The Best Inverse Play, as the Market Goes "Back to the Future"

Money Morning Contributor
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Markets produced their strongest returns in four years in October – ignoring a steady stream of bad economic news and lousy corporate earnings.

The Dow Jones Industrial Average soared 8.5% while the S&P 500 jumped 8% for the month.  The Nasdaq Composite Index was driven higher by strong big tech earnings. It skyrocketed by 9.38% and is now back above 5000.

Last week’s gains were muted with the Dow rising 0.1% or 16 points and the S&P 500 rising 0.2% or 4 points, so perhaps the jubilation is ebbing. The Nasdaq Composite Index gained 0.4% on the week.

Of course, some strategists are calling for the rally to continue and for the market to gain another 10-15% by year-end.  All I can say is that if they want to send over what they are drinking, I will take a sip. But I will not reach my hand into my pocket and follow them into the market. The market is extremely overbought and investors should proceed very cautiously from here.

Credit markets also joined the party. The average yield and spread on the Barclays High Yield Bond Index rallied by 59 and 67 basis points, respectively, in October. That’s an extremely strong performance. The average yields on energy bonds and basic industry bonds – the weakest industry sectors – even rallied slightly, though they still remain deeply distressed.

The spread on Barclay’s Investment Grade Bond Index also rallied by 11 basis points back down to 150 basis points. The yield on the 10-year Treasury bond ended the month at 2.15%, after the Fed’s October meeting predictably led to nothing. The Fed has continued to play Hamlet regarding a potential 25 basis point interest rate hike in December.

Fed Promises and Large-Caps are Driving the Delorean

October’s gains were of the “Back to the Future” variety as investors piled into momentum trades – all based on tired central bank promises to keep printing money until the global financial system simply collapses under its own weight.

Of course, the former tenured economics professors didn’t phrase their promises exactly that way, but that is the logical outcome of what they are doing. After countless bouts of QE, which have produced tens of trillions of debt and little growth, they decided to double down on failure. Their policies will prove to be one of the most profound intellectual and moral failings in history. It is going to drive the world over a cliff.

The first estimate of U.S. third quarter GDP growth came in at 1.5% this week, higher than I expected but still pathetic. The U.S. economy is running barely above recession levels, especially when you consider that the data is cooked.

The financial media and Wall Street continue to tout a (non-existent) self-sustaining economic recovery, while investors chase stocks higher on the hope-and-prayer that central bank policies, which have failed so far, will suddenly work now that we are at the end of the Debt Supercycle. Most investors are just trying to salvage a terrible year, but they are placing themselves in harm’s way because the market is getting very frothy again.

If anybody had any remaining doubts about the credibility of the financial media, they were put to rest once-and-for-all by the performance of CNBC’s talking-heads at the Republican Presidential Debate last week. Not only did CNBC troika demonstrate their obvious bias, but they also exhibited an ignorance of the facts and of basic economics. This explains why CNBC is considered a laughing stock by serious people in the investment world.

Anyone who listens to CNBC, or anyone else in the mainstream financial media, for investment advice deserves to lose all of their money. Eventually people are going to realize that the mainstream media in this country has become a clear and present danger to our freedom and our pocketbooks.

The rally has been weighted to large-cap stocks – particularly large-cap tech stocks. Companies like Apple (Nasdaq: AAPL), Amazon (Nasdaq: AMZN), Alphabet Inc. (Nasdaq: GOOG), (Facebook: FB), and Microsoft (Nasdaq: MSFT) are among the few reporting strong earnings, and they have an outsized impact on cap-weighted indexes.

How To Protect Against a Stealth Bear

Much of the rest of the market remains in a stealth bear market, especially anything energy or commodity related. Several of the oil giants reported earnings last week and their results were ugly.

They included big losses and large job cuts. The oil giants are reporting tens of billions of dollars of negative cash flow this year and are trying to restructure their businesses to be profitable based on expectations that oil prices will stay lower for longer. December West Texas Intermediate crude ended the week at $46.59 per barrel. In addition, natural gas prices have collapsed further from already depressed prices, putting further pressure on the sector.

December 2015 natural gas ended the week at $2.31 per million British thermal units – down 8% on the month. Investors should start preparing for dividend cuts at the oil giants in 2016 if prices don’t begin to rise. And they should remember that industry fundamentals, important as they are, pale in comparison to the impact of a strong dollar on commodity and energy prices. With further QE expected from Europe and Japan, the dollar is likely to remain strong and maintain pressure on oil prices for the foreseeable future.

Finally, the circus at Valeant Pharmaceuticals (NYSE: VRX) continued last week. The company’s stock dropped by 16% on Friday to close at $93.77 per share (it lost another $1.47 after hours, down to $92.30).

My column on Sure Money provides the details of the latest disclosures regarding the company’s relationship with Philidor. Valeant drop-kicked the mail-order pharmacy on Friday after CVS (NYSE: CVS), Express Scripts (Nasdaq: ESRX) and other major drug chains cut off ties with it.

VRX has now cost hedge funds billions of dollars. And the company is likely to be subject to multiple investigations and lawsuits that will tie down its management for years to come. This is wholly appropriate for a company that prays on sick people by raising drug prices (by an average of 66% a year over the last five years). And they do this after buying up other companies and firing thousands of their workers.

I’ve recommended that investors buy March 2016 puts at up to $4.50 per share because I expect the stock to move much lower.

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