The Piper Is Being Paid

 | Aug 15, 2013 | 11:57 AM EDT
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You don't want rates to climb at the same time earnings are coming down. You want rates to climb because earnings are going higher. You don't want the consumer spending less and the 10-year note going to 3%. You want consumers spending more and the 10-year going to 3%.

So what we have right now is a combination that should, unfortunately, if you are a bull, take us down to let's say 1643 on the S&P 500, give or take a point (thank you Matt Horween for your levels.)

It's too difficult to shrug off both Cisco (CSCO) and Wal-Mart (WMT) on the same day. I can excuse Cisco, as I did earlier, by simply pointing out that there really is no big guide-down and plenty was robust. Wal-Mart's tougher, especially in light of Macy's (M) miss yesterday. You can't have the biggest department store miss and the largest retailer in the world miss and not think that the boogeymen of higher taxes, higher gasoline prices, unemployment insurance, rising rates, furloughs and the sequester aren't at last dinging the strong consumer.

We know the housing stocks have been clocked despite incredible -- and ridiculously high -- homebuilder sentiment, the strongest since 2005. Boy is that worrisome. We also know that auto sales simply can't be as robust as they have been with higher rates and lower disposable income. Where is the leadership going to come from? I can't find any to speak of. Very worrisome.

The piper's being paid.

The macro numbers, like weekly claims, justify the higher rates even as we can't find enough business activity at the enterprise or micro level to justify paying higher price-to-earnings ratios for stocks. Higher rates mean lower PEs, and that means the PEs for the market are too stretched.

So, here's what has to happen.

First, stock prices come down. I mentioned 1643 on the S&P 500, but maybe it goes down as low as 1610 if the 10-year keeps going higher (the iShares Barclays 20+ Year Treasury Bond Fund (TLT) still looks like a short to me).

Second, expectations come down. That's what's happening now, a real ratcheting lower of estimates.

Third, when that process is completed, rates should stop going higher and better reflect the slowing economy.

Fourth, internationally oriented stocks do better because Asia and Europe are getting better, not worse. So, they are the places to go into the weakness. Those and the stocks that have little cyclical exposure that have come down enough -- like ConAgra (CAG), PepsiCo (PE), Kimberly-Clark (KMB), Johnson & Johnson (JNJ), Clorox (CLX) and Colgate-Palmolive (CL) -- will become buys.

This process might be more gradual than today's prices indicate, if only because a lot of money is still on the sidelines and a lot of hedge funds need to catch up. But it is the odds-on scenario, and it must be prepared for.

That doesn't mean it can't switch on a dime. We saw rates top out and we had a terrific equities rally after they did. However, we now know that estimates are too high for the companies reporting now, and that means we will even give a haircut to companies that reported good numbers as recently as a month ago.

Action Alerts PLUS has an extremely high cash position. We are looking to redeploy in precisely the multinational kinds of companies mentioned above. We don't have to sell to do so.

But if you don't own the "right" stocks, you need the bounce this market keeps giving you to reconfigure, unless you can take some pain while expectations and earnings estimates and valuations are ratcheted down to what can only be called more "realistic" levels.

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