Snap out of it folks, the global recession has begun. Your options going forward are 1) continue to believe the nonsensical high-fivers who cast aside the obvious and routinely parade their Bullish cases on CNBC, or 2) position yourself now to rake in the spoils of your lesser informed investing brethren.
Option 1 investors fall for the standard "position yourself defensively" line touted by the so-called professionals. Two to three years from now, Option 1 investors will be looking back to this time and wonder why they allowed their accounts to melt away. Option 2 investors are not happy with mere "capital preservation". Option 2 investors will take the bull bear by the horns ears and ride their accounts to unprecedented levels. Outperforming the market is exponentially easier in a down market than it is in an up market. Don't allow yourself to be paralyzed by the headlines, or misled by the misled.
By taking some of the steps I'll outline below, you'll be set to profit from the global recession. To be clear, I am a long term bull. When you look at the long term charts of any major stock market, you have to be:
But taken in
smaller chunks, there are definitely periods of time that being a bear
would have been substantially more
profitable:
Why I think the
U.S. is in Recession:
For the
last nine months, economists have argued over whether or not the U.S.
would slip into recession. Although there are still a few unbelievers
out there, with Greenspan announcing we are in one and Bernanke recently admitting it was possible,
you can be pretty sure it's here. By its' definition, a recession can't
be labeled a "recession" until it's been here for six months.
Will the next
two quarters deliver the necessary negative GDP growth to officially
claim a U.S. recession? We won't know for several months. But the
housing crisis is not showing any signs of going away. It was the
housing crisis that really led us into the situation that we are now
in. As long as housing prices continue to fall, the situation will only
get worse:
By the looks of
this chart, we are in for further declines. Since houses are owned by
consumers, consumers are getting pinched hard. The days of easy credit
are rapidly diminishing. As home equity declines, home equity lines of
credit are disappearing. Consumers are increasingly turning to credit
cards to make ends meet:
This continued
reliance on "plastic" will continue to pinch the consumer even more.
Bankrupties are already up 30% over last year's pace.
Retailers are taking drastic steps to increase
sales. These steps are not working.
Corporate
earnings are projected to plummet.
Jobs are being lost at an alarming rate:
The government
is even feeling the pinch through declining payroll
taxes:
Finally, banks have been hemorrhaging losses at an
alarming rate.
In summary, GDP is slipping,
housing prices are in freefall, consumer debt is skyrocketing,
bankruptcies are climbing, consumer spending is dwindling, earnings are
cascading, jobs are being slashed, and, oh yeah…our banks are
insolvent. Yet the market presses on as if we've already seen the
bottom. Still not convinced? Feel free to go back to the opening
paragraph and be an Option 1 investor. I'll be happy to collect your
losses.
Why I think the Recession
has gone Global:
Now that most
analysts have faced the obvious and agree that a U.S. recession is
here, or at least on the way, the new argument has turned to whether or
not the recession will be contained to the U.S. or whether it will go
global. You may have heard the term "When the U.S. sneezes, the world
catches a cold." The idea is that the U.S. economy is the world's
largest and anything that affects the U.S. economy, ultimately affects
the world economy. Other economists feel that regional economies are
"decoupled" and not affected by U.S. problems (I think these guys are
Option 1 investors). Let's face it, the world's economies are more
globally intertwined than they ever have been. With China, Russia,
India, and other emerging markets rapidly accepting Capitalism as a way
of life, our opportunities for global trade have expanded
exponentially. This fundamental change has brought new wealth to
countries that have been repressed for so long. But at the same time,
it has tied them even closer to the U.S. economy.
The best way to determine whether or not the
global economy is being affected is to follow the trade of goods. The
majority of goods travel by sea. The best way to measure the amount of
goods being shipped by sea is to look at the Baltic Dry Index. The BDI
combines amount of cargo being shipped by sea and prices paid for that
cargo in one index. As you can see in the chart, shipping levels
started to drop off around November of '07:
The second
thing I look at is railroads. Although it is true that railroads are
landlocked, the majority of our commodities get to ships by rail first.
So rails are an important part of the global economy. Conventional
wisdom says that as gas prices continue to rise, the cost of trucking
will cause more demand to ship goods by rail. With gas at record highs,
the rails should be booming right now. Although they have had a nice
run, the global economic downturn is starting to catch up to the
railroads as well.
Finally, several foreign stock
markets are getting hammered, which is
further signs of the global
recession.
What
I think stocks will do:
U.S.
stocks are still WAY overvalued. We are off only 12% from our record
close in October 2007. This barely even qualifies as a correction.
Compared to P/E ratios of other global markets, we are still the most
overvalued market:
Source: Bespoke Investment Group
Corporate
earnings will plummet. Most analysts have not factored this in yet. The
next few quarters will see numerous misses and continual guiding of
estimates lower. The analysts are always late to the
party:
Ignore Jim
Cramer and turn off CNBC if you have to focus, but there are very few
sectors worth being bullish on. Even the sectors that should do well in
this environment (gold, silver, aerospace, and possibly consumer
staples) will be overtaken by the negative momentum of a falling stock
market. Obviously, 100% of the stocks will not be negative, but picking
in choosing in these dangerous headwinds is foolhardy.
