Reuters / Kai Pfaffenbach
- A high-ranking Wall Street stock strategist breaks down a plausible chain of events that could send the US stock market quickly tumbling.
- Christopher Wood, head of global equity strategy at Jefferies, is specifically worried about escalating tensions in the Persian Gulf, what that would mean for oil prices, and how that would impact the overall equity market.
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The stock market got everything it asked for last week.
After climbing in anticipation of a rate cut from the Federal Reserve, investors were all but assured by Jerome Powell & Co. on Thursday that they’d get their wish at July’s meeting. That send equities rocketing even higher, and they closed at a record before hitting another intraday high on Friday.
But Christopher Wood, head of global equity strategy at Jefferies, isn’t counting his lucky stars quite yet. In fact, the author of a long-running and widely-read report called "Greed & Fear" is eyeing the all-time high with a great deal of skepticism.
"Greed & Fear does not trust the US stock market at this level," he wrote in a recent client note. "Nor should investors."
It’s not that Wood doesn’t understand why equities are currently at their highest-ever levels. It’s that he sees an entirely plausible scenario where it all comes crashing down.
At the center of this bearish outcome is the price of oil, something that isn’t usually talked about as an equity-market headwind until it’s severely out of whack. Wood says it could quickly emerge as a threat to stocks if prices spike on continued tensions in the Persian Gulf.
Built around a surge above the $100 level, Wood’s supposed forecast is aggressive. He knows that, and he still wants to sound the alarm on the possibility.
"This has every chance of happening, with the Donald still pursuing his incendiary policy trying to impose a ban on Iranian oil exports," he said.
In Wood’s scenario, investors will see $100-plus oil as inflationary, which would send Treasury bond prices down and their yields up. That’s when the real fun begins.
"If that happens in any violent way it will blow up the ‘risk parity’ model and the machines which trade around that model," he said.
The model he’s referring to is one employed by quants and focused on the allocation of risk. Decisions — usually automated and powered by machines — are made in terms of volatility, rather than allocation of capital.
In this specific case, the higher yields caused by spiking oil would prompt a sharp de-risking. That means the quick selling of large swaths of stocks. This is a particularly palpable risk when stocks and bonds are highly correlated. And guess what? They have been for months. In Wood’s mind, this threatens the very nature of risk parity.
Further, since it’s an investing practice normally conducted by emotionless and price-insensitive computer models, the pain could be simultaneously mechanical and unforgiving.
To be sure, this is not Wood’s base case. But the fact that the possibility even being discussed by a high-ranking equity strategist should be cause for concern. And for that reason, investors would be best advised to tread with caution.
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