It's Christmas (Market Chaos), All Over, Again

I just had a moment thinking about today’s action in the market that inspired me to pen a small note tonight, ahead of tomorrow’s regularly scheduled programming.

The market sold off in sharp fashion today after the Federal Reserve did exactly what almost everybody on Wall Street thought they would do: cut by 25 basis points.

Interestingly, the “whisper scenario” that started to bubble up to the surface over the last few days was whether the Fed might even wait on cutting, despite more than 95% of the Street unanimously believing a rate cut was set for this month. The last-minute concern came from inflation and producer price index data that all but indicated inflation is under control. In fact, progress on inflation appears to have stalled, while at the same time, the economy continues to slow and the job market follows suit.

Today gave me an immediate flashback to the week before Christmas in December 2018. Those who have been reading my blog for a long time know that I have harped endlessly on the fact that market crashes don’t usually occur until the Fed actually starts cutting rates. From September:

This situation is not unlike the one we have with the stock market and the economy now. In addition to the American consumer being tapped out, I’ve pointed out multiple times that the stock market has a history of finally cracking and giving way after cuts begin. In essence, cuts finally happening could wind up being the biggest "sell the news" event in recent memory.

In countless posts here, I have used 2018 as an example. When the market started to drop precipitously at the end of 2018, just days before Christmas, the Fed sped up rate cuts and blew more air back into a bubble that would continue up until today.

Remember just a few months ago when I was making fun of Jeremy Siegel for requesting an emergency 75 basis point cut during the yen carry trade chaos?

Well, the market is more than 15% higher than those lows right now and, despite today’s “chaos,” is still just a couple of percent off its all-time highs. The market is going to return nearly 30% this year unless all hell really breaks loose in the next 12 days.

Today stood out because, over the last week, including in an interview with Chris DeMuth that I’ll be releasing in a couple hours, the idea of leverage has haunted me.

Perhaps it was Interactive Brokers founder Thomas Peterffy talking about the alarming amount of margin outstanding that he saw, or perhaps it was crypto’s recent skyrocket higher—as I pointed out in this piece just days ago—that alerted me to the idea of leverage. Day after day, I’ve watched Bitcoin skyrocket higher, fully aware that people are likely utilizing monster leverage to buy it. I’ve watched public companies sell stock to buy more Bitcoin. I’ve watched insane volume in the options market driving tech stocks higher and pushing the Shiller price-to-earnings ratio to almost 40x. As I discussed with Chris DeMuth, even equities now have leverage—with what feels like more 2X and 3X levered ETFs out there than there are underlying products for those ETFs to track.

Source: WSJ (and this was before the election, from August 2024)

The options market, levered ETFs, options on futures, and leverage on crypto are all tails that have been wagging the dog. As the market has moved higher, an entirely new generation of unsophisticated gambling addicts disguised as investors has pressed their bets all the way up. This includes every single person on social media who told you to “have fun staying poor” and every self-made millionaire you’ve seen posting on r/WallStreetBets as a result of buying options in tech stocks.

It’s these kinds of examples that make me ponder the question: Is it really different this time? But today, I’m remembering another lesson—that for every single time I’m exasperated at how euphoric things have become and mystified by the market’s resilience, there lies an even larger comeuppance and devastating lesson for those who get the market wrong.

Heading into the close today, we may have gotten a small taste of how much leverage the system has taken on. But whether or not we are even close to being fully liquidated remains to be seen (spoiler alert: hell no). One thing is for sure: we don’t have another rate cut planned to balance us out anytime soon, and Jerome Powell’s commentary today leaves the door open to a hawkish 2025. Of course, that won’t happen if the market seriously crashes before President Trump takes office.

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So once again, we are faced with the question: Is this simply another “BTFD” situation, just like every other plunge in markets has been for the last hundred years? Do we turn a blind eye to valuation and the economic reality here in the United States because the central bank won’t let markets crash for long? Or could it really be different this time, heading in the wrong direction for most market participants?

In some respects, I hope that I continue to be wrong with my prognostications about eventual disorder and chaos the likes of which we’ve never seen before. But the word leverage continues to haunt me - as does the idiom that unprecedented monetary policy, blowing an unprecedented bubble, will yield unprecedented results.

To close out 2024, we’re going to see how much it haunts the rest of the market.

Everybody is already ready to close the book on an extremely successful 25% or 30% year for markets. But as the old saying goes: “Stocks take the stairs up and the elevator down.” So if I were bullish, I’d be hoping and praying that today was just an aberration, because if it is the beginning of a bigger deleveraging or liquidity event, people’s historical recollection of 2024 may be starkly different than many have already written in the history books to close out the year.

There are 4 trading days until Christmas, and 9 trading days until 2025. Strap in.

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