John Cassidy

Go long on the economy, and hedge on stocks

February 11, 2013: 5:00 AM ET

Even if the economy continues to recover, the markets are in for a rough patch.

By John Cassidy, contributor

turbulent-stocksFORTUNE -- Pity the poor economic forecaster. Following the resolution of the fiscal-cliff crisis and the Republicans' decision not to push the U.S. government to the brink of default, at least for now, things appeared to be looking up. Retail sales and factory orders were decent, job growth was steady, and the political fog appeared to be clearing, at least partly. At Davos a few weeks back, some CEOs were talking about the economy finally taking off into a self-sustaining recovery. Then came the shocking news that GDP growth turned (slightly) negative in the fourth quarter of 2012.

Now what? Most forecasters reckon that this year will ultimately turn out pretty much like last year, when GDP rose by just 2.2%. I'm a bit more optimistic. I think the October-December mini-slump was an aberration largely caused by Hurricane Sandy and the biggest drop in military spending in 40 years. Indeed, my advice for the rest of 2013 is this: Go long on the economy and hedge the stock market. With Ben Bernanke pouring tens of billions of dollars a month into the financial system, interest rates hovering at record lows, housing recovering, and the international outlook improving a bit, don't be surprised if GDP and job growth turn out better than anticipated. But whatever happens to the economy, don't assume that the Dow will continue to sail serenely skyward. Investors are getting overconfident, which is often a sign of trouble ahead.

MORE: Why Americans still feel poor

In the past 16 months, the S&P 500 (SPX) has tacked on about 400 points and risen by more than 35%. Since March 2009, when the market hit its low, the index has been up about 120%. Without trying to resolve the theological question of whether this is a new bull market or a big rally in a secular bear market, we can be sure of one thing: Stock prices have already discounted a lot of good news. Between November and January, barring one week in December, they basically went straight up. A trader friend of mine who buys and sells stock market volatility had little or nothing to do.

We are now in the strange situation where a string of good economic news or a string of bad economic news could set off a correction. If growth exceeds expectations, investors will fret about the Fed withdrawing its stimulus, bond yields will back up, and stocks will look less attractive. By some measures, they are already stretched. According to Yale economist Robert Shiller, who looks at 10-year earnings rather than one-year earnings to smooth out cyclical fluctuations, the historical average for the market price/earnings ratio is 17.5, and the current figure is 22.8. Over time, prices usually revert to the mean. If economic growth falters, corporate profits will certainly suffer. Even now they are growing much more slowly than they were. Between the end of 2009 and the end of 2011, S&P 500 earnings jumped from $57 to $96, underpinning the big market rebound. Last year earnings rose by just two bucks, to $98, according to S&P. Yet many Wall Street analysts are predicting that this year they will somehow come in at $110 or more, which is wishful thinking.

MORE: A record month for fund inflows is cause for caution

The most likely source of a negative shock is Washington. If the two sides fail to reach an agreement on spending by March 1, the economy will be hit with some $50 billion in automatic cuts. According to the consulting firm Macroeconomic Advisers, this alone would reduce GDP growth by about 0.7%. Combined with the tax hike that was part of the fiscal-cliff deal, its consequences would be even more serious. I'm assuming the politicians will follow their usual practice and kick the can down the road, agreeing on cuts but suspending the implementation of most of them. But who really knows? With small investors and trend followers still buying stocks, the weight of money may keep the market buoyant for a while longer. This is a good time to take profits and hedge your positions.

This story is from the February 25, 2013 issue of Fortune.

  • Let's jump off the fiscal cliff

    The shock of more than half a trillion dollars in tax increases and spending cuts could send us into another recession.  But with a little stimulus, it might be a blessing, not a curse.

    By John Cassidy, contributor

    FORTUNE -- With the election almost upon us, Wall Street is starting to focus on the possibility that, come Jan. 1, 2013, the economy could hurtle over a "fiscal cliff" consisting of $600 MORE

    Oct 15, 2012 5:00 AM ET
  • Obama should have fired Bernanke a long time ago

    With the economy limping along just months before the big election, the president is probably wondering if he should have sent his Fed chairman to the unemployment line.

    By John Cassidy, contributor

    FORTUNE -- In the summer and fall of 2009, President Obama faced a tricky decision: Should he reappoint Ben Bernanke, whose four-year term as chairman of the Fed was coming to an end? On the one hand, Bernanke had MORE

    Aug 20, 2012 7:00 AM ET
  • Bernanke fiddles while Obama burns

    With weak job growth, falling retail sales, and the threat of chaos in Europe, Ben Bernanke should be doing more. But it's hard not to feel sorry for him.

    By John Cassidy

    FORTUNE -- After six years at the Fed, Ben Bernanke is facing some of the harshest criticism of his chairmanship. Following last week's meeting of the Federal Open Market Committee, reporters repeatedly pressed him on why he wasn't doing MORE

    Jun 28, 2012 5:00 AM ET
    Posted in:
  • The real jobs threat to Obama

    Job-hunters getting back on track is encouraging, but it's likely to bump up the unemployment rate.  And that could give Mitt Romney some much-needed ammo as the election gets closer.

    By John Cassidy, contributor

    FORTUNE -- Uh-oh! Those deep breaths you can hear are coming from the White House. With November fast approaching, it is facing the possibility that the unemployment rate, which has come down sharply in the past six MORE

    Apr 26, 2012 5:00 AM ET
  • Just in time for Obama - the economy is looking up

    Voters are starting to take notice that a recovery is finally taking root. For a president who wants to get reelected, that's welcome news.

    By John Cassidy, contributor

    FORTUNE -- Writing in this space a couple of months ago, I said I was cautiously optimistic about 2012. Well, my caution has greatly diminished. Since Christmas, nearly every economic indicator you can think of has come in stronger than expected: GDP, retail spending, the MORE

    Mar 2, 2012 5:00 AM ET
  • Can 'Super Mario' save Europe and America?

    A fragile recovery in the U.S. could get derailed by a European meltdown. ECB chairman Mario Draghi can keep things on track.

    By John Cassidy, contributor

    FORTUNE -- Who will be the most important person in economics in 2012? President Obama? Mitt Romney? Ben Bernanke? My candidate is Mario Draghi (a.k.a. "Super Mario"), who took over as chairman of the European Central Bank. Though virtually unknown to Americans, the dapper Italian technocrat could MORE

    Jan 24, 2012 5:00 AM ET
  • 2012 forecast for the economy: Cautiously optimistic

    Jobs are up, and gas prices are down.  Cash registers are ringing, and house prices are back in line. But if politicians can't get their act together, the whole show could stall out.

    By John Cassidy, contributor

    FORTUNE -- After four years of recession and subpar growth, could 2012 be the year the U.S. economy finally snaps out of its funk? Despite the turmoil in Europe, many Americans would like to think so, MORE

    Dec 13, 2011 5:00 AM ET
About This Author
John Cassidy
John Cassidy
Contributor, Fortune

John Cassidy is a journalist and author. He is a staff writer at The New Yorker, a columnist at Fortune, and a regular guest on television and radio programs. His latest book, How Markets Fail: The Logic of Economic Calamities, was published in November 2009. Before joining The New Yorker, in 1995, Cassidy worked for seven years at The Sunday Times of London, where he was the Washington correspondent and the business editor, and for two years at the New York Post, where he was the deputy editor. Cassidy's first book, Dot.Con: The Greatest Story Ever Sold, came out in 2002.

Current Issue
  • Give the gift of Fortune
  • Get the Fortune app
  • Subscribe
Powered by VIP.