- Stocks are in for a world of pain in 2022 as an inflation-driven recession creates a bear market.
- That’s according to Bank of America, which expects the S&P 500 to fall below 4,000 points later this year.
- “Hawkish Fed now wants to address issues of wealth inequality and inflation…start with the overvalued stock market,” BofA said.
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Investors are in for a world of pain in 2022 as an inflationary recession will trigger another stock market correction, Bank of America said in a statement on Friday.
“Inflation causes recessions,” the BofA bluntly stated, and right now inflation is “out of control,” the statement said.
Inflation has been running hot amid renewed consumer demand as COVID-19 recedes, combined with ongoing supply chain disruptions and a spike in commodity prices due to the Russian invasion of Ukraine. Prices are rising at a rate not seen in over 40 years.
And almost all previous recessions have been preceded by bouts of inflation, including in the late 1960s, early 1970s and 2008. “The last dominoes to fall in terms of recession expectations are higher yields and a weaker dollar,” BofA said.
After the “inflation shock” comes the “interest rate shock” that will eventually lead to a “recession shock,” the statement said. And that recession will see the S&P 500 fall below the key 4,000 mark by the end of 2022, BofA said, representing a potential downside of 11% from current levels.
Interest rates are on the focus for investors, especially after this week’s Federal Reserve minutes that revealed the Fed plans to hike interest rates by 50 basis points in May. The minutes also revealed the Fed’s plan to reduce its balance sheet by $95 billion a month later this year.
The Fed’s balance sheet had grown to $9 trillion from a pre-pandemic level of about $4 trillion. “Fed balance sheet of $9 trillion to fall to $6.5 trillion by the end of 2023. Quantitative tightening [is the] Opposite of quantitative easing [which means] higher bond yields and higher volatility,” BofA said.
“Quantitative easing has been very optimistic [for] Financial assets. Quantitative tightening by design will be negative [for] financial assets,” BofA explained. The Fed’s practice of buying fixed income securities over the past two years was designed to inject liquidity into credit markets so companies could borrow amid a global pandemic. That surge of liquidity tends to eventually flow into stocks and creates pressure to buy and drive up prices.
“[A] A new era of the belatedly hawkish Fed, now suddenly keen to address wealth inequality and inflation issues via monetary policy, begins with an overvalued stock market,” BofA said.
This line of thinking aligns with former Fed President Bill Dudley, who commented earlier this week that the Fed must inflict pain on the stock market to curb inflation.
“One thing is certain: to be effective, [The Fed] Stock and bond investors will have to inflict more losses than before,” Dudley said.
Ultimately, any dip in the S&P 500 to new lows this year would result in a significant whiplash for investors, but it would align with a bear market indicator more than 100 years old that has many traders seriously considering a possible recession: the steep one Sell-off in transportation stocks known as the Dow Theory.