I’ve read most of the well-known books about stock picking/trading/investing. The one I find myself going back to more than any other is Marty Zweig’s Winning on Wall Street.

My favorite part of the book is the introduction, in which Zweig recounts how he famously predicted the 1987 stock market crash. I think the information presented in those few pages is a timeless reminder of how the largest crashes in recent history have occurred and how similar conditions appear in the lead-ups. One particular part I always come back to when things seem extra frothy is the following:

What bothered me were the similarites to 1929, 1946, and 1962. The familiar pattern was gross overvaluation in P/E's and yields along with straight-up price movement which lacked a major correction for years and which had produced doubles or a lot more in the Dow. When these conditions had existed, I found that, late in bull markets, there was a major rally lasting several months which evolved out of a minor correction (the one which started in the fall of 1986 at 1755), another minor correction (spring of 1987 from 2404 to 2216), then a narrow smaller blowoff rally to the final high lasting 2-3 months (which peaked this time in August at 2722).

Those earlier markets then began what looked like "normal" corrections, but which soon cascaded into breaks. The key, and what upset me in September, was that as the smaller correction unfurled, the sentiment on Wall Street was "buy 'em."

I think that last part is particularly informative because indeed it has been my experience that the worst selloffs come as wolves in sheep’s clothing. Bull markets work people over time into an attitude of overconfidence, complacency, and the expectation that if anything at all were to sink the market, it would have to be something REALLY big like a terrorist attack or the Fed hiking rates 4% without warning.

This is folly. History shows us that in old bull markets when things really get extended, it takes very little to upset the market. The trouble for the bulls is that they have now formed a world view that people selling on such a small news item (Roger Babson in 1929, Kennedy’s comments regarding the steel industry in 1962, or the Fed hiking a single time in 1987) must be ill-informed and that they will be happy to take the idiot bears’ shares off their hands at such a bargain price. In these circumstances, stock prices no longer have any relation to fundamentals, they are just traded on a basis relative to prior highs. Amazon at anything under $3000 must be a bargain.

While reading the previous quote from Marty Zweig last week and observing the price action in the market over the past couple of weeks I have a strong suspicion that we are at the doorstep of a crash. In Zweig’s account, he cites the Dow. Everyone has their own opinions of the indices and their relevance. Mine is that the Dow was the index that mattered in a prior time. But in the past ten years or so, the Nasdaq has replaced it as the major indicator of the market’s strength. You can also use the S&P if you like (as most do), as it’s market cap weighting allocates most of its weighting to the same few primary constituents that carry most of the NASDAQ, hence the very close correlation in these over the past few years.

If you look at a chart of the past year, you can see that the crash of February/March of 2020 looks a lot more like a correction in the rear view, albeit a major one. Then in September through October we got another, smaller correction. After the election in November, the market began rallying violently with the small caps and average stocks carrying the slack that the mega cap tech names gave up after the September correction. Given the extreme exuberance among the Bitcoin, Tesla, growth stock and SPAC crowd, I have a feeling we are in this last, narrow 2-3 month blow-off rally Zweig referred to in his analysis.

In the summer of 1929, right before the markets made their final top, many stocks doubled in a period of just a few months after having experienced a small correction in March. $TSLA, $MSTR, $BTC, $ROKU, $PTON, $IPOC (or $IPOE or $IPOF or all of them) have doubled or more since the middle of November (less than two months)!

I believe the time is drawing near for a major crash that will likely hit tech stocks the hardest but won’t spare any sector. I also believe Bitcoin will crash if this happens, as has happened in every major correction we’ve had in the past few years.

One final point. A normal question to raise at this take would be “but what about stimulus and the Fed?” Those are obviously bullish factors, but only to a point. At some point equities become too stretched and positioning too aggressive. This is when markets are at their weakest, and to reiterate the earlier point, it takes very little to unseat the market. Once markets begin a downtrend at these levels, they can become panicky very quickly, in a reverse feedback loop.

We all know about stimulus. We all know about the Fed. And we are all trying to take each other’s money in the market. So at some point you have to part company with the common narrative that everything is bullish. I believe we’re at a point where pretty much anything could cause an initial break. One recent potential factor is interest rates which have started moving up recently and just crossed 1% yesterday. Interestingly, I heard Kevin O’Leary say just today on CNBC that it would require rates above 3% to impact equities. In the same introduction from Winning on Wall Street that I cited at the beginning of this post, Zweig wrote that leading up the the 1987 crash most were insistent that the Fed would have to hike rates at least three times for the market to take note. The first and only hike happened in August of 1987.

As I’ve written in my past couple of entries, what I’m looking for is a downward trend to begin on a seemingly innocuous catalyst. Nobody can say what this will be. But the tell-tale sign will be the bulls completely writing off the catalyst as a nothingburger while the market continues down. There will be rallies along the way to assuage the bulls’ concerns and allow them to get trapped further. I believe this setup will be an unbelievably favorable risk reward for near dated out of the money puts on most anything. In my prior post I talked about Intel and IBM which I still think would be great put plays due to their low IV. However I am becoming more and more enamored with the idea of ARKK, as that is as clear a bubble as I have seen in some time.

I’m sure I will have more to say on this over the next few weeks.