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Why I Am Chopping My US GDP Forecast to 1.5%

For the past two years, I have maintained a GDP growth forecast for the US of 2% a year. I have not stuck with this figure because I am stubborn, obstinate, or too lazy to update my analysis of the future of the world?s largest economy. I have kept this number nailed to the mast because it has been right.

I have watched other far more august institution with vastly more resources than I gradually ratchet down their own numbers towards mine, such as Goldman Sachs (GS) and the Federal Reserve. So I feel vindicated. But now that they are coming in line with my own subpar, lukewarm, flaccid 2% prediction, I am downsizing my forecast further to 1.5%. This is not good for risk assets anywhere, and may be what the markets are shouting at us with their recent hair raising behavior.

I am not toning down my future expectation because I am a party pooper or curmudgeon, although I have frequently been called this in the past. After all, hedge fund managers are the asset jockeys that everyone loves to hate. My more sobering outlook comes from a variety of fundamental changes that are now working their way through the system.

First, let me start with the positives, because it is such a short list. The work week is now the longest since 1945, no doubt being helped by onshoring triggered by rising Chinese wages. The car industry is in amazingly good shape, although the vehicles they are selling in larger numbers are much smaller than the behemoths of the past, with thinner profit margins. Credit is expanding, if you can get it. The housing market has finally stopped crashing and might actually add 0.3% to GDP this year.

Now for the deficit side of the balance sheet. The $4 trillion in wealth destruction created by the housing crash is still gone, and will remain missing in action for at least another decade. The home ATM is long gone. Income growth at 1.7% is still the slowest since the Great Depression, and is far below the historic 3% annual rate. Not only do people work longer hours, they get paid much less money for it.

Home mortgages rationed to only the highest credit borrowers has cut housing turnover off at the knees. This means fewer buyers of appliances and other things you need to remodel a new home purchase. It also kills job mobility, trapping worker where the jobs aren?t. Notice that vast suburbs remain abandoned in Las Vegas and Phoenix, while thousands live in impromptu RV camps in booming North Dakota.

If you want to understand the implications of the fiscal cliff at year end, watch the cult film, Thelma and Louise, one more time.? That?s where the heroines deliberately go plunging into the Grand Canyon in a classic Ford Thunderbird. The noise surrounding the presidential election is going settle ones nerves about as much as scratching one?s fingernails on a chalkboard.

The global situation looks far worse than our own. This is not good, as foreign sources account for 50% of S&P 500 earnings, and as much as 80% for many individual companies. To understand how wide the contagion has spread, look at the numbers put out on a recent JP Morgan forecast.

The European impact on our economy is about as welcome as the 1918 Spanish flu, when million died. (JPM) cut their expectation of growth there from -0.1% to -0.5%. Italy is shrinking at a -2.2% rate. Their prediction for growth in Latin America has been chopped -0.5% to 3.3%, while China has been pared by -0.5% to 7.7%. Japan is enjoying a rare 0.5% pop to 2.5%, but that is expected to fade once a massive round of tsunami reconstruction spending is done. Overall, global growth is decelerating from 4.5% to only 2%, with 82% of that growth coming from emerging markets. The last time a global slowdown was this synchronized was in 2008. Remember what stock markets did then?

All of this may be why hedge funds are fleeing this market in droves as fast as they can, including myself. Many of the small and medium sized funds I know are now 100% cash, and the big ones are only staying because they are trapped by their size. There are few good longs out there for the moment and fewer shorts. Prices are gyrating on a daily basis, triggered by overseas headlines where every else seems to have an unfair head start.

Suddenly the yacht at Cannes, the beach at the Hamptons, and the golf course at Pebble Beach seem much more alluring. Yes, clients dislike it when their managers are flat because they are getting paid for doing nothing. But they hate losing money even more.

Did You Say 1.5% US GDP Growth?

My Tactical View of the Market

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The easy money has been made on the short side this year for a whole range of asset classes. While we will probably see lower lows from here, the risk/reward ratio for taking short positions in (SPX), (IWM), (FXE), (FXY), (GLD), (SLV), (USO), and (CU) are less favorable than they were two months ago.

