#420 Larry McDonald: The Market Has Already Crashed. The Index Just Hasn’t Noticed

Nike

Across the shows: 3 speakers in other episodes, 0 bullish and 2 bearish calls, past 30 days

• Larry McDonald · The Bear Traps ReportBullish

  Nike, a fallen hall-of-fame brand, is a high-conviction pick flagged by his capitulation model.

  Nike is a hall-of-fame brand that is down about 70%. McDonald cites his seven-factor capitulation model, which measures the intensity of selling, the distance below the lower Bollinger Band and relative strength, as the basis for the view. The transcript cuts off before the full case is made.

  “We have a stock called Nike, hall of fame brand. ... We have a capitulation model, seven factor model, that measures the intensity of the selling,”at 35:53

• Larry McDonald · The Bear Traps ReportBullish

  Nike has capitulated to deep lows; cash flow and dividend cover make a large rebound plausible by 2028.

  Nike shows a 'category five capitulation' with its price far below the lower Bollinger Band on weekly and daily relative strength. He compares it to Intel's 2024-25 low (since up about 150%), Alibaba's 2022 low and ExxonMobil in November 2020. Such lows typically form at quarter and year end, when companies 'kitchen sink' results and portfolio managers sell names they don't want on year-end holdings reports, so they can buy back next year. Free cash flow of roughly $2-3 billion against about $8 billion in cash supports a 5% dividend. He says this is a cushion rather than true downside protection, and concludes the probability of a Nike-like doubling or tripling by the 2028 Olympics is rising.

  “the probability that something like a Nike is by the Summer Olympics in 2028 is up a 100, 150, 200% from here. I wouldn't be surprised.”at 37:47

CoreWeave

Across the shows: 2 speakers in other episodes, 0 bullish and 3 bearish calls, past 30 days

• Larry McDonald · The Bear Traps ReportBearish

  CoreWeave's straight bonds at ~13.7% signal it is shut out of debt markets and forced into converts.

  CoreWeave's straight bonds are trading around 13.7%, versus the 8-9% coupon they were issued with. The bond was issued at par and now trades near 80 within about a year, so rates have risen and prices have crashed. Once a neocloud cannot issue straight debt in investment-grade or junk markets, it has to go to the convertible market. That is the pattern McDonald links to serial convertible issuers and eventual default risk.

  “Right now, today, CoreWeave is trading their straight bonds, trading, like, 13.7%.”at 6:37

iShares Expanded Tech-Software Sector ETF

Across the shows: 1 speaker in other episodes, 1 bullish and 0 bearish calls, past 30 days

• Larry McDonald · The Bear Traps ReportBearish

  Software rally has played out; IGV is back at highs on Palantir froth, so he'd buy puts.

  He was previously bullish on software and bought Workday and other software names in his trade alerts. Software then suffered a severe capitulation in June, when fears that AI would destroy the sector hit it. The software ETF (transcribed as IGB, but the IGV is meant) is now back at its old highs. Its large Palantir weighting trades at 'obscene levels', and money is rotating out of semiconductors into software. He is no longer bullish and says he would buy puts on the ETF, a speculative trade with about a one-year horizon.

  “the software ETF, like the IGV, is back at the old highs. It has a large component of Palantir, which is trading at obscene levels. So, yeah, I'm nowhere near as bullish software.”at 38:28

Apple

Across the shows: 4 speakers in other episodes, 0 bullish and 2 bearish calls, past 30 days

• Larry McDonald · The Bear Traps ReportBearish

  Apple's margins are being squeezed by memory costs that may have risen as much as 100%.

  He cites rising interest rates and falling profit margins as the reason the stock market is vulnerable, and gives Apple as an example. Apple's memory costs have just gone up, and he argues the memory cost per iPhone may be up about 100%. This squeezes margins on every device it builds. The figure is speculative (he says 'must be') and is offered as an illustration.

