Tag Archives: short selling

The bears capitulate

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I usually am not so sure about things, but the markets are looking very stretched at the moment. Sentiment among bears is of capitulation. Everywhere I go on the blogosphere, I see posts and comments about how the market is rigged by Goldman or repo desks or the PPT, and that trading against robots is a no-win situation. I hear that fundamentals don’t matter, that the bulls are in control, that the transports have confirmed the industrials, that China will drive copper the moon and still buy it all, yada, yada, yada. The upshot is that traders seem to think that the bears will be totally crushed no matter what.

Well, what exactly have the bears experienced during the 50% rally from March 6 to today? I’d say that is about as severe a drubbing as you can take in the market, the polar opposite of what the bulls got last autumn and winter. It is time for a reversal, and not a small one. This is Spring 1930 all over again:

Above chart of the Dow Industrials from Yahoo!

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Everybody has seen these before, but here are a few quotes from that post-crash reprieve:

December 28, 1929
“Maintenance of a general high level of business in the United States during December was reviewed today by Robert P. Lamont, Secretary of Commerce, as an indication that American industry had reached a point where a break in New York stock prices does not necessarily mean a national depression.” — Associated Press dispatch.

January 1, 1930

RESERVE BANK AREAS FORECAST NEW YEAR
Despite the obvious slackening of the pace of business at the close of the year, leaders in banking and industry throughout the country maintain an optimistic attitude toward the prospects for 1930.
January 13, 1930
“Reports to the Department of Commerce indicate that business is in a satisfactory condition, Secretary Lamont said today.” – News item.

January 21, 1930
“Definite signs that business and industry have turned the corner from the temporary period of emergency that followed deflation of the speculative market were seen today by President Hoover. The President said the reports to the Cabinet showed the tide of employment had changed in the right direction.” – News dispatch from Washington.

January 24, 1930
“Trade recovery now complete President told. Business survey conference reports industry has progressed by own power. No Stimulants Needed! Progress in all lines by the early spring forecast.” – New York Herald Tribune.

March 8, 1930
“President Hoover predicted today that the worst effect of the crash upon unemployment will have been passed during the next sixty days.” – Washington Dispatch.

May 1, 1930
“While the crash only took place six months ago, I am convinced we have now passed the worst and with continued unity of effort we shall rapidly recover. There is one certainty of the future of a people of the resources, intelligence and character of the people of the United States – that is, prosperity.” – President Hoover

June 29, 1930
“The worst is over without a doubt.” – James J. Davis, Secretary of Labor.

July 6, 1930

‘BUSINESS CYCLE’ SEEN AT NEW PHASE; Bankers Hold Downward Trend in Markets Indicates Recovery Is Near. DENY ANALOGY TO 1920-21 Economists Point to Superior Credit Conditions Now, Holding Easy Money Points to Revival.

August 29, 1930
“American labor may now look to the future with confidence.” – James J. Davis, Secretary of Labor.

September 12, 1930
“We have hit bottom and are on the upswing.” – James J. Davis, Secretary of Labor.

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The bears were down but not out in June, and quite a few armchair traders jumped in to have another go at the fast money they found when they jumped on board the sell train in October and February. Well, 100 points in about 12 trading days left them flabbergasted, and toasted more than a couple of levered accounts. When traders are flabbergasted, they tend blame manipulation, and concluding the game is rigged, all but the gamblers bow out.

Well, this trader is not flummoxed. I’ll freely admit traded this rally poorly by thinking I should only buy at 620 and then not jumping aboard when we took off on huge breadth and volume from 666, and then by shorting high-flying junk and starting to buy my long term puts too soon, but I can chalk those up as trading school tuition fees. Nothing that has happened this year should surprise anyone these days, when it is so easy to look at 80 years of daily Dow closes on Yahoo. If this is 1988 and not 1930 I will eat the Tom McKans my wife hates so much and take up a respectable profession like welding.

Speaking of 1987 and expectations for a depression, Trader, the cult documentary on Paul Tudor Jones, is finally up on Youtube. People were recently paying $1000 bucks for this thing on VHS. I can’t say that it is worth that kind of dough, but it is definitely worth an hour of your time to watch one of the contemporary greats in his element as he trades what he thinks is the analogue of 1928-29.

UPDATE: Trader is gone. The producer had it taken down. But, it is still out there if you know where to look… a certain renegade financial site has posted a link. I’ll leave it up to readers to figure out which.

Some thoughts on the bear market.