Of course, the ultimate arbiter will be the news play and the economic data releases. It they continue to worsen as they have done, you can expect a brief rally in the (SPX) up to the 1,340-1,360 range before the downtrend resumes. First, we will revisit the old low for the move at 1,290. Then 1,250 cries out for attention, which would leave us dead unchanged on the year. Lining up next in the sites is 1,200. But to get that low, probably by August, we would need to see something dramatic out of Europe, which we may well get. For the Russell 2000, look to sell it at the old support range of $78-80, which now becomes overhead resistance, to target $72 on the downside.

Don?t underestimate the devastating impact the Facebook (FB) debacle will have on the overall market. Retail investors lost $6 billion on the deal after institutional investors were given the heads up on the impending disaster and stayed away in droves. The media has plenty of blood on its hands on this one. The day before the pricing, one noted Cable TV network reported that the deal was oversubscribed in Asia by 30:1. Morgan Stanley reached for the extra dollars, increasing the size, and boosting the price by 15%. It all came to tears.

Expect investigations, subpoenas, congressional hearings, prosecutions, multi million out of court settlements, thousands of lawsuits, and many careers ended ?to spend more time with families.? Horrible thought of the day: Apply Apple?s (AAPL) 8X multiple, which is growing at 100% a year, to Facebook, which is not, and you get a (FB) share price of $5. None of this exactly inspires confidence in the stock market.

Notice that emerging markets have really been sucking hind teat this year, dragged down by falling commodity prices, a slowing China, and a general ?RISK OFF? mood. This is probably the first sector you want to go back in at the summer bottom to take advantages of their higher upside betas.

The Euro went through the old 2012 low at $1.260 like a hot knife through butter. On the breach, a lot of momentum programs automatically kicked in and doubled up their short positions. That is what has taken us all the way down to the high $124 handle in the cash. Let?s see how the market digests this breakdown. The commitment of traders report out on Friday should be exciting, as we already have all-time highs in short positions in the beleaguered European currency.

The problem is that any good news whispers or accidental tweets on the sovereign debt crisis could trigger ferocious short covering and gap openings which the continental traders will get a head start on. So again, this is not the low risk trade that it was months ago.

Still, the 2010 lows at $1.18 are now on the menu. I would sell all the ?good news? rallies from here two cents higher. Aggressive traders might consider selling penny rallies, like the one we got today. Notice that the Euro is rallying into the US close every day. This is caused by American traders covering shorts, not wishing to run them into any overnight surprises.

The Japanese yen seems to be stagnating here once again, now that the Bank of Japan has passed on another opportunity to exercise more much needed quantitative easing. Therefore, I will use the next dip to get out of my September put options at a small loss. There is a better use of capital and bigger fish to fry these days.

The Australian dollar has been far and away the world?s worst major currency this year, falling from $110 all the way down to $94 on a spike. It now languishes at $97. I long ago stopped singing ?Waltzing Matilda? in the shower. I hope all my Ausie friends took my advice at the beginning of the year and paid for their European and American vacations while their currency was still dear. We could see as low as $90 in the months to come.

Gold (GLD) and silver (SLV) still look week, as this week?s failed rally attests. The strength of the Indian rupee still has the barbarous relic high priced for the world?s largest buyer, and this will continue to weigh on dollar based owners. But we are also reaching the tag ends of this move down from $1,922. Speculative short positions are at a multi-year low. It would take something pretty dramatic to get me to sell short gold again. For the time being, I am targeting gold at $1,500 on the downside, $1,450 in an extreme case, and $25 in silver.

We are well into the move south for oil, which peaked just at the March 1 Iranian elections just short of $110/barrel. The market now seems to be targeting $87 for the short term. The global economic slowdown is the clear culprit here. But in the US, we are starting to see a clear drag on oil prices caused by the insanely low price of natural gas. You can see this clearly on the charts below where gas has been rising while Texas tea has been plunging. Utilities and industry are switching over to the cleaner burning ultra cheap fuel source as fast as they can. As a result, greenhouse gas emissions are falling faster in the US than any other developed country, according to the Paris based International Energy Agency. Sell any $4 rally in crude and keep a tight stop.

