Protect Your Portfolio from the Fraudulent Economy

Something doesn't add up.

Last week, the US government announced that the economy grew 0.6% in the first quarter. Most financial commentators define a recession as two consecutive quarters of negative growth. So if the economy grew 0.6% last quarter we couldn't possible be in a recession, could we?

Yes we could… and we are.

For starters, a recession is not defined by two consecutive quarters of negative GDP growth. According to the National Bureau of Economic Research, a recession is "a significant decline in economic activity… lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales."

Based on this official definition, we've been in a recession for months. Incomes are down, real GDP is shrinking, employment is falling — we've cut 250,000 jobs since the year began — and retail sales have fallen off a cliff.

Now, about that GDP growth… The government arrived at its GDP growth of 0.6% by assuming that inflation was 2.6%. This is flat-out fraudulent. According to the official inflation numbers — the Consumer Price Index — inflation year over year is averaging 4%. So the government is claiming that inflation was nearly cut in half last quarter, despite the dollar falling to several record lows. When you include the official inflation numbers, the US economy actually shrank 0.8% last quarter.

And real GDP growth was even worse than that. You see, the CPI doesn't account for food or energy expenses. I don't know about you, but I still eat food and drive my car. Real inflation, that is, the actual increase in costs that most US families have experienced, is somewhere between 5% and 10%. Using this data, real GDP growth in the first quarter was worse than negative 1%!

Folks, the Feds are lying to us. They're trying to convince us that the recession is over without even admitting we're in a recession in the first place. And investors are being duped into believing that the bull market has resumed: a recent Barron's survey revealed that 50% of institutional investors were bullish. Only 12% were bearish. And nobody was "very bearish."

On the whole, the market believes that our economic troubles only pertain to the financial sector. If you exclude financial stocks, the S&P 500 has only fallen 10% since the beginning of 2007. In reality, numerous industries — automotive, heavy machinery, retail— have been posting recessionary results for several months now.

The US is in a recession, there is no doubt about it. And it's looking far more serious than the recessions of 1990 and 2001. When the market finally realizes this, it will plunge dramatically. Now, I can't tell you precisely when this will happen. But historically the S&P 500 has made most of its gains between November and April. I think it's highly probably that we will see stocks tank sometime within the next six months.

If you're fairly new to investing, I strongly suggest moving some of your portfolio out of stocks and into cash right now. Those of you who have been involved with the markets for some time should consider establishing some short positions to hedge your portfolio.

There are a number of great bear ETFs. The UltraShort S&P 500 (SDS) returns two times the inverse of the S&P 500. So if the S&P 500 falls 5%, SDS returns 10%. If the S&P 500 falls 10%, SDS returns 20%. Stocks have built up some strong upward momentum, so it's a little early to short just yet. But as soon as the market starts to show signs of weakness, it'll be time to sell.

The crowd thinks stocks have resumed a bull market and that the worst if over. When they find out they're wrong, there's going to be a sell-off panic. And we'll ride it all the way down.

Disclosure: No stock position.

Comments

[karchad]

it's articles like this from amateurs that enabled me to make money in 1988, 1991, 2003, and soon-to-be 2008. Please keep writing them. I need sky-is-falling articles to keep the negative sentiment going. As a long-term investor, it's the only way i can make money. Keep 'em coming!
Probably the same author will urge you to buy financials after they are up 100%.

[karchad]

Let me say this. Readers, ask yourself this: are you a long-tem investor? If you're a trader, or admitted short-termer, then skip the rest of this post, i have no gripe with you. If youre a long-termer, read on.... Why wouldnt you be buying financials and homebuilders and others after they are down some 70%???? If you're a long-termer, when exactly WILL you be buying? When the news is good? Then you're not a long-termer. When the stocks rise 100%? Then you're not a long-termer. When your friends are also buying these things? Not a long-termer. If you're truly a long-term investor, meaning 5 years or more, you should buy any sector that's down as severely as financials and homebuilders. No, i cant guarantee you will make money in the next week, or even next month (sounds like the theme song to "Friends". But you will profit handsomely in 5 years. Okay, sermon over, this senior is tired of typing.

[iThinkBig]

I agree with you in principle Karchad but this is different. This uncertainty is different as the conditions are all a perfect financial economic storm. In the past, mark to market assets off the balance sheets didn't exist. So where do you invest if you don't know which bank will need a bailout and which one won't? And will the FED keep printing money? Global investors are not investing in bonds, they are investing in essential commodities? Does that tell you something? I like the pharma companies right now. Unless prescription drugs are going away, I see nowhere but up for a handful of companies with massive cash reserves and hiring new guidance. That to me is a lot safer five year play then the financials. Socialism is the religion of the day now in America and what is wrong has become right. Healthcare will need to be subsidized or you'll have 70 million pissed off boomers. They will get there meds unless there is no U.S. economy at all..

