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A chief investment officer at a $5.8 billion firm lays out why a dot-com-style bubble brewing in stocks will culminate in a 30-40% crash — and says the Fed could set it off

A chief investment officer at a $5.8 billion firm lays out why a dot-com-style bubble brewing in stocks will culminate in a 30-40% crash — and says the Fed could set it off

Chris Zaccarelli, CIO at Independent Advisor Alliance, breaks down how easy financial conditions are sending stocks down the path toward a crash.

Worries about a bubble in the stock market have been growing since valuations spring-boarded off their March 2020 lows amid unprecedented monetary support from the Federal Reserve.

These concerns have only grown stronger since November, when investors became excited about the prospect of robust fiscal stimulus from a Democrat-controlled government. Around the same time, pharma companies rolled out multiple COVID-19 vaccine discoveries.

The S&P 500, hovering near 3,900, now sits right around all-time highs and is up about 18% since the beginning of November.

As a result, some notorious bears like David Hunter, Mark Yusko, and Jim Rogers have been calling for a crash in 2021 or 2022.

Yet the major players on Wall Street don't see such a scenario playing out soon, with the economic recovery ahead and easy Fed policy in place for the foreseeable future. Neither does Chris Zaccarelli, the chief investment officer at Independent Advisor Alliance, which manages $5.8 billion in assets.

But if market conditions stay unchanged, Zaccarelli said a crash can indeed happen later rather than sooner, likely in 2023 or after.

He compared the current timeline with the dot-com bubble era, and said we're in the equivalent of 1997 or 1998, a couple of years or so before that bubble burst.

"I think we're definitely well on our way down that path. It's going to be very difficult for the Federal Reserve to pull back on the stimulus that they put into the system too quickly," Zaccarelli told Insider by phone on Thursday.

"I think there's a lot of political will to continue putting money into the economy through fiscal stimulus, through the Congress, as well as keeping monetary conditions very easy with what the Federal Reserve is doing," he continued. "So I think because those two large players in the economy have a lot of conviction towards running things hot, it's going to take us down that path."

In the meantime, Zaccarelli said he thinks the market could rise as much as another 100%. But it will then likely crash 30-40%, he said.

How the crash will happen


Zaccarelli laid out a specific series of events he thinks will lead stocks to this drop.

First, the easy financial conditions in place now will continue to drive up valuations. But such conditions will lead to sustained inflation above 2-2.5%, Zaccarelli said.

This will then force the Fed to raise interest rates, he said, which will remove liquidity from the system and send stocks tumbling. A lower level of liquidity means investors would have a more difficult time finding buyers for their assets, lowering prices.

"The Federal Reserve is going to be stuck between a rock and a hard place, and they're going to eventually do what they did in the late 1970s, early '80s, and just raise rates to crush inflation, and that's going to really hurt the market," Zaccarelli said.

Some experts say inflation is not expected to take hold in 2021 as the job market recovers losses suffered from the pandemic. They reject the idea that we will see inflation even afterwards, citing the lack of inflation following Global Financial Crisis stimulus and continued advances in cost-lowering technologies.

However, many anticipate it will pick up in 2022 and beyond as large monetary and fiscal stimulus packages increase the money supply. Inflation indicators like Treasury Inflation-Protected Securities (TIPS) and rising commodity prices are indeed showing that investors expect to see higher levels of inflation in the years ahead.

But the Fed has also committed to letting inflation run above 2% since it has lagged in recent years. They have said that they would let rates stay near zero through 2023, but it is unclear at what point afterward they would intervene to slow inflation's pace.

Current conditions make Zaccarelli's argument a compelling one. But time will tell how the trajectory of inflation, stock valuations, and the Fed's decision-making plays out.

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