What Event Will Sink the Stock Market? Yields? Tariffs? Trump?

The answer is not yields, tariffs, war, famine, or Trump; although any of those could contribute to the selloff.

Here is a Tweet discussion leading up to the correct answer which will likely surprise many.

Gaga Over Real Estate

Thinking back to 2005, I recall this magazine cover.​

Gaga Over Real Estate

Things do not get any better than Time Magazine going "gaga" over real estate, right on the cover.

The media reflects the mood.

I wrote about it at the time and accurately called the top even though sentiment is extremely hard to judge.

Gaga Over Tax Cuts

In January 2018, nearly everyone was giddy over Trump tax cuts and business investments that are not likely to happen.

In February, investors were so convinced stocks could not drop that they were shorting the VIX more and more every time the VIX rose.

Things finally snapped.

Inflation Sentiment

With nearly everyone so hell-fire convinced inflation is on the way, I propose Inflation is in the Rear-View Mirror.

Before anyone shouts that I have lost my mind, please read the discussion about what inflation really is and how things work in the real economy.

If the Fed reverses course will it be as bullish as before or will investors react as if the curtain was pulled on the Wizard of Oz?

Peak Equity Sentiment?

Have we seen peak sentiment in equities this cycle?

I do not know the answers to those questions, nor does anyone else, but valuation speaks for itself, as noted in Sucker Traps and the Arithmetic of Risk.

The VIX

In regards to the VIX massacre, what happened? Inflation fears? Rate hikes? Anything?

You can conjure up a catalyst, but what really happened is there was a sudden sentiment sentiment change regarding the notion that being short volatility was a guaranteed smart thing to do.

Junk Bond Whales

Junk bonds and equities are correlated. They both represent risk assets.

​Four days ago I noted that a Mutual Fund Whale Goes "All In" On Junk Bonds.

Just like the VIX speculators, the junk bond whales have no concerns about valuation.

How does BST do market timing? The fund uses a computer program.

Bear in mind, many of the securities in the ETF are extremely illiquid. A credit manager informed me that "up to 90% of the bonds in HYG don’t trade on a daily basis."

What can possibly go wrong?

Buy the Dip!

With "buy the dip" so overwhelmingly pervasive, there does not have to be any catalyst for a sustained decline.

I strongly suspect there will not be one.

  1. Does anyone recall a catalyst in November of 2007, one month ahead of the Great Recession? If there was one, what was it?
  2. Does anyone recall Bernanke's denial on the housing bust?
  3. Does anyone recall Greenspan's worry the economy was overheating in summer of 2000, right before the dotcom bust?

Regarding question three, the FOMC minutes show Greenspan was concerned about overheating right before the dotcom crash.

hmmm.

What will change this time?

Sentiment.

The same thing that changed in 2007 with equities, 2006 with housing, and 2000 with dotcom stocks.

The pool of greaters fools will eventually run out, and it won't take a recession or a drop in earnings (although both are coming).

Here's something to think about: Perhaps the pool of greater fools has already run out. If it has, when will you know?

Mike "Mish" Shedlock

Comments (33)
No. 1-25
CautiousObserver
CautiousObserver

“Does anyone recall a catalyst in November of 2007, one month ahead of the Great Recession? If there was one, what was it?”

Bear Stearns CDO losses.

Excerpts copied from Wikipedia:

On June 22, 2007, Bear Stearns pledged a collateralized loan of up to $3.2 billion to "bail out" one of its funds, the Bear Stearns High-Grade Structured Credit Fund, while negotiating with other banks to loan money against collateral to another fund, the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund. Bear Stearns had originally put up just $25 million, so they were hesitant about the bailout; nonetheless, CEO James Cayne and other senior executives worried about the damage to the company's reputation...
A September 21 report in the New York Times noted that Bear Stearns posted a 61 percent drop in net profits due to their hedge fund losses. With Samuel Molinaro's November 15 revelation that Bear Stearns was writing down a further $1.2 billion in mortgage-related securities and would face its first loss in 83 years, Standard & Poor's downgraded the company's credit rating from AA to A...

Mike Mish Shedlock
Mike Mish Shedlock

Editor

Why did the market top in November? The catalyst was in June? September?

AWC
AWC

And what form might the change of sentiment take? Tens of millions of baby boomers, and/or their money managers/ pension fund operators, getting spooked by the perception that maybe markets won't go up forever, and deciding it might be a good time to take profits before the "Herd" comes up with the same idea?

AWC
AWC

This approaching Pension/IRA/401 K unfunded liability obligation is coming up like a "pig through a python."

CautiousObserver
CautiousObserver

It is hard for me to remember 2007 events within one month. I do recall when Bear Stearns had to pledge extra collateral. It was in the summer of 2007 and people in the news were calling it a “modern day run on the bank.” Someone overheard me at lunch discussing that with a friend in a restaurant. Next thing I know the eavesdropping couple was calling their broker.

I expect the trigger this time will also be that someone big will suffer big leveraged losses. I expect the Fed will address the issue quickly; however, the Fed may not be able to undo the damage to confidence.

Am I bending over to pick up pennies before that steamroller arrives? No.