Since I am a temporary bear, I will be shorting
US stocks, primarily through ETFs. If you are not a fan of ETFs, then
run a screen for stocks that have high Long Term Debt/Equity. Here are
the top five when I ran the screen:
• CPI Corp. (CPY)
• Crown Holdings (CCK)
• Alliance Imaging (AIQ)
• Dean Foods (DF)
• JER Investors Trust (JRT)
You
want to be short companies that have a lot of debt and little equity.
Their long-term survival in a tight-credit market like this will be
very difficult.
How to play this
with ETFs:
You want to be buying
the ETF's that short the market and/or specific sectors, such as:
DOG (Short the DJIA) and PSQ (Short the NASDAQ)
But I prefer to be aggressive with this and
utilize the ProShares Ultrashort ETFs. These use 2:1 leverage to
maximize the ability to capitalize on this downturn. Here are my
favorites:
DXD (Ultra short DJIA) QID (Ultra
short NASDAQ) SKF (Ultra short financials) REW (Ultra short technology)
SRS (Ultra short real estate)
What
commodities will do:
Commodities
have been on a tear already. Two factors are feeding this. One is the
basic laws of supply and demand. The second is speculation. Supply and
demand is somewhat predictable by analyzing global macroeconomics.
Speculation is the wild card. When it turns against you, you can lose a
lot of money. With that in mind, let's look at how I see a few
different commodities playing out over the next several years.
Grains:
I believe the
move in grains is for real. I see food prices continuing to stampede
higher. Why is the cost of food getting higher? China's emergence from
a social-agricultural economy to an emerging-capitalist economy has
caused a mass movement of people away from the rural farming areas into
the more urban areas. Everyone has focused on how rapidly their economy
has expanded, but nobody focused on how that would affect global food
prices when the farmers stopped farming. China is not the only nation
causing this "food crisis", but it is certainly the largest. I have no
doubt that speculation has added to the rising grain prices, but the
main fuel has been pure supply and demand. This problem will only get
worse. The price of grains will continue to go up.
Gold and Silver:
I see
gold prices being set by an even mix of supply/demand fundamentals and
speculation. As wealth grows in emerging markets, the demand for gold
jewelry has increased. But the majority of demand is coming from the
markets. Gold is both a hedge against inflation and a "safe-haven"
against a falling market. Having a falling U.S. dollar only adds to the
upward pressure on gold prices. Gold is also being fueled by massive
speculation. It has received a lot of press and with it, a lot of
speculative money. I see gold being very volatile this year, but
ultimately, the fundamentals will take gold higher. As for silver, it
follows gold, but with less fanfare. Look for opportunities to get into
silver when gold is outpacing it.
Other metals:
The global recession is going to eventually
level-off the price of other metals (non gold/silver). They may even
decline. I think these metals may continue to run a bit higher, but not
for long. I would be avoiding these in the near future.
Oil & Natural
Gas:
Perhaps more than any other commodity, oil
is rampant with speculation. While I will not deny there are
fundamental supply and demand issues driving the price higher, as well
as a weak dollar boosting it even more, the price has gotten to a point
that is unsustainable for the global economy. Rising gas prices are
pinching the consumer just as much as falling home prices. Is gas in
short supply? No. If it was, you'd have to wait in line to fill up your
tank. We have not seen that. In fact Valero recently slowed down refining due to
slowing demand. Smaller airlines are rapidly going bankrupt due to the
high oil prices. As the global recession progresses, worldwide
industries will require less and less oil. I expect oil to remain
extremely volatile due to the speculation. We may see $125 and $150 a
barrel in the near term, but ultimately, I feel a slow sustained
pullback is in the future of oil.
Natural gas is
a different story. As a cleaner energy source, natural gas has lagged
behind the big increases in oil. I expect natural gas to outperform oil
in the near term. After oil peaks and heads lower, I expect natural gas
to stagnate, then eventually turn lower as
well.
When
will it end?
I believe a severe
recession and a severe market correction are in the near future. But
this whole article would be meaningless unless I quantified the exact
moment I will return to the Bull camp. Don't you love it when analysts
make stock picks and price projections without a time frame? For me,
the turn will not happen until the very thing that got us into this
mess leads us out of this mess…housing. I believe the U.S. economy will
lead the world out of the global recession. Exactly when will that
happen, I don't know. But when I see the Case-Shiller Index turn
positive, so will I.
Author's Disclosure:
Currently long SKF and DXD.
Sources: (click to follow through to source)
standardandpoors.com [pdf file]
This article has 12 comments:
In a month, for about 2,100 miles I use 15 gallons of gas, and 18.00 of electricity. At today’s cost of $3.25 per gallon, that is a total of $66.75. That works out to be about 3.2 cents per mile. In a standard Prius, that would be 6.5 cents per mile. In my Yukon that would be 27 cents per mile.
