In my view, the wave of liquidity has numbed traders and investors into a false sense of security in the bull market that "dies hard".
New all time highs, something considered unfathomable to many in March, is now at hand and further gains are increasingly expected by a growing consensus.
Even though the Fed is unlikely to stop, with stocks elevated from the March lows we should (always) be on the lookout for adverse outcomes and associated risks that could cause an abrupt market reversal.
Many of those that were bearish in March (and under the desks) are bullish today (and looking up to the sky) - not because of any meaningful fundamental reason or upward reassessment of S&P earnings (as, arguably, the prospects have deteriorated) - but because, in part, market participants have grown ebullient. ("Price has a way of changing sentiment." - H/T Divine Ms M).
Of course the "rip your face off rally" (that I expected) has had a big assist from the Federal Reserve - who's infusion of money into the markets, including corporate bond purchases, initially turned the market higher and has continued to generate a wave of "don't fight the Fed" thinking.
Not surprisingly, strategists' S&P price targets have gravitated higher coincident with the strong momentum in equities since mid-March.
There are numerous conditions - discussed below - that could result in a very abrupt reversal and actionable drop in the averages:
Indeed, the wise man considers the "ifs" - the contrary - and constantly evaluates, and often rallies against, "group stink".
In constructing this list, it is a tautology that the skeptical might look for something that contradicts the reasons for the market rising - that could cause a reversal.
My view is that the period leading up to the November election holds a list of unique and potentially worrisome risks:
- Fundamentals: Economic and corporate profit expectations remain too optimistic. High frequency economic data is starting to level off as bankruptcies expand (especially of a small business- and restaurant-kind), businesses stay closed down and temporary layoffs are becoming permanent. The travel (airlines), restaurant, entertainment and commercial real estate industries have been gutted and will never be the same. I continue to believe that S&P EPS profits will not eclipse 2019 levels for at least three years.
- Technicals: Are deteriorating. As Divine Ms M observed this morning - market breadth and new highs (only 59 yesterday) are lagging, the extraordinary role of a small number of tech companies are contributing to the market rise, investor sentiment is growing ebullient (put/call ratios at a multi-month low), the National Association of Active Investment Managers (NAAIM) has its highest long exposure in years at 102.4, bond rates and inflation breakevens are rising, Nasdaq gapped higher on Wednesday with the lowest volume in a month and the US dollar is off the lows.
- Covid-19 Remains A Wildcard in the Fall. Currently the virus continues to spread and fatalities are expanding. Travel restrictions are now tightening. Schools and universities are either closing or have a markedly reduced schedule, and small business openings remain uncertain. The recent fragile rise in consumer and business confidence could be fleeting.
- Speculation, Which Has Run Amok, Is Beginning to Moderate. Losses in the "shiny objects" may now be accumulating. This could be a jolt to the Robinhood, David Portnoy, and speculative trading crowds.
- The China/U.S. Rift Is Widening. China will likely play hard ball in the face of a increasingly likely Trump loss. We can expect the President to retaliate - perhaps dramatically so.
- For a Host of Reasons Our Society is Fractured, Distrusting Partisan and Increasingly Tribal. An intensification of violence (from cities to suburbs) could shake confidence as social issues become more heated leading into the November election. So could the President's increasingly divisive rhetoric (yesterday he resuscitated birtherism charges against the Democratic VP nominee, Senator Kamala Harris), more Administration moves seeking to compromise the sanctity of the November elections, and other factors could contribute to growing and unstable social hostilities and instability.
- The Social Safety Net Is Beginning to Fade/Policy Mistakes Could (Re)Surface. As I predicted weeks ago, Federal unemployment benefits are getting extended but only a fraction of the $600. PPP is expiring in early August and is not being replaced or at a fraction of the previous level. The end result of both is less consumer spending and more challenged small businesses. Moreover, if Congress doesn't pass another fiscal stimulus or extension of some benefits it could get really ugly for many people and lead to more social upheaval (further shaking market confidence).
- Market Structure (Passive Investing) Remains a Significant Risk.The intoxicating advance since March could easily move into reverse (and morph from a romance into a horror movie) - confirming my observation that "buyers live higher" but "sellers live lower". Leveraged risk parity and low volatility are potential (though not yet kinetic) fuses.
- A Democratic Sweep Will Result in More Distributional Policies. Higher individual and corporate tax rates a possible wealth tax, and potential threats to the monopolistic positions of the tech market leaders could undermine growth and the markets.
- With A Plethora of Unusual and Intensifying Uncertainties (Many Discussed Above), There Are Numerous Knock On Problems That Could Reverberate in Our Economic and Markets Systems. Let's call this the "unknowable".
(This commentary originally appeared on Real Money Pro on August 14. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass's Daily Diary and columns from Paul Price, Bret Jensen and others.)