Plunge Protection Team Gives You Another Opportunity To Short The Market

Insider Monkey’s mission is to identify the best stocks to buy and sell using the signals that are sent by the best hedge funds and corporate insiders. I am Insider Monkey’s research director. I have been sourcing potential investment ideas from hedge fund 13F filings, investor letters, and investment conferences, and then analyzing these stocks myself and then recommending only the ones that presenting favorable return/risk characteristics.  We launched this investment strategy 3 years ago and my portfolio of stock recommendations returned 72.9% during these 3 years, vs. the market’s 31.8% gain (download a sample issue).

I have never before made macro predictions and then use them as input factors in my models even though I have a PhD in financial economics. That’s because it is seldom simple to make accurate and divergent predictions about the direction of economy. The key adjective here is “divergent”. That’s why I have no respect for hedge fund managers or economists who have been making dire predictions for the last decade.

However, I got a tingling sensation in my brain when I first heard about China putting its Hubei region under lockdown about a month and a half ago. China’s leaders don’t care about human lives; they care about economic growth. That’s why the news of China sacrificing economic growth over saving human lives meant only one thing: they knew something the rest of the world didn’t; that the spread of the new coronavirus will sooner or later hit their economic growth and the longer they wait the deeper the economic effect of the coronavirus will be on their economic growth.

At that time I didn’t know whether the world would be able to contain the virus and slow down its spread. I also didn’t know how fast the virus was spreading. So, I didn’t take any action.

Italy reported its 3rd confirmed coronavirus infection just a month ago. Fifteen days after that Italy reported its first death from COVID-19, the coronavirus infection. That’s when I started digging deeper. The virus appearing in China and Iran isn’t a huge deal for us. Trump wouldn’t have trouble taking action against travelers from these countries. However, Italy is a different story. My first hunch was that the virus would spread from Italy to other European countries and by the end of March it would spread from Europe to the US.

I sent an email to our premium subscribers on February 26 and asked them to hedge their market exposure by shorting the stocks we already told them to short in the February issue of our quarterly newsletter, published on February 18th. For the past three years, we identify and share a list of 5-10 stocks that are likely to underperform the market every quarter with our premium subscribers. Over the last 37 months, these stocks lost a cumulative 39.7%, vs. 34.1% gain for the S&P 500 ETF (SPY) and 8.2% gain for the Russell 2000 ETF (IWM). This is another great reason for you to subscribe to our newsletters. Our subscribers outperformed the market by shorting in the middle of a massive bull market. You are probably upset about the losses you incurred over the last couple of weeks. Well, the portfolio of our 7 short recommendations lost 24.8% between February 18th and March 6th, meaning that our subscribers enjoyed nearly 25% gains from this portion of their portfolios.

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One day after I emailed my coronavirus update, the United States reported its first coronavirus case that wasn’t tied to any of the previously known cases. That meant one thing: I was too optimistic. Coronavirus was already spreading throughout the US and it was just a matter of days when we’d see coronavirus related deaths within the US.

Remember, Italy reported its 3rd coronavirus case on February 7th and its first death from coronavirus within 15 days. Fifteen days after that death, Italy has 7375 infections and 366 deaths. United States is roughly 3 weeks behind Italy in terms of the spread of the coronavirus. By the end of March, we will probably be in the same position as Italy is in now.

A week ago I published the new issue of our monthly newsletter and recommended a bunch of short positions. The S&P 500 Index was at 2954 at that time. The US financial markets shrugged the coronavirus related news during the past week and the indices rallied during the last hour of trading on Friday. Overall, the S&P 500 Index gained 18 points for the week. I am not the type of person who believes in the “Plunge Protection Team”, but the market’s reaction towards the close was really confusing to me. For example, Alphabet Inc. (NASDAQ:GOOGL) shares climbed from 1259 to nearly 1296 during the last hour of trading. Advertising rates will probably collapse as travel and entertainment related stocks feel pain. The last time we had a recession scare was at the end of 2018, and Alphabet Inc shares were trading at $1030. So, it wouldn’t be a wild guess to predict that you can buy GOOGL shares at much lower prices than $1300.

Anyway, this weird move in the market also gives you a good entry point to short the market. I know that the US economy will shrink for 2 consecutive quarters in 2020. I put the probability of this happening at 90% at this point. We always experienced a bear market (a decline of at least 20% from peak to trough) during recessions. So, if history is any guide, we should see the US stock indices to decline at the very least 20% (potentially 30%) from peak to trough over the next 3-6 months.

I usually don’t publish my stock recommendations publicly before things happen. I put bread on the table by selling newsletter subscriptions. Once a year or so I make an exception. Make a note of this prediction. Better yet, do yourself a favor and hedge your market exposure. You will thank me later.

Disclosure: I am net short SPY. I also have negative market exposure through ProShares Short S&P500 (SH) and ProShares UltraShort S&P500 (SDS). This article is first published at Insider Monkey.