The Great Disconnect: Gambling Mentality Has Greatly Mispriced Stock Market Risk

By the Curmudgeon with Victor Sperandeo

Introduction:

A multi-year U.S. equity bear market is long overdue. As we’ve noted in several previous Curmudgeon/Sperandeo posts (like this one), the last true bear market ended in March 2009.

Since the 2008-2009 financial crisis, U.S. stocks have enjoyed a 17-year winning streak, largely due to extremely accommodating monetary policy (ZIRP, QE, etc.) and tech-driven trading ease. It’s effectively turned stock and options trading into a video game, prediction markets into event casinos, and zero-dated options into lottery tickets for asymmetric payoffs.

Computer trading algorithms, fattened on post-2009 historical anomalies, have been programmed to buy every dip – including last April’s “Liberation Day” steep decline and the selloff in March due to the war in Iran which has resulted in a V-shaped recovery (see Victor’s Perspective below).

"Laissez les bons temps rouler" (let the good times roll) now trumps Buffett's "Be fearful when others are greedy," especially for younger investors weaned on perpetual bounces. If the past 20 years have rendered fear irrelevant, could risk be mispriced?

Rampant gambling fever amplifies blind spots: record leveraged ETF filings for 4-to-5x daily returns (despite SEC doubts); 24/7 bitcoin 5-to-15-minute prediction bets, margin debt at all-time highs- both in absolute terms and as a percentage of GDP (see chart below).

Margin debt is a 2-edge sword -- propelling stocks higher during uptrends, but accelerating and deepening declines during stock market selloffs. When equity in a long position drops below a pre-determined level (FINRA Rule 4210: requires a minimum maintenance margin of 25% of the market value of securities), margin calls result in brokerage firm forced selling of long positions. Forced liquidation continues until the margin requirement is met. This tends to have a cascading affect – resulting in more selling - when margin debt is sky high. Large-scale liquidations create intense selling pressure, which drives stock prices down further. Expect that to happen when “buying the dip” doesn’t work anymore.

Jason Zweig wrote in Saturday’s Wall Street Journal:

“The war in Iran is a seething stalemate, the price of oil is up about 60% this year, inflation jumped to 3.3% in March—and still U.S. stocks set all-time highs this week.

A kind of gambling fever seems to be setting in. In February and March, asset managers filed to launch dozens of exchange-traded funds that would seek to quadruple or even quintuple the daily returns on stocks and other assets, even though regulators have reportedly indicated they might not be approved. On prediction markets, you can bet whether the price of bitcoin will go up or down in the next five to 15 minutes—24 hours a day.”

Curmudgeon’s History Lessons:

The last few years of stock market euphoria easily exceed the party like trading atmosphere prevalent in 1999 – the year before the dot com bubble burst! Most investors/traders either weren’t around then or have forgotten that the NASDAQ Composite declined by approximately 78% from its peak on March 10, 2000, to its closing low on October 9, 2002. The index fell from 5,132.52 to 1,114.11 during this period, marking the climax of the bursting of the dot-com bubble. Although the market hit its lowest point in October 2002, the downturn lasted until early 2003 before starting a sustained recovery. It took 15 years (until 2015) for the NASDAQ to fully recover back to that all-time high!

Let’s not forget about the huge 2007-09 S&P 500 drawdown during the “great financial crisis.” On October 9, 2007, the S&P 500 closed at an all-time high of ~1,565. On March 9, 2009, the S&P 500 bottomed at ~676, representing a 55%–57% decline. It took over four years from the March 2009 bottom before the index established a new record high in April 2013.

A survey of hundreds of Barclays online brokerage clients during the financial crisis found that their willingness to take risks shriveled as the stock market crashed. The opposite is the case today. Research conducted by economists Gene Amromin and Steven Sharpe show that during periods of rising stock prices, investors expect higher returns at lower risk.

Data Points:

· Investor reactions often seem incongruous with reality. After diplomatic negotiations between America and Iran collapsed in Islamabad, investors shrugged it off. They remain unbothered by President Donald Trump’s decision to use the U.S. Navy to blockade the Strait of Hormuz, by oil trading above $100 a barrel, or by Iran threatening to attack ships and ports.

· Geopolitical under-reaction screams complacency – markets are celebrating the end of the Iran war, yet the IRGC has closed the Strait of Hormuz and fired on any ships attempting to cross it.

· Trump's social media fueled drama: Bomb Iran to Stone Age, Wipe out Iran’s civilization, Pope-Jesus memes, etc. All generate cinematic noise, numbing markets as his Truth Social snippets supplant analysis and clear thinking.

· As a result, people are stuck in heightened emotional states that block the slow, calm thought needed to contemplate difficult issues.

· BofA suggests "de-escalation trades"; JP Morgan and Morgan Stanley screamed "buy the dip" last week.

Victor’s Perspective of the Rally:

This current steep rally in the NASDAQ 100 and S&P 500 is somewhat unique in the history of U.S. equity markets. The upward slope of the advance from March 30^th to April 17^th is approximately 78 degrees. That’s larger than the 60% slope of the Dow Rails and Industrials rally after the July 8, 1932, depression bottom!

