Has the time come to sell stocks or even go short? I think it has, and here's why:
Bullish news is everywhere. Profit margins are high. Innovative products and services inspire optimism. Look at the cool smartphones from Apple (NASDAQ:AAPL), Qualcomm (NASDAQ:QCOM) and Google (NASDAQ:GOOG). You just talk at them and they can convert the sound of your voice into a text message and then send it to someone halfway around the world! With iPads, you spread your fingers apart and some webpage out there in cyberspace appears bigger and bigger. What a wonderful world we live in!
Yet this wonderful world of spending on cool gadgets is being supported in significant part by Mr. Bernanke's printing and then lending to Mr. Geithner to give to Americans to spend, 100 billion dollars a month, or 8.5% of monthly GDP. Think tax credits, extended unemployment benefits, aid to states, medicare and medicaid spending, food stamps, yada, yada, yada. All that money goes straight from Mr. Bernanke's printing presses into the economy with the big banks and Mr. Geithner as intermediaries. Bank lending might be down, but government borrowing and spending is making up for it.
When all this money printing stops, as it is supposed to in the next month, Mr. Geithner is going to have to get that 100 billion dollars (to give to Americans to spend) from someone other than Mr. Bernanke, or else tighten his belt. Either way, the economy will suffer.
If Mr. Geithner starts borrowing more from foreigners, life might go on much as it did before. But foreigners are showing increasing reluctance to hold U.S. debt. It will take significantly higher interest rates to get them to do so, and that will create even more problems for housing and for a consumer already under significant pressure.
If Mr. Geithner starts borrowing more domestically, again perhaps enticing lenders with higher interest rates, then we'll have a different problem. That money will be unavailable for domestic spending. If interest rates get high enough, perhaps people will even sell their equities and lend to Mr. Geithner. That won't be good for the stock market. If the Republicans get their way, Mr. Geithner won't have to borrow quite so much, but the free money spigots will be turned off (or at least turned down), and consumer spending will suffer all the same.
Add in $110 oil eating away at consumers every month, another big wave of foreclosures coming at the real estate market (creating a further negative wealth effect to dampen spending), mean-reverting (i.e. shrinking) corporate profit margins, intractably high levels of unemployment, especially of the long-term unemployed, and you have a cocktail of problems that the stock market just won't be able to shrug off. Finally, consider the fact that we are back at dangerously high levels of price to ten-year inflation adjusted earnings.
The case has to be made that at this point in time an investor should be entirely out of the equities market, or even net short. At the very least, we are probably looking at a 15% correction which would take the S&P 500 index to 1160. If crude oil goes above $150 a barrel for Brent by year end, we are almost certainly looking at another full-on bear market.
But won't a slowdown in the U.S. economy cause oil prices to fall? Not necessarily. The U.S. went into recession in late 2007, but oil prices continued higher until the middle of 2008. Only a complete meltdown of the global economy in 2008 took the upward pressure off oil prices. The U.S. economy, with only 22% of world oil consumption, is no longer the most important factor in the world oil market.
Thus, we could very well see a replay of the events of 2007-08 in the coming 12 months, with the stock market heading lower beginning about now, the economy entering recession by year's end, and oil prices continuing to rise well into 2012. If we do, the next leg down in the stock market will be a dramatic one indeed. Hold onto your hats!
Recommendation: Long December 11 $57 puts on the QQQ. Cost: $3.50 a share. Downside protection for the end of QE2 for just 6% of the value of the underlying asset. By the way, QQQ is 12% AAPL, so one eighth of your QQQ put will be a put on Apple stock. A more conservative approach would be the puts on SPY. The just out-of-the-money December 11 $133 puts are at $6.05 a share.
At $6.05 a share, an investor can hedge a $100,000 portfolio with a premium of just $4,549. Just imagine how well you will sleep at night with a few of those babies in your portfolio when the printing presses stop spinning in June.
Goodbye, QE2. We'll miss you! Bon voyage!