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This post started as an email that got way too long. I added some charts and put it up here:

The rally has not surprised me (on March 31 I expressed the opinion that we would hit 900 or higher by summer:

…more likely in my mind is a protracted rally extending to 900 or higher by summer, then rolling over to meet a date with 400 next winter. Look at last year’s rallies from March to May and July to August for an idea of what this might look like, though on a larger percentage and time scale because we are correcting a larger sell-off. The case for such a move is bolstered when you hear major investment banks’ strategists calling this a dead cat bounce. Too many people are still afraid to call a bottom, and they need to be suckered into long positions before this is over (along the same lines, too many traders are embracing the dead cat bounce and need to be shaken out before it can get back to leading the buy-and-holders to slaughter).

That said, I was leaning closer towards 900 than 1050:

I am highly skeptical, though respectful, of calls for a the mother of all bear market rallies. Robert Prechter and some other Elliott Wavers, as well as Tim Knight (slopeofhope.com) seem to be anticipating a 6-month or longer rally to as high as 1050. I simply don’t see why that is necessary in this environment. This is a depression, and the last one was accompanied by bear market that, after the first 6 months, maintained the momentum of a cruising supertanker. Rallies of 20 percent and 2 months were about all you got from April 1930 to July 1932 as the Dow dropped from about 295 to 41. That deflation-driven event was a much more orderly bear market than the jagged trajectory of the dot-com crash, which occured while the credit bubble continued to expand. Interestingly, the 1966-1982 secular bear (a brutal 75% loss in real terms) also traced out such a series of steep plunges and rallies as the bubble kept inflating thanks to a compliant Fed and the abandonment of the last trace of the gold standard. Employment was down, but animal spirits were still running high with the computing boom, the advent of securitization, and new innovations in consumer credit.

Though I saw this rally coming a mile away, I have traded it very poorly. First, I put too much emphasis on picking the absolute bottom for a buy-in.  Back in Feb and March I got out of most of my shorts by the time we were under 700, and I entered a bunch of limit orders to put over 1/2 of my net worth in SPY on the long side. Unfortunately, those orders started at 620, and we bottomed at 666. So I missed the bounce, and not only that, starting in April I began to short the junk stocks that were flying the highest and have been the real driver of this market. That was way too soon, and they kept on going, to the surprise of many a long-short fund as well. The outperformance of junk was a surprise, but the overall bounce has not been. When you have mood as compressed as it was back in March and you reach an exhaustion point after 18 months of a strong bear trend, you get a big reversal, which can then generate the extremes of optimism needed to set up the next plunge.

I’ve been buying long-term puts on the S&P and Nasdaq again since late March (way too soon, considering that I expected the rally to continue). I bought a bunch more yesterday, by the way. I view it as extremely unlikely that this market doesn’t decline to the point where solid value offers support — that would be a sub-10 PE and dividend yield of over 5% on dividends that have to fall by 50% or more from here to around $12 for the S&P. That would be the 240 level, but it should take at least a couple more years to get there (or below), if not four or five.

What has always worried me as a short in this market is not a 5-8 month rally, but a 12-18 month affair  like some of those that Japan has experienced in its long bear market since 1989:

Source: Yahoo! finance

That said, Japan’s financial sector was deflating while exports were improving, families had savings and the rest of the world was growing. Today’s situation is much, much more severe of course, and we can only find a parallel in the Great Depression for so many of the economic trends we are seeing. The longest bounce in that bear market was 5 months, and it was of similar magnitude (48% from Nov. ’29 to April ’30; we’re up 47% in the 4.5 months since March 6).

This is the Dow from 1928 to 1931:

Source: Yahoo! finance

And here’s how that bounce looked from 1933:

Source: Yahoo! finance

The S&P500 is now the most overvalued in history by PE (infinite as of this quarter’s running 12 month total, or a dot-com-esque 32 times current annualized earnings levels, about $7.50 per quarter). The dividend yield is about 2.5%, but dividends are nearly as high as earnings right now, which is completely unsustainable (they should be less than half of earnings). On a sustainable basis, the yield is 1.0 – 1.25%.

Here is the S&P PE ratio (TTM data through 12.31.08) going back to 1936. (the dates read right to left, since I can’t figure out how to reverse them in Excel). Data through 6.30.09 would be off the chart:

Real (U-6) unemployment is approaching 17% and climbing, and that is if you exclude the likely 6 million illegal immigrants who are out of work now (who used to take home $100 per day as construction cleanup boys or dishwashers). Throw them in, as we would have in the 1930s, and you get a solidly depressionary 20%.


Credit is still being withdrawn everywhere you look, whether in home equity, credit cards or small business loans. There has been a bounce in the corporate bond market, but that is due to the same technical forces that are driving the stock market, and the big bankruptcies are just beginning. Only the very weakest have gone under so far, like the car companies.

So with this backdrop, I don’t expect this summer’s good feelings to last into the holidays. The markets should start to roll over again soon, since the big-money value investors needed for a sustained advance can find no reason to buy in, and the little guy has been burned too many times to chase this market very far. Volume is very thin, and an unusually large fraction of trading is taking place between automated programs.

