Stocks are highly likely to crash in the next 2 months as investors are still too distracted by fads to price in credit risk, market guru says

• Equity markets are likely to decline sharply within 60 days, said market guru Larry McDonald.
• That's because, as credit risk is rising, investors continue to focus on markets fads like AI.

The stock market is likely to decline sharply within the next two months, Larry McDonald of "The Bear Traps Report" said.

That's as investors continue focusing on market fads like artificial intelligence and neglect the losses that banks are sitting on since the Federal Reserve's rate hikes slammed prices of debt.

"Those are massive losses under the surface. Our 21 leading systemic risk indicators are pointing at the highest probability of a crash or a sharp drawdown in the next 60 days. It's the highest probability since Covid," he said on CNBC.

The Nasdaq, which has outperformed the S&P 500 and Dow Jones Industrial Average this year, is ignoring this credit risk, McDonald added.

A similar pattern has played out before, with stock investors failing to assess risks as early as other investors do, he said.

"What happens is, as a shock comes in, credit markets start to price in the risk but equities don't — they focus on things like AI or things like the dot-com revolution in the '90s."

Characterizing today's situation as a "rolling credit crisis" — one that started among regional banks and has moved on to threaten other sectors, such as commercial real estate loans — McDonald said the unrealized losses in the bond portfolios of banks and insurance companies have not gone away, but will continue to reduce lending capabilities.

And while McDonald acknowledged that the central bank's efforts to infuse liquidity into the banking system has helped stem a greater issue, he said that the credit risk is enough to "veto" the Fed's focus on inflation.

Earlier this month, he predicted the Silicon Valley Bank meltdown may cause the Fed to cut rates by 100 basis points by December to prevent contagion in the financial system.

In recent days, others have also warned of a stock market crash. Last week, Jeremy Grantham said the implosion of an "everything bubble" could tank the S&P 500 by up to 50%, and plunge the US economy into a painful recession.

And Macro Mavens founder Stephanie Pomboy said the stock market could plunge 30%, as the current pressure on banks could spread to commercial real estate, corporate credit, municipal bonds, and other markets.