What Could Go Wrong?

It’s been up, up and away for the stock market.

Savvy investors are worrying, but they have been worrying for the last few thousand Dow points.

John Crudele again sounds the tocsin:

So let’s see: Bubble-like; the highest inflow of cash into stocks since 2000; companies without earnings or even revenues valued in the billions; and, my gawd, CNBC finally trying to be honest!

Let me translate all of this into plain English for you: A lot of people are worried that stocks are headed for another crash.

And I’m one of them.

He is not just talking about a garden-variety correction. Crudele anticipates a crash for the ages:

You think the market declines in 2007 and 2008 were bad? The next big decline in the stock market is going to legendary — and gruesome.

Of course, neither he nor anyone else really knows when this is going to happen. No one knows whether the Dow will hit 25,000 before it crashes or whether it will crash next week.

For now, investors are riding the wave of Fed liquidity, fully confident that the Fed has it all under control.

Fewer and fewer people still believe in the Federal government, but the investor class believes, as an article of faith, in the Federal Reserve.

People keep buying stocks because they believe that nothing could possibly go wrong. With such sentiment running rampant Crudele is right to ask what could go wrong. He is looking for the next black swan event.

Right now everyone fears the dreaded taper, the moment when the Fed decides to cut back on its bond buying. But, as long as investors are confident that the Fed cannot do so, the party will continue:

The most obvious danger for stocks is the Federal Reserve. On Wednesday, Ben Bernanke’s Fed kept its market-rigging $85 billion-a-month bond-buying program unchanged because the economy isn’t quite right yet.

I’m hardly the only one who thinks this Fed program, which goes by the innocent name Quantitative Easing (QE), is the devil itself. But devil or not, it’s the one thing keeping stocks in heady territory.

The Fed’s policy-making Open Market Committee said on Wednesday the economy just wasn’t strong enough for it to stop rigging the bond market, which is being done to keep interest rates unnaturally low.

Those low rates, in turn, are sending investors scurrying to stocks despite the fact that corporate earnings are rising only moderately.

What could go wrong? Glad you asked. Crudele offers his own speculation. What if, he says, the Fed loses control of long term interest rates?

Crudele writes:

Rates on government securities are up substantially over the past five months, even though they have recently backed off from recent highs. But if the market defies the Fed again and takes interest rates back up, all bets on QE are off.

I have no inside knowledge on the thinking of the Chinese, who hold the largest amount of US debt. But that country can’t be happy with what the Fed has done to its American investments.

We don’t know whether the trigger will be pulled in Beijing. But, if you are thinking of what could ruin investors’ rosy scenario, the Fed's losing control of the bond market would certainly be high on the list.