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The new massive stimulus package has just pumped trillions into the economy, and now we’re passing through a moment of relative calm as the flood of printed money is functioning as a Band-Aid laid over our deep economic wounds. The stock market rally continues to push valuations even higher, but a number of investors, traders, and hedge-funds do not believe this crazy frenzy will be sustainable for much longer. Warnings of a stock bubble burst don’t stop coming up. But in face of a fresh liquidity injection, the market has entered a stage where stocks won’t cease to go up until the price bubble becomes so overblown and so fragile it inevitably explodes. Even though stocks have shown great resilience in face of all the devastating events happening all across the globe, over the past few days, we do not see much volume in the market, and this is something that traders are closely watching because when stocks start moving higher on a lower volume this is a warning sign for a stock market crash.
We have to consider the economy didn’t come back to life due to economic growth. The Fed defibrillated our collapsing economy with monumental piles of dollars created out of thin air. The stock market isn’t recording record-highs for almost a year by itself either. The Fed’s near-zero interest rates and “assurances” to make stocks more appealing at the expense of safer bonds is what has been supporting the current rally. That’s why most hedge funds, and, most notably, David Einhorn’s Greenlight believe the market might be on its way for a reckoning, as this “engineered” recovery will come at a price.
As there’s a record pile of money sitting on the sidelines and a large part of that pile is expected to flow into the economy after the sanitary outbreak is over. Additionally, a historical infrastructure bill is being drafted by the current administration office to allegedly rebuild “crumbled” America. Biden’s new plan is to spend $2.25 trillion. But to avoid falling into a deeper debt hole, Biden’s master plan is to fund his spending bill by increasing taxes for big corporations. According to a UBS study based on their quant models, equity analysts made a list of S&P 500 stocks that were the most exposed to the prospect of a stock bubble burst, and it includes big tech names that are now at the very top of the stock market, such as America’s gaming giant Activision Blizzard, Apple, and Facebook, as well as Starbucks and Chipotle.
Thus, while this staggering spending spree would sound great for stocks, companies would likely pay for it with higher taxes and higher interest rates. Elevated rates, in turn, make stocks look less attractive for investors since they become riskier assets. And faced with the prospect of widespread losses, only the unprepared or the blind will hold on to volatile stocks. And a speedy sell-off never failed to trigger a stock market crash or, at the very least, a significant price correction.
Signs of rising inflation and higher interest rates are already sparking chaos on Wall Street. But the Fed keeps arguing the economy can handle it. David Einhorn doesn’t think so. In a recent note to clients he wrote: “The Fed has indicated that it believes any abnormally high inflation will be transitory. We wonder, how will the Fed know? Do price increases come with a label that says ‘transitory’?,” he asked.
A shift in investors’ sentiment has already started. Now, according to the results from the latest E*Trade survey, an increasing majority of investors believe the stock market is in a bubble. As Einhorn’s Greenlight, most hedge funds are aware that the current bull run isn’t backed by real economic prospects, and once stimulus support is withdrawn, we are likely to see the market rally rapidly fading. If hedge funds begin to join investors’ sentiment shift and start walking away from risky stocks, we are likely to see the U.S. stock market plunge, as their absence leaves the door open for a significant correction or a stock market crash.
In a time when retail traders have been boosting a dozen stocks of bankrupt companies and Wall Street is registering a boom in penny stocks, it is evident the market is unbalanced and valuations are completely unrealistic. That’s why Einhorn concluded his letter highlighting that “from a traditional perspective, the market is fractured and possibly in the process of breaking completely”. A crash is just a matter of time. With a market crumbling from within and without real support, there’s only so much the Fed’s printed money can do to avoid everything from blowing up in the air. You can’t say you haven’t been warned.”