Famed market watcher who called out subprime mortgage crisis warns stocks will plummet: ‘It’s highest probability since COVID’

In 2005, years before the subprime mortgage crisis triggered the Great Recession and left millions of Americans homeless, Larry McDonald was vice president of the notorious, now-defunct global financial services firm Lehman Brothers. As a young trader, he, along with many of his peers, warned that something was amiss in the real estate market that year. It was “living on borrowed time,” he explained years later in a 2009 year New York Times Articleand Lehman Brothers “headed straight for the biggest subprime iceberg ever seen.”

But McDonald’s bosses ignored his warnings, and the 158-year-old Lehman institution finally went under in 2008 after the housing bubble burst. The S&P 500 would lose about 50% of its value in the 17-month bear market that ended in March 2009.

Now McDonald, the publisher and founder of the widely read investment newsletter The Bear Traps Report, is warning of another stock market crash. He says the “Lehman systemic risk indicators” he developed in the wake of the subprime mortgage crisis, which include things like corporate default rates, short interest rates in stock markets and investor sentiment surveys, are all red flags.

“[O]Our 21 systemic risk indicators from Lehman point to the highest probability of a crash or sharp decline over the next 60 days — the highest probability since COVID,” he said said CNBC Tuesday referring to the COVID-induced market slump in March 2020.

McDonald believes investors are ignoring the risk of a “rolling credit crunch” following the failure of Silicon Valley Bank And signature bank and the unexpected demise of Swiss lender Credit Suisse and an over-focus on the rise of new technologies like artificial intelligence and robotics.

“We’ve seen this before at Lehman, what’s happening is a shock, credit markets Start pricing risk, but stocks don’t. They’re focused on things like AI or things like the dot-com revolution in the ’90s,” he warned, citing the mistakes investors made before the dot-com bubble burst sent stocks plummeting in 2001.

McDonald noted that even after the Federal Deposit Insurance Corporation (FDIC) stepped in this month to bail out both uninsured and insured depositors at SVB and Signature Bank, US banks are still holding hundreds of billions of dollars unrealized losses. Mortgage-backed securities and US Treasuries, which make up a large part of many banks’ holdings, have taken a significant hit following a series of aggressive Federal Reserve rate hikes over the past year. These losses have created significant instability for some banks, forcing many of their peers to tighten lending standards and prepare for potential bank runs.

McDonald said the banks’ problems are now spreading to the commercial real estate market due to the slowdown in lending, and he fears they could infect other sectors of the economy as the Fed hikes rates to fight inflation.

The good news is that this is “not a Lehman event” that will cause a devastating recession, “it’s just a rolling, slow-moving credit crunch because the Fed is fighting it behind the scenes,” McDonald said. But that doesn’t mean shares are safe — a sharp drop is imminent, he warned.

This story was originally featured on Fortune.com

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Source : finance.yahoo.com

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