During the final weeks of 2021, the typical year-end discussion on Wall Street will revolve around whether there will be a “Santa Claus rally.” Indeed, it’s entirely possible that the S&P 500 will offer up a final melt-up as much of the tax-loss harvesting has already been done.

Besides, December and January are known for being strong months, seasonally speaking. It also feels bullish when the markets shake off a slew of potential black-swan events, including the Federal Reserve’s expectation of raising interest rates potentially three times next year.

Other problematic developments include the rapid spread of Omicron, as well as fast-rising inflation, supply-chain woes, and a lack of workers. Despite these market headwinds, as we’ve seen over the past decade, investors always seem to find a way to climb over the wall of worry.

Analytic firm Nomura has even gone so far as to predict an epic melt-up in the equities market to close out the year. No one ought to be surprised if this actually happens, and institutional investors are under tremendous pressure to show “window dressing” year-end gains in order to appease their clients.

The point is, I don’t recommend placing any big bets on a volatility ramp-up in December or even in January, for that matter. You can certainly protect yourself with a portfolio that’s diversified into stocks, commodities, and cryptocurrencies, but that’s quite different from shorting the equities market or staying in an all-cash position.

Courtesy: Real Investment Advice

That having been said, it’s also likely that 2022 will be replete with volatility. It will sucker less experienced investors into a losing trade with head-fakes, as Fed tightening cycles can induce brief rallies before all-out panic sets in.

The fact is, rate hikes have a deeply negative impact the stock market. When these are combined with a tapering and eventual phase-out of the Fed’s bond-buying purchases, the so-called “Fed put” will be effectively eliminated.

Sure, corporations will still be able to buy back shares of their own stock, and there will be cash on the sidelines to buy the dips for a while. Just don’t forget that Federal Reserve Chair Jerome Powell raised bond yields in late 2018, with disastrous results for the stock market.

At the same time, it’s going to be difficult for the Fed to renege on its threat/proposal to raise the Fed funds rate in 2022. Inflation isn’t going away – even Jerome “Transitory” Powell acknowledged this – and the central bank will be under pressure to take action by increasing bond yields.

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    Plus, the excuse that Powell used in 2020 – namely, the economic impact of Covid-19 – won’t be an excuse anymore. The “Fed put” will expire, and the already expensive stock market will have to support and justify itself somehow.

    No matter how you slice it, current large-cap stock valuations are clearly stretched. For instance, the S&P 500 trading at a forward P/E Ratio of 22.3x FY2021 EPS, far above its 10-year historical average of 17.4x.

    Courtesy: currentmarketvaluation.com

    Feel free to pick your poison. If you prefer the Buffett Indicator over the forward P/E ratio, then you’re still trading in severely overbought territory, the likes of which we haven’t witnessed since the dot-com bubble.

    Hopefully, you have some gold in your possession in order to protect yourself against the financial fallout that could occur in the coming year. Gold’s enduring value came to the fore in the 1970s, when stagflation gripped the nation but the gold price soared to new heights.

    And going back to the dot-com bubble, the dot-com bust that followed marked the bottom of the gold cycle at that time. Astoundingly, the gold price rocketed from less than $300 per ounce in mid-2000 (as the dot-com boom started to unravel), to $1,900 in 2011.

    So, Santa Claus might not bring us a bout of market volatility this holiday season. That’s fine, as the delayed gift of a powerful gold-price rally will more than make up for an uneventful ending to the year.

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