I’m not typically a “nervous Nellie,” but recently I find myself more worried than Wall Street about the state of the economy. Last year I pounded the table to buy every dip, especially off trade war headlines with China. This year, I cringe to see the rebound from the quarantine crisis, which appears clearly overblown.
The fact that the NASDAQ set new all-time highs raises a lot of flags. My first instinct was to short these overheated markets, but to do so in a way that allows for interim choppiness to resolve itself. Soon enough reality will set in that government stimulus will not be sufficient to get us out of the hole we find ourselves in.
Some of yesterday’s comments from U.S. Federal Reserve Chairman Jerome Powell support this thesis. He said the number of unemployed who will not get their old jobs back is projected to be “well into the millions.” This is a terrifying statistic, yet you wouldn’t know it from the stock market.
Wall Street is assuming that we are headed back to normal quite soon. In reality, the new normal will certainly be less than 100% capacity of what we had before. This isn’t supposition, but a simple fact of the social distancing measures and such put in place as a response to the viral pandemic.
To that point, yesterday Starbucks (NASDAQ:SBUX) announced the company will take a $3 billion hit to revenues. They said that they will have “modified operations” and “limited seating,” and that some stores will be “mobile orders only.” There is just no way the new P&L (profits and losses) numbers will be as good as they were before, and investors’ response has been to stick their heads in the sand.
Starbucks is just one case study that illustrates my wider concerns regarding Wall Street attitudes. The current scenario reminds me of the dot com bubble, but much, much worse. Back then the problem was too much hope and greed. This time around we actually have a broken economy.
The virus is still here and the vaccine maybe more than a year away. In addition, we have at least 20 million people out of work. Yet sentiment flipped 100% positive on Friday after just one hotter-than-expected jobs report, whose relatively “good” numbers are still objectively awful.
I still truly believe in buying the dip for quality stocks, but I refuse to chase after upside against such sheer uncertainty. Some stocks deserved to rally, such as Amazon (NASDAQ:AMZN), but plenty of others, with little to no support from fundamentals, were only levitating in sympathy.
Here are 3 stocks I predict will take a swoon when the material reality of our economy douses the market with cold water.
- The Invesco QQQ Trust (NASDAQ:QQQ)
- The iShares Russell 2000 ETF (NYSEARCA:IWM)
- SPDR Gold Shares (NYSEARCA:GLD)
This is a mild way to place a bearish bet on the economy without taking on too much risk.
Overheated Stocks to Short On this Massive Bounce: Invesco QQQ Trust (QQQ)
The NASDAQ rally to new all-time highs started with mega-cap stocks. Then frothier tickers such as Zoom Video (NASDAQ:ZM) and Shopify (NYSE:SHOP) had their day in the sun. When those got tired yesterday, the rally rotated back to mega-caps, with Apple (NASDAQ:AAPL) and Salesforce (NYSE:CRM) up 3% and 4% respectively. This clearly suggests that investors aren’t interested in cashing out of the market, as buying continues apace.
So the net effect of their actions is continually more bullish than the day before. This can’t go on forever, but trying to time the exact moment to catch a falling knife is quite difficult.
The best way to take a bearish position with decent margin for errors is to utilize the options market. To short the NASDAQ, I recommend the ETF QQQ and there are a number of different approaches you could take here.
For myself, I would rather keep it simple and buy a vertical put spread, where I can control my total risk size and the odds of success. To execute this I buy the August $235/$230 put spread for $2.50 per contract. This is my maximum risk, and if prices fall below the spread, I stand to gain $7.50.
Another way investors can short QQQ while leaving room for error is to sell bear call spreads above current levels. This is a slightly more forgiving path that accounts for the possibility that the NASDAQ continues to rally from here. For this trade, sell the August $265/$270 call spread.
This would be a credit, so you would collect $1 per contract (my maximum reward), but I won’t need a rally to win. If the QQQ stays below the spread, you’ll retain my maximum profits. Otherwise, you stand to lose $4 per contract if this madness persists. In either case, you can accept the maximum loss and manage your percentage of success.
The iShares Russell 2000 ETF (IWM)
While large-cap NASDAQ stocks hog all the headlines, the small caps have piqued my attention. This is a basket of 2,000 stocks and even though collectively they don’t amount to two mega-caps, the way they trade speaks volumes about “the market.”
Of late, small caps have been lagging. Case in point, yesterday they fell as the NASDAQ rallied, and they last peaked in 2018. Part of the recent rally has been on the backs of banks, which were overextended and shortable just two days ago. When banks fall they put downside pressure on small caps. This will continue and probably gather steam, particularly if the NASDAQ loses its luster.
Usually the IWM small caps ETF runs faster in both directions than the QQQ, so it should also make for an exciting short. It has been vulnerable mid-term, so as of last night’s close investors could buy the September $135/$125 debit put spread for $2.50. When the correction comes, you can win up to $7.50 per share if the IWM stock falls through the spread into September.
Here a bear call spread would also work, without necessitating a rally to win. Moreover, if you’re feeling especially bearish, you could do both and really amplify the potential profits.
Under that setup, even a small drop in the IWM would yield huge profits because the expense base is practically nil.
The SPDR Gold Shares (GLD)
Being long gold is often a hedge on the stock market. So bullish gold trades are another way to short equities now. This is especially true these days because of how aggressively central banks have been printing money. While their respective economies certainly need their help, the rhetoric that they’re spewing everyday is unbelievably irresponsible.
Never before have we had a Federal Chair appearing on TV every other month to reassure investors that they can still print plenty of money. I still remember the days when we needed a decoder ring to understand whatever Mr. Greenspan was saying. A more balanced approach by the central banks lies somewhere between these two extremes.
The end result is that the action of the Federal Reserve, given the massive size of the stimulus, is killing the value of cash. So something else has to be a better bet to hold value.
Gold and Bitcoin are two assets the government cannot control. My preference is to buy gold because of its lengthy history, and I find it simpler to trade as well. I do hold physical gold for the long term, but investors can very simply use GLD stock to place similar long-term bets.
The easy trade is to buy at-the-money leap call options or call spreads that accomplish the same thing. When I have confidence in the value of a ticker, I can also sell puts or put spreads in order to finance my upside purchase. In this case I can get long gold with minimal out-of-pocket expense.
To accomplish this I sell the December $145 put and collect $3 per contract. Gold can fall 15% and that portion is a 100% win. In addition I can buy either GLD stock or the December 2021 $155/$160 debit call spread for $2 which would more than double my money, even absent a rally. Doing both would then make this trade a huge win with a credit to open. The risk from selling the put is that you would have to buy GLD stock 11% below current prices.
In closing, I want to reiterate that my nature is to be bullish, and frequent readers know this already. But I do take pause when I see irresponsible behavior, especially when it stems from the top financial leaders of our country.
Mr. Powell yesterday did not addressed the risk to the economy from the new set of health rules that prohibit us from going back to what we had before. This is a quantifiable obstacle to recovery, yet it was simply glossed over.
And speaking of math, I also found it unbelievable that they forecast negative GDP for 2020 yet see next year rebounding to above normal. This is simply astonishing, and though I am not an economist, it seems mathematically improbable.
None of the reporters pushed back on that front either.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.