After many months of fighting all the naysayers predicting the next big stock market crash, I am finally succumbing to the seductive story of the dark side, and getting negative on equities. I am often early, so maybe this means the rally is about to accelerate to the upside. I am willing to take that chance. It would be just like me to pound the table on the long side, and then abandon the trade right before it goes parabolic.
But when I examine the current environment, I worry the credit expansion wave that has been dragging stocks higher is about to crest. Before I go into my reasons for switching sides, let’s take a moment to remember how we got here.
I’ve been bullish for a while. Not because I thought things were well in the world. No, I was bullish for almost the opposite reason. As I stared at the massive expansion in the ECB, Bank of Japan and Swiss National Bank’s balance sheets, I thought there was no point in standing in front of the monetary expansion freight train. The amount of printing by these banks was truly staggering. We have become somewhat numb to these sorts of numbers, but a combined $14.5 trillion dollar Central Bank balance sheet is Johnny Depp crazy.
For a while we had the perfect storm of good news. A new American President who promised tax cuts, deregulation and fiscal infrastructure spending. The ECB and the Bank of Japan were filling blue tickets as fast as their clerks received fills. The Federal Reserve was tightening, but they had not yet pulled out any pink tickets for their inventory, and it appeared the US economy would be able to weather slightly higher rates.
Stocks exploded higher. Even with some very accomplished hedge fund veterans preaching caution, the price just kept rallying in their face. The more bearish they got, the more it rallied.
But over the past few months, slowly the story broke down. The President, once revered by Wall Street, failed to pass his health reform legislation, which pushed the tax cuts further into the future. Shortly thereafter it became obvious the much salivated infrastructure stimulus would also be difficult to pass through Congress. Almost overnight, the President become more of a liability for US equities than an elixir.
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