I will attempt an explanation. No idea of the probability of the scenarios I outline below becoming real but the risk is not zero. I am not being alarmist but just laying out a possible scenario to try and respond to your question. This situation is akin to situations that occur in major bull markets that are close to their top (note the massive leverage that Bears Stearns, etc had to mortgage backed securities leading up to the GFC and huge upticks in margin lending in dot com boom in 2000). I have also attached an excellent good podcast about this situation which explains more and demonstrates how dangerous this situation is. Remember what happened to Long Term capital hedge fund in the 1990's when it blew up.
The chart shows that for every leveraged hedge fund having a bearish position (ie expect stock market to fall) there are 100 leveraged hedge funds that are positioned for the stock market to keep going up ie they use large amounts of debt to buy stocks or futures or options to massively leverage their positions. The long positioning of hedge funds mirrors the current euphoric views of retail and insto investors with the former having the highest ever optimism that stocks will keep going up while instos or fund managers have the lowest cash holding ever. There is also a lot of margin lending ATM.
The situation is highly dangerous and can cause massive and terrible financial contagion impacts. It is the opposite of a short squeeze.
Firstly, these leveraged hedge funds source the debt from banks primarily the large US banks like JPM, Citi, BOA, etc. If the share market falls say 5% then the losses of the hedge funds can be 15% if the fund has 66% debt. Some hedge funds will be more highly leveraged than 3 times. The amount of loans from banks is, I understand, well over $US1tr and maybe over $2tr (saw an article on this a few months ago).
If contrary to these funds long position the stock market falls 5%-10% some hedge will cover their long positions buy selling shares which forces stocks to fall even further. If stocks fall by over 10% most leveraged hedge funds will be covering like mad forcing stocks prices even lower eg as happened in 2022. The problem is acerbated by 2 matters - most of recent buying in the US stock market has been from ETFs ie passive investing which now hold more than 50% of stocks in the US. In addition the stock market is highly concentrated in the US increasing risks and there is the AI bubble.
That is, the current US share market is in a situation where an unforeseen event (did we have one yesterday from China on AI?) that results in a significant drop in share prices may have a major negative financial impact. Not only will leverage hedge funds be covering by selling stocks but investors will be withdrawing funds from these hedge funds and also from ETFs and non-leveraged funds with little cash to cover redemptions will be selling. If some leveraged hedge funds go bust (eg like LTC in the 1990's and there have been others) from falling stock prices and default on their debt then the banks may face significant losses - note banks may call in their loans once the net assets of hedge funds reach a certain level which would force hedge funds to sell stocks en mass making falling stocks prices even worse. The situation, if banks and hedge funds do not manage the situation well, could end up becoming a very bad situation - if it is poorly managed then there could be another banking crisis resulting in much further contagion as we saw in 2008 - there will most likely be more QE and a major increase in US government and other governments debt as in 2008 but possibly much more than in 2008. There are so many of these hedge funds and the dollars involved are massive eg if loans are $US2Tr with 3 times leverage then $US6Tr of assets..
Lastly what will happen to POG? It there is a significant fall in stocks POG will go down as investors sell to pay of loans leverage to long positions to the share market as what happened in 2008 and in 2020. But the POG will then rise possibly substantially due to QE, lower interest rates and much larger government debt. There has been a huge inflow of capital rom the rest of the world into the US stock market and that capital will turn into an outflow. The US may go up initially but in my view will then go down significantly.
There are lots of other cracks that could cause problems. Howard Marks who called the dot com bubble just before it burst and called the MBS market bubble before it burst in 2007-08 has recently called a bubble in the stock market (there is also a housing bubble in the US, sub prime bond bubble and some also believe private markets are a bubble - if they all break the events may make the 2008 GFC look like a walk in the park (which is clearly a worse case situation). Then there is Warren Buffet holding over $US325b in cash).
I am increasing my cash levels and redeeming some of my managed funds.
I desperately hope the above situation never materialises - if it does no idea when it will happen but if Trump reduces banking regulations then the probability of the above evens happening will increase significantly. Note that hedge funds are largely unregulated as are private markets.
Apologies if this explanation unsettles you there is a chance it could happen and some experts have been talking about it.
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