Shorts are Still the Better Trade

February 6, 2009

(bettertrades) - Contrarians are shouting to the hilltops that the bulls are lurking around the corner. Don't believe them. If you want to keep making money over the next few months, stay short.

We know the stock market is forward looking. We know stocks will pick up well in advance of an economic recovery. But there's too much morose data in the pipeline that will sharpen bearish sentiment. And a retest of the October lows still waits in the wings.

On February 6, the Labor Department is expected to report a 7.5% unemployment rate for January, up from 7.2% in December. Take a look at this chart provided by Econoday.

The unemployment picture is painting a bleak forecast for the U.S. economy. On February 5, the Labor Department reported jobless claims climbed 35,000 for the week ended January 31 to 626,000, representing the highest rate since 1982.

Rising unemployment serves to decrease not only aggregate consumer spending but also wage rates. Lower spending by consumers in the midst of deflationary conditions translates to lower company earnings. Without an earnings driver, stocks prices have little upside potential.

Further dividend cuts are also lurking in the background as earnings growth slows. The financial sector has already been slammed by a tornado of dividend cuts, specifically the banking industry. Citigroup (C) and Bank of America (BAC) head the list of banks that have been forced to effectively wipe out their dividend.

Equities rebounded Thursday on the shoulders of a unusual rally in the financials (After being down as much as 2% midday), but investors continued to buy safe haven Treasuries, sending yields on the long end of the curve lower. The benchmark 10-year note yielded 2.923% at the close of trading.

On top of horrific January auto sales reported earlier this week, a separate report issued by the Commerce Department said factor orders slip by 3.9% in December as demand for big ticket items continues to drop.

Bulls point to a rally like Thursday afternoon, where the Dow Jones Industrial Average reclaimed the 8,000 mark after dropping well below it intraday. Investors hoping to catch the bear market at its bottom have been hoping for a bottom since the full effects of the credit and housing crisis took hold in late 2007.

But the bears aren't willing to hibernate just yet. Unemployment is soaring, housing prices are still in decline, and the viability of the financial sector (Which is needed to stage an extended rebound) is still in question. So keep those shorts in place because there are still a few shoes left to drop.