Here Is the Only Certainty You Can Have Right Now for the Stock Market in 2022
Having nerves of steel will be even more important than usual in 2022.
Inflation, or rather the word “inflation”, has been a key topic in the financial markets in 2021. Throughout the year, investors were worried about the arrival of high inflation. All along the year, Jerome Powell and Janet Yellen did their best to reassure everyone that inflation would only be transitory at worst.
After inflation reached the highest level in America in 39 years in November 2021, it became impossible for Jerome Powell and the Fed to continue in the same denial. The Fed has therefore changed its tune and the inflection of its ultra-accommodating monetary policy will arrive much sooner than expected in 2022.
Even so, the word “inflation” has not had the effect that investors had feared on the stock markets. The big question is whether the stock market crash that everyone has been waiting for will happen in 2022. Some believe it will, others are afraid of missing out on potential profits while the S&P 500 and the Dow Jones are still close to their record highs reached at the very beginning of 2022.
Under these conditions, it is a complete fog that prevails for 2022. We will have to wait several weeks to see a real trend emerge. If fog is still on the horizon for 2022, one certainty is emerging: the word “volatility” should be a keyword of 2022.
The markets are on edge, waiting for the slightest announcement from the Fed to overreact
If you look in a dictionary, here's the definition of the word:
“Volatility: liability to change rapidly and unpredictably, especially for the worse.”
Now let's apply this word to finance. Volatility is the amount of change in the price of a stock or an index. This volatility is measured by observing past variations over a given period: this is the “historical” volatility. It is then deduced from the prices of options instruments, i.e. implied volatility, which therefore corresponds to the evaluation of future, and not past, fluctuations of a stock or an index.
The benchmark for volatility is the VIX. This is the volatility index of the S&P 500 index. This index is calculated continuously. Some people will speculate on this VIX index, through the futures market, or the options market. So some investors will buy VIX when they think the markets are going to get more choppy than investors anticipate.
You can also sell the VIX if you think the markets will become calmer. It is often said that the VIX is the index of fear in the financial markets. However, to be more accurate, it should be called the index of nervousness in the markets.
At the beginning of 2022, the VIX is in the 20% zone:
We can also see that as soon as the Fed speaks, it rises strongly. It rose more than 5 points in the middle of the week when Jerome Powell spoke and the minutes of the last FOMC meeting of the Fed in December 2021 was published.
Volatility will be a strong trend in 2022. Investors will need nerves of steel
In times of great calm, the VIX trades around 13-14. In times of major crisis, it can soar above 80 as was the case in March 2020 at the beginning of the COVID-19 pandemic.
On the previous chart, you can see that the VIX fluctuated between 14 and 38 over the year 2021.
Before the release of the minutes from the Fed's last FOMC meeting 2021, the markets were already expecting the Fed to raise interest rates and reduce liquidity injections. However, the tone of the minutes was much more hawkish than expected. The Fed is worried about inflation getting out of control now, after months of saying that inflation would only be temporary.
This concern about inflation leads to a rate hike. Such a rise, in turn, induces a climate of uncertainty and therefore more erratic fluctuations in the financial markets. Volatility will therefore increase. These prospects of rising key rates and reduced liquidity injections now give us the first certainty for 2022: volatility will be one of the keywords of this year.
So as an investor, you need to be prepared to have nerves of steel.
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