nasdaq Composite index. Right now, both look very expensive on fundamentals.
US stock valuations look inflated
Currently, the S&P 500 trades on a trailing price-to-earnings ratio of 28.8 and an earnings yield below 3.5%. The dividend yield is under 1.3% a year. Meanwhile, the Nasdaq trades on a trailing P/E ratio of 35.9 and an earnings yield below 2.8%. The dividend yield is a miniscule 0.65%. By historical standards, these ratings are toweringly high. Personally, I can only remember higher valuations during the 1990s dotcom boom — and before the stock market crash beginning in March 2000.
What’s more, according to this website, US stocks look overvalued or strongly overvalued on four out of five key measures. Naturally, these pumped-up prices worry me, because all stock market crashes are preceded by overrated and exaggerated stock prices. That’s because high prices create fragile markets, leading to bubbles that eventually burst. However, one thing that reassures me is that US earnings growth is going great guns. For example, in Q3/2021, S&P 500 earnings growth was a staggering 42.4%. Wow. But this comes on the back of a strong ‘base effect’, plus the US economy faces several headwinds in 2022. These include supply bottlenecks, labour shortages, and inflation well above target, leading to the possibility of higher interest rates.
Wall Street expects 2022 to be fine
Wall Street’s top investment banks seem confident about US economic growth and interest rates. Morgan Stanley expects inflation to fall considerably in 2022, while remaining above the US Federal Reserve’s target of 2% a year. Hence, the bank expects no Fed rate rises until 2023. But Goldman Sachs believes consumer inflation at a 30-year high will force the Fed to raise rates by July 2022. Meanwhile, Morgan expects the US economy to grow 4.6% next year, while Goldman predicts 3.9% growth. And here are five banks’ predictions for the S&P 500 at end-2022:
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With the S&P 500 currently at 4,636.96 points, these forecasts range from a fall of 5.1% at Morgan to a rise of up to 14.3% at Wells Fargo.
Finally, what do I think? I think I’ll cross my fingers, hope for the best, and keeping buying cheap UK shares!