A few more stock market pullbacks, then a big one, are coming, warns this manager. Here’s how investors should prepare.

“We enter 2022 with relatively high valuations, a 7% inflation rate in the United States and the three biggest catalysts for major bull markets from March 2020 to 2021,” Donabedian told MarketWatch in an interview Monday. He said those catalysts – monetary and fiscal policy and the earnings boom – will be less supportive this year.

“We’re going to have to get used to pullbacks of at least 5% in the market, and at some point in the year we’re probably going to have a full correction because that’s exactly how markets work” around of Federal Reserve policy changes, the manager said.

“We reminded clients as the year approached that it is normal to have at least a 10% correction in the S&P SPX,
+0.69%
during the year. We will probably see that.

With this in mind, he has positioned portfolios for more cycle-sensitive sectors that entered 2022 at relatively low valuations. Small businesses, which were beaten in January, have been on his radar.

“Small caps have extraordinarily low valuations relative to large caps and I basically said to our relationship managers, ‘If you don’t have small cap exposure for your clients, you’re underweight.’ “

Going further, Donabedian said he sees opportunities in biotechnology. And while they do have some of the megacap tech, he doesn’t view them as “table buys,” and those kinds of fairly highly valued stocks aren’t the best for a Fed tightening scenario. He passes on names of beat memes, which he throws around with crypto, special purpose acquisition companies and other “speculative investments”.

He said investors need to understand that the environment ahead will not be a “rising tide” market lifts all boats, as the Fed slowly raises the cost of money and takes liquidity out of the market. Well-run businesses will thrive, but those that won’t, he says.

“There’s a Warren Buffettism about when the tide goes out, you see who’s swimming naked. There is something to be said for that. It’s a less forgiving macro environment for businesses,” Donabedian said.

Other ways to protect clients’ money is to double down on inflation protection in their stock portfolios, and one of them is to use a “diverse commodity pool”, which will directly benefit from higher inflation. Other advice includes an underweight to traditional fixed income securities, but exposure to floating rate debt.

But the manager worries that investors are “not sufficiently considering the implications of a permanently higher rate of inflation in the economy. And by that, I mean it’s an issue that hasn’t been addressed, not even on the back burner.

“The new inflation norm will probably be closer to 3½% and for four years, and I think there’s a little sense in the market of ‘Well, that’s better than seven,’ which is the current reading. But it’s a whole new world, in many ways, and that means the Federal Reserve is going to have to do more to contain inflation than the markets are currently pricing in and it’s not just this year, it’s is over several years,” he mentioned.

Managing cost pressures will be a much larger and more variable challenge for companies, he said. “The end result will be a greater dispersion of returns within the market.”

The buzz

Read about “the persistent irrational optimism of US investors revolving around Groundhog Day” from the Russian Ministry of Finance.

Airlines have canceled hundreds of flights as a winter storm hits much of the United States, with natural gas prices NG00,
+11.05%
soaring.

Facebook parent Meta META,
+1.79%,
Qualcomm QCOM,
+0.78%,
T-Mobile TMUS,
+1.28%
and Costco COST,
+0.65%
are in the earnings spotlight, all coming Tuesday night,

Alphabet share GOOGL,
+1.73%
traded above $3,000 for the first time ever after Google’s parent company announced a 20-to-1 stock split and better-than-expected results. Some wonder if Amazon will be the next to separate?

Hold my latte. Starbucks SBUX,
+0.45%
reported a softer holiday quarter and warned of continued price increases as the labor market is tight and inflation squeezes profits.

Elsewhere, Advanced Micro Devices AMD,
+2.21%
stock soars 10% after chipmaker and General Motors GM blowout results,
+2.54%
rallied the shares with the promise of a cheaper electric car to come. PayPalPYPL,
+2.24%
sinks on disappointing earnings forecasts.

Ahead of Friday’s payroll data, the ADP report on private sector payrolls showed that 300,001 jobs were cut in January. Homeownership rates for the fourth quarter are also ahead.

The steps

ES00 Equity Futures,
+0.64%

YM00,
+0.04%
are up, led by those of the Nasdaq-100 NQ00,
+1.21%,
and elsewhere, European and Asian markets not closed during the holidays increased. gross LC00,
+1.05%
is weaker ahead of an OPEC+ meeting of oil producers that may surprise investors.

EURUSD euro,
+0.36%
is up after a surprise jump in inflation, a day before the twin meetings of the Bank of England and the European Central Bank.

And: As March rate hike looms, investors face ‘perilous’ backdrop of heightened volatility

Table

MacroTourist blogger Kevin Muir points to a possible reason for last month’s stock sell-off — essentially the dumping of the Treasury’s General Account, the Treasury Department’s current account — last month. His chart shows how a massive $500 billion drawdown from Dec. 17 coincided with this pullback.

Read more here.

Stock tickers

These were the most active stock symbols on MarketWatch as of 6 a.m. ET.

Random plays

Go fast: teacups marking Queen Elizabeth II ‘Jubbly turntable.’

This lightning 477 miles long broke a world record.

Italian student on Reddit wants to know why Americans are struggling despite a much higher minimum wage.

Need to Know starts early and updates until the opening bell, but sign up here to get it delivered to your inbox once. The email version will be sent around 7:30 a.m. EST.

Want more for the day ahead? Register for The Barron’s Dailya morning investor briefing, featuring exclusive commentary from Barron’s and MarketWatch editors.