Baby boomers might tank the stock market - and the Fed can't escape a recession forever, a finance guru warns

• Passive investors face big losses as baby boomers start to yank their savings, Larry McDonald says.
• The Fed can't forestall a recession as the economy is cyclical and has to shrink at times, he says.
• "The Bear Traps Report" founder predicted in May the S&P 500 would end the year down 40% from here.

Investors in index funds are barreling toward disaster, and the Federal Reserve can't stave off a recession forever, Larry McDonald has warned.

"Passive investing idiocy will go down in FLAMES - everyone long the same stocks - all the retirement plans at risk - the oldest Boomers and their $78T of wealth are near 80, starting to cash out," the founder of "The Bear Traps Report" tweeted on Saturday.

Instead of picking stocks themselves or trusting a fund manager to do so, passive investors put their money in index funds or exchange-traded funds that track a variety of stocks. Warren Buffett and Jack Bogle have praised index funds as a relatively safe, cheap way for unsophisticated investors to gain broad exposure to the stock market. In contrast, the likes of Peter Lynch and Michael Burry have blasted passive investing as a bubble that has mindlessly raised the valuations of the largest public companies to dangerous highs.

McDonald's tweet suggests he's concerned that so many people have effectively bet their life savings on the handful of Big Tech stocks that dominate the market. He also seems worried that baby boomers, who hold a large chunk of America's wealth, are beginning to sell their stocks, paving the way for a severe market downturn.

The former Wall Street trader — and author of "A Colossal Failure of Common Sense: The Incredible Inside Story of the Collapse of Lehman Brothers" — cautioned in another tweet that the Fed can't stop the economy from contracting.

"The Fed can do whatever it wants, but it can't change the essential nature of capitalism," McDonald wrote on Friday. "It can suppress animal spirits - good luck with the beach ball under water.."

In a bid to combat historic inflation, the US central bank has hiked interest rates from virtually zero to north of 5% since early last year, and signaled it will continue raising them. Inflation has dropped from a peak of 9.1% last June to 4% in May, while both employment and consumer spending have held up strongly. The brightening backdrop has fueled hopes among investors that the Fed can conquer inflation without tanking the economy.

However, McDonald's view is the economy is cyclical and naturally suffers downturns, and animal spirits — the human emotions that affect consumer confidence — can't be controlled indefinitely. His belief appears to be that resilient consumer demand will ultimately buckle under pressure from fast-rising prices and higher interest costs on mortgages, credit cards, car loans, and other types of debt.

McDonald has been sounding the alarm on stocks and the US economy for several months. He told Insider in May that the S&P 500 might slump to around 3,000 points by December  - a 40% drop from its current height to its lowest level since June 2020.

He pointed to the Biden administration reining in spending after the debt crisis, a disappointing set of upcoming company earnings, and the banking sector's woes spurring lenders to pull back.