Investment Contrarians

When the Fiscal Cliff’s Averted, the U.S. Will Finally See the Real Troubles That Lie Ahead

By for Investment Contrarians |

When the Fiscal Cliff’s AvertedThe only people crying “Y2K” back in 1999 were information technology (IT) professionals looking for job security. Even without their help, disaster was averted, the rising sun greeted the world on January 1, 2000, and life was good.

Fast-forward to 2012, and the doomsayers are at it again. Except this time, it’s the members of the U.S. government wailing about an “economic Armageddon” if the fiscal cliff isn’t averted come January 1, 2013. Unlike Y2K, the fiscal cliff is a real issue that needs to be addressed; but the end result will be the same: at the last second, disaster will be averted.

Unfortunately, as we make our way to the end of the calendar year, indecisiveness and political jockeying are spooking the global investing community and wreaking havoc on the markets. At a time when the international community needs the U.S., the world’s largest economy, to show confidence, it’s the political infighting capturing the spotlight.

In spite of all the wailing and gnashing of teeth, the fiscal cliff will be avoided and life as we know it will continue. And that’s when the real problems begin. With the centric fiscal cliff stealing all the limelight, it’s been tough for investors to focus on the fact that America’s economic rebound is contingent on a financially strong international community. Domestic economic growth cannot be stimulated in isolation.

In January 2013, investors will see that the real underlying factor affecting the stock market is the global economy and its impact on corporate earnings.

On November 15, it was announced that the collective economies of the eurozone fell by 0.1% between July and September. While the third-quarter retreat was an improvement over the second-quarter’s 0.2% reduction, two straight quarters of contraction mean the region has dipped back into a recession.

The double-dip recession is particularly bad news because it is hitting once-strong economies like Germany and France. In fact, France, the eurozone’s second-largest economy, narrowly avoided falling into recession in the third quarter. Without economic stalwarts to rely on, the eurozone recession could last longer and have a big impact on U.S. consumers and companies.

Why should investors care about the eurozone?

In 2011, the U.S. exported $268 billion in goods to the eurozone and imported $368 billion, making it America’s top trading partner. According to S&P 500 data, roughly 14.0% of all S&P 500 company sales come from Europe. (Source: “Trade in Goods with European Union,” United States Census Bureau, last accessed November 22, 2012.)

Not surprisingly, economic deterioration in Europe would have serious implications for American companies, especially in light of tepid third-quarter earnings season…which was the weakest quarterly earnings season since 2009. Total third-quarter earnings are down roughly 4.7% from the same period last year, while total revenues are down almost 10.0%. Only about 38% of the reporting companies have beaten revenue expectations. (Source: “Q3 Earnings Season Winding Down—Earnings Preview,” NASDAQ via Zacks, November 16, 2012.)

It doesn’t look any better for the fourth quarter…or for the first half of 2013. According to FactSet, the fourth quarter of 2012 is on pace to tie the third quarter as one of the most negative for guidance on record. More than three times as many S&P 500 companies issued negative earnings-per-share (EPS) guidance for the fourth quarter, compared with those that issued positive guidance. For investors looking for a rebound in 2013…you may have to wait until the second half of the year. (Source: “High number of S&P 500 companies issued EPS guidance in October during Q3 earnings season,” FactSet, October 31, 2012.)

With the eurozone in recession, France and Germany showing signs of weakness, and a huge number of S&P 500 companies issuing negative guidance, where are investors to turn?

With markets slipping, it might be a good time to examine a short-term foray into exchange-traded funds (ETFs), which go up when the S&P 500 goes down.

Guggenheim Inverse 2x S&P 500 ETF (RSW) – This ETF seeks to match 200% of the inverse performance of the S&P 500. If the S&P 500 goes down one percent, this fund goes up two percent.

ProShares Short S&P500 (NYSEARCA/SH) – The ProShares Short S&P500 inversely tracks the daily performance of the S&P 500. If the S&P 500 goes down one percent, this fund goes up one percent.

As the U.S.’s largest trading partner, the European economy has a direct impact on the American economy. If the region’s recession is prolonged, it could significantly impact the U.S. economy and, by extension, corporate earnings. In the coming quarters, those ETFs that track inversely to the S&P 500 could move to the upside if the index falls.

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