Tuesday, December 28, 2021

Timing The Mega Crash

Whenever people ask me when will the market crash, I say it's inevitable. The next question: When is that? After all, in the year that saw the launch of an actual 'FOMO' ETF, no one wants to leave the casino before it explodes...

The two key determinants of the magnitude of a crash are positioning and point in the cycle. Today's investors have been well-conditioned to believe they can get bailed out from any type of "Black Swan event", including one caused by Fed policy error itself. Which is why they are now taking far more risk at this latent juncture than at any time in the past even while knowing the Fed is now in the midst of a likely policy error. All the inevitable consequence of moral hazard.

"lack of incentive to guard against risk where one is protected from its consequences"

"Our clients are fearful, but none of them are at the point of getting out,” he said. “They haven’t got the guts to pull out"

What are you going to do? Dump all your large-caps and invest in all emerging markets stocks. No one is doing that”

he has told investors sitting on huge gains in stocks such as Microsoft that it is time to sell some of their holdings. That’s not a conversation he says has always gone well"

There is no alternative,” he said. “From what I see investors are more skittish, but they are not acting on it"

Got that? It takes guts to get OUT of this market, not in. Cash is trash, and sheeple forget that after Y2K Microsoft was dead money for 15 years after losing -60%. Right now they're all waiting for Apple to eclipse a $3 trillion Germany in market cap to propel the S&P higher. I predict Tech will go down -80% and it won't come back for decades. It will be a total disaster for today's dumb money investors who learned nothing from Y2K. It took until 2015 for the Nasdaq to overcome its 2000 era high. Now they're all piled back into it like it's the Fort Knox of investments.

Insiders on the other hand are not "skittish" about getting out. Satya Nadella dumped HALF his shares in a two day period.

We all know that when this latest Fed taper explodes, pundits will blame Fed policy error, for legal purposes. Whereas they have been blaming the Fed for being too slow in raising rates, soon they will "pivot" to blaming the Fed for being too fast in raising rates. What they want is a Goldilocks market, not too hot and not too cold. And if it all explodes, they expect instantaneous bailout. 

Unfortunately, the two main determinants of the magnitude of a crash are positioning going into the crash and where we are in the cycle. In this case, investors are positioned record aggressively for this point in the cycle. What is extremely ironic is that today's pundits evince supreme confidence in Fed control over the cycle, and now the Fed is actively tightening, yet investors are STILL leaning into risk. Why? because they have a bi-polar view that Fed incompetence creates buying opportunities, and Fed omnipotence prevents them from getting out of control. A theory that will not sound as intelligent after the fact as it does now.

Worse yet for today's morons, is that the Fed has been warning all year about elevated risk asset prices:

May 2021:

"Vulnerabilities associated with elevated risk appetite are rising. Valuations across a range of asset classes have continued to rise from levels that were already elevated late last year"

Fed Chairman Jerome Powell has repeatedly said that as long as interest rates stay low, the valuations are justified"

November 2021:

"Across most asset classes, valuation measures are high relative to historical norms. Since the May 2021 Financial Stability Report, equity prices rose further"

The share of investment-grade issuance with the lowest investment-grade ratings remained at historically elevated levels"

A steep rise in interest rates could lead to a large correction in prices of risky assets"

It's all there. Everything a Sesame Street bull needs to know, but was afraid to ask. 

Putting together cycle risk with positioning, here we see the Fed balance sheet monthly % change. Back in 2008 the Fed eased on a record scale and yet stocks bottomed five months later. They declined -40% from October 2008 for a total -55% decline. Meanwhile, we see that the pandemic in 2020 arrived at a point earlier in the cycle than 2008 and with far less leverage than abides today. This amount of leverage at this point in the cycle portends far more extreme dislocation than anything we've seen in recent decades. 

Zooming in on low volatility stocks, we see that positioning is the highest level of the cycle, while breadth is at the worst point in the cycle while recession stocks are leading. This is a far more lethal set-up than what abided in March 2020. 

What this all sets up is a 1930 style value trap. After the crash, investors will be told that it's time to buy/hold stocks. No one will want to tell them their losses are permanent. For a while as in 1930, the market may slowly begin to rise for a period of time. However, under the surface, companies will be going bankrupt en masse. At that point, the strategy of continually borrowing our way out of debt will come to an unforeseen bad ending.

Cycle denial will be lethal for those who are addicted to bullshit.