We're about to find out.
I liken the current stock market environment to stepping into The Twilight Zone or the Great Unknown. This post-pandemic market has been brutal in terms of rotation. Most growth stocks have tumbled amid the inflation and interest rate uncertainty; unfortunately, the inflation news is going to get worse, starting with this Wednesday's December CPI report. There is good news on the horizon, but we're going to need to be patient and avoid the traps and pitfalls along the way.
The biggest issue with both higher inflation and higher interest rates is that they eat into valuations of growth companies. There are safe(r) havens, but typically you want to avoid areas of the market where valuations are highly dependent on future earnings growth rates. Hopefully, the following chart will help to explain this visually:
The red-dotted vertical lines mark bottoms in the annual inflation rate, just prior to a significant rise. Think of these as "Stop Signs" or "Red Lights" for growth stocks. The green-dotted vertical lines mark tops in the annual inflation rate. Consider these "Go Signs" or "Green Lights" for growth stocks. Growth stocks tend to struggle significantly relative to value stocks during periods of rising inflation. I see the core inflation rate rising to 6-7% before topping. If I'm right, growth stocks could still have plenty of relative weakness ahead.
The overall market has held up well thus far. Why? Because the dozen or so large-cap stocks that comprise a big portion of the indices have held up very well. But if this market begins to roll over and key leaders like Apple (AAPL) lose support levels, it could get ugly very quickly. ETFs are flush with stocks like AAPL, MSFT, GOOGL, FB, TSLA, etc. Could AAPL fall 20%? 30%? I believe so. First, let's look at the NASDAQ 100 ($NDX) longer-term 10-year weekly chart:
We have seen the NDX soar off the March 2020 low with nary a significant decline. Every new high has been accompanied by a lower weekly PPO since Q3 2020. The bottom panel shows the 12-week ROC. We have not seen a 12-week period that declines since the March 2020 low. The only other time we've seen that during the current secular bull market advance was back in 2015. We actually saw a couple of very insignificant 12-week declines, but, for the most part, the NDX simply kept rising. When it did finally fall, it fell hard in the summer of 2015, falling from a high of nearly 4700 in July 2015 to its subsequent low just beneath 3800 in 5 weeks! Given the higher inflation readings that we'll see over the next 3 months, we should not rule out the possibility of a very significant decline over a fairly short period of time. I believe the odds of such a decline are rising very rapidly.
Any large decline in AAPL or MSFT will make investors VERY nervous. And an AAPL, MSFT, GOOGL, etc. falling rapidly will have a HUGE impact on the major indices because they're the largest component stocks. A drop in AAPL of 30% in a short period of time would not be unprecedented at all:
If you look at the last four significant declines on AAPL, they've ALL occurred after AAPL had a 12-week rate of change in the dangerous 20-30% range. We're at 19.45% right now, but we were above 20% recently. It's also very important to point out that not every trip into this ROC 20% or above range has resulted in a decline. This is NO GUARANTEE. Instead, we should view AAPL as a VERY RISKY long proposition at this point, especially knowing that inflation is likely to rise as we move throughout the first few months of 2022.
I'd be a seller of AAPL, or at least I'd have put protection in place.
All of this is just scratching the surface of what we face heading into 2022. I'm nervous. And if you follow my articles, you know that I'm very bullish longer-term. The short-term, however, is extremely risky. I believe we're going to see a 10% correction to possibly a 20% cyclical bear market due to inflation fears and the fears of higher interest rates.
I will be sharing my thoughts on Saturday, January 8th during our 3rd annual Market Vision event that begins at 8:45am ET. If you'd like to be a part of the biggest event of 2022, it only takes a FREE 30-day trial membership at EarningsBeats.com to be a part of it. For more information about the event, our speaker lineup, and how to sign up, CLICK HERE.
I hope to see you at Market Vision 2022. It will be the most important event you attend in 2022!
Happy trading!
Tom
