A U.S. stock market crash is a real possibility. It's been a long time since we have been in an environment where this was on the table. For those of you who know me, I think I've proven that I'm not one of these end-of-the-world guys. We can probably all agree that I call it like I see it and have no directional bias. I walk around daily proud not to care whether the market doubles or gets cut in half. We just want to be on the right side of the trend.
The risk for most of the month has been skewed in favor of the bears. As breadth has gotten worse and momentum has confirmed downside pressure, I believe there is unlimited risk in the market right now. Nothing is out of the question.
In my opinion, we are in a stock market environment where a crash is entirely possible. Now, just because it is possible doesn't mean it will come. I think of it like the city of Miami — where I grew up — during hurricane season. Just because it's the season doesn't guarantee that a storm will come, but it is absolutely the time to be aware that one can show up and destroy your home or even kill you if you're not prepared.
Hurricanes don't hit Miami in February, and stock market crashes aren't sparked from all-time highs. It's more of a process. The thing is, the ingredients for a market crash are absolutely starting to appear. That storm off the coast of Africa may not hit our house in Miami. It could head towards the Carolinas or disappear altogether. BUT yes, it can hit Miami. That's the environment I think we're in right now – very limited upside to buying stocks, other than for counter-trend trades, but unlimited downside potential.
And what's wrong with a 20-30% correction? It would actually be perfectly normal. Will we get rallies? Yes absolutely. We'll probably get some of the biggest rallies ever, because historically the biggest and fastest moves come within the context of an overall downtrend.
But I still think we use any rallies we do get as an opportunity to: 1) lighten up on any long positions; and, 2) short the stocks and sectors that perform the worst, or not at all, if/when the indexes have their counter-trend rallies. Preparing for a volatile meltdown is a wise idea, in my opinion. People underestimate the power of a leverage unwind and forced selling. At this point in my career, there is nothing that surprises me. I've seen it all, or enough anyway. So to not be aware of the elevated risks right now seems really foolish to me.
If you've been following along, we have NOT seen this type of potential risk in over two years.
Now, does it have to be a crash? No. We can trade in a range for a while. I agree with the thoughts of Fidelity's Jurrien Timmer. Here is the range he pointed out on Monday:
A look at the #SP500 since January 2017: After a mostly steady climb last year, this year has been choppy. What do I expect to see now? A trading range in the middle of the highs (around 2,900) and low (around 2,550). pic.twitter.com/gdauHj2jED
— Jurrien Timmer (@TimmerFidelity) October 15, 2018
This is entirely possible and in my opinion the best outcome for the perma-bull passive crowd to escape this one without getting killed. With credit spreads still tight, this is the higher probability right now, especially with the obvious infrequency of market crashes.
Betting on market crashes all the time is a fast way to go broke. They don't happen often. The opportunity cost is expensive too. Not only are you losing money on your short, but there are potential gains that compound later on that you're missing. It adds up quick. The data really has to suggest caution to make that hard choice of being in cash or shorting stocks, both of which i condone right now.
Am I rooting for a crash? Truthfully, yes. The implications of a crash aren't exactly the best for people – 401(k)s will be slashed, firms will go under, people will lose jobs. I don't want any of these things to happen.
I like heavy cash positions and selling into strength.