Stocks Headed For Steep Decline As Economy Skids And Europe Tumbles

Includes: SPY
by: Colin Lokey

Six days ago I published an article advising investors to sell stocks and stay out of the market (at least out of equities) for the foreseeable future. The Dow has finished lower in every single session since then, on its way to six straight losing sessions, the worst streak in 10 months. The premise of the aforementioned article was that there is essentially no justification for stocks to trade at four year highs amidst worsening economic data, tepid appetite from retail investors, and, most importantly, an extremely volatile situation in Europe. Make no mistake, the situation has gotten materially worse over the past week.

As for the economy, April's Non Farm Payroll number says it all: on Friday the Bureau of Labor Statistics reported that the economy added only 115,000 jobs last month, missing expectations of 160,000 by a wide margin, and providing confirmation that the recovery is grinding to a halt. Although the official unemployment rate fell to 8.1%, the drop was largely the result of the decline in the labor participation rate which has hit a 30 year low.

In a sign of rising anxiety, retail investors are continuing to pull money out of stocks. According to the Investment Company Institute, domestic equity fund outflows quintupled during the week ended May 2 compared to the week before, jumping from $1.16 billion to more than $6 billion. This trend has led to a precarious situation in which stock mutual funds now hold a record low 3.3% of their investments in liquid assets.

Perhaps the worst news for stocks, however, is that Europe has hit the point of no return - Europeans simply are not going to stand for anymore austerity. The French showed their disdain for budget cuts and fiscal responsibility Sunday by electing the anti-austerity candidate Francois Hollande, an event which could undermine the entire fiscal reform effort in Europe as former French president Nicolas Sarkozy served as a key supporter for German Chancellor Angela Merkel's hard line stance towards irresponsible EU member nations.

Worse, elections in Greece were a complete debacle - no party emerged victorious and the country was unable to form a stale coalition government, a situation which will likely lead to a rejection of the terms of the EU/IMF bailout, and an eventual exit from the Eurozone. As Greece tumbles, the rest of the EU's member nations may well decide that the path of austerity simply is not appropriate given the current no-growth environment. If the EU rejects austerity wholesale, downgrades are sure to follow and the downward spiral accelerates.

As the news continues to worsen, investors should ask themselves if they want to be around when the dominoes begin to fall. There is absolutely no reason not to get out now ('buy low, sell high', and we are near four year highs) and every reason to believe that we are near the top end of the range for the short to intermediate term. Short S&P 500 (NYSEARCA:SPY), long VIX.

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