I found this past weekend a good time to blend some advice with news and analyses. Given current market conditions, not to mention what I do for a living, the most important piece of advice is to start looking at the short side of things - of anything - of everything.
Why?
•I cannot see, and have not read about, potential upside catalysts for the stock market other than corporate earnings. And this is a problem for two reasons; first, I see serious stagnation in the real world and a potential double dip that will hit corporate profits in the second half of the year, led by the banks. Second, as the market prices in interest rate increases (I see them coming around the end of Q1 of next year), the earnings multiple on the S&P 500 will have to rise to compensate for a commensurate fall in bond prices. The math is simple; as interest rates on Treasuries rise, the risk adjusted value of a stock goes down, unless earnings increase. And that ain't gonna happen.
•Potential downside catalysts - from 10% to 25% to the super bearish view (not mine) of a retracement to the previous lows - are numerous: A full fledged currency crisis in the EU; China blows up in measured ways but blows up nonetheless; Wall Street sees the double dip sooner than I think they will and sells off when bank earnings - and forecasts - in Q2 or Q3 disappoint; Iran and Israel get into something; there is a terrorist attack on US soil; a big bank comes back to the Fed and Uncle Sam (if one does, and I am not saying this will happen, it will be Citigroup (C)); a Republican victory in November, something provides a trading pop but then people are reminded of another two years of total gridlock. The number of potential downside catalysts - the cumulative amount of nervousness they inject into the market - is considerable and far outweighs potential upside catalysts.
•The market, in fits and starts, is now valuing companies and segments more on fundamentals than it did a year ago, and I see this move back to the future as increasing each quarter. And there are many, many fundamentally flawed companies sporting stock prices reflective of a rally in the market, not in their business.
•Shorting can take many forms, from simple risk management to speculative plays on a company blowing up, and there are more and more investment instruments for investors to turn to, from inverse ETFs to options spreads, to play the downsize in a straightforward manner with acceptable levels of risk. And, as I repeated a zillion times in my book "Sell Short", individuals should never actually short a stock. Investors and traders can now "go short" a stock, a market segment or industry, a country, a commodity, a currency, real estate - almost anything - using ETFs and options.
So, what looks good right now and for the rest of 2010?
My view of the market and individual companies - as well as countries, market segments and the Washington Nationals baseball team - is based on fundamentals, and those are based on real world data, fourth grade math, and a totally agnostic approach when analyzing the data with your math skills. Nothing more. Using this approach (which has worked quite well for me in the past and is summarized in my book), this is some of what I have seen happening for the rest of 2010 and with that view come some ideas. I will talk about segments and their ETFs. You can look at some names or tune in later when I write about some specific companies.
•The Double Dip: We will get GDO growth this year, tapering off in Q3 and Q4, and the bulls and pundits and blow-dried economists and politicians will all smile. In reality, we have stagnation now and in the real world that ultimately drives corporate profits. We will have a double dip recession in the second half; forget official statistics. The critical data points when making this kind of forecast are the drivers of economic activity - national income; household wealth; household and business credit; exports; consumer confidence; a fifth is small business confidence. Guess what, folks? With the exception of exports, all are declining right now. And exports are still well below where they were and are dependent on a troubled, stagnating Europe and a willfully slowing China and its new economic colonies, the rest of Asia.
The key headline data point is total employment, not unemployment of jobless claims or jobs lost. It is people working, times hours per week, times wages per hour. Total it up and throw in government transfer payments, and you get what people have to spend - and that has been declining and there is no sign it will not continue to decline. And with no new stimulus in sight, declines in spending power by the American people will accelerate in the second half of the year.
With stagnant or shrinking spending power, people buy what they need, occasionally what they want, not what they want and rarely what they desire. The ETF here is the XRT (there are puts available). As for names - think of products one does not need. Start there.
•The Banks: They are still broke and they will get broker in the second half of the year. By broke I mean the largest money center banks - that excludes Goldman (GS) and Morgan (MS) - are, as a group, insolvent if we go back to 2007 accounting rules and put their off balance sheet obligations on their balance sheets. Since they know they are broke, they are not lending in anticipation of having to set aside more capital rather than raise it from investors. Or to provide their own liquidity - which is why banks have almost a trillion dollars now on deposit at the Fed. And since they are not lending, there is no lubricant for the economy and even if other factors turned positive, this lack of credit would strangle any modern economy - any old one too for that matter.
One real world anecdote tells it all. A friend in the construction business for more than a generation, and a builder of box stores for major brand names, had a contract pending to build another one. His long time bank, a super regional, has told him to get lost. This is a 100% no risk project, and he still got told to get lost. The play here is the XLF (puts are available) - and there are double (SKF) and triple (FAZ) inverse ETFs but they do not always move with the Dow Jones Financial Index as well as they should.
•Homebuilders: Everyone is excited about the nascent recovery in the housing market. That is the same as getting excited that the Jamaican bobsled team lost by fewer seconds than the last Olympics. New home starts were roughly 1.6 million at the peak; used to be, on Wall Street, one million was the bottom, time to buy the homebuilders. We are at a run rate less than 600,000 and these stocks and hopes are holding up. Foreclosures are at an all time high and will begin climbing again, based on mortgage default rates, in 2-3 months. A wave of resets hits in the second will set the stage for another spike early next year. These homes - 6-7 million over the next 30 months - compete with new home sales as many are sort of new. This sector has been kept afloat by not one but two pieces of legislation that no one talks about and fewer know about - tax rebates for past profits in the billions. That largesse is over and many homebuilder balance sheets are creaky. Who is going to refinance them? I could write a short book - and it would be like a novel - as to why home prices will be stuck, nationally, until 2012, maybe 2013 and this means lower revenues per unit and lower margins per unit sold by the homebuilders. The ETF here - and yes, it has puts - is the XHB. As for names -- start with the weakest balance sheets, sort of like finding the fattest sow among all the pigs.
•China: A bubble blowing up in slow motion, the air being let out by the Chinese government. I will write more on that in another post - but the ETFs with puts are the PGJ, focusing on the domestic Chinese economy, and the FXI, dominated by Hong Kong listed stocks. And with China will go many emerging markets.
Stay tuned.