[whidbey]

The assessment is entitled to a hearing on its facts. I am not persuaded that we know what a modern recession looks like factually. I think that sentiment is what guides consumer behavior, it is not based on facts alone, but local impressions. Sentiment is not positive and I presumer consumers will behave in that manner. As for early buying the the equities, it is a good way to turn a nest egg into a memory. Let the market lead you and follow slowly.

[CloroxCowboy]

Karchad, I have a long term portfolio so these are my questions for you:

Why do so many long term investors jump down the throats of those attempting to analyze factors in the market beyond historical price changes?

Why do long term investors perpetually use the negative sentiments ("sky is falling" mentality if you prefer) of others to prop up a diluted version of long term investing that is narrow-minded, ironically short-sighted, and most of all seems to be based on a fear of stepping outside a system that requires very little thought?

Investing can be watered down to such an extent that any semblance of true security/market analysis is basically non-existent. And yes, you will make money with those methods. You will also make money "investing" in a savings account at the corner bank, but I believe many people on this site are looking for slightly more than a "tuck the money under the mattress" approach to managing their finances.

Should we buy financials when they are down 70%? Quite possibly. Should we buy financials simply BECAUSE they are down 70%? ...ummm no. Price percentages are not the only numbers out there that need to be considered.

iThinkBig makes an interesting point that we have yet to discover just how deeply this credit cancer has spread into assets of financial companies. Underlying subprime bonds as well as the derived trillions in CDOs that could really screw the pooch for these same companies. Factor in that Bear Stearns, a major financial name, was in dire trouble only a short time ago, and it would not surprise me too much if we see more meltdowns in finance.

As to the argument that buying financials today will result in a handsome profit within 5 years, I would ask you to turn back the clock to the Nasdaq circa 2001. The entire average was down 50% - granted that's not 70%, but a decent analogy - and there were many tech companies down much more. Fast forward 5 years and those purchases a non-analytical long term investor was surely making in '01 are below water.

My point in all this? Don't pretend to speak for all long term investors. I do not subscribe to these myopic viewpoints or strategies and other long termers share my desire to understand the complete picture and make the most intelligent investments possible.

PS - The author is arguing that the news is already good. He's saying that many people's friends are already buying back into financials. Read and understand the article.

[CloroxCowboy]

After all my ranting there is serious typo in my PS...should be "friends are already buying back into the market." I realize that the author is discounting financials in his analysis.

[StateOfConfusion]

The way I read the article is that the economy is and will be much worse that is being admitted. I don't think the crisis is over and there will be another leg down. I'm a long term investor (as defined by the IRS = 1year or more).

I invest in many small companies and by nature they take a whle to develope. I have rarely bought financials (IMH being one) and I would not buy them now. Companies that are biotech and alternative energy related are long term investments.

I suggest that someone wanting to do this, look at NNVC, QTWW, AXVC and ENON for a start. I own all of these. Financials are depending on the US gov. to bail them out but who will bail out the government?

[adan]

i lean toward the gist of the article (and as per CloroxCowboy above in the comments); karchard's comments seem too throw away for me

that and a keystroke get you to the next pg :-)

[Whisper OnThe Wind]

I don't know if the sky is falling, or if the economy is going further down the tubes. I DO know that fully half the crunch problem was in the people taking out mortgages they either knowingly couldn't afford or knowingly did not read the contracts or purposely did not take the contract to a lawyer for advice. We can try to blame the banks for ALL of the problem, but 98% of the people were and are paying their bills on time, so maybe it isn't as bad as the media want us to believe. Maybe the market is showing us NOW that it is tired of the media hype and it wants to buy.

[Bryanb]

I agree with you in principle as well Karchad; I too am a long term investor who likes to buy quality when there is "blood on the streets" with a 2 year view, but I think it is still too early to buy with both hands now. It seems like there is pain in your environment and discomfort developing in Europe, but no blood yet. I went long in January and am now short. I feel more comfortable being short, because there is bad news out there and sentiment is rather fragile. I look forward to both scorn and praise.

[statePoet1775]

"invest for the long-term" That sounds very good, even virtuous. But the business cycle is still with us despite the efforts of the Fed to suppress it. This bust will be long and deep according to Warren Buffet and others. It could lead to great political changes ala The Great Depression. I would reckon that today is a time to be very prudent.