7 Causes the Inventory Market May Crash in January


In lower than per week, we’ll formally be ringing in a brand new yr. Nonetheless, Wall Avenue is perhaps unhappy to see 2021 come to a detailed. The benchmark S&P 500 (SNPINDEX:^GSPC) has greater than doubled up (+24%) its common annual complete return of 11% (together with dividends) over the previous 4 a long time, and it hasn’t undergone a steeper correction than 5%. It has been a real working of the bulls.

However as we flip the web page on 2021, it is fairly doable Wall Avenue may lose its luster. Under are seven causes the inventory market may crash in January.

A twenty dollar paper airplane crashing and crumpling into a financial newspaper.

Picture supply: Getty Photographs.

1. Omicron provide chain points (home and overseas)

The most obvious obstacle for the S&P 500 is the continued unfold of coronavirus variants, of which omicron is now probably the most predominant in the USA. The problem is that there isn’t any unified world strategy as to how finest to curtail omicron. Whereas some nations at the moment are mandating vaccines, others are imposing few restrictions, if any.

With a large variance of mitigation measures being deployed, the only best threat to Wall Avenue is sustained or brand-new provide chain points. From tech and client items to industrial corporations, most sectors are susceptible to working shortfalls if world logistics proceed to be tied into knots by the pandemic.

A printing press producing crisp one hundred dollar bills.

Picture supply: Getty Photographs.

2. QE winding down

One other pretty apparent high-risk issue for Wall Avenue is the Federal Reserve happening the offensive towards inflation. As a reminder, the Shopper Worth Index for all City Shoppers (CPI-U) rose 6.8% in November, which marked a 39-year excessive for inflation.

Earlier this month, Federal Reserve Chairman Jerome Powell introduced that the nation’s central financial institution would expedite the winding down of its quantitative easing (QE) program. QE is the umbrella program answerable for shopping for long-term Treasury bonds (shopping for T-bonds pushes up their worth and weighs down long-term yields) and mortgage-backed securities.

Decreased bond shopping for ought to equate to larger borrowing charges, which in flip can slow the growth potential of beforehand fast-paced shares.

A hand reaching for a neat stack of one hundred dollar bills used as bait in a mouse trap.

Picture supply: Getty Photographs.

3. Margin calls

Wall Avenue also needs to be deeply involved about quickly rising ranges of margin debt, which is the sum of money that is been borrowed by establishments or traders with curiosity to buy or short-sell securities.

Over time, it is completely regular for the nominal quantity of excellent margin debt to climb. However for the reason that March 2020 low, the quantity of excellent margin debt has come near doubling, and now sits at practically $919 billion, in accordance with November knowledge from the impartial Monetary Trade Regulatory Authority. 

There have solely been three situations within the final 26 years the place margin debt excellent rose by at the least 60% in a single yr. It occurred simply months earlier than the dot-com bubble burst, nearly instantly forward of the monetary disaster, and in 2021. If shares drift decrease to start the yr, a margin-call wave could really accelerate things to the downside.

Professional traders sitting at their desks and talking on the phone.

Picture supply: Getty Photographs.

4. Sector rotation

Generally, the inventory market dives for purely benign causes. One such risk is that if we witness sector rotation in January. Sector rotation refers to traders transferring cash from one sector of the market to a different.

On the floor, you’d assume a broad-based index just like the S&P 500 would not be fazed by sector rotation. But it surely’s no secret that growth stocks within the know-how and healthcare sectors have been primarily main this rally from the March 2020 bear market backside. Now that we’re properly previous the one-year mark since this backside, it would not be all that stunning to see traders locking in some earnings on corporations with valuation premiums and migrating a few of their money to safer/worth investments or dividend performs.

If traders do start to decide on worth and dividends over development shares, there’s little query the market-cap-weighted S&P 500 will discover itself beneath strain.

A visibly concerned person looking at a rapidly rising then plunging stock chart on a tablet.

Picture supply: Getty Photographs.

5. Meme inventory reversion

A fifth motive the inventory market may crash in January is the potential for a dive in meme shares, similar to AMC Leisure Holdings and GameStop.

Though these are grossly overvalued corporations which have turn out to be indifferent from their respectively poor working performances, the Fed famous in its semiannual Monetary Stability Report that near- and long-term risks exist with the way in which younger and novice traders have been placing their cash to work.

Particularly, the report highlights that households invested in these social-media-driven shares are likely to have more-leveraged steadiness sheets. If widespread sense prevails and these bubble-like shares start to deflate, these leveraged traders could don’t have any selection however to retreat, resulting in elevated market volatility.

A magnifying glass placed atop a financial newspaper, with the words, Market data, enlarged.

Picture supply: Getty Photographs.

6. Valuation

Though valuation isn’t ever sufficient, by itself, to ship the S&P 500 screaming decrease, historic precedents do suggest Wall Street may be in trouble come January.

As of the closing bell on Dec. 21, the S&P 500’s Shiller price-to-earnings (P/E) ratio was 39. The Shiller P/E takes under consideration inflation-adjusted earnings over the previous 10 years. Although the Shiller P/E a number of for the S&P 500 has risen a bit for the reason that introduction of the web within the mid-Nineteen Nineties, the present Shiller P/E is greater than double its 151-year common of 16.9.

What’s way more worrisome is that the S&P 500 has declined at the least 20% in every of the earlier 4 situations when the Shiller P/E surpassed 30. Wall Avenue merely would not have a very good observe report of supporting excessive valuations for lengthy intervals of time.

A green chart plunging deep into the red, with quotes, arrows, and percentages in the background.

Picture supply: Getty Photographs.

7. Historical past makes its presence felt

Lastly, traders can look to historical past as another excuse to be involved in regards to the broader market.

Since 1960, there have been 9 bear market declines (20% or extra) for the S&P 500. Following each of the previous eight bear market bottoms (i.e., not together with the coronavirus crash), the S&P 500 underwent both one or two double-digit share declines within the subsequent 36 months. We’re now 21 months faraway from the March 2020 bear market low and have not come near a double-digit correction within the broad-market index.

Understand that if a inventory market crash or correction does happen in January, it will signify a incredible shopping for alternative for long-term traders. Simply remember that crashes and corrections are the value of admission to one of many world’s best wealth creators.

This text represents the opinion of the author, who could disagree with the “official” suggestion place of a Motley Idiot premium advisory service. We’re motley! Questioning an investing thesis — even one among our personal — helps us all assume critically about investing and make choices that assist us turn out to be smarter, happier, and richer.


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