'When the S&P folds in half, everybody gets hit': A veteran market bear cites 4 reasons why stocks are at risk of a broad-based crash – including the possible implosion of high-growth names like Tesla
- Markets are due an "extraordinary reassessment," which could prompt a stock market crash, according to short-seller Rob Majteles.
- Frenzied markets don't represent the reality of the current situation, he says.
- Majteles highlights the four key catalysts that could cause the crash.
- Visit Business Insider's homepage for more stories.
The stock market correction will be enormous as investors start to see the reality of the crisis at hand, according to Rob Majteles, a short-seller and founder of Treehouse capital.
Citing Ben Hunt's theory of markets as a 'political utility', Majteles argues that they simply don't express views on risk reward or the state of things.
"I have no doubt whatsoever, if equity markets in particular, reflected the agony on the ground, we would have dealt not just with, you know, better and broader relief and stimulus packages, we probably would have tackled the pandemic more seriously," Majteles said.
But he believes even the current frenzied markets will need to see reality and that "eventually there will be an extraordinary re-assessment – there always is."
He added: "I'm not unique in pointing to the enormous array of frenzy behaviour – they're obvious to all of us, [and] they cannot sustain themselves."
Majteles is bearish across markets, joking that he might be the only person left with puts on the S&P. He also argues that a correction will not be isolated to singular companies, but rather a broad-based crash.
However, Majteles isn't alone in thinking a crash is on its way.
Mark Yusko, a Morgan Creek hedge fund manager, argues that the market's valuation has gotten too far above fair value and been there for too long. This means it is therefore unequivocally due for a meaningful pullback, he told Business Insider in a December 17 interview.
To play a crash, you need to know where it is coming from. Business Insider asked Majteles to highlight the most possible catalysts for his forecast crash, here are the four he picked, and the reasons why:
Debt implosion in China
Chinese markets have been one of the shining success stories of 2020, driven by the growth-heavy gains in the equities markets, but also the attractive yield offerings in Chinese bonds.
But, Majteles argues that investors may have become complacent in their admiration for the region, saying that it has become an "overwhelming concern."
"Everybody's gotten used to the idea that there is no financial crisis possible in China because somehow the central government can always find a way to suppress it, bury it, or handle it with no ramifications for markets anywhere else," he said.
As the Chinese markets have slowly opened up to foreign investment, their stability has become "integral" to global flow and it was "naive" to think otherwise, he said.
Despite the higher yields on offer, the market is full of corporate and local authority debt – much of it bad. In the first quarter of 2020, Chinese banks climbed despite lenders deferred a combined 1.5 trillion yuan ($212 billion) in loans after the country went into lockdowns caused by coronavirus.
The Chinese government has continued to bail out those affected, suppressing yields. For some investors, however, this is merely a ticking time bomb.
Growth stocks have been at the heart of the rally within the US equities market, with the FAANG stocks and so-called 'stay-at-home' making historic gains as investors piled into defensive stocks.
Archetypal companies like electric vehicle producer Tesla and video-conferencing software Zoom have surged during the crisis, rising 672.09% and 464.2% respectively so far this year.
But it could be these companies, which have ridden so hard this year, that pose a risk to global markets.
"I think you would see one or more notable companies implode somehow," Majteles said, using Tesla as an example. "Tesla has been a bellwether for a lot of confidence around a lot of topics. If its accounting and financials continue to raise the questions they raise, there is a moment in time where that could catalyze certain reactions," he explained.
Many investors have rotated into value stocks to take advantage of economic recovery, but also to avoid any major corrections in growth valuations.
Some investors are looking warily at US company valuations, and if one or several heavily-weighted S&P members take a hit, it's bad for everyone and could possible trigger a large scale sell-off. "When the S&P folds in half, everybody gets hit," Majteles said.
Commercial and real estate mortgages
Mortgages were the catalyst for the 08-09 global financial crisis, as bad debt crippled global markets. But, Majteles argues that the market continues to "embed enormous, enormous debt risks," he said.
Of course, several reforms across the banking sector have taken place since then that protect those using banking services, notably, the introduction of negative interest rate and zero interest rate policies (NIRP/ZIRP) and better cash buffers.
However, with low rates, and therefore borrowing costs, lending has become both easier, cheaper, and more attractive. With more world economies taking a hit during the coronavirus, this makes the possibility of defaults ever more likely, jeopardizing global markets.
As of Q319, the total amount of US mortgage debt outstanding was $15.84 trillion, according to data from the St. Louis Federal Reserve. To put that in context, that is equivalent to around 75% of the entire US economy.
"You'd have to see notable firms go upside down – as they did in March – on their leverage," Majteles noted, arguing that investors and firms simply expect the Fed to step in and save them.
"So what's the big deal? Do it again," he joked.
Throughout the coronavirus crisis, governments around the world have had to take out unprecedented levels of leverage to finance public monetary policy.
The level of US government debt stands at "staggering" levels, he said, totalling $27 trillion in October 2020, compared with the country's GDP at $20.54 trillion.
With so much leverage, central banks have had to increasingly step in as buyers, ultimately keeping rates depressed.
"The Fed is becoming the buyer of choice of the US government debt, at some level even that amount of buying becomes problematic," Majteles said. He added that a bad auction or buyer strike could be hugely consequential, acting as a catalyst.
The US is running large budget and trade deficits and needs flows from Treasury purchases to help fund those. A drop-off in demand might seriously undermine investor confidence in US government debt and, by extension, the economy, which could trigger a wider markets sell-off.
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