SPX: Another Great Shorting Opportunity

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Shorting stocks complete nan semipermanent is simply a fool’s errand arsenic nan cumulative effects of dividend payments and nominal GDP maturation thin to consequence successful dense losses. However, location are times erstwhile shorting tin beryllium highly profitable, and I judge specified a clip is upon us, for 3 main reasons. Firstly, pinch overnight liking rates astatine 4.6%, nan liking received from shorting nan S&P 500 Futures (SPX) is supra nan 1.7% dividend output that you person to salary out. Secondly, nominal GDP maturation is poised to slow sharply arsenic nan system enters recession, which suggests net and dividend maturation will beryllium weak. Thirdly, valuations person risen backmost into highly overvalued territory and a downward mean reversion is likely. Finally, cracks are appearing successful nan enslaved marketplace and look apt to spill complete into nan banal market.

Shorting The SPX Is Highly Cash Flow Positive

When shorting stocks, investors person liking payments for lending nan money to get nan stock, and successful return must salary immoderate dividend payments that nan banal makes. Currently, overnight USD libor is 2.9% higher than nan dividend output connected nan SPX, meaning that a short position will output a dependable affirmative return each other equal. As nan floor plan beneath shows, nan existent dispersed is nan highest since November 2007, pursuing which short sellers made a killing.


Overnight USD Libor Vs SPX Dividend Yield (Bloomberg)

Nominal GDP Growth Is Set To Collapse

While shorting nan SPX generates affirmative rate flows arsenic liking rates transcend nan dividend yield, a cardinal facet that must beryllium taken into relationship is nan gait astatine which dividends are apt to turn at, which tends to way nan capacity of nominal GDP. If nominal GDP maturation exceeds 2.9% past shorting will apt make losses assuming nary alteration successful valuations.

1-year breakeven ostentation expectations presently beryllium astatine 2.9% and existent GDP maturation is apt to beryllium antagonistic complete this period. The Conference Board's Leading Indicator Index, for instance, sits astatine -6.0% which is accordant pinch antagonistic existent GDP maturation complete nan adjacent fewer quarters.


LEI Vs Real GDP Growth (Bloomberg, Conference Board)

Money proviso maturation is besides pointing to a illness successful nominal GDP growth. M2 maturation is often a bully starring parameter of consequent nominal GDP growth, and it is now successful contraction for nan first clip connected record. If CPI maturation is faster than money proviso maturation arsenic is nan lawsuit astatine present, this suggests that existent GDP is successful contraction. I would not beryllium amazed to spot nominal GDP move antagonistic complete nan adjacent 12 months, peculiarly if banal marketplace sentiment turns sour and nan request for rate surges, but moreover if this does not occur, 2.9% seems optimistic.

Valuations Face Downside Risks

The rally successful nan SPX since nan October lows has seen valuations emergence backmost into utmost territory. The price-to-sales ratio is supra immoderate different constituent successful history extracurricular nan past 2 years, and free rate flows are successful diminution amid aggravated downside separator pressure.


SPX PE Ratio, PS Ratio, And Profit Margins (Bloomberg)

The equity consequence premium - nan quality betwixt expected returns connected nan SPX and expected returns connected rate aliases bonds - whitethorn good beryllium nan lowest it has ever been from an ex-ante perspective. For instance, if nominal GDP maturation averages 2.9% complete nan adjacent 12 months and dividend payments travel suit, this would consequence successful 4.6% full returns aft taking into relationship nan existent dividend yield, which would beryllium successful statement pinch existent liking rates, meaning a zero percent equity consequence premium. Considering that nan semipermanent mean equity consequence premium is 5%, this suggests that stocks look awesome downside risks. The SPX dividend output would person to emergence to 6.7% successful bid for nan equity consequence premium to return to its semipermanent mean based connected nan supra assumptions, which would require a 75% diminution successful banal prices.

The Bond Market Is Giving An Early Warning Signal

Renewed upside unit connected US inflation-linked enslaved yields is putting unit connected firm enslaved yields. In 'normal' economical conditions, rising existent enslaved yields thin to coincide pinch narrowing precocious output in installments spreads arsenic some are driven by improving economical conditions. However, nan Fed's progressively restrictive argumentation is now occurring alongside a deterioration successful economical conditions which is causing precocious output firm enslaved spreads to stay elevated. As a result, existent precocious output enslaved yields are rising and propose renewed downside for nan SPX.


SPX Vs Real High Yield Bond Yields (inverted) (Bloomberg)

Risks To Consider

Shorting futures is risky successful nan consciousness that losses tin theoretically beryllium infinite arsenic location is nary precocious bound to banal prices, and this consequence is heightened erstwhile utilizing precocious leverage. Such bearish equity bets are not recommended arsenic an outright position but alternatively a hedge against agelong positions. Personally, I americium now afloat hedged, pinch my short US equity positions afloat offsetting my agelong equity positions, which are concentrated successful emerging markets. I americium besides aggressively agelong Treasury bonds, which should besides use if my short US equity positions suffer out.

This article was written by

Stuart Allsopp floor plan picture

I americium a full-time investor and proprietor of Icon Economics - a macro investigation institution focussed connected providing contrarian finance ideas crossed FX, Equities, and Fixed Income based connected Austrian economical theory. Formerly Head of Financial Markets astatine Fitch Solutions, I person 15 years of acquisition investing and analysing Asian and Global markets.

Disclosure: I/we person a beneficial short position successful nan shares of SPX either done banal ownership, options, aliases different derivatives. I wrote this article myself, and it expresses my ain opinions. I americium not receiving compensation for it (other than from Seeking Alpha). I person nary business narration pinch immoderate institution whose banal is mentioned successful this article.

Editor: Naga

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