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It's Time to Take Money Off the Table: Here's Where to Begin

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Sell trading positions, buy long-dated out-of-the-money puts, or move into "safer" dividend plays.

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* Earnings will disappoint. Painchaud tracks trends in earnings estimate revisions and surprises, and the trends are not good. They show an ongoing deceleration. "This tells us that earnings are not going to support the multiples in the market," says Painchaud. "We expect a very poor third quarter reporting season." Already, we've seen negative surprises or bad preannouncements from Intel (NASDAQ:INTC), Norfolk Southern (NYSE:NSC), and FedEx (NYSE:FDX). This is a bad sign since Intel is consumer facing, and Norfolk and FedEx are good economic bellwethers, as shipping stocks.

How bad will things get?

Painchaud projects an 18-month correction that could take stocks down 30%. Part of his reasoning is that stocks and the economy are often weak in the first year of the presidential cycle. The theory is that incumbent presidents try to pump up the economy as much as possible in their fourth year to get reelected. Conversely, they try get all the bad stuff out of the way in the first year, which can weigh on the economy.

I think a projection for an 18-month bear market taking stocks down 30% is too dire, given the progress in Europe, and the Fed's new QE3 commitment to spend up to $40 billion per month buying debt, as long as it takes to move employment to acceptable levels. Indeed, euphoria surrounding QE3 could support investor sentiment and stocks following a near-term correction.

But there's a potential problem here, responds Painchaud. What if inflation starts to rear up? That's not so farfetched. The Fed and Washington have pumped huge amounts of stimulus into the system. Energy prices have remained elevated long enough to start bleeding over significantly into the price of goods and services soon. A significant portion of the consumer price index inflation measure is housing, and home prices and rents have been moving up significantly in many markets. In short, the big inflation scenario is potentially real. Since the Fed follows a dual mandate of supporting employment and containing inflation, big inflation would have investors worrying the Fed will take away QE3, which would spark selling in stocks.
No positions in stocks mentioned.

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