The Coming Market Crash
In late 2015 and early 2016, the S&P 500 crashed twice due to tightening liquidity
I am releasing this publication during the Q4 2021 earning season. There is a lot of noise and discussion about company results. However, one of the most important things to do as an investor is be proactive, not reactive, and be forward thinking. Markets as a whole are historically reactive, meaning emotions play a heavy role and tend to exacerbate moves. The goal is to have a plan and be aware of the three sides of each coin: the heads, the tails, and the in between (side). We are going to look forward at the impending, very large threat that looms ahead of us. Controlling your emotions will be crucial.
This may be one of the most important publications I will write in the back half of 2021. I can almost guarantee that investors and traders alike will benefit from the information presented here today. I am going to talk about the upcoming market crash/correction and two different hedging strategies BluSuit uses.
The best investors and traders know how to make money regardless if the market goes up or down. They know how to handle their emotions, think proactively and adjust their expectations.
Here is what you can expect from this publication:
We’ll look back on history and see how ending quantitive easing in 2014/2015 impacted the markets and the strong correlation between the Fed’s balance sheet and the S&P in 2020/2021.
We’ll talk about two different hedging strategies to ensure wealth preservation
Note: Half of this will be complimentary, talking about the correlation between QE and the financial markets. The second half, talking about shorting/hedging strategies, will be members only.
For the second half of 2021, I have released a few publications talking about how important the Fed’s balance sheet expanding is to maintain stable stock prices. Historically, this has been time tested and proven where there is a direct correlation between quantitative easing (Fed buying U.S. treasuries, or U.S. government debt) and a rallying stock market. This is best represented by going on the Fred Website.
The blue line represents the Fed’s balance sheet. It increases when they do QE (quantitative easing) and decrease when they do quantitative tightening (let their balance sheet decline). The first thing you can notice is that there’s a direct correlation with the S&P and the Fed’s balance sheet.
First, I’d like to direct your attention to 2014 and we’ll talk about how this historically played out. In late 2013, tapering was announced where it created a mild pull back in the indices but markets continued to go up. It wasn’t until QE ended in 2014 that we began to see the S&P trade sidewise in relation to the Fed’s balance sheet. During this time, stocks essentially went no where and traded down until November of 2016.
In November (2016) stocks began to rally with the promise of corporate tax breaks, which enhanced business and earnings growth acting as a different form of stimulus. This created a near 2 year rally in stocks until early 2018 when quantitative tightening was announced. This is represented in the sharp downturn in stocks at the beginning of 2018.
In the back half of 2018, in the name of China trade war, the Fed began shrinking its balance sheet and hiking rates, we saw a steep sell off. Many investors were confused why such bearish behavior took place in the broader markets but it had a lot to do with contracting liquidity in the system and a rising federal funds rate (interest rates). It wasn’t till the Fed backpedalled at the FOMC in December that we saw a reversal in stock prices. They announced they would hike taxes only twice rather than the scheduled three times, bringing a more dovish tone. They didn’t raise rates at all in 2019.
In late 2019, they announced a balance sheet expansion (but insisted it wasn’t QE, lol ok) where we began to see stock prices rise rapidly again. This was obviously met with the Corona Virus lockdowns in early 2020 where the stock market saw is steepest and most violent crash in history. In response, the Fed quickly expanded its balance sheet and the Federal Government passed trillions of dollars of government stimulus. With the liquidity tsunami, we have witnessed a historic rally in stocks. Since the beginning of 2021, the Fed’s balance sheet and the S&P have moved hand in hand. It’s near impossible to ignore how correlated they are.
The story tells us a lot but what conclusion can we draw here?
This means the stock market has reached a point of centralization (unlike ever before) and the Fed can heavily influence stock prices. In November of 2021, the Fed announced that they will reduce asset purchases by $15B in November and December. The idea is that they will readjust their stance by January 2022 if economic data (inflation) gives indication otherwise. Essentially, this is saying J-Pow is not going to be as quick as they were in 2015 and in 2018 to tapering/rate hikes. They don’t want the market to decline like it has before.
As investors and traders, this begets the biggest question. How should we respond and how should we prepare to preserve/protect our wealth? This is exactly where we get into a few different strategies:
We can long value stocks, which historically perform well during market volatility but still decline
We can go cash heavy, or
We can leverage a few different shorting/hedging strategies to make money during a market decline
Do I know markets will crash? No, nobody does. Nobody knows precisely when either. For example; Michael J Burry was 2 years early on the 2008 housing crash. However, I do know the market will crash eventually and having the following tools in your tool belt will bring confidence and a little extra profits to buy a bottom.
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