When China catches cold, copper gets pneumonia. So does Australia (FXA), (EWA), for that matter. The China slowdown will most likely continue on into the summer, knocking the wind out of the red metal. If copper manages to rally back up to $3.60, grab it with both hands and throw it out the window. Cover when you hear a loud splat. That works out to about $26.50 in the ETF (CU).

It all points to a highly choppy and volatile ?RISK ON? rally that could last a week or two. It will be a time when you wish you took your mother in law?s advice to get a real job by becoming a cardiologist or plastic surgeon. Do you want to know when I want to reestablish my shorts? If you get a modestly positive nonfarm payroll on at 8:30 am on Friday, June 1, that could deliver a nice two day rally that would be ideal to sell into.

Charts Are Breaking Down All Over

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They say a picture is worth a 1,000 words, so here are 4,000 words worth. My friends at www.stockcharts.com put together this series of charts establishing beyond any reasonable doubt that the ?RISK ON? trade is breaking down across all asset classes.

Everything is breaking down, simultaneously and in unison, including the S&P 500 (SPX), Gold (GLD), Silver (SLV), Oil (USO), Copper (CU), the Euro (FXE), the Australian dollar (FXA), and the Canadian dollar (FXC). In the meantime, Treasury bonds (TLT), (TBT) are moving from strength to strength.

The news from Europe can only get worse. An American recession, considered impossible by strategists only a month ago, is now looming large as our own economic data continues to deteriorate. The flight safety has exploded into a stamped, driving the US dollar index up 12 consecutive days, a new record.

I have included a cartoon below from my old employer, The Economist, that neatly sums up the implications of the Socialist win in the French presidential elections. German chancellor, Angela Merkel, is meeting French president, Fran?ois Hollande, for dinner at Das Austerity Euro-Caf?. Austerity preaching Merkel is having a miniscule single sausage for dinner, while Hollande is enjoying a sumptuous repast and obviously ordering the most expensive wine from the list.

The cartoon would be funnier if it weren?t so true. Austerity is now suffering a retreat on the order of Napoleon?s retreat from Russia in the winter of 1815. Her Christian Democratic Union party suffered its worst post WWII defeat in last weekend?s North Rhine-Westphalia elections. It is now looking like Germany will have to accept a higher inflation rate as the price for bailing out Europe, something it is loath to do. Needless to say, this is terrible news for the Euro.

If these charts continue to break down, as the news flow dictates they should, here are my immediate downside targets.

(SPX)? 1,280
($INDU)? 12,200
(IWM) $70
(FXE)? $126
(FXA) $95
(GLD) $150
(SLV)? $25
(USO)? $32
(CU)? $22

Don?t Worry, She?s Picking Up the Bill

Euro Crash Warns of More to Come

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A few years ago on the Old Square in Brussels, a delicious luncheon of moules marini?res paired with an excellent white burgundy with some European Central Bank officials ran far longer than expected. They were attempting to convince me of the long term viability of the Euro, to no avail.

That seriously delayed my departure from Belgium to Salisbury in the English countryside to visit some clients resident at Highclere Castle, which is now the subject of a major TV series. I raced my twin engine Cessna at full power into the sunset, across the English Channel, past the white cliffs of Dover, because my destination airfield had no lights. By the time I arrived it was too dark to land, my alternate airport at Southampton had suddenly closed because of a crash, and I only had 15 minutes of fuel left.

I knew that the pub at the end of the grass runway kept a radio with the tower frequency always tuned in. So circling at 1,500 feet overhead in the pitch black darkness I called in and ordered a full bottle of Ron Rico rum. I told the bartender to pour out 16 shot classes and line then up on the bar. I then broadcast my predicament and said that anyone who would take a rolled up newspaper and dip it in the rum, set it on fire, then line up to light the runway would get a free pint if I landed successfully. I said that if I didn?t get help immediately, I might take out nearby Stonehenge, or perhaps Salisbury Cathedral, in the imminent crash.

Within seconds, I could see the flaming torches dispersing along the field, some in a somewhat drunken fashion. I landed right between the two ragged lines of my improvised landing lights, which lit up the field as clear as day. It was the first time that I landed on a runway that was living, breathing, and even staggering.

