October 15, 2009 – We think the markets are totally overdone at current levels and the risk/reward is leading heavily in the risk side of the equation. To that end, we like the short ETF positions on the Nasdaq and the DJIA – respectively, NYSE:QID and NYSE:DOG.
Here is our rationale:
The markets have been on a tear since March. The DJIA is up 3,560, or 55% while the Nasdaq is up 899, or 71%. While the 100-day simple moving averages are 8.9% and 9.7% below current trading levels.
The markets have been pricing in widening expectations that the economy is stabilizing based on a steady string of ‘less bad’ news. But in our opinion, the news is still bad:
• 9.8% unemployment – in order for the economy to get mark-to-market its job situation to pre-recessionary levels, it would have to add 500,000 jobs per month for the next 16 months. But businesses aren’t investing back into the workforce yet, due to…
• Still tight credit markets – commercial banks are not lending. We looked this morning at commercial loans and the pace of declines in commercial loans is actually accelerating – down 1.1% in July, down 2.3% in August and down 2.5% in September.
• Credit card defaults are still at historic highs, delinquencies are up and home foreclosures still on the rise -RealtyTrac reported this morning that the number of homes in foreclosure rose more than 5% from summer to fall, impacting almost 938,000 properties in the July-September quarter. Foreclosure-related filings are now on pace to hit about 3.5 million this year, up from 2.3 million last year. And with unemployment at 9.8% and expected to rise well into the 10% range into 2010, the outlook for homeowners remains poor.
• Now, the dollar is sliding amidst unchecked debt spending and monetary expansion – the implication here is that erosion in the dollar will usher in inflation.
Against this backdrop, we can’t be bullish. The consumer is the fundamental engine for our economy. If the consumer is in disrepair, the economy will not expand, period. But valuations in stocks are reflecting just the opposite. Valuations relative to forward earnings on the S&P;500 have not been this high in years!
We don’t see where the corporate performance is going to come from given the current state of the consumer. In a ‘healthy’ economy, consumers are expected to spend 97% of their disposable income to support 70% of GDP, while consumer credit has tipped to about 22% of GDP.
Add to the equation the fact that consumers are on the hook for $7.5 trillion of the close to $12 trillion national debt and consumer debt represents about 69% of GDP!
The fundamentals are just not there for growth. But this is exactly the opposite of what the markets have been telling us for the past few months.
As the saying goes, the markets can stay irrational longer than you can stay solvent. Regardless, we think a prudent strategy at this point is to hedge against downside risk and the QIDs and DOGs are, in our opinion, a good hedge.
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