South Korea is flashing warning signs of a global recession…

South Korea is known as a “canary in the coal mine” for the global economy. The country is a major exporter of cars, mobile phones, and personal computers. It’s also the 11th-largest economy in the world. It has a bigger economy than Australia, Russia, Spain, or Mexico.

Last month, South Korean exports plummeted 15.8%. It was the country’s largest monthly drop since 2009. It was also the tenth month in a row that South Korean exports dropped from the previous year.

Many South Korean companies blame the huge drop in exports on China’s slowing economy. China is, by far, South Korea’s largest trade partner. The country sends 25% of its exports to China.

•  China’s slowing economy is dragging down the entire region…

Last year, China’s economy grew at its slowest pace since 1990. And last month, China’s services sector grew at its slowest pace in seven years.

China’s factory output also fell for the eighth straight month in October. Yesterday, Bloomberg Business said China’s manufacturing activity hasn’t been this slow since the global financial crisis. Factory orders in Indonesia, Malaysia and Taiwan are shrinking as well.

The bad economic data pushed Asia’s major stock markets down on Monday. China’s Shanghai Composite Index fell 1.7%. Japan’s Nikkei Index fell 2.1%.

•  U.S. investors also got bad news yesterday…

Last month, the ISM Manufacturing Index fell to its lowest level in three years. This index measures the health of the U.S. manufacturing sector. It was the fourth straight month that U.S. manufacturing activity fell.

Manufacturing makes up 12% of the U.S. economy. Economists and investors watch the manufacturing sector for clues about where the broad economy is headed…

Casey readers know manufacturing profits are falling. Two weeks ago, machinery manufacturer Caterpillar (CAT) reported awful third-quarter results. The company’s quarterly sales were 19% lower than a year ago.

Caterpillar expects sales to drop again in 2016. It would be the fourth year in a row the company’s sales have dropped. That’s never happened before in Caterpillar’s 90-year history.

Caterpillar sells the tractors, bulldozers, and cranes that build the “real” economy. Like South Korea, many investors consider Caterpillar a bellwether for the global economy. Caterpillar’s customers aren’t buying much right now, which points to trouble.

•  A weakening global economy is bad for U.S. stocks…

Since bottoming in March 2009, the S&P 500 has gained 211%. At 80 months and counting, the current bull market is 30 months longer than the average bull market since World War II.

However, E.B. Tucker, editor of The Casey Report, says the mini stock market crash in August was the beginning of the end of the bull market. He explained why in a recent issue of The Casey Report.

We believe the era of asset prices soaring on a wave of easy credit is over. Last month’s major stock market decline is the start of a very tough time for stocks and the economy…

The market has recovered in the past two weeks. But we think it’s only temporary. In other words, we’re in the middle of a “dead cat bounce.” It’s looking a lot like 2007.

To fight the global financial crisis, the Fed cut its key rate to effectively zero in December 2008. It has left rates at effectively zero ever since. This has made it extremely cheap to borrow money…

Seven years of easy money has caused prices to soar. Prices for commercial property, bonds, and stocks have all hit record highs, thanks to the Fed.

At some point, the U.S. stock market will fall back down to Earth. When that happens, everything from blue chips to penny stocks will plummet. But overpriced stocks will probably fall the hardest…

•  The flood of cheap money has sent restaurant stocks soaring…

The Dow Jones U.S. Restaurants & Bars Index has gained 256% since the bull market in U.S. stocks started six years ago. And despite a mostly flat market in 2015, restaurant stocks continued to perform well. As a group, they’re up 19% in 2015, compared to just a 2% gain for the S&P 500.

Many major restaurant stocks are now very expensive. For example, pizza chain Papa John’s (PZZA) has a price-to-earnings (PE) ratio of 41 right now…Starbucks (SBUX) has a PE ratio of 35…and burrito chain Chipotle (CMG) has a PE ratio of 38. The S&P 500’s PE is just 22. (A high PE ratio means a stock is expensive.)

Yesterday, Bloomberg Business noted that investors are betting against Papa John’s stock.

The number of shares being shorted — a bet that the stock will fall — has risen to 5 percent of those outstanding, near the highest level in six years, according to data compiled by Bloomberg and Markit Ltd. The investors are wagering that Papa John’s will have a tough time sustaining its lofty price-to-earnings ratio…

E.B. Tucker agrees that Papa John’s stock is way too expensive.

I’ve been baffled by Papa John’s for a long time. The stock price trades at 27 times free cash flow. That’s a tremendous premium for a fast food company. That’s what investors pay to own companies that produce groundbreaking cancer drugs or some other life-changing technology. It’s not the price you should pay to own a pizza chain best known for its garlic butter dipping sauce.

Bloomberg Business reports that short sellers are also targeting other major restaurant stocks.

Shake Shack Inc., the burger chain that went public in January, saw short interest soar after its stock price more than doubled. In that case, investors are betting that its valuation has gotten way ahead of its expansion plans: The chain boasts a $1.65 billion market value despite only having 74 locations as of September. Noodles & Co., which has a PE ratio of 39.1, also is heavily shorted.

•  Expensive stocks will fall the hardest during the next crash…

According to a useful metric, the CAPE ratio, U.S. stocks are 59% more expensive than their historic average. In fact, U.S. stocks are almost as expensive as they were at their 2007 peak.

Since the 2008 financial crisis, global central banks have printed trillions of new currency units (dollars, yen, euros, yuan). Instead of producing real growth, companies and investors have simply used these currency units to buy assets like stocks, oil fields, and office buildings, making these assets very expensive. Almost nothing is cheap right now.

This isn’t the time to be aggressive with your portfolio. It’s a time to be conservative. It’s a time to build up a large cash position, so you can buy bargains after the next correction or crash. You might even consider shorting very expensive stocks as a way to profit from the coming downturn.

We also think everyone should own some physical gold. Gold is the ultimate form of wealth insurance. It’s preserved wealth through every kind of crisis imaginable. It will preserve wealth during the next crisis, too.

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Chart of the Day

Restaurant stocks have pulled away from the rest of the market this year…

Today’s chart shows the performance of the S&P 500 versus the Dow Jones U.S. Restaurants & Bars Index. This index tracks the performance of many U.S. restaurant companies. It follows major restaurant stocks such as Starbucks, Buffalo Wild Wings (BWLD), McDonald’s (MCD), and Panera Bread (PNRA).

The chart starts in March 2009, when the bull market in U.S. stocks began. As you can see, restaurant stocks basically tracked the broad market for the past six years. They started to separate from the pack this year.

The U.S. Restaurants & Bars Index is up 19% so far this year. The S&P 500 is up only 2%. Many major restaurant stocks have become incredibly expensive during this rally. We think some of these stocks will be the first to fall during the next crash.

Regards,

Justin Spittler
Delray Beach, Florida
November 3, 2015

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