Heading into 2022, I am worried there could be a stock market crash over the next 12 months. There are growing pressures on the stock market and economy, and these could weigh on equity prices in the year ahead, potentially causing a significant market decline.
I think three primary challenges could ignite a stock market crash at some point in 2022.
Stock market crash risks
The first is rising inflation. This is climbing around the world due to several factors. Commodity prices, particularly energy prices, have jumped over the past six months, and this is having a knock-on effect on the economy. At the same time, food prices have also jumped and, in many regions, wages are growing as well.
Here in the UK, the Bank of England expects inflation to hit 6% in the next few months. This is just an average. Energy and food inflation could be significantly higher.
Rising prices will make it harder for companies to maintain their profit margins. If costs increase significantly, profits will fall, ultimately leading to lower equity valuations. Falling profits could also cause an investor exodus and a stock market crash.
The second factor that could contribute to a stock market crash in the year ahead is the winding down of quantitative easing by central banks.
Quantitative easing has helped support equity markets over the past 24 months. Confronted with near-zero interest rates on fixed-income securities, investors have had no choice but to buy stocks. As central banks increase interest rates, some investors may leave the equity market searching for income elsewhere. As these investors sell out, it could spark a stampede away from equities into other assets.
High valuations are the third and final reason I believe a stock market crash could materialise in 2022. As equity prices have surged over the past two years, some growth stocks are trading at multiples last seen in the dot-com bubble. This trend could reverse in 2022 as the world starts to move on from the pandemic.
As the world re-opens, investors may start to question if these growth stocks can meet their lofty expectations. Once again, this shift in sentiment could lead to a broad sell-off as investors stampede out of the market.
Investing for the next decade
Of course, all of the above is just speculation. There is no guarantee a stock market crash will happen in 2022. And even if it does, I am not taking any action right now.
Here at The Motley Fool we are long-term investors. I am only interested in buying a stock if I am prepared to hold it for the next 10 years, no matter what might happen to it in the near term.
This is the approach I will continue to use over the next 12-24 months, no matter what happens in the broader equity markets. I plan to keep focusing on high-quality stocks, which have the potential to expand, no matter what the future holds for the market and the economy.