On the surface, the U.S. economy looks great.
Unemployment has come down to around 5% today. This means more paychecks and in turn, spending. Spending moves the economy forward.
One area Americans are spending again is housing. Home prices are almost back up to pre-crisis levels. Americans are also traveling more. We pay less in gas costs but spend the savings elsewhere.
The economy is chugging along. As a result, the U.S. stock market is near all-time highs. The bull market is over seven years old. It’s the second longest in U.S. history.
Everything is rosy, right? That’s what politicians and the Fed would like you to believe. But at Kehm Research, we look past the face value. Great investing comes with healthy skepticism.
Let’s take a look under the hood.
First up is unemployment. The widely stated 5% rate doesn’t count millions of able-bodied Americans. Some estimates put unemployment closer to 25%. If you want proof, I recommend reading our article on software replacing jobs.
Now home prices have recovered, but once again, the fundamentals are shaky. The lending standards are tighter but mortgages are cheap. Historically low interest rates have pushed more people to buy. Unfortunately, low rates won’t last forever. The Fed is already slowly raising them. This will put pressure on home sales.
The government had to take extreme measures to keep rates low. It pumped over $4.4 trillion into the market. The U.S. has racked up massive amounts of debt. The U.S. debt is over $19 trillion dollars. That’s over $160,000 per taxpayer. The U.S. debt is out of hand.
For comparison, the U.S. has been eating unhealthy and smoking for years. Now the side effects are starting to kick in. The U.S. has quit smoking (QE) and is using nicotine patches to get by. Fixing the real problem will be tough.
The U.S. debt is a major issue. Unwinding it will devastate the economy. There simply isn’t a good solution so politicians keep kicking the toxic can down the road. But there is one area that will fall before the government’s tower of debt…
Short the S&P 500
The average bull market lasts three years. The one we’re in today is over seven years old. This aging bull market is now stumbling and it’s on its last legs.
One reason the stock market has climbed this long is lower rates.
Low rates spurred companies to take on more debt. The companies used this cheap cash on acquisitions and buybacks. Last year the S&P 500 companies spent about $1 trillion on acquisitions and buybacks. That’s more than was spent on new equipment and R&D.
Acquisitions boost earnings but a premium is paid. Acquirers get the short end of the stick and often pay too much. It’s almost always better to own shares of the company being acquired.
Now buybacks have even less benefit. It reduces the shares outstanding and raises earnings per share. It makes companies look more profitable but little actually changes. Buying back shares in an aging bull market is even worse.
The evidence pointing to an overvalued stock market keeps piling up. And there is one more powerful piece I’d like to show you.
Even with all the acquisitions, company earnings in the S&P 500 are dropping. They have dropped for the last three quarters. They’re expected to drop more. It’s a bad sign.
I’m now betting against the S&P 500 with two thirds of my total portfolio. I’m shorting the SPDR S&P 500 ETF Trust (SPY).
The S&P hit a high of $2130.82 just over a year ago. Since, it has tested that level multiple times with no success.
Last Friday the S&P 500 closed just 1.5% below its all-time high.
I now think it’s a great time to short the S&P 500 and I’ve taken action. A whopping two thirds of my portfolio’s value is short. The reward could be big, but more importantly, I’m keeping the risk low…
Risk On Risk Off
Investing is all about risk to reward. Focusing solely on the reward won’t get you far for long.
One major risk is that the U.S. dollar is the best of the worst currencies today. Other countries are charging negative rates. It’s pushing foreign investors to the U.S. markets. This money flowing in could push the S&P 500 higher.
Many economic factors could push stocks higher. It would be bad for my short position… but my biggest concern is irrational investors. The stock market is a voting machine. Supply and demand determine share price. Although the evidence I’ve shown you pointing to an overvalued market is strong, investors could keep pushing stocks higher. A quote by John Maynard Keynes best sums it up…
“Markets can remain irrational longer than you can remain solvent”
With this in mind, I have a stop loss ready to manage the risk with my short position. If the S&P breaks above $2130.82 (closing day price), I’m out. It’s as simple as that. This way I’m only risking about a 1.5% loss.
Using a stop loss will let me admit I’m wrong and move on. It eliminates emotional trading. Emotions are not your friend when trading.
Time is also a risk when shorting the market. I have no doubt the S&P 500 will be trading higher 10 years from now. I will be out of this trade within the next 6 months and hopefully much sooner. A dividend is coming up next month on the SPY that I’d prefer not to pay.
If the trade moves in my favor, I also have a win taking strategy ready. Ask me about it…