2021-11-26

The Coming Tech Bear and The Day the Stock Market Dies

Quoth The Raven has a couple of pieces on potential market turmoil. The latest: Happy Thanksgiving, Now Here's Two Reasons Why The Market Could Collapse In December

He outlines a run out of overpriced tech into the rest of the market. Read it. I want to take things in a different direction here. The key point for novice investors to understand, and the second thing behind "inflation is good for stocks" that they don't understand, is that valuations are ephemeral. Tesla has market cap of $1.1 trillion and Wal-Mart $400 billion presently. If everyone who owns Tesla (TSLA) decides they want to buy Wal-Mart (WMT), there won't be $500 billion flowing from Tesla stock into Wal-Mart stock creating a net zero change if the market was only these two stocks. For the sake of this argument, assume everyone who sells Tesla wants to buy Wal-Mart. Investors who want out of Tesla have to sell it to someone holding Wal-Mart. What happens if $100 billion worth of Tesla holders want out, but only $10 billion of Wal-Mart holders want out? I can tell you what happens: Tesla stock will collapse. Only $10 billion can get out.

All of the super bullish longs are in a roach motel. Once the market mood changes, they can't all get out. This causes torsclusspanik, gate-closing panic, a term from Medieval Germany when you didn't want to be caught outside of the walled city gates when the city was coming under attack. Tesla holders will panic sell because hanging around probably means taking a 90 percent haircut on the value. This is a small example, but it will play out across the entire sector once the market realizes the taper is for real and short-term rates are going up.

The larger crash comes on the day the stock market dies. That's when the market realizes the Federal Reserve will adandon stocks to fight inflation. My expectation of how it will play out is fairly simple in theory, but the facts on the ground are impossible to predict and trade. The realization could come during or after a market panic, similar to how stocks have gone vertical since March 2020. It could be a series of panics like in the 1970s instead of one big bear market. The core idea that will drive these losses is inflation.

In my big crash scenario, the market realizes that the Federal Reserve's rescue will cause inflation. Instead of sending oil below $0 in spring 2020, something like the opposite occurs. Oil goes to $500 per barrel because everyone holding futures contracts demands physical delivery (while Comex let the price collapse in 2020, you can bet they'll force everyone to take cash settlement in the opposite scenario). Think of the speculators running GameStop higher, but with oil, silver, gold and platinum. The bond market collapses because inflation is soaring. Long-term rates go up instead of down in a panic because the market anticipates the Federal Reserve will do a new round of QE. Central banks around the world realize they have to reverse policy and maybe even raise rates. The options are two forms of collapse and one doesn't involve destroying the currency. They allow deflation to do the work of finally ending the credit wave that began in the 1970s.

The the series of panics scenario, there are multiple repeats of March 2020, each time causing higher inflation, each time the predictions of hyperinflation grow louder, each time the Federal Reserve hikes interest rates higher than before, sparking a panic in financial assets to similar nominal lows, maybe even rising lows giving the appearance of a bull market. At the end of this cycle they hike to economy-killing heights as Volcker did in the early 1980s. Inflation doesn't goes away until the end of this scenario. It cycles between say 2 percent and 20 percent. The inflation adjusted losses in stocks exceed 90 percent even if stocks are in a technical bull market because nominal prices are in an uptrend.

I think the stock market could "die in a day" because the market thinks inflation will lift stocks. If this thinking holds, it creates the conditions for a panic the moment the market realizes inflation is bad for stocks. The nightmare scenario for bulls would unfold if the market is shocked by multiple assumptions failing simultaneously. Inflation makes stocks go down, the Federal Reserve takes actions that hurt both stocks and bonds to contain inflation. If the market doesn't wise up before something like this starts playing out, conditions for a crash will be in place. If the market wises up, something more like the 1970s could play out. In either case, there will be a massinve bear market in the real value of financial assets.

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