This 'elephant in the room' could send stocks into a tailspin, Wall Street bear David Rosenberg warns

David Rosenberg says he's worried about a serious risk that investors are largely overlooking.

The Gluskin Sheff chief economist and strategist warns that the Federal Reserve's balance sheet reduction —not rising interest rates — could have drastic implications for stocks.

"This is the elephant in the room," he said Wednesday on CNBC's "Trading Nation." "The Fed doesn't really have to do anything on rates. Just the balance sheet alone is going to create quite a significant liquidity squeeze next year."

Rosenberg, who has been known as perma-bear on the Street for decades, stopped short at the size and scope of the market impact.

"It's uncertain as to whether that causes an outright recession," he said. "But it's certainly going to trigger, I think, a significant slowdown that we're already starting to see in a lot of the credit-sensitive data."

Rosenberg spoke after Fed Chairman Jerome Powell signaled that interest rates were close to neutral, leaving investors to speculate that fewer hikes are ahead over the next 13 months.

"It doesn't change my opinion of where Fed policy is going to be going over the next year — which is probably a little tighter than what's priced in right now," Rosenberg said. "There's never been a Fed tightening cycle at any time where the Fed didn't go above that fabled neutral level."

Yet Powell's comments still helped spark a rigorous rally on the Street. The Dow and S&P 500 saw their best day since March 26. In the first three sessions of this week, the Dow is now up 1,081 points.

"The market really wanted to rally," said Rosenberg. "A lot of this is because of a lot of hope over the coming G-20 summit on the weekend, and hopes of diffusion over this trade war with the U.S. and China."

Rosenberg contends the markets aren't accurately pricing in the Fed policy risks.

"We're going to be seeing with no fiscal stimulus next year, the peak impact of Fed tightening, the lagged impact, hit the economy and the markets more forcefully in 2019," Rosenberg said. "That will be a major theme."

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Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

Follow Michael Santoli on Twitter @michaelsantoli

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