S&P 500 (SPX) Could fall over 30%,Stockman

Contrarian? market analyst David Stockman, who came to fame as President Reagan's director of the Office of Management and Budget (OMB), sees a "gigantic, horrendous storm" about to hit stocks, sending the S&P 500 Index (SPX) down more than 30% to 1,600, per CNBC. Meanwhile, other market participants are increasingly confident, even as the major indexes continue to reach new all-time highs. For example, the cost of "black swan" insurance, used by hedge funds to protect against sharp stock market declines, has plunged to its lowest level since the financial crisis, as reported by the Financial Times.

This represents a remarkable divergence of opinion about the future direction of the markets.

High Political Risk

Stockman views the controversy over President Trump's firing of FBI Director James Comey as "a huge nothing-burger," per CNBC, and opines that "the system is determined to unseat Donald Trump." Among Stockman's worries, per CNBC, is "hysteria about Russia-gate for which there is no evidence. If they [the Senate] can bog themselves down in this, then we have a dysfunctional, ungovernable situation in Washington." In this environment, and with the August recess for Congress fast approaching, this means that enacting Trump's program of tax reform and infrastructure investment is becoming less likely, Stockman adds. Indeed, Stockman also is concerned about a government shutdown in the next few months, and the possibility that it could erase all the market gains since the election, and more, he told CNBC.

The plunge in the cost of "black swan" insurance reflects a less gloomy view. Nonetheless, investors who agree with Stockman can make 25 times their money if the S&P 500 falls 7% in the next month by purchasing put options on the index. As the FT describes, the one month 97-93 percent put spread on the S&P 500 becomes profitable to the buyer if the index declines by at least 3% over the next month. The maximum profit would be reached if the S&P drops by 7% or more, the FT says, based on data from Bloomberg.

Low volatility in the equity markets, and expectations of continued low volatility in the near future, are key factors behind the low prices of these options contracts, the FT says. In fact, unrepentant bulls also can make similarly outsized gains in the options market. If the S&P 500 rises by 5 to 10% in the next three months, buyers of the three month 105-110 call spread on the index can make 38.5 times their money, the FT computes.

Source: Investopedia