Why We Are Due for a Brutally Ugly 2011-2012

by: Galileo Russell

Corporate America has been flying high since the recession, barely looking back since March 2009. The S&P 500 (NYSEARCA:SPY) is up over 70% in just under 2 years, the rally has been astounding to say the least. But are we really in 70% better shape as a nation since March 2009? No way. The dollar has continued to decrease in value, investments that feed off fear like gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) have soared. But forget about the dollar and gold, housing prices are still as low as in 2009, when they "crashed." The signs of a major market correction have been right in front of us this whole time, but no one has seemed to notice.

Financial analysts as a whole seem to have come to the consensus that the end of 2011, through 2012, will be excellent times for American companies all around. All America's favorite stocks like Apple (NASDAQ:AAPL), Cisco (NASDAQ:CSCO), J.P. Morgan (NYSE:JPM), Amazone (NASDAQ:AMZN), General Electric (NYSE:GE), Alcoa, Inc. (AA) and Netflix (NASDAQ:NFLX) have projected growth numbers above 10% from 2011 to 2012. No wonder everyone has been so bullish on the market for the past year, with future growth expectations as high as they are everything looks dirt cheap at today's prices.

Along with making bold predictions for established companies, a new breed of ridiculously valued momentum stocks have taken over the market. I'm talking about Open Table (NASDAQ:OPEN), lululemon athletica inc. (LULU), Ulta Salon, Cosmetics & Fragrance, Inc. (ULTA), LinkedIn (NYSE:LNKD), Salesforce.com (NYSE:CRM), Chipotle Mexican Grill, Inc. (NYSE:CMG), MercadoLibre, Inc. (MELI), and the list goes on forever. All of these stocks are trading at 50+ trailing P/E ratios if not 70 or more. Not only that but even when you factor in the outstanding 40% growth rates these stocks are given you'd have to hold on to your investment for 3 years for the earnings to catch up the stock for a normal valuation.

The market is down over 4% so far in June and it seems as if everyone is turning into a bear. It's been clear for a while the chart of the S&P 500 (SPY) has been overbought throughout this run over the past 2 years. Now the question is whether we are in for a normal pullback or steep market correction.

I believe we could have a very steep market correction ahead of either 15-20%. Let me explain why. With outlooks as good as they are for America's leaders Q2 earnings can only do one thing, and that's disappoint. Q1 was phenomenal, with the majority of S&P companies blowing out estimates and creating a brighter future outlook. In other words, suprising on earnings has become the norm. In my opinion if we see anything less in Q2 the market will react very poorly.

Even without these artificially raised expectations it's easy to make a bear's case for today's market. The dollar is almost at its weakest point ever, if this trend continues the ultimate result will be the U.S. economy turning from outsourcing hard labor to outsourcing management positions. Basically going backwards.

To attempt to stifle the decline of the economy, and stimulate growth in 2009, the government has been pumping massive amounts of money into the economy. As one would reason in basic supply and demand principles, this has caused a drop in the value of the dollar. The Fed is hoping with pumping money into the economy we will see a turn around in consumer spending and therefore a first step toward getting from a deficit to a surplus. Yet, the opposite is happening, our debt, now over $14 trillion, continues to increase and is showing no signs of slowing down, despite the Fed's desperate attempts at quantitative easing (pumping money into the economy, aka QE1 & QE2). As the value of the dollar decreases our bonds look weaker (that's why we recently saw Moody's drop the rating of U.S. Government bonds) to foreign governments. As a consequence, to get them to buy our debt we must raise interest rates. If U.S. Government raises interest rates to entice foreign nations such as China and Inda to buy our debt (we need them to buy our debt since it is over $14 trillion and keeps climbing) then the government will also be unknowingly forcing itself to want higher inflation.

For example, if China buys $1,000,000 of our debt for 5% per year (just an example folks, not real numbers) we are going to want the dollar to inflate 5% that year so it's like we are borrowing the money for free. But, if we want the dollar to inflate we will print more money (the Fed could say this is a double plus, get rid of debt easier, stimulate the economy) yet this is awful, because if we inflate the dollar more our bonds will look even weaker. Then the next year China might only want to borrow that $1,000,000 for 7% per year. Essentially the U.S. Governemt is digging itself into a huge hole and is showing no signs of getting out.

Forget the corporate growth projections, those have time to come up short. India, China, Brazil and consumers are buying massive amounts of gold now because of the exact fears I've mentioned above. Although my article has a very negative outlook on the U.S. Market it is excellent for traders. With what is in my opinion a very clear negative market direction profiting could be very simple. That is why a potential short of the SPY and a long of GLD or SLV could be an excellent move at today's market levels. If you're riskier, shorting the overvalued momentum stocks like OPEN, LULU, ULTA, LNKD, CRM, CMG and MELI could be another huge way to gain from an ugly year or two in the markets.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.