As I taxied to my parking space, the starboard engine ran out of fuel and shuddered to a halt. So I just abandoned the plane there to retrieve the next morning. Needless to say, I bought rounds for the house that night until no one was left standing.

Watching the Euro shatter its four month support line this morning at $1.2950, I felt exactly as I did all those years ago in the dark skies over the Wiltshire countryside. The concern was that my put options would run out of fuel before the currency made its big break, forcing me to crash and burn, as I almost did over England. The move sent my short position in the beleaguered currency soaring, and rendered the calls that I sold short only yesterday into dust. It was a good P&L day for the Mad Hedge Fund Trader?s model portfolio.

I am now seriously thinking of becoming a card carrying member of the Greek Communist Party, for it is their young leader, a Mr. Alexis Tsipras, who provided the final straw that broke the camel?s back. Its leaders threatened to challenge the legality of the recent bailout in court. Is Greek rescue package number three now in the cards? The development threatens to undo all of the hard won progress made this year towards resolution of the continent?s sovereign debt crisis. Did anyone expect that asking people to vote for their own austerity and starvation was going to work?

Long term currency watchers had been mystified as to why the Euro had held up so well in the face of such obviously collapsing fundamentals. The markets were rife with rumors of European Central Bank support at $1.30 to prevent a widespread panic that would ignite wholesale Euro dumping. My own theory was that the trade became so obvious and one sided that hedge fund short covering prevented it from falling further. Today, the fundamentals turned so dire that massive selling finally? cleared out? those positions, which is how these things always end.

All I can say is that when it rains, it pours. The profusion of the market developments that I have been predicting all year have suddenly come true in the last few days; the awful April nonfarm payroll, a global synchronized recession that is accelerating to the downside, and the end of the grotesque overpricing of the US stock markets. Also coming home to roost are the contagion effects on all ?RISK ON? assets, including equities (IWM), commodities (CU), oil (USO), the Euro (FXE) (EU), gold (GLD), silver (SLV), and a huge flight to safety bid for the dollar (UUP) and Treasury bonds (TBT).

I thought this summer might be boring. Perhaps I could be wrong. And you wanted me to manage your money? Anyone for a return flight to Brussels to finish that bottle of wine?

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Highclere Castle

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A White Burgundy

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The Brussels Old Square

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A Cessna 340

My Advanced Instrument Landing System

The Hard Numbers Behind Selling in May.

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If I had a nickel for every time that I heard the term ?Sell in May and go away? this year, I could retire. Oops, I already am retired! In any case, I thought that I would dig out the hard numbers and see how true this old trading adage is.

It turns out that it is far more powerful than I imagined. According to the data in the Stock Trader?s Almanac, $10,000 invested at the beginning of May and sold at the end of October every year since 1950 would be showing a loss today. Amazingly, $10,000 invested on every November 1 and sold at the end of April would today be worth $702,000, giving you a compound annual return of 7.10% .

My friends at the research house, Dorsey, Wright & Associates, (click here for their site at http://www.dorseywright.com/ ) have parsed the data even further. Since 2000, the Dow has managed a feeble return of only 4%, while the long winter/short summer strategy generated a stunning 64%.

Of the 62 years under study, the market was down in 25 May-October periods, but negative in only 13 of the November-April periods, and down only three times in the last 20 years! There have been just three times when the "good 6 months" have lost more than 10% (1969, 1973 and 2008), but with the "bad six month" time period there have been 11 losing efforts of 10% or more.

Being a long time student of the American, and indeed, the global economy, I have long had a theory behind the regularity of this cycle. It?s enough to base a pagan religion around, like the once practicing Druids at Stonehenge.
Up until the 1920?s, we had an overwhelmingly agricultural economy. Farmers were always at maximum financial distress in the fall, when their outlays for seed, fertilizer, and labor were at a maximum, but they had yet to earn any income from the sale of their crops. So they had to borrow all at once, placing a large cash call on the financial system as a whole. This is why we have seen so many stock market crashes in October. Once the system swallows this lump, it?s nothing but green lights for six months.
After the cycle was set and easily identifiable by low end computer algorithms, the trend became a self-fulfilling prophesy. Yes, it may be disturbing to learn that we ardent stock market practitioners might in fact be the high priests of a strange set of beliefs. But hey, some people will do anything to outperform the market.

