3 reasons why the S&P 500 could be headed for an imminent 48% drop, according to an investment chief who crushed the market during the coronavirus crash

The S&P 500 could be headed for a drop of up to 48%, according to James McDonald, the CEO and chief investment officer of Hercules Investments.McDonald said the new strain of COVID-19, historically elevated tech stock valuations, and already-priced-in stimulus leave the stock market vulnerable to a crash if investor sentiment suffers a sharp negative shock.”Monday’s selling pressure isn’t a sign that a major market crash is imminent, but crashes do begin with shifts in short-term sentiment like we have seen in recent sessions,” said McDonald. He recommended investors have exposure to volatility instruments, which can offset losses in core holdings if markets fall. Visit Business Insider’s homepage for more stories.The S&P 500 could be headed for a drop of up to 48%, according to James McDonald, the CEO and chief investment officer of Hercules Investments.In a recent note to clients, McDonald — who profited off of the pandemic crash in March with bullish wagers on stock-market volatility — laid out three reasons why the market is especially vulnerable to such a swift downturn right now.

(1) A new strain of COVID-19 in the UK The perceived future harm of the new COVID-19 strain in the UK will introduce additional risk to markets, according to McDonald. That’s especially true since recent vaccine progress led many investors to expect a smooth return to normal life following the vaccine’s rollout, he said.”The new strain is one of many potential catalysts that can shift sentiment and trigger violent selling, especially as stocks hit record highs as recently as Friday,” McDonald wrote in a note.(2) Historically elevated tech valuationsMcDonald said recent valuations in the technology sector have exceeded levels seen before the days and weeks prior to the major market crashes of 1929, 1987, 2001, and 2008. “The idea that tech stocks should keep rising in the face of the Covid-induced headwinds was an idea rooted in historic optimism. As we see now, eventually reality strikes and changes things overnight,” he added. Read more: Bank of America unveils its top stock pick in each of the 11 S&P 500 sectors and explains why they’re poised to dominate in the year ahead

(3) The stimulus package isn’t enough to offset the economic fallout of COVID-19 The $900 billion stimulus package was necessary, and largely expected by investors — but it won’t be enough to limit the economic fallout of the pandemic, according to McDonald. Given these circumstances, McDonald says the S&P 500 could crash down to 1,900 if investor sentiment suddenly turns negative. In addition, the Dow Jones industrial average could drop to as low as 15,000, a roughly 50% drop from current levels, he added.The investment chief said that markets have always crashed in the weeks and months following 52-week highs, and it will only take a change in sentiment to trigger a large sell-off. Both the Dow and S&P 500 closed at record highs last week, but have pared back gains since then.”Monday’s selling pressure isn’t a sign that a major market crash is imminent, but crashes do begin with shifts in short-term sentiment like we have seen in recent sessions,” said McDonald.He recommended investors have exposure to volatility instruments, which can offset losses in core holdings if markets fall. 

“Risks here are as high or higher than potential gains, so it only makes sense to have a defense in place,” McDonald concluded.Read more: BANK OF AMERICA: Buy these 26 cheap and fundamentally rock-solid stocks before the economic rebound sends them soaring in 2021

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