Research from Warren Pies (co-founder of 3Fourteen Research), recently highlighted by Chris Martenson at Peak Prosperity, identifies the 9.8% surge in the S&P 500 over the 10-day period ending in mid-April 2026 as being in the 99.7th percentile of all 10-day returns since 1950! There have been only 20 instances in the last 76 years where the market has risen this sharply in such a short window.

What makes the sharp up move even more baffling, is that it has occurred without any bullish news (until Friday’s announcement that the Strait of Hormuz would reopen, but that was quickly reversed on Saturday with the Strait now completely closed). This is very puzzling to someone who has traded since 1968… and studied markets back to 1896.

President Trump is constantly on TV and/or social media saying the “deal with Iran is very close.” He is talking the stock market up every day with that type of propaganda. This type of “Presidential promotion” is of the highest order, and to my knowledge has never occurred before, and certainly not in this P.T. BARNUM like manner. An article titled, “Stocks Were Headed for a Rout, then Trump Hit Social media,” from the March 24^th Wall Street Journal best exemplifies this phenomenon:

“Early Monday was another bleak day for markets. Oil prices were climbing. Stock futures were sliding. A rout in government bonds was showing no signs of abating. Then President Trump took to social media. Trump posted that the U.S. military would postpone strikes on Iranian power plants. The reason: “productive conversations regarding a complete and total resolution of our hostilities.”

The reversal was immediate and stark. Stock futures surged into the green, swinging a decline of almost 1% into a climb briefly exceeding 2.5%. Oil futures dropped precipitously, with Brent, the global gauge, falling from above $112 a barrel to below $100 in seconds. Bonds rallied. Even after Iran denied talks, the tone was set. Investors cheered the efforts to end a war that has sparked the largest oil shock on record, while threatening to fuel inflation and slow global growth.”

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Victor- Economic Problems Persist:

While high oil prices drive inflation higher, there are many other U.S. economic problems:

l The Private Credit Market ($3.5 trillion) is imploding, as is commercial real estate. To a large degree, so is residential real estate, as property taxes and mortgage rates are rising beyond median household income.

l AI is being used as an excuse to cut jobs at many tech companies while job creation is very slow. Also, AI blowback is emerging from states and counties which are complaining about rising electricity and water price increases due to tremendous power and cooling demands from AI mega data centers.

l Astronomical U.S. government deficits and debt lead to higher borrowing costs while student debt at ~$1.7 trillion poses a severe challenge to many younger Americans.

l As discussed in depth last week, all-time lows in consumer sentiment leads to greatly reduced consumer spending, which constitutes ~70% of U.S. GDP.

l The personal savings rate is the lowest it has been since 2008, outside of pandemic-era swings. “It wouldn’t take much for real disposable income to turn negative and for this to result in a recessionary outcome,” said Joe Seydl, a markets economist at JP Morgan Private Bank.

-->With all the above “disconnects from reality,” the only explanation I can come up with for the recent steep rise in stock prices is that the equity market is being manipulated by the U.S. government. The mechanics of that are beyond the scope of this article. Please email the Curmudgeon if interested in the details.

Curmudgeon’s Conclusions:

1. The longer the Iran conflict drags on, the bigger the economic aftershocks will be. While oil prices have surged, fertilizer and helium prices have also soared. High fertilizer prices will likely impact farmers and crop prices going forward. A recent CNBC article suggests that food will soon cost more at your local grocery store. Helium is a key component in the chip manufacturing business and that could create challenges for the semiconductor industry and AI data center buildouts. Jet fuel shortages are becoming critical in some parts of the world and prices are rising rapidly.

Consumers are already paying much more for gas now and this could get worse in the coming weeks. The cheapest regular gas price in the SF Bay area is currently $5.35/barrel. Diesel gas prices have reached record highs, exceeding $8 per gallon in some parts of San Francisco. California statewide averages for diesel are hovering around $7.55 per gallon, driven by refinery closures and supply issues. That will surely increase transportation costs and drive cargo prices much higher. Common diesel vehicles include heavy-duty pickups, large SUVs, commercial trucks/semis, buses, cargo vans and many agricultural machines.

2. At some point in time, a great unwinding of long stock, futures, and options positions will occur. Loss aversion will replace Fear of Missing Out (FOMO). Algorithmic trades will deleverage in unison, exposing post-crisis trading addictions. Investors that underrate economic, geopolitical and systemic risk will pay a severe price.

Cartoon Courtesy of Hedgeye

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End Quote:

This quote reflects his belief that freedom in a civilized society is inseparable from the people’s ability to be informed honestly.

“If a nation expects to be ignorant and free, in a state of civilization, it expects what never was and never will be. The functionaries of every government have propensities to command at will the liberty and property of their constituents. “Thomas Jefferson

Thomas Jefferson was the primary author of the U.S. Declaration of Independence and the 3^rd President of the U.S.

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Wishing you peace of mind, good health, success and good luck. Till next time………

The Curmudgeon
ajwdct@gmail.com

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever-changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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