The year is almost over, and that means Wall Street strategists are revealing their top stock market predictions for the new year. Because their price targets are wrong nearly all of the time, I usually ignore these forecasts. As a long-term investor, they don't affect my portfolio strategy at all.
The stock market roller coaster
When investor fear is high, volatility increases. This was never more evident than in March of 2020 when the pandemic first took hold of the U.S. economy. It wasn't unusual to see the S&P 500 move more than 5% in a single day around that time, uncharacteristic for the large-cap index that most of the time doesn't go up or down more than 1% in a trading day.
The VIX, which is the Chicago Board Options Exchange (CBOE) Volatility Index, is an indicator of expected volatility for the U.S. stock market over the next 30 days. The so-called "fear gauge" spikes in times of heightened uncertainty. After skyrocketing at the start of the pandemic, it has since come back down to more normalized levels.
If you've been paying attention to the financial news lately, there's a lot on investors' minds as we head into 2022. Topping the list is inflation, caused by an unexpected surge in consumer demand as the economy started opening back up earlier this year. Global supply chains are backed up, businesses are having trouble finding workers, and consumers are facing rising prices for food, gas, and rent.
As a result, investors cling to anything the Federal Reserve says about monetary policy, especially now when inflation is soaring. Although the central bank gave the market clarity on its intentions in 2022 (accelerated tapering of bond buying and three rate hikes), I have zero doubt that they will change their plan at some point. Furthermore, I fully expect volatility to increase meaningfully before each of the Fed's eight meetings next year.
And we can't forget about the ongoing pandemic. The coronavirus omicron variant is quickly spreading throughout the U.S., and we can't count out the possibility of new strains being discovered in 2022. All of this supports my belief that volatility will be elevated next year.
Here's what investors can do
Being mentally prepared for high volatility is only half of the battle. And even if you are ready for it, dealing with your emotions during times of huge price swings is incredibly challenging. That's what makes investing such a fascinating field. The smartest investors don't always win; the ones who have the right temperament do.
With that being said, for investors who can't stomach volatility, there is a viable option for you. Focus on owning blue-chip companies like Apple (AAPL -0.37%), Berkshire Hathaway, or Coca-Cola, large enterprises with proven track records and dependable business models. While the iPhone maker still operates in the tech sector, its unquestionable importance in consumers' daily lives, plus its remarkable ability to generate massive amounts of free cash flow, make it a relatively safe bet. These bigger companies generally do not experience major price fluctuations that high-growth stocks like Etsy, Peloton, or Roku do.
I want to point out that for long-term investors, volatility is not the same as risk. Warren Buffett views risk as the chance of a permanent loss of capital. And this can happen when you incorrectly assess a company's prospects or its valuation. Volatility, on the other hand, is just the price we must pay in order to have a chance at beating the market.
No one knows your emotional make-up better than you. Understanding yourself and your biases will guide your investing decisions and determine whether you can handle times when uncertainty and volatility are high. I think 2022 could be a continuation of this, so position your portfolio accordingly.