A U.S. Stock Market Crash is a Real Possibility

JC Parets
October 18, 2018

A US stock market crash is a real possibility. 

We have not been in an environment where this was on the table for a long time. 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 to not 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) to 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 melt down 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 2 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 permabull 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. (See: No, I Don't Think This Is The End Of The World)

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 the potential gains that compound later on that you’re missing. It’s 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. 401k’s will be slashed, firms will go under, people will lose jobs. I don’t want any of these things to happen.

But what can I do anything to prevent it? I remember asking myself the same question in 2008. I remember Madison Avenue the day Bear Stearns got bought by JP Morgan for $2. It was complete mayhem. People walking out with boxes of their stuff, Bloomberg and CNBC trucks and satellites everywhere. It was st Patrick’s day. People drunk on the streets. Giant Irish guys with bagpipes walking around. It was the best day of my career to that point. Over the prior month I had built the biggest short position of my life.

What could I have done at that point other than short these banks? I was actually really long $SKF which was the double short ETF at the time. Young lads, this was before the triples. The struggle was real back then.

So what can I do about the implications of me possibly being right? I’m thinking that like in 2008, I can try to profit from it, to help me and my family, and I can help others along the way who follow my work so they can profit from it as well. That will be good for their families, and their clients’ families and we go on from there.

We can then take some of our profits and help others with it. I was just at Traders4acause in Las Vegas this weekend, for example. We’re raising money for some amazing causes. That’s how I see it. But to ignore it just because I may not like the outcome of being correct is just stupid.

So yes. I do hope we crash. We get it over with quick and we move on. A grind sideways for a while is annoying. I like buying cheap premium and riding uptrends. Selling upper ends of ranges and buying lower ends is more difficult in my opinion. Either way, I firmly believe that these are the cards we’ve been dealt. 

I like heavy cash positions and selling into strength.

JC

 

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