Look at it this way, at gas costs of $3.25;
Yukon, $568.75/month
Prius, $136.5/month
Plug-in Prius, $66.75/month
Those are numbers and Real Dollars you can take to the bank!
Do the math for yourself… your car vs. a 50mpg Prius.
Burning Fuel, “any liquid fuel” in our cars to throw into the air for all of us, and our children, to breathe into our lungs is bad. Why keep being a slave to a pump when electricity is already pumped into your home and you can even make it on the roof of your house.
Plug-in cars are now going to work for everyone, but they are coming even if I have to build them all myself. I’ve done five so far and more are on the way.
take up consumer spending where Americans leave off are wrong.
Together, they may be twice as big, but have 8-10 times less income.
As early as mid-summer, Chindia will have to cut back on production.
And they will either join us in our economic morass, or start a war to keep on producing.
thoughts appreciated.
It is also argued that the U.S. will take the rest of the world with it. The evidence here is thus far rather thin. You point to the Baltic Dry Index and railroad activity data. The data on world stock markets clearly indicate that it the U.S. markets that are the most overvalued.
Though 'pockyclips' (see above) is right in pointing out that the growing middle class in India and China (and other emerging market countries) will not be able to fill the gap created by U.S. consumers in recession mode, the worldwide growth of the middle class (who are middle class in terms of purchasing power parity of their local curency) is resulting in much stronger domestic markets which might continue to grow even during a U.S. recession.
The decoupling thesis may have been carried too far, but it remains to be seen whether the rest of the world will go into economic collapse because U.S. consumers are having difficulty with their mortgage and credit card payments and that the world will only re-emerge from this when these same consumers (and their banks) have their financial affairs back in order.
Half of the construction cranes in the world are said to be currently found in China and would appear to be, thus far, still active.
They are trying so hard to spare our feelings and wanting us to know the grim truth. Not since the great depression has there been a time of World-Wide slowdown of all the world indexes at the same time (except South America), all trading below their 200 day moving average.
Both PE and earnings can fall in a long..."prolonged recession," one that might last 5 years to bottom and 5 years to recover to the present level. I say that because with the expected $1 trillion dollar loss of capital by the worlds banking system, there will be insufficient capital going forward to finance homes, business and commercial real estate to do anything more than just limp along, year after year. It will take a long time to recover that lost investment capital... and much longer still to recover the $6 trillion already lost by the stock markets all over the world. That stock-wealth is no longer available to be sold to invests in wealth production or to prop up liberal government with high taxes, etc. as we will soon have with the liberal democrats taking the congress and white house. Sound like we are going back to 90% tax rates to sustain our present appetite for social programs. It will be very hard to cut budgets of national/state/local as well as personal budgets back to the point that we spend what we have, rather than what we can borrow. This truly is a crisis.
I am ultra short SRS and FXP. I am playing these like a cash register, they go up and down in short sharp swings which can be very profitable. I look for SRS to rise sharply after the REIT earnings are announced, the first week of May.
I admire his confidence but sometimes all the study in the world of an old test doesn't prepare you for the test that has yet to be written.
AnonGeneral: Shorting the Russell 2000 should be just as profitable as shorting the Nasdaq or the Dow. However, small caps tend to lead large caps when coming out of a downturn, so I would expect the Russell 2000 to be the first of those three indexes to turn positive.
globalmacro: I think it's a bit unfair to jump on one bad pick. For the record, I have only written articles on Seeking Alpha for three stocks. If you visit my blog, you will see that my Monthly Stock Portfolio is up 3.92% since it's inception on October 1st. The S&P 500 is down 11% over the same period. That's nearly a 15% outperformance in just six months. When you go to my blog, feel free to see my Motley Fool Caps Ranking. I currently outrank over 98% of the other stock pickers on that site. I'm more than willing to admit a bad pick, but let's get the rest of the facts on the table before you go around trying to smear my reputation.
Natural gas is the ONLY viable alternative energy solution to oil based products. It's technology is already proven and in place and it's the cleanest tech. for combustion engines. Like it or not, world automakers are not going to retool just to make eco-friendly vehicles! We've been down the hybrid road before and it's just "show and tell". If you think natural gas is going down in price long term, I'll buy all you want to sell!!!!!
After all, nothing happens without a reason my friends. This could have been prevented long back itself, but it was not. And its not that the powers that be, are unaware of an impending trouble.
My view is that this will go on to become a global phenomenon - the global economy will come to a grinding halt, reversing years of progress & globalization and will ultimately force a complete restructuring of the global economic system. I'm not predicting a doomsday, but just giving an outlook based on simple math & common sense.
I'd like to say this to rustypipes: I agree with you that natural gas is a fantastic way to go for an interim energy solution. Natural gas pipe supply lines are everywhere. Every service station could have a compressor and just change your empty tank for a full one. I heard Boone Pickens say the same thing. As for your disdain for the Prius I think you missed the point. The Prius may not be cheap but that matters less than the fact that it dosen't pollute the atmosphere as much as other cars and it helps preserve what small amout of light sweet crude we have left. I think that as more hybrids are produced they will be cheaper to build and even more efficient to drive.