There’s a cute statistic going around that in the second half of years ending in 7, the equity markets have had poor returns: 1987 (Black Monday), 1997 (Asian Crisis), and the 2007 (Financial Crisis). Whaddaya know? 2017 also ends in a “7.” And we just happen to be in the second half of the year.
There are a few candidates for catalysts: any of several possible Trumpidity Crises, a North Korean Crisis, an auto subprime Crisis, the brick and mortar collapse crisis, the divided nation Crisis, the Gulf of Mexico Swallowed My Glasses Crisis… the list of possibilities are long. This is also compounded by the fact that many people think the equity markets are overvalued. I estimate that 75+% of the “experts” out there think equities are overvalued. So it seems like all pieces of an equity crash are coming together in the fall of 2017. Last week there were some rumored portfolio rotations from equities in to fixed income, which fits in with this narrative.
I suppose you can’t beat the “solid” math behind 3 for 3. The random walk hypothesis would imply that this logic is like saying, “the number 8 appeared in the winning Powerball numbers the last three times. Therefore, an 8 is likely to win again. Okay, I suppose those past crises were fairly large events. And they all happened to have occurred in years ending around “7.” But sample size of three… mmm.
My general take is, if everyone is expecting it, it’s unlikely to happen. Obviously, it’s possible. We’ve had those Fed ease protection calls in anticipation of an “event” in the fall. Those long Oct and Nov ease calls we got for “zero” look pretty amazing right about now. But it’s more to own the tail. I’m not sure anything happens.
Back in the old days, when the opinions of large funds mattered, they could move the markets enough on their own to cause an extreme move. In the current environment, a large fund would find itself against a bunch of algos (that probably find cross-market value – so the fund would be in effect fighting not just the US markets, but the global markets), a bunch of ETFs (that are always auto-buying), a bunch of vol strategies that probably result in mean-reversion, and a bunch of central banks and pension funds that have nothing better to do than to buy. Good luck trying to move that market, buddy.
I like looking at both sides of a trade. So if a lot of people are thinking that equities crash and therefore sell, what could happen? The efficient market hypothesis would then suggest that by October, we will either have:
- a small chance of a MASSIVE decline. You just need to catch some algo off-guard to cause an air-pocket(s), and/or hit some technical level(s) everyone wants to jump on. Millenials love shorting the VIX, after all. And some kind of large catalyst helps. Or…
- a large chance of a smaller short squeeze. Smaller, relative to the massive equity crash potential, but still substantial. Pretty much what you would expect, when you are on a consensus trade, and it doesn’t pan out. Then you find out you are now behind your benchmark for the month and you are in a mad scramble to cover.
I have no idea which scenario will pan out. However, I do think we need some ease calls for Scenario 1, and have some deferred hikes (especially on this flat curve) for Scenario 2. Will the “sell equities – buy fixed income popular trade” persist going forward until October? It’s a long time between now and October. I think the market reaction to the data next week could shed some light.