It is important to remember that this cyclicality is not 100%, and you know the one time you bet the ranch, it won?t work. But you really have to wonder what investors are expecting when they buy stocks at these elevated levels, over 1,400 in the S&P 500.

Will company earnings multiples further expand from 14 to 15 or 16? Will the GDP suddenly reaccelerate from a 2% rate to the 4% expected by share prices when the daily data flow is pointing the opposite direction?

I can?t wait to see how this one plays out.

Thank Goodness I Sold in May

Bidding Up the Market

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A few years ago, I went to a charity fund raiser at San Francisco?s priciest jewelry store, Shreve & Co., where the well-heeled men bid for dinner with the local high society beauties, dripping in diamonds and Channel No. 5. Well fueled with champagne, I jumped into a spirited bidding war for one of the Bay Area?s premier hotties. Suffice to say, she has a sports stadium named after her.

The bids soared to $11,000, $12,000, $13,000. After all, it was for a good cause. But when it hit $13,200, I suddenly developed lockjaw. Later, the sheepish winner with a severe case of buyer?s remorse came to me and offered his date back to me for $13,200. I said ?no thanks.? $12,000, $11,000, $10,000? I passed.

The current altitude of the stock market reminds me of that evening. The higher it goes, the more people love it, until they don?t. As the bidding becomes more frenzied, not an hour passes without another technical report hitting my inbox screaming that the market is overbought, high risk, and cruising for a bruising.

When I did the research for my webinar this week, I had to struggle to find a single positive economic data point over the previous two weeks. The only one I found was the weekly jobless claims, which fell 5,000. Well guess what? This morning jobless claims rose by 13,000. That was the last fundamental economic point the bulls could hang their hats on.

If the current rally fails in the next few days, it could set up the head and shoulders top needed to drive managers more aggressively to the sell side.? After all, they have to be seeing the same thing I am, that the economy runs off a cliff at the end of the year.

For a more sobering view of the market, take a look at the two charts below for the Dow Average. If we don?t clear the old support at 13,000 in the next few days, which is now resistance, we may have the makings of a serious head and shoulders top setting up. The fact that this is happening in the run up to May makes them even more interesting.

Who was the hottie in question, you may ask? She shall remain nameless, since she is now happily married to a tech titan and with kids, and gentlemen don?t talk. Suffice it to say, she has a San Francisco Bay Area sports stadium named after her. I?ll let you figure it out.

Jobless Claims Give More Fodder to the Bulls

Diary

No, the important economic event of the week was not the snail like progress towards solution of the European debt debacle. It was the weekly jobless claims announced on Thursday that plunged 23,000 to 381,000, a six month low. That puts it well below the 400,000 level where the economy is generally thought to be expanding.

Yes, you can argue that there are all kinds of temporary, one off hires in these numbers, as retailers step on the gas going into the Christmas season with temp hiring. But there seems to be a lot more than that going on here.

More confirming data came out the next day showing that December consumer sentiment leapt to a surprising 67.7, from 64.1. I think that one big factor in consumers? more positive feelings derive from the fact that the stock market that is no longer crashing, and double dip fears for the economy are now but distant and fading summer memories.

And you can?t view the reports in isolation. They are only the latest in a long stream of modestly improving economic reports which occasionally blow out to the upside.

The news may be enough the enable the S&P 500 (SPX) to tack on another 25 to 50 points by year end. All Europe has to do is to shut up for a few weeks and the US markets will rise. Given that this is the last real working week of the year, that is a distinct possibility.

I am going to use this strength to unload my remaining ?RISK ON? positions in silver (SLV) and the (TBT) so I can go into the New Year fresh, with a flat book. Keep in mind, also, that this is a lousy place to buy. As my friend and former mentor, Barton Biggs, always used to tell me, always leave the last 10% of a move to the next guy.