  “Look at Apple. I mean, they've got memory costs that just went up... Your cost of memory in each one of those iPhones, it must be up a 100%.”at 40:15

AI infrastructure & data centers

• Larry McDonald · The Bear Traps Report

  Data center financing is breaking down as high-yield markets shut and data center IPOs get canceled.

  The tertiary parts of data center financing are cracking, which typically does not happen in a strong bull market where these areas are well bid. Two data center REIT IPOs were canceled in the last week. Hyperscalers like Meta, Microsoft and Amazon can still issue investment-grade debt, but neoclouds cannot finance themselves in high yield, so they are turning to the convertible market. McDonald calls this a warning sign.

  “And I think the biggest one from the last week or two is the tertiary elements of data center financing is starting to break down.”at 3:54

• Larry McDonald · The Bear Traps Report

  A populist backlash against data centers could rise sharply if Democrats win the midterms.

  If Democrats take the House and Senate, and inflation and impeachment pressure build against Trump, the populist movement against data centers could gain strength. AOC is now the top bet to become the 2028 nominee. McDonald says this could cause convergence next year, adding to the other forces that could unwind the market.

  “you could see a situation where the threat to data centers because of that populist movement against it goes up a lot.”at 25:40

• Larry McDonald · The Bear Traps Report

  Data center financing may eventually need a federal backstop, though AI companies have not yet received one.

  AI companies are worried about their liability and are asking for a federal backstop behind the scenes, and that request has not yet been granted. McDonald argues, alongside the race against China, that the data center financing effort may eventually need federal support, much as the government financed debt after World War Two.

  “We've got maybe this whole data center financing thing needs some federal backstop at some point.”at 33:14

US stock market outlook

• Larry McDonald · The Bear Traps Report

  The index is at highs but internals have crashed, and a year-end convergence into the new year is coming.

  The S&P 500 is at all-time highs, but beneath the index it has suffered a 1987-style crash, with well-known brands like Harley-Davidson down 30-40% and Lennar down 45%. Passive investing is making the distortion worse, and many funds are long the index while shorting individual stocks. Quarter-end and year-end tax-loss selling from mutual funds and individuals widens the spread between the broken parts of the market and the index. McDonald expects a convergence into the new year, with the index flat or lower while breadth improves. New lows versus new highs have reached their most consistent levels since the dot-com crash.

  “So that's why the S and P is at all time highs, But the market has actually crashed internally. I think we've had a 1987 crash internally.”at 18:25

• Larry McDonald · The Bear Traps Report

  Market-cap-weighted index concentration in mega-cap tech leaves markets top-heavy and vulnerable to rotation.

  Because the S&P 500 is market-cap weighted, each new passive dollar flows about 13 cents into Nvidia and Apple. McDonald says roughly half the market is now effectively AI, and new IPOs such as SpaceX and Anthropic will add more. The Nasdaq 100's market value has grown from about $12 trillion at the end of 2022 to about $43 trillion, much of it in tech. If $5-6 trillion rotates out of tech into the rest of the market, the heavy side of the seesaw rebalances. He warns fiduciaries about this concentration.

  “And the S and P 500 is a market cap weighted index, which means that every dollar that goes in, 13¢ goes into NVIDIA and Apple.”at 22:36

• Larry McDonald · The Bear Traps Report

  Expects the US index to crash because high bond yields are squeezing equities; the market is close.

  The bottom line is that bond yields are too high. Using the rule of 72, a 6% bond doubles in 12 years and an 8% bond in nine, which are equity-like returns that compete with stocks. Stocks were supported for the last decade by low rates. Now rates are up and profit margins are falling; he cites Apple's memory costs as an example. He says the index will crash and that the market is close to it.

  “I think we're going to crash on the index. We're close. The bottom line is the bond yields are just too high.”at 39:58

Credit markets

• Larry McDonald · The Bear Traps Report

  Convertible bond issuance surging among serial issuers is a strong risk indicator, as in 1999 and 2021.

