Be Wary. Is This Market Going To Crack?

SPY data by YCharts

Totally hard to time a market. I know people that have lost a lot of money trying to short bonds because of the US Federal Reserve action. I also know a lot of people that have burned a lot of cash trying to short Japanese debt.

Startup valuations are going to be affected if the market decides to lose it’s froth.  If I were a startup today, I’d be figuring out how to integrate revenue into my model.  I’d also be thinking really hard about organizing a bridge round of financing, or opening up a round to get some money in the door for what could be a choppy sea.  Revenue is always the best choice of the two.

One day last week, I was judging an entrepreneurial pitch at a University of Chicago class.  The pitches were very good and polished.  I asked one of the teams, “How would your business perform in a bear market?”  Older people like me clearly remember 2007, 2008, 2009 and also remember the 1998-2000 market, and the monster one day crash in 1987.  The generation that is graduating from college today doesn’t remember the earlier markets, and they were in middle or high school for the last debacle.  In many cases it doesn’t register.  Trading since 2009 was just press the blue button and buy.

The recent action of huge ups, and huge downs gives me a little pause. Markets often change direction when price action is like that.  On the other hand, it could be a consolidating move where the market will step up higher.

Last fall I was contemplating when the bull market might crack.  I thought May.  I didn’t have any data to support my thought.  Only my gut.  I didn’t foresee oil dropping like it did, or some of the other international events that have happened.  It just sort of felt like it was time.

One other thing that is different this time is virtually every market that is traded is entirely electronic.  In 2008, there were still some humans manning some of the control mechanisms.  Not anymore. Liquidity is much thinner, despite higher volumes.   If you want to execute a big order or move a number, there is a lot of slippage.  The lean hog ($HE_F) contract at $CME was down 24% in a week.  Oil ($CL_F) had a big move and huge daily, weekly, monthly percentage drops.

Markets today don’t trade on the fundamentals of price and quantity.  Supply and demand signals are messed up.  The most important metric in markets today is time.  Central bank actions have altered traditional risk/reward metrics.  The cost of capital should be more expensive.  These breaks are not buffered, and they don’t feel really orderly to me.

Are we seeing the beginning of the crack?  It sure feels like it.  It’s not going to be Armageddon, but breaks always hurt.