With So Much Volatility in 2022, Where’s the Stock Market Headed Next?
The stock market has been volatile since the beginning of 2022. We’ve been seeing wild swings and a lot of indecisiveness: one day stocks soar and the next day they drop severely. With this, you might be wondering what the worst-case scenario is for the stock market.
To answer that, one has to pay attention to the charts. They can give some idea of how bad the downside could be for the stock market, assuming a major downward move has already begun.
Please note that for the analysis here, the S&P 500 is being used as a measure of the broader stock market.
Look at the chart below. It plots the S&P 500 and its 200-week moving average. Pay close attention to how the S&P 500 has acted around this moving average.
Since about late 2011, the S&P 500 has found strong support from investors around its 200-week moving average. It’s been like clockwork: the S&P 500 soars, it drops to its 200-week moving average, buyers come in, and the upside begins again.
Assuming the S&P 500 goes down to its 200-week moving average, it would have to drop by roughly 23% from where it currently stands.
Chart courtesy of StockCharts.com
Here’s another thing worth noting. Since late 2011, the S&P 500’s biggest move to the upside from its 200-week moving average was about 85%.
Around when the upside gets this high, a sell-off starts and the stock market comes back to this moving average. Since the bounce off its 200-week moving average in 2020, the S&P 500 jumped by a bit more than 81% and started to move lower. Could this be saying that much more selling is right around the corner?
Could the S&P 500 Drop by 61%?
Look at another chart below. It plots the long-term performance of the S&P 500.
Assuming a major move to the downside has begun, the stock market tends to drop until it hits a major support level. For the S&P 500, if it breaks below its 200-week moving average, the major support levels are much lower and there could be a scary decline.
Chart courtesy of StockCharts.com
The next biggest support level below the 200-week moving average is around 2,275. That would mean a decline of 48%. Below this, the next big support level isn’t until around 1,700. That’s 61% below the current S&P 500 price!
Mind you, for the stock market to go down by that much, it would mean there’s a massive fundamental problem that threatens the economy and earnings. It could be anything from a financial crisis, to liquidity issues, to a severe economic crisis.
What to Do if the Stock Market Plummets
Remember, my goal is never to scare you. Rather, it’s to tell you where opportunities could be, how you could grow your wealth, and how you can protect it. This isn’t a call for a stock market crash or a recommendation to sell shares. I’m just trying to inform you how bad things could get.
If what we’re seeing with the stock market is the beginning of a major downward move, it might not be a bad idea to set stops on your existing positions and give your portfolio a good look. Remember, we had one of the best stock market rallies in history between March 2020 and late 2021. If a stock you own hasn’t done well lately, it might be time to pause, reflect, and consider whether it’s worth holding anymore.
Moreover, thanks to financial innovations, there are ways to capitalize on the stock market’s downside. These are certainly risky investing instruments, but they can provide immense upside once there’s a mass exodus from the stock market.
I will end with a quote from Warren Buffett: “Risk comes from not knowing what you’re doing.” By understanding how bad the downside could be, you’re essentially reducing a significant amount of risk in your portfolio.