  Convertible bonds are the last place a company can borrow before it runs out of options, after friends and family, banks and the bond market. When convertible issuance explodes and the same companies keep returning to the convertible market, McDonald sees a warning sign. He cites Six Flags, Adelphia, Tyco, Enron and Lehman as examples. Tesla and MicroStrategy are exceptions. He says the last two times this pattern appeared, in 1999 and 2021, it foreshadowed a major event.

  “So the bottom line for people watching us right now, the convertible bond market is a very good risk indicator.”at 7:58

• Larry McDonald · The Bear Traps Report

  Stress is spreading in the riskiest junk debt, with CCC yields jumping and leveraged loans under pressure.

  Pockets of weakness now exist that were not there before. CCC-rated bonds, the junk of the junk, yielded about 12% three months ago and now yield about 17%. A chief investment officer McDonald spoke with pointed to leveraged loans, which are floating rate, so they absorb higher rates directly. He also cited telecom disruption from SpaceX and rising consumer credit risk in auto financing and telecom.

  “It's very clear that there's pockets of weakness in the market that weren't there. Triple c's, okay, for example, which is the junk of the junk, they were, like, 12%, three months ago, now 17.”at 11:05

US rates & the Fed

• Larry McDonald · The Bear Traps Report

  The Fed is more likely to deliver three cuts than three hikes because the consumer is too weak.

  Front-end rates have risen from about 3.5% to 4.5% and long-term mortgages are at their highest in years, which tightens financing for households. Jet fuel and diesel costs are sharply higher. Interest on the debt is about $1.1 trillion and would rise further with more hikes. McDonald argues the Fed is starting a hiking cycle into a wounded consumer, so tightening is already doing the Fed's work. He expects the Fed to fake a hike, perhaps one more, then tip its hand to a softer path. He says he is getting this view from smart money in his chats.

  “I'm seeing, like, a lot of smart money starting to say there's no way they hike three times. We're gonna get three cuts.”at 12:33

• Larry McDonald · The Bear Traps Report

  A 10-20% stock drawdown would push the Fed to flip to rate cuts, given huge equity wealth.

  Rate cuts typically come after market stress. A 10-20% drawdown would hurt household wealth, which is concentrated in stocks and is now very large, so the Fed would 'definitely' move to cuts. This is a rate-cut response to a crash, not a forecast of cuts before one.

  “So if you had a 10, 15, 20% drawdown, they would definitely flip to cuts. Because the household wealth that's in stocks now is just obscene.”at 40:50

Gold & precious metals

• Larry McDonald · The Bear Traps Report

  Silver is one of the best trades over twelve months, and his firm is buying after the January flush-out.

  His firm sold into a rally in January, then began buying as silver fell about 50% from its highs. The speculative hot money from that top has been flushed out. Silver has data center and solar demand, with solar capacity coming online rapidly in the US and China. Household ownership of precious metals is still low, at about 0.7% of household wealth versus a possible 2-2.5% in a real commodity bull market. Silver also carries Fed sensitivity, so a Fed pivot would help it.

  “Gold, silver, like silver right now, is probably one of the best looking trades looking out twelve months because if they tip their hand that they could be done,”at 16:08

• Larry McDonald · The Bear Traps Report

  Gold could jump from about 4,000 to 6,500 once the Fed admits it is on a softer path.

  A rising front end of the yield curve pulls money into dollars and hurts gold, since gold pays no interest. But that front-end rise reflects Fed posturing rather than a real tightening. As the consumer weakens and interest on the debt grows toward $1.3 trillion, the Fed probably cannot keep hiking. Once it tips its hand toward a softer path, gold, like a beach ball held underwater, should rise sharply. McDonald sees that move taking about a year and a half.

  “gold is like that beach ball underwater. All of sudden, goes from 4,000 to 6,500.”at 28:22

US Treasuries & yields

• Larry McDonald · The Bear Traps Report

  Long-duration bonds offer better risk-reward than equities, with Apple's 2060 bond a prime example.