Winging My Way Back From China

Diary

I am writing TO you from my first class seat on Singapore Airlines, winging my way the 12 hours from Hong Kong to San Francisco. While most airlines jettisoned their first class sections years ago as a cost saving measure, Singapore carried on to maintain its reputation as the best airline in the world. The small section at the front of the bus is populated with a few Chinese billionaires, Taipans, and CEO?s flying at shareholder expense. They are transported in untold luxury with a fully flat bed almost the size of a regular single and a 24 inch high HDTV with a vast movie library. The plane carries double the number of stewardesses on American airliners.

They say a change is as good as a vacation, and this trip certainly fit the bill. I covered 23,000 miles in 17 days, which is really a trip around the world, touching down in New Zealand, Australia, Singapore, Hong Kong, and mainland China. The people I met were fascinating, and included a Maori chieftain, an Australian media mogul, gold miners from Queensland, sheep farmers in New South Wales, Chinese bankers, a Singaporean F-5 combat pilot, and senior officials from the People?s Republic of China. I even managed to track down a Chinese renegade rare earth miner on his day off, and the good news is that he didn?t shoot me, as long as I didn?t take pictures.

I heard some amazing stories and gained some first class intelligence, which I will translate into killer trading opportunities. I will be feeding these out as fast as these old, arthritic and scarred fingers can type them. Alas, I can only knock out about 1,500 words a day before it starts to turn to mush and my back gives out. I will be publishing a series of Pacific country reports over the next four Fridays.

The market? Ohhhh, you want me to talk about the market! Let me give you my quickie read here. My fall rally kicked in right on schedule, my call to cover all shorts coming within a point of the actual bottom in the (SPX). This is the closest I have ever come picking an absolute bottom. After that, it was off to the races with a ?RISK ON? trade with a vengeance. Corporate earnings are coming in much better than anticipated.

This has triggered a buying stampede for all risk assets as hedge fund traders rush to cover shorts and conventional managers frenetically readjust substantial underweight positions they only recently achieved. This has truly been the year from hell, and the word is that 40% of active managers are underperforming their benchmarks by 250 basis points or more.

Having discounted a double dip recession that was never going to happen, Mr. Market is now backing that possibility out again. The net result of all this was to take the S&P 500 from a 1,075 bottom up 17% to just short of my target at the 200 day moving average of 1,275. The entire script unfolded exactly as I expected. Followers of my Macro Millionaire trading service got the memo in my October 8 webinar, The Short Game is Over, and have been laughing all the way to the bank since then. Their year to trade performance now stands at a new high of 42.13%.

The easy money in this move has been made, and we are now bumping up against 200 day moving averages across all equity classes. Expect a prolonged battle to be fought here. So this is not a great place to initiate new positions. Bonds have died, but yields have not risen as much as I would have thought, given the ebullience of the price action.

The (TBT) is the sole position I currently have in my portfolio, and it has only picked up a measly 23% in this move. I would have expected more.

Expect the rally to fail several times at these levels before they make further progress. There is a lot of hot money to flush out here before they can mount a break out to the upside. Take a look at the chart for crude oil and the (USO), which is telling you that this risk on will have longer legs than most expect. What will be the trigger? Surprise progress on the European sovereign debt crisis, or even a deliberate kicking of the can down the road.

One additional note. You have noticed some modifications to the website. No, it has not had a sex change operation to get even with me for my absence. I am launching a major upgrade, redesign, and improvement in functionality, plowing in new capital that thousands of new subscribers have afforded me. The final version will be up and running in a couple of days. But like all great birthing events, this was has not without surprises, difficulties, and setbacks.

Rather than willingly give up its toys to the new kid on the block, our hosting service has chosen to break them instead. In addition, moving over two War and Peace?s on the Internet, the extent of the content I have written over the past four years, is no piece of cake. It took Tolstoy seven years just to write it once, but that was in long hand with a quill pen, so I?ll forgive the old man.

For those who wish to participate in Macro Millionaire, my highly innovative and successful trade mentoring program, please email John Thomas directly at madhedgefundtrader@yahoo.com . Please put ?Macro Millionaire? in the subject line, as we are getting buried in emails.

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