Black Swans Are Circling

Basking in the glow of my 31% gain so far this year, I have to start wondering what could go wrong. Call me a pessimist, a paranoid, and worrywart, but whenever things got this good in the past, they were about to turn very bad. It is not my intention to ruin your day. But I may well do that if you read the rest of this piece.

Traders are piling on new longs with reckless abandon, gushing about the sweet spot for equities, Goldilocks, and how different it is this time. Retail flows into equity mutual funds have turned positive for the first time in years.

However, I am hearing a rising tide of negativity from the jungle telegraph. Don’t forget to sit down when the music stops playing. This is just a trade, not a new golden age. There are “black swans” circling out there everywhere, and the risk is that they alight upon us in great unexpected flocks, like a scene out of Alfred Hitchcock’s classic film, The Birds.

Let me give you a list of things that can still go wrong this year:

*The ten year Treasury bond spikes to 4% and money finally gets expensive. About one third of present day corporate earnings are coming from assorted forms of financial engineering, like share buy backs and refinancing’s, that disappear when money becomes dear. This is why you are getting profit growth against no top line growth.

*The sequester looks like a big nothing now, but could develop into something much more serious in six months when the federal funds in the pipeline dry up. Don’t forget the reverse multiplier effect.

*Falling disposable incomes created by this year’s tax hikes on earners over $450,000 haven’t yet translated into falling consumer spending. But it will, as it always does.

*A Middle East flare up causes crude to soar to $120 a barrel and gasoline rises to $5 a gallon, putting the brakes on an already low economic growth rate.

*Europe blows up again, sending the dollar through the roof. Better keep taking those Italian lessons to get a head start on the next “tape bomb.”

*Seeing stock prices soar and the jobless rate fall, Ben Bernanke ends QE3 early, paring it down to maybe QE 1 ½.

*China’s weakening data flow persists, and the country falls into a double dip recession. Weak commodity and precious metals prices tell us this has already started.

*High frequency traders and quants, starved for a big mean reversion, smell blood in the water and trigger another “flash crash.” Volatility goes through the roof. The short vol crowd in Chicago gets wiped out.

*Retail investors conclude they were right to stay away and bail on what they have remaining.

*A giant asteroid hits the earth and destroys all life as we know it, except for cockroaches and Twinkies.

And here is the scariest thing of all. All of these black swans could hit at the same time and reinforce each other, possibly around May or June. Could this be the fifth consecutive “sell in May and go away” year?

This conjures up the vision of a “ground hog year”, where 2013 is a carbon copy of 2012.  A strong first quarter is followed by two dead quarters, and then a strong year-end finish. This is what “lost decades” look like. Look at the 30 year chart of the (SPX) below and tell me this isn’t happening.

Of course, this is just one of many possible scenarios that could play out this year. As for me, I’m booking my chalet in Zermatt in the Swiss Alps now to beat out the rest of you.

SPX 3-12-13

The Birds, Crows

I Said Black Swans, Not Crows

matterhorn-Copy2-1

See You Later