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Don't Get Complacent. It's very easy to get lulled into comfort, and many investors seem to be drifting back into complacency as negative headlines have eased.

For traders and investors planning to open up new positions or add to existing ones, ignoring the (for now quiet) fundamentals is going to have adverse consequences once the headline news starts to go negative again. Granted, we've had some "good" news recently, and the market doesn't appear particularly expensive on a simple 12 month, trailing basis. I quote "good" to emphasize its short-term, and highly questionable nature.

The so-called improvements in certain economic statistics are almost entirely a result of unprecedented amounts of excess liquidity being provided to credit markets courtesy of the Federal Reserve. While the short-run effects of these easy policies are beginning to reflate some of aspects of the very bubble that we should be liquidating, they've done nothing to create an environment for much larger, more critical structural issues to begin healing.

Take a Step Back from the Positive News and Observe our Structural Deficiencies

Among these structural issues is housing's weakness. While the Federal Reserve believes (or just has to publicly maintain the belief) that housing's weakness stems from undesirable mortgage rates, the reality is that there is a glaring credit shortage due to an undesirable lending environment. More importantly, American citizens haven't saved meaningfully for over a decade, income growth has been stagnant since the beginning of the recession, and purchasing power has slowly eroded. As a result, many Americans don't even consider buying, and even if they do, most don't qualify for loans. The Fed's actions have exacerbated housing's issues by producing a credit shortage (and the Fed is considering embarking on a massive program to push mortgage rates even lower) and have further distorted market equilibrium with excessive liquidity. The consequence is this stagnant, partially reflated bubble that has now been frozen by aggressive central planning.

European, Market-Moving Catalysts

Though not (directly) a result of Fed policy, Europe's outlook, even over the next few months, is dire. Not surprisingly, headlines have shifted to corporate earnings and an improving U.S. economy. Volatility has plummeted to 21, the Dow is creeping in on its 52-week high, and optimism has soared to rarely seen highs. While I don't trade or invest based on sentiment alone (heck, sometimes it's actually warranted), there have been no legitimate resolutions to Europe's woes. The risk-on trade has returned as European officials have apparently said the right things, but the real near-term catalyst, once again, is Greece.

Greece has billions in debts coming due at the end of March, and will finally default if they do not receive yet another tranche from the lenders of last resort, the IMF, ECB, and the EU. The issue now is that despite prior news that Greece and the EU could squeeze a 50% pay cut out of most of the bond-holders, a large portion of hedge-funds and other private asset managers are unwilling to bend for Greece. Their justified inflexibility could absolutely lead to a trigger of credit-default swaps, consequently setting off a series of unknown systemic financial events. The end-game appears to be near for Greece, and likely the EU (and probably the Euro) as we know it, but markets are as confident as ever.

Even if Greece magically pulls through this crucial debt repayment, Greece's economy is still an unsustainable zombie. Greek banks are losing capital (deposits) every month as the run on them continues, and credit is completely running dry. There is essentially no way to restore confidence in Greek markets, and a natural reset (default) of the country will eventually occur.

Elsewhere in the Eurozone, Italy is still paying nearly 7% on their 10-year, clearly an unsustainable level in a country that needs to enact further austerity measures. As taxes increase, government spending plummets, and confidence erodes, tax receipts will edge lower as economic productivity sinks. Additionally, the LTRO deployed by the ECB has allowed major European financial institutions to swallow even more sovereign debts using cheap capital, but this has vastly increased the ECB's leverage and is only a temporary aid.

Conclusions

JP Morgan (NYSE:JPM) reports on Friday; this is definitely an important announcement. A huge beat could give financials some momentum, pushing the whole market higher for a bit. Unfortunately for longs, the financials have the most to lose in the event of an escalation in the Europe crisis. If JPM's numbers come in strong and financials are pushed upward, it only adds to the opportunity on the short side.

Regardless, I believe traders should begin initiating and/or adding to some shorts now as a hedge against upcoming European drama, and also as a contrarian play to what many now believe is a fundamentally improving U.S. economy. Furthermore, corporate profit growth has almost certainly peaked, and some industries may begin to see some earnings declines. This thesis plays for the intermediate and long-terms. In short, current market levels appear to imply that the European crisis has been alleviated, and that the U.S. long-term growth story remains intact. Investors are wrong on both accounts.

As for specific short ideas, I still emphasize betting against insanely valued low cash flow stocks, such as Salesforce.com (NYSE:CRM), LinkedIn (NYSE:LNKD), and Dunkin Donuts (NASDAQ:DNKN). Newer, richly valued issues with poor cash flows and no dividends tend to get hit the hardest during times of high market volatility. While Lululemon (NASDAQ:LULU) is actually showing some fantastic growth, it has been bought heavily recently, and appears to be trading at its near-term ceiling -- it's exceptionally difficult to justify a price to earnings multiple of 55 on a $9 billion company that doesn't pay a dividend. I think Lululemon LULU is a nice short play here as well.

For those who maintain a truly bearish, almost apocalyptic view, investment banks like Credit Suisse (NYSE:CS) and Deutsche Bank (NYSE:DB) have significant, critical exposure to Europe. As I have mentioned before, these firms are sitting on mountains of cash that are slowly depreciating in value, and could lose a significant amount of purchasing power if the Euro goes bust. Though BAC doesn't have a tremendous amount of direct EU exposure, it too is regaining significant price momentum at a very odd time. I'd be very surprised if BAC earns the $1 per share for fiscal 2012 that some are projecting, and negative headline risk is going to keep a ceiling on it for quite some time. Regulators are going to keep coming after the firm, and private lawsuits are going to nibble away at real and intangible resources for an unknowable duration; BAC could also offer nice potential from the short side.

Stay ahead of the next few months by ignoring today's news. Now is a good time to be looking into the future for significant catalysts, and there is no shortage of negative ones.

Source: Stay Ahead Of The Investment Trend: Begin Initiating Shorts Now