Why the Sell-Off Happened - and How to Make Money on It

Shah Gilani

It shouldn't come as any surprise that U.S. stocks went into free-fall mode last week.

The signs were everywhere. I'll prove it to you in a moment.

What's likely to happen next is no less frightening, so investors better look for cover.

But before that happens, I'm going to show you all the telegraphed signs that this was coming and what to look for next.

Then I'm going to show you how to cash in...

Investors Were Only Too Happy to Forget About the Fed

The big, big picture that too many investors lost sight of was that the U.S. Federal Reserve's zero interest rate policy (ZIRP) and massive quantitative easing moves didn't stimulate economic growth.

And it didn't work when the European Union, Japan, and China tried them, either.

Lower interest rates were supposed to stimulate consumption, production, and gross domestic product (GDP) growth. And they were designed to lift asset prices - in the case of the Fed, this was an articulated policy goal.

In the Federal Reserve's "wealth effect" scenario, consumers would feel better about the economy's prospects (and their own) by watching stock prices rise.

Rising stock prices, fueled by cheap money in the U.S. that financed $2.7 trillion worth of stock buybacks in the past six years, of course lifted share prices and increased earnings per share metrics (because the same or lower earnings are measured against fewer shares).

The one-two punch of corporations buying their shares at ever-increasing prices and better earnings metrics made stocks look better and better to the untrained eye. And that created a "virtuous momentum"-fueled push to higher highs for equity averages.

While other countries were following the Federal Reserve's lead, China not only lowered interest rates but embarked on a debt-fueled stimulus tear - including runaway infrastructure spending.

According to McKinsey Global Institute research, China's total public and private debt burden skyrocketed from less than $7 trillion in 2007 to more than $28 trillion by mid-2014. And still, China's GDP growth has been slipping badly.

The combination of low interest rates diverting investment capital and savings into capital markets, chasing equities and increasingly lower yielding fixed income securities, and China's stimulus efforts to increase infrastructure, manufacturing, and its exports, which led to over production and stockpiling of commodities, brought us to this point.

That's a big, big picture I just painted, of course. But beneath that, mechanical realities were signaling trouble.

The price of oil has been sliding. When the price of the most important commodity in the world starts to slide, it's not just because America's new record production of 10 million barrels a day is tipping the supply side of the equation.

And it's not that other producer countries desperate for revenue (which is another indication of trouble) are pumping furiously.

The price of oil, that critical bellwether, is crashing because global demand hasn't been rising as much as it was, because global growth is slowing. That's been a flashing light.

Shah Gilani

About the Author

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Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.

Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.

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