Take Profits – Then Take Cover

Michael E. Lewitt

Investors should not be fooled by the strong performance of stocks last week. Fundamentals have not changed and still present major headwinds to a market recovery.

Oil ended the week at $29.64 per barrel (WTI crude), which is still too low to save struggling fracking companies from the junk heap. The junk bond market backed away from 10% yields but is still a disaster zone. And major hedge funds are still nursing double-digit losses.

What we saw was a classic short-covering rally inside a bear market that has further to run. Readers should not let their guards down and let themselves get fooled into diving back into dangerous waters. If they do, they will drown.

The Dow Jones Industrial Average gained 418 points (2.6%) to close at 16,391.39 last week, while the S&P 500 jumped 53 points (2.8%) to 1,917.78. The Nasdaq Composite Index, home to the most speculative stocks, jumped by 4% to close at 4,504.43. Investors should use rallies like this to lighten their stock exposures before the market takes another leg down.

Stocks were pushed higher by more idiotic comments from European and Japanese central bankers promising to make greater efforts to destroy their currencies and create inflation. Worse, they promise to do so regardless of whether they destabilize the global financial system in the process. Markets were also treated to more remarks from a variety of U.S. Federal Reserve officials sending mixed signals about their intentions to raise interest rates further.

The sheer incompetence of central banks is reaching such epic proportions that it is only a matter of time before markets lose whatever scraps of confidence they have left in this confederacy of dunces. Japan's economy is falling apart again, Europe's is not behind, and despite reports to the contrary, the United States is going nowhere. Coming after over 600 interest rate reductions and $12 trillion of QE, it is about time for the world to declare further central bank efforts dead on arrival.

Corporations Are in Crisis-Level Condition

Last week, Bank of America confirmed work done over the past couple of years by other firms like Societe Generale and Goldman Sachs, showing that corporate balance sheets are in terrible shape. Corporations are more leveraged today than they were in 2007 before the financial crisis. This was disguised by low interest rates until the junk bond market collapsed and interest rates on investment grade companies blew out.

Now all of these highly leveraged companies are going to have to start refinancing their debt at much higher interest rates and many of them are not going to be able to do that. This means that many of them will default. The combination of an orgy of borrowing by energy companies expecting $100 oil, private equity companies borrowing to pay themselves dividends, and corporations borrowing to buy back stock has left corporations with huge debt burdens that they can't repay.

Equity analysts, such as the one that recently upgraded IBM without paying any attention to the company's negative tangible net worth, don't pay much attention to balance sheets. But they are going to be a big story in the months and years ahead as the credit cycle unwinds and dozens of companies default.

A lot of commentators are obsessing over whether the United States is going to enter a recession. This is based on their belief that we can't have a bear market without a recession. By the time they reach a conclusion, it is going to be too late for investors.

At the zero bound – when interest rates have been lowered to zero – the normal rules do not apply. We are already in a bear market that started in late 2014 after China's economy hit a wall, the commodities complex collapsed, and the Fed ended QE.

There is nothing on the horizon that would lift stocks out of a bear market – the U.S. economy is not going to suddenly explode into 4% growth and neither China, Europe, nor Japan is going to reverse their economic slides. The global economy is suffocating under too much debt and there is little that central banks can do to stop it. Only a coordinated pro-growth fiscal policy plan would have a chance of making a difference and there is virtually no chance of one materializing.

Some commentators and readers say I am too negative. But I am not negative – just realistic. I don't want Money Morning Members to lose money. In a bear market, it doesn't matter what you own. All of your stocks and junk bonds are going down.

Your best plays right now are cash, gold, and Treasuries – along with very beaten down stocks and assets that you can afford to hold for a long time. You should be more worried about the return of your money than the return on your money.

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Michael E. Lewitt

About the Author

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Prominent money manager. Has built  top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.

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