The market doesn't seem to go down any more. While leading economic data from the U.S., and Europe, and Asia, has consistently deteriorated since last April, recent sell-offs have been short and small.
The S&P 500 and its tracking traded fund, SPY (SPY), is up over 25% since the market low of last summer's. Market leaders such as Citigroup (C), General Electric (GE) and Caterpillar (CAT) are also up over 15% in the last couple of months alone.
Leading economic indicators in the U.S., China, and most emerging markets, have consistently deteriorated over the last several months. Still, equities have consistently rallied on the prospect of new and stronger monetary policies being enacted. The weak and deteriorating economic data had increasingly raised hopes for more aggressive actions by Central Bankers.
This is why I think now that the Fed has finally acted, it sets up a nice opportunity to short the S&P 500 and the Dow Jones industrial fund (DIA).
The first reason why I think Bernanke's recent announcement creates a good shorting opportunity is because the Fed and ECB will likely have very limited tools moving forward if growth continues to decelerate. The market has rallied repeatedly in previous months because of the fear the Fed or ECB would likely announce aggressive new stimulus if the economic data continued to deteriorate. Now that the Fed and ECB have acted, the risk and reward of shorting the S&P 500 have reversed.
The second reason why Bernanke's actions should be shorted is because the Fed's actions will likely fail to stimulate growth. The Federal Reserve cannot force banks to lend. With corporations able to borrow at historically low rates, and the 30 year mortgage trading at historically low rates as well, the Fed's new bond buying program won't improve access to credit for small businesses and individuals. With the banking system having been better capitalized than at any time in its history for some time, it is unlikely that these new monetary policies can address these problems.
The third reason why the Fed's recent announcement should be sold into is because Bernanke's recent announcement likely signals that the ECB is not ready to take aggressive actions. U.S. companies reported strong fiscal first quarter earnings growth in North America. Still, the significant recent deterioration in EU and Asian economies is the primary reason cyclical companies sold-off hard in mid-April. The economic data has continued to significantly deteriorate in these markets, and most leading emerging markets have been very weak recently as well. While China also recently announced a fairly modest $150 billion stimulus infrastructure spending plan, the U.S. and China are pursuing much less robust fiscal and monetary stimulus than these countries enacted in 2008 and 2009.
Europe is China's biggest trade partner, and the recent German PMI data and Spanish GDP data were significantly below expectations. China and Japan also recently reported anemic year-over-year export growth, and China's July PMI showed contraction. While the European fiscal crisis has lingered for nearly three years now, leading economic indicators in the core of Europe are beginning to significantly deteriorate as well.
German courts recently approved ECB bond buying, but Draghi still faces a strict mandate prohibiting the ECB from pursuing stimulus policies. Many European countries are also divided on continued bailouts and Draghi's existing bond buying program. Europe's financial system remains significantly undercapitalized, and the ECB has no plan to deal with the long-term structural debt problems that the PIIGS face.
The fourth reason the market should be shorted on Bernanke's recent announcement is because the market has likely priced in further stimulus. While Apple (AAPL) continues to make new all-time highs, the stock has consistently underperformed the S&P 500 over the last month, and the company's biggest overseas markets in Europe and Asia continue to weaken. Apple's new iPhone 5 launch has been well-known and anticipated for some time, and traders have likely priced in much if not most of the likely earnings the company will get from this new product launch. Apple now trades at nearly 13x average estimates of next year's likely earnings, and analysts have not lowered expectations for first quarter earnings at all in recent months despite the significant recent deterioration in economic data in Europe and China.
Industrials and energy stocks have also led the rally for some time, but many leading cyclicals such as GE and Caterpillar have underperformed the S&P 500 recently. The energy sector has underperformed the broader indexes over the last several weeks as well, and oil has failed to rally over $100 a barrel on the recent stimulus announcements. Industrial companies have given fairly tepid recent guidance, and many market leaders in cyclical sectors are now trading at 12-13x -- fairly high estimates for next year's likely earnings.
To conclude, the threat of Bernanke and Draghi acting was always much greater than the actions the Federal Reserve or European Central Bank could likely take, and congressional gridlock will likely prevent further fiscal stimulus. While many safe heaven investments, such as dividend stocks, were overvalued, companies such as Altria (MO), Procter & Gamble (PG), and AT&T (T), have sold off hard on inflation concerns. With cyclicals having also rallied hard over the last several months and many leading dividend stocks 8-10% off these companies' highs, shorting the broader indexes or reallocating capital to more conservative sectors are likely to be good strategies near-term.