If you believe in the tooth fairy or the “truth” in the official data coming from the Chinese government, then you may dismiss what I am about to say. But everyone else, read closely.
This rally is sham — a traders’ scam. It may last for a while, but the market is simply setting itself up for something much worse than a decline. If this rally continues up to Dow (DJI) 9,000 or so, another potential crash is in the offing.
Why?
Well our already terrible economy is getting worse and we’re headed toward 10% to 12% unemployment — some say more.
One person who says more (13%-plus unemployment, in fact) is one of the most well-respected analysts in the world, Meredith Whitney. She is my favorite analyst and, more importantly, someone who has been spot-on with her calls for more than two years — about everything.
I met Ms. Whitney the day after she told people to sell Citigroup (C) when it was at $40. I was overwhelmed not just by her analysis but her agnosticism — she had no axe to grind.
Her insight inspired me to do some extensive research on the banks that led my ChangeWave Shorts subscribers to make unspeakable profits on short positions in the banks.
On July 13, Whitney said Goldman Sachs (GS) would handily beat earnings estimates. It did, and the market rose 185 points.
She also said this might be a one-to-two-quarter phenomenon, that unemployment would reach 13%, and that home prices, nationally, could end up bottoming at around 50% of their peak.
But the market ignored those calls. It’s sort of like having your doctor tell you “Congrats, you’ve lost weight,” and then going out and eating an entire pizza forgetting that she also told you that you need to lose another 50 pounds to be healthy.
On July 14, Mort Zuckerman, editor-in-chief of US News & World Report also made the case for much higher unemployment. In an op-ed piece in the Wall Street Journal, he said real unemployment was really 25 million people, and that it is going to get much worse before it gets better. He also said wages were stagnant and the work week was shrinking.
In fact, almost no one except for Larry Kudlow, who is still fantasizing about being a member of the Fed or becoming an economic pope, seriously sees any hope of the employment situation getting better any time soon.
What Does Unemployment Mean for Stocks?
More unemployment means less national income, which means less consumer spending, which means more unemployment.
Rising unemployment means more and more mortgage, auto loan and credit card defaults, which reduces available bank capital. This means less credit, the lubricant of economic growth.
Less consumer spending, less credit and less economic growth means lower corporate profits. Corporations have cut expenses to the bone — and generated temporary profits in doing so. But continued revenue loss or stagnation means a fall in profits. And lower corporate profits means a lower stock market.
Right now, the market is trading at multiples of future profits in-line with a growth economy — a 3%-4% growth economy. This is quite an assumption and it’s a dangerous one for investors who are long.
You you cannot hide unemployment statistics. Press releases and headlines cannot fudge the reality. A reduction in the rate of job loss is not an increase in jobs. And unemployment is a direct line to falling corporate profits and falling stock prices.
How to Trade This Rally
So, trade the rally, but recognize it for what it is — something that can disappear overnight. Keep your trades to the upside short term and on a short leash.
Also, start building short positions as hedges against your long ones until the market breaks — and then it’s on to the short side.
Learn The Best Way to Short Stocks.
Michael Shulman is the editor of ChangeWave Shorts. To learn more about him, read his bio here.
