The Sovereign Investor

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Time to Prepare for the Bear

By Chad Shoop

“Let’s make a bet,” my 6-year-old son said to me when I picked him up from school the other day. “I bet we get home at 2:56. If we get home then, you owe me $10!”

“Sure,” I said. “But you owe me $10 if you’re wrong.”

Seeing as I had control of the wheel, I figured it was a bet worth making just to prove a point — don’t gamble, and never bet money on something the other person is in control of.

At the end of the bet, another life lesson came into the picture — the different interpretations of what exactly defined the bet. That brings me to the issue at hand today.

So let’s make a bet, just to prove a point: I’ll bet you $10 that we entered an earnings recession back in April when our investment director, Jeff Opdyke, pointed it out. You can take the other side of that bet, and say we are not yet in an earnings recession.

The truth is an argument could be made for both sides of this bet. Officially, an earnings recession is two consecutive quarters of falling corporate earnings. However, there are many different ways to define what corporate earnings are.

You could look at net income, operating profits, earnings per share or adjusted earnings per share. Either one could technically define an earnings recession, which is why we could both be wrong in our current bet, or we are both right, depending on how you look at it.

This is what I mean by interpretations.

Maybe you have a lot of confidence in corporate America and trust their adjusted earnings to be a true reflection of the current situation. Maybe I focus on profits they’re actually generating by looking at operating profits, which went into a recession earlier this year.

No matter how you look at it now, an earnings recession in even the broadest sense is becoming a reality, and that means trouble may be just ahead … as well as opportunities to profit.

The Fed’s Battle Not to Kill the Market

As I mentioned, back in April, Jeff Opdyke called out that we were in the midst of anearnings recession even though we are just now hearing it in the mainstream media. At the time Jeff wrote his article, reported earnings per share according to GAAP (generally accepted accounting principles) had declined 17% from the third quarter of 2014 to the fourth quarter of 2014. Then from the fourth quarter to the first quarter of 2015, earnings fell another 4% — meaning we entered an earnings recession as he expected. And the picture hasn’t really improved since, considering the number of companies who have continued to cite the strong dollar as the reason for lower revenue.

The mainstream media is so far behind because it focuses on the manipulated side of earnings data, adjusted earnings per share. But the fact that even these “adjusted” earnings have entered a recession makes Jeff’s message even a starker reality today.

His takeaway: The Fed is not in a position to raise interest rates.

If the Fed started to normalize rates, which will still be much lower than anyone expects, it would further crimp profits in corporate America and slow the economy.

Plus, we haven’t been in an earnings recession since the Great Recession in 2008 to 2009, so this statistic paints a gloomy picture for what’s ahead.

A rate hike in December would most surely send us on a path where stocks plummet, which is why I don’t think the Fed is ready to make its move yet. Right now, stocks as a whole are near all-time highs, despite earnings peaking a year ago. Stocks will ultimately follow the path of earnings.

But, here’s the good news: You know what to expect and you can be prepared.

Steps to Prepare for an Earnings Recession

A bear market is always swifter and more vicious than a bull market. You can expect heightened volatility and large drops by 5% or 6% several days in a row. And by taking action today, you stand to benefit when the market nears a bottom.

Here are some easy steps you can do now:

  1. Limit your exposure to stocks.
  2. Take some profits off the table.
  3. Add protection on the few positions that you want to let ride.
  4. Make a few trades that benefit through a bear market.

Then, when the turmoil seems to be at its peak, and we will let you know when that day nears, this will be when you want to jump back in and catch the rebound in stocks.

By the way, you can keep your $10, as long as you understand the life lesson to be learned: Interpretation can change your perception of the market, but it doesn’t change the fundamental shifts developing, some just notice them sooner than others.

So who won the bet between my son and me?

Well, after I drove a little faster to ensure I would arrive just before 2:56, I ended up pulling into our driveway at 2:55. And just as I put the car in park in our garage, the clock hit 2:56.

Clearly, I felt I won the bet, considering we pulled into the driveway and our garage one minute early.

My son sought an individual arbitrator (his mom) to plead his case. She ruled in his favor.

 

  • Sunshine1011

    Chad Shoop, ranked #3692 of 4714 bloggers (near the bottom) and an average return of MINUS 19%, and a one out of five star rating. You perma bears will never learn.