On Monday, October 19th, 1987, financial markets broke. The Dow Jones fell by 22.6 percent, the largest one-day drop in the index’s history, and it is referred to as “Black Monday.” A lot of different factors contributed to it that only existed at that unique moment, but generally the dynamic that led to this cataclysmic day was one of an overvalued market running into strong economic headwinds and unexpected events like very high deficit figures announced the week before which began the market’s slide.
Almost no one can predict a crisis, the entire point of a crisis is few saw it coming and the market panics in the face of it. What you can do however, is look at the conditions that crises spring from to spot patterns and this is a situation where cataclysmic financial history rhymes more each and every day. This is the third most expensive stock market in history, having a higher Shiller PE Ratio than the peak of the 1920s boom. A few years after that peak, the market’s Shiller PE Ratio dropped to the third-lowest on record, demonstrating the dynamic that over-valued markets run into when forced to confront a reality that doesn’t fit their euphoria.
And this current stock market is over-valued. I’m done listening to any suggestions to the contrary. It was already over-valued under Joe Biden because it priced in nearly all of the assumed societal gains from AI. If those don’t materialize, the market will be forced to price them out. But the AI bubble isn’t the market’s biggest problem, it’s more of a second-order effect of what could accelerate a market downturn should market participants ever pull their heads out of the sand and rejoin the rest of us in our dystopian reality.
Trump today said what he has long said, that he will not reduce tariffs on China without them giving him something first and he’s not interested in another 90-day pause, and the market instantly pulled back as soon as the words left his mouth. In my book, given how often the market reacts sharply to already known facts when Trump repeats them, it’s proof that the market is in full-blown denial. For the first two months of the year, markets did not believe that Trump was serious about imposing tariffs, and a lot of people lost a lot of money by simply denying the reality of 40-plus years of public statements by the president of the United States. Now that the tariffs are in place, the market is telling itself another lie that still is in line with the original mistake they made that wiped out trillions in wealth.
Trade deals typically take about 18 months to negotiate and the US usually spends about six months just coming up with its negotiating position. Not all trade deals are created equal, and some negotiations will go quicker than others (like South Korea who didn’t have any tariffs on the US to begin with and should be easy to renegotiate the deal Trump ripped up), but on the whole, it’s a long and tedious process that does not happen overnight. The market has ignored this known dynamic in favor of believing the propaganda from our Mad King, as demonstrated by Vanguard Global Head of Research Colleen Cunniffe saying “we are cautiously optimistic we’re through the worst” of the volatility around tariffs.
Trump claims to negotiate with China, and the market goes up. China says that’s not happening, and the market still goes up. Trump says what he has long maintained, and the market goes down. It’s all so fucking maddening that I really fail to see much of a distinction between the hopium-driven view of the stock market and the hopium-driven view of crypto anymore.
That said, one problem with saying “the market,” as a whole is that the S&P 500 is dramatically concentrated in just a handful of stocks. The ten largest companies comprise 38 percent of the S&P 500’s market cap, and they are all very exposed to China to varying degrees. If Apple had to operate permanently with 145 percent tariffs, the S&P 500 would plunge to the depths of hell, but it’s not. It’s up today. A big part of today’s rally is Tesla rallying off its catastrophic earnings proving it’s a cult posing as a carbon credits company that sells a couple of cars, but that may not matter when Trump just waived federal regulations making it easier to turn Elon’s cars that people don’t buy into robotaxis. Without that move, the S&P 500 would not be having a great day. The idiosyncratic risk of ten companies genuinely threatens the health of the entire market, and the existence of the phrase “the magnificent seven” proves this is nothing new. The whole market goes as Apple, Microsoft, Nvidia, Google, Meta, Amazon and Tesla goes.
Trump has already blinked twice when bond yields spiked, so the market is clearly believing that they can force him out of this idea that is the culmination of his entire life filled with bad ideas. The problem is, he hasn’t really blinked the way they want him to.
The first time Trump blinked, he actually raised the total effective tariff rate because raising tariffs on China outweighed reducing tariffs on our other trading partners. This time, he merely said that tariffs will eventually come down to around 50 to 65 percent on China, but they are still 145 percent right now. The market is pricing in a future that Trump is promising but has yet to deliver.
So what happens if he doesn’t deliver?
Well, the market is going to have to price out the rosy low tariff future it is pricing in right now. Let’s take this thought experiment a step further and say that Trump escalates the trade war or fires Jerome Powell or does something insanely disruptive that the market doesn’t expect.
That’s how panics happen. If the market is elevated, that has a way of accelerating the panic because of how big the gap is between asset values and reality.
Whether the Dow Jones can still drop 22 percent in a day is up to the quants to decide, but the simple fact is the market is pricing in a future Donald Trump explicitly does not want, which means it is setting itself up for Donald Trump to pull the rug out from underneath it. The stock market being over-valued is the primary risk here because despite all the chaos this year, every single person who bought the S&P 500 before May of last year is still in profit and April is roughly flat so far, making it a lot easier for folks to sell should the ground shift beneath their feet.
Just because the market is over-valued does not mean it has to come back down to fair value, and Tesla has long proven that markets can stay irrational far longer than the people shorting them can remain solvent. There is a self-fulfilling prophecy to everyone in the market telling each other it’s all going to be okay, but the danger comes in what happens if that belief is proven wrong beyond a shadow of a doubt and the market gets caught offsides. Stairs up, elevator down, as the classic market saying goes and its crypto cousin regularly proves, and this market wholly detached from the reality Trump is presenting is setting itself up for one hell of an elevator ride down should the right unexpected conditions materialize.
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