The Moment of Terror

I have already seen discussion of when the Federal Reserve will reverse course and ease policy. There's always some of this in the abstract, but I'm referring to discusson of a more imminent reversal as in, what level of the S&P 500 Index reverses policy? SPX 4300? SPX 4000?

This expectation is why I am extremely confident in holding bearish positions. I seldom see this assumption questioned in the mainstream. It's a bit frustrating because I like to see other views on this, and most people I come across who have thought about this, agree with me. Our assumption is the exact opposite of the mainstream: how can the Federal Reserve shift dovish with crude oil at $70 per barrel? There is very low open interest in crude oil at the moment. Were Powell to say "just kidding about the taper" tomorrow, crude would be $100 per barrel by March at the latest. How would stocks react if oil is $100 per barrel? Energy would do well. Maybe financials would do well if there wasn't stagflation, but banks will collapse along with the bond market at some point. We saw what tech did yesterday with crude up $2 per barrel. Rising crude and falling stocks are a sort of unclosable, sustainable alligator jaws. Way down the road there would be mean reversion, but over a period of 12 to 24 months, there would be relentless stock market selling with only small brief pauses so long as energy was rapidly rising in price. The assumption that the Fed can't raise rates because it would bankrupt the government would be blown to smithereens as treasury auctions fail, interest rates soar and USG starts cutting social spending because runaway interest costs risk collapsing the economy.

I don't believe this will happen because I do not believe the Federal Reserve will intervene until they are reasonably confident they will not unleash the above scenario. They will wait until the 30-year bond is sub-1.5 percent and maybe even closer to 1.0 percent or even at a new all-time low. They will wait because unleashing the above scenario is far worse. The above scenario is the endgame that eliminated the possibility of any bailouts or intervention. It triggers the mother of all deflationary collapses because it means inflation is over as a policy. Far better to let the stock market tumble 20 percent or even 40 percent and take crude oil with it, take the CPI back to 2 percent, take the PPI negative. Then the Fed can do another round of QE. The 13-year experiment in failure can continue.

If the market gets what it wants, it will quickly learn, sort of like the market did yesterday, that what it wants is the absolutely worst outcome possible. Or the market is wrong and the Federal Reserve isn't suicidal, and there's no help coming for leveraged and margined bulls. When the market realizes this there will be panic, and then there will be capitulation and a tradable bottom will be made. This realization will cost several hundred points on the S&P 500 Index and probably at least 3,000 on the Nasdaq.