Expect market volatility in 2022

If there's one word that describes the stock market from March 2020 through the end of 2021, it's resilient.

Amid chaos and uncertainty, the S&P 500 moved higher. If 2022's rocky start tells us anything, it's that the stock market has entered a new phase summarized by another word: Volatile.

Rising inflation, supply chain issues and labor shortages mean that this market environment has uncertainty as well. But unlike the past two years, there won't be stimulus from Congress or the Federal Reserve to provide investors with a sense of stability.

In investing, setting expectations is important. It can help you deal with fluctuating investment accounts and avoid making irrational decisions with your portfolio. Here are three reasons why you should expect market volatility in 2022:

1. Midterm elections

At our firm we have a golden rule: Keep politics from interfering with portfolios. But we do pay attention to election cycles, and midterm election years have historically been the most volatile of a four-year presidential term. This is especially true in the months leading up to those elections. On average, midterm years have seen an intra-year, top-to-bottom decline of 17%. Clearly markets do not like uncertainty, especially when it comes to potential changes in policy.

2. A hawkish Federal Reserve

The Federal Reserve oversees the U.S. economy. They provide stimulus in times of recession or economic downturn. They can also step in during an economic expansion to keep the economy from overheating, which is what's happening now.

To slow strong demand for goods and services, the Fed can raise interest rates, which discourages lending and economic activity.

Just a few months ago, consensus was that the Federal Reserve would raise interest rates once this year. However, with inflation near a 40-year high, many now believe the Fed will be more aggressive in 2022, potentially hiking rates four or five times. This has created an uncertain landscape for stocks and the underlying economy.

3. The market was due

70. That's the number of all-time highs made by the S&P 500 last year. It was the second-best year ever for all-time highs. This took place with minimal downside volatility, which is abnormal. Following the pandemic crash in March of 2020, the S&P 500's largest top-to-bottom decline was just 5% through the end of 2021. That's far lower than the average intra-year decline of 14%.

Simply put, when the market moves higher for an extended period of time, it's healthy for investors to take profits. This can create a market sell-off resulting in increased volatility. In 2022, we've already seen a 10% correction and the year is just getting started.

But it's not all bad ...

Don't panic yet. Drivers of short-term volatility may not be long-term perils. Volatility, although stressful, is a normal part of a functioning stock market. It's ultimately why stocks have outperformed the majority of other asset classes, as risk and return tend to be correlated. Let's expand our time horizon and take another look:

• Midterms: Going back to World War II, the S&P 500 one year after a midterm election has been higher 18 out of 18 times.

• Hawkish Fed: In the previous eight rate hike cycles, the S&P 500 was higher one year following the initial rate hike all eight times.

• Market was due: When the S&P 500 gains at least 25% (as it did in 2021), stocks have been up the next year the last seven times that's happened.

Of course, no one knows what the future holds. But embracing volatility may help you weather the storm and come out ahead in the long run.

• Jim Platania Jr. CFP®, CPA is a Wealth Management Adviser at Platania Financial Inc., located at 2 W. Northwest Highway, Arlington Heights, IL 60004. He can be reached at info@plataniafinancial.com or by phone at (847) 870-7526.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indexes are unmanaged and may not be invested into directly. Securities and advisory services offered through LPL Financial, a registered investment adviser. Member FINRA/SIPC.