At a PE multiple of 20 times earnings, US equities (SPX) are at the top of a seven year valuation range. Emerging markets are even worse, with China sporting a positively bubblicious 40 multiple.
There is no doubt that corporate managements panicked at the beginning of 2009 and chopped overheads at an unprecedented rate, leading to the eye popping, jaw dropping 700,000 monthly nonfarm payroll losses we witnessed. With the economy snapping back faster than any of them expected, they accidently created the widest profit margins in history.
Don’t expect lightening to strike twice in the same place. Those margins can only shrink from here, either through the long delayed rehiring of workers that bumps up costs, or because of a subpar recovery or double dip recession that slashes revenues. Equities are a lose-lose trade here, threatening more downside than upside. My former mentor, Barton Biggs, taught me to always leave the last ten percent of a move for the next guy, which I always considered sound advice.
Unfortunately, with interest rates at zero, and $9 trillion sitting in short dated instruments, some models value equities at infinity, and many traders seem hell bent on taking stocks there. So as expensive as equities are here, they may be about to surf a New Year tidal wave of liquidity to even greater heights. During their eighties stock market bubble, the Japanese loved to quote a favorite local expression: “When the fools are dancing, the greater fools are watching.” That was the decade when we took the multiple on Japanese stocks from 10 up to 100. The same may apply now to American equity investors.
I think this next boost could well be setting up one of the great shorting opportunities of the decade, which could start tomorrow, next week, next month, or by summer at the latest. The risk/reward of a long equity position here is terrible. I am particularly keeping in my crosshairs sighted on anything with a poor balance sheet, especially in financials, REIT’s, housing, and retailers. The bell ringer that the top is in will be a failed Treasury auction that triggers frightening, simultaneous sell offs in stocks, bonds, and the dollar. With the volume of government debt offerings increasing at an ever accelerating rate, it’s only a matter of time before this happens. Just as last year delivered a “V” market, this year could bring us the inverted “V”, or a Greek Lambda, “ᴧ”.
If some bully is holding you by your ankles outside a high floor window, threatening to let go if you don’t buy equities, only pick the emerging market variety (NYSEARCA:EEM) where forecast GDP growth rates are the highest. Think the BRIC’s, Brazil (NYSEARCA:EWZ), Russia (NYSEARCA:RSX), India (NYSEARCA:PIN), and China (NYSEARCA:FXI), with South Korea (NYSEARCA:EWY), Taiwan (NYSEARCA:EWT), and Indonesia (NYSEARCA:IDX) thrown in for a more sophisticated flavor. I prefer my portfolio with a generous soy sauce and ginger flavor, with a little kimchee thrown in for spice, a nice Russian pavlova for desert, all washed down with some strong Brazilian Arabica coffee.
But keep an itchy trigger finger on your mouse, because when the turn comes, there will be no place to hide. And make sure you increasingly add downside protection in the form of cheap puts, or some simply simple stop losses as we grind our way up towards our appointment destiny. Also be sure to beat the rush by booking long vacations at that house in the Hamptons, the lakefront property at Tahoe, or the mega yacht in the Mediterranean, early.
For more iconoclastic and out of consensus analysis please visit me at www.madhedgefundtrader.com .