  Apple's 2.5% bonds due 2060 trade at 47 cents on the dollar, so many bonds now offer equity-like returns. If the 30-year Treasury yield returns to 4%, that bond would rise to 73, about 18% a year if it happens within three years. McDonald would rather own that bond than Apple at 10 times sales and a $5 trillion market cap. He says investors are increasingly recognizing that bond risk-reward is much better than stocks.

  “Because if the thirty year treasury goes from back to 4% because of some reason, that bond would go from 47 to 73.”at 31:09

• Larry McDonald · The Bear Traps Report

  Treasury's November refunding will likely drop the 20-year bond, and Fed bill purchases could support yields.

  The quarterly refunding announcement comes out in early November and sets out Treasury's issuance plans. McDonald thinks it will probably kill the 20-year bond and shift issuance toward shorter maturities. Treasury can also threaten to issue less or to buy back bonds. The Fed's facility for buying T-bills, about $10 billion a month, could be turned on to support Treasuries, echoing the Fed-Treasury coordination of 1946-1951 when debt was financed after the war. He calls this financial oppression that pushes down rates.

  “High probability, I think [Bessent] kills the twenty year. It actually kills it. It says we're not gonna issue twenties anymore.”at 32:16

US consumer

• Larry McDonald · The Bear Traps Report

  Consumer-facing companies are under massive stress as household financing costs and energy prices rise.

  Home Depot and McDonald's are each down 30-35%, Netflix is down 40-50%, and Nike and Lululemon are each down about 70%. Higher mortgage and financing costs for ordinary households, and higher jet fuel and diesel prices, are hitting spending. McDonald says financial conditions are tightening at the consumer level at a high rate of change, which is acting like rate hikes.

  “Companies that face the consumer are under massive stress.”at 12:09

Oil & fuels

• Larry McDonald · The Bear Traps Report

  Refined product prices are the real shock, and the White House has misjudged their second-order effects.

  Jet fuel is up 60-70% and diesel is up about 66%. Diesel goes into every truck, so shipping costs are rising and Amazon is raising prices because of them. What matters is diesel, gasoline, home heating oil and other refined products, not crude. Refined products are harder to move around the world than crude, and global refining capacity has been cut back. McDonald says the White House has misjudged these second- and third-order effects.

  “And the White House is unfortunately miscalculated here on the second, third order effects of the refined products globally.”at 14:18

US deficit & government debt

• Larry McDonald · The Bear Traps Report

  Hitting the debt ceiling would halt net new Treasury issuance for months and rally bonds.

  McDonald says the debt ceiling was hit in January and the Treasury General Account holds about $1 trillion. Extraordinary measures push off payments. In each of the last two episodes when the debt ceiling was hit, the Treasury stopped issuing net new debt for three to five months, only rolling maturing bills. He says this would rally bonds.

  “they stop issuing net new debt. [...] That's another thing that would rally bonds.”at 34:42

AI chips & semiconductors

• Larry McDonald · The Bear Traps Report

  Semiconductor stocks are rolling over and underperforming as money rotates out into software.

  Trillions of dollars flowed into semiconductors, tied to data center financing and the tertiary parts of the market. Semis are now 'starting to puke lower' and underperforming. The money is rotating out of semis and into software, part of a back-and-forth rotation between sectors while the broader market does not crash.

  “The semiconductor stocks are starting to puke lower, underperform. That money's actually rotating out of semis going over to software.”at 39:04

Market sentiment, positioning & volatility

• Larry McDonald · The Bear Traps Report

  Family offices are rapidly buying tail-risk funds for crash protection, as credit spreads are very tight.

  He and fund manager Lee Robinson see a large rise in family-office interest in tail-risk funds. These funds buy crash protection, such as credit default swaps on names like MetLife, because investment-grade spreads are so tight that betting against them is cheap. He cites Robinson's fund being up about 800% in 2008. He gives an example: a family whose $100 million became $300 million in equities could move $5-10 million into a tail-risk fund.

  “I'm seeing a large explosion of interest in family offices that want to own tail risk funds. And that's crash protection.”at 41:18