DAVID KOTOK: 5 Potential Stock Market Shocks Where The Outcomes Are Unknowable

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Photo: MdE (de), Wikimedia Commons

David Kotok of Cumberland Advisors has a had a bullish slant when it comes to stocks.  From his latest note:We think the bull market that started on October 3 is only half over as to price change and only one-third to one-fourth over as to time.

Of course, investing in stocks is not without its risks.

In his latest note, Kotok identifies 5 possible upcoming shocks that could throw markets into a tizzy.  From his note:

Of course, we cannot know the result of a potential risk before it happens.  We cannot know the outcome and the policy shift.  Therefore, the anticipatory period preceding the risk and the aftermath, if as and when the risk is realised, are not symmetrical.  In other words, you are investing in asymmetry.  Knowing this in advance allows an asset-allocation rebalancing as the circumstances and probabilities change.  In other words, reassess, reassess, reassess risks and rebalance, rebalance, rebalance.

'What will a twist cessation bring to bond yields? Will it change home mortgage interest rates? Delay a housing market recovery? Alter the steepness of the yield curve? Or the flatness of the yield curve? What happens to bond credit spreads? Pricing of repo collateral? Maybe the whole thing will pass as a non-event. Nobody knows.'

Source: David Kotok, Cumberland Advisors

'...How much will markets anticipate these outcomes? How deep is fiscal drag? Is there a fiscal drag? Is Ricardian equivalence dead? How large is the policy shift danger to our country from the Congress? From this president? From next year's president, re-elected or new? All of these tax-spend-borrow outcomes are probable in the present-day realm of American politics. That puts our American destiny in the hands of a class of people who are very unpopular and despised by the majority of American citizens. Our politicians have become the scurrilous, scatological scoundrels that we elect and send to Washington...'

Source: David Kotok, Cumberland Advisors

The Bank of Japan has leaped to the top of the G4 central banks when it comes to balance-sheet expansion.

The FDIC limit on non-interest-bearing demand deposit insurance is scheduled to revert back to the pre-crisis level at the end of this year.

'...What will be the impact in the money-market end of the yield curve? Will there be an extension of the termination date if markets begin to tighten? What will happen to repo rates? Repo collateral pricing? How closely is the Fed watching this development, since the Fed has been providing the market with more repo collateral (T-bills) through its Operation Twist? Is there a relationship, or will there be one? Can the banking system withstand larger withdrawals of zero-interest deposits if corporate agents deem deposits to be insecure without FDIC insurance coverage? ... Readers who are still worried about the safety of their bank deposits may check the FDIC website for the current rules.'

Source: David Kotok, Cumberland Advisors

Watch the price and futures prices of Brent crude.

'...Libyan production is not coming back in a hurry (hat tip to Barclays for superb research on the risk of Libyan civil war). Geopolitical risk is high in the Persian Gulf (Iran) and in Nigeria (see the developing news story of turmoil in this important oil-producing country). Worldwide demand for oil inexorably rises. US energy policy still fails to accelerate our move to energy independence. Despite Energy Secretary Salazar's protestations, the fact is that the Obama Administration has a failed energy policy and continues to pursue it. We do not drill, we do not encourage the use of natural gas in an accelerated and proactive way, and we do stymie new production and exploration. We do have pipelines running in the wrong directions, and we do have distorted domestic oil pricing because of excess inventories in Cushing, Oklahoma...The range of forecasts of the oil price is a mile wide. We have seen a low of $40 a barrel within two years and a high of $175. We lean to the higher price, not the lower one.'

Source: David Kotok, Cumberland Advisors

Kotok stops at 5, but leaves it to the readers' imagination to think of more. If you don't have much of an imagination...

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