Daily Gains Letter

How to Make the Most of the Inevitable Changes in the Market

By for Daily Gains Letter |

Downward Growth Revisions Still Offer Chances to ProfitRight now, the S&P 500 is just two percent from its all-time high and the Dow Jones Industrial Average is just half a percentage point away from its own record. That’s why I think it’s the perfect time to short both.

The stock market indices have gotten ahead of themselves. In fact, they might be the only spot in the entire U.S. economy showing signs of growth—the markets are running counter to every economic indicator they are supposed to reflect.

The International Monetary Fund (IMF) cut its growth forecast for both the U.S. and global economics. The downward revisions come on the heels of the Federal Reserve saying it would most likely start to taper its $85.0 billion-per-month quantitative easing policy this year. This action will, of course, lead to an increase in interest rates.

After initially predicting U.S. 2013 growth of 2.2%, the IMF revised it downward to 1.9% in April, then modified it downward again this week to just 1.7%. (Source: “Emerging Market Slowdown Adds to Global Economy Pains,” International Monetary Fund web site, July 9, 2013.)

That means that the IMF has revised its 2013 economic growth projections for the U.S. downward by almost 25%. It also altered its projections for the U.S. economy in 2014, from 2.9% down to 2.7%.

The downward revisions shouldn’t come as a big surprise. Unemployment remains high, S&P 500 companies continue to sit on record sums of cash, and gold prices have tumbled. Japanese government bonds have tanked and China’s economy is cooling; so, too, are interest rate–sensitive sectors, like utilities and homebuilders.

Here at home, the writing has been on the wall for ages. During the first quarter of 2013, 78% of S&P 500 companies issued negative earnings-per-share (EPS) guidance; during the second quarter, 81% of S&P 500 companies issued negative guidance.

Even with the downward revisions, S&P 500 companies continue to miss the mark. Oracle Corporation’s (NASDAQ/ORCL) third- and fourth-quarter results showed no revenue growth, and FedEx Corporation (NYSE/FDX) revised its full-year adjusted EPS forecast downward to an increase between seven percent and 13%, well below the 21% consensus many analysts were expecting. Alcoa Inc. (NYSE/AA) kicked off the traditional second-quarter earnings season saying it lost more money than expected because of restructuring costs.

Even with the U.S. and global economies looking increasingly unstable, the S&P 500 and Dow Jones Industrial Average responded with strong gains. Investor optimism, it seems, knows no bounds.

But that optimism will eventually fade. Once the Federal Reserve stops supporting the markets, the S&P 500 and Dow Jones will have to stand on their own economic footing. At that point, it will be impossible for investors to overlook mediocre and disappointing results and downward revisions.

And that could be a tipping point for the S&P 500—and markets in general.

Astute investors with patience could profit from exchange-traded funds (ETFs) that short the S&P 500, Dow Jones Industrial Average, and Russell 2000 Index. The ProShares Short S&P500 (NYSEArca/SH) ETF seeks a return that corresponds to the inverse (-1x) of the daily performance of the S&P 500, while the ProShares UltraPro Short Dow30 (NYSEArca/SDOW) ETF seeks daily investment results that correspond to three-times the inverse (-3x) of the daily performance of the Dow Jones Industrial Average.

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