When the data to back up the green shoots theory fails to show up after another few weeks or months, and even official unemployment is solidly into the double digits and climbing, while another huge wave of mortgage resets hits the middle class, there will be no hope at all left to support this market, and it will slide to levels not seen since George Bush Sr. was in office.

It will then still not be a safe long-term buy. For that, considering all of the obstacles that the government has created to profit-making, we need to get back to Reagan-era levels, somewhere under the bottom of the 1987 crash.

S&P500:

Source: Google finance

Mish takes Peter Schiff to the cleaners

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Mish has composed a detailed post on the many ways in which the vociferous Peter Schiff has been dead wrong on just about everything in this crash (the two actually had a little debate in December 2007). Mish’s post is essential reading for anyone who is considering following Schiff’s investment advice. In his own way, the man is usually just as wrong as the Pollyannas that he challenges on bubblevision.

Here is an excerpt:

Schiff’s Investment Thesis

  • US Dollar Will Go To Zero (Hyperinflation).
  • Decoupling (The rest of the world would be immune to a US slowdown.
  • Buy foreign equities and commodities and hold them with no exit strategy.


12 Ways Schiff Was Wrong in 2008

  • Wrong about hyperinflation
  • Wrong about the dollar
  • Wrong about commodities except for gold
  • Wrong about foreign currencies except for the Yen
  • Wrong about foreign equities
  • Wrong in timing
  • Wrong in risk management
  • Wrong in buy and hold thesis
  • Wrong on decoupling
  • Wrong on China
  • Wrong on US treasuries
  • Wrong on interest rates, both foreign and domestic

That’s a lot of things to be wrong about, especially given all the “Peter Schiff Was Right” videos floating around everywhere. The one thing he was right about was the collapse of US equities and no part of his investment strategy sought to make a gain from that prediction.

I will admit that I was nearly taken in by Schiff’s thesis back in 2006 when I first became bearish on the economy and stock market. I even opened an account for someone with his firm, but the only thing I did with it was short the US market — I took none of his brokers’ advice on favored mining juniors.

I owe Mish and Robert Prechter a huge debt of gratitude for beating some sense into me with solid logic. Readers can easily check my archives to see my pre-crash stances on commodities, gold stocks, Treasuries, the dollar, the Swiss Franc and the Euro and the inflation/deflation debate. I can report that things have turned out very well for those who went against the crowd of contrarians, swallowed their fear of the dollar, and shorted not just US stocks but almost everything else in sight. All the world was a bubble.

On the need to stay nimble

Yes, the deflationists were right and hopefully all made some money or at least avoided terrible losses, but nobody can afford to get cocky. The markets do not trade on fundamentals on anything but the longest time-frames, so the ability to read the prevailing mood and adjust accordingly is a critical part of asset management. So is the willingness to contradict yourself and change your mind.

I see now that this deflation can last even longer than I had suspected, and that there may be even ways to avoid hyperinflation, such as negotiated Treasury debt forgiveness, but there is no need to try to guess about outcomes that are years away when you know how to read the signs as they come and remain humble and liquid enough to change your stance as needed.

By the way, Mish manages client accounts

Mish is an investment advisor representative with Sitka Pacific (not Euro Pacific!), a firm that manages private accounts on a percent of assets fee basis. I am not a client, but I would not hesitate to suggest giving them a call. I am working on setting up my own firm of this type, which offers many advantages over hedge or mutual funds, especially when set up with the protections that Sitka Pacific has included. My own style of trading is somewhat different from any of the strategies Mish uses (for example, I am willing to go net short or to a majority cash position), and of course I am not always in agreement with Mish on every aspect of the markets.

SEC determined to drive hedge funds out of US

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From Bloomberg:

Sept. 17 (Bloomberg) — The U.S. Securities and Exchange Commission, responding to a market rout this week, may require hedge funds to disclose their short-sale positions and plans to subpoena the funds for their communication records.

Hedge funds and investors managing more than $100 million in securities would be “required to promptly begin public reporting of their daily short positions,” Chairman Christopher Cox said in a statement today. The enforcement division will obtain “disclosure from significant hedge funds” regarding “past trading positions in specific securities,” Cox said.

Lawmakers including U.S. Senate Banking Committee Chairman Christopher Dodd and regulators say short sellers may have contributed to a market crisis by spreading false information and using abusive tactics to attack companies. Hedge funds and other investors argue that poor business strategies are to blame, not short sellers.

“A lot of hedge funds don’t like being forced to disclose their long portfolios, so they’re really not going to like this,” said Sean O’Malley, a former SEC lawyer and now a partner at Goodwin Procter LLP in New York. “There is going to be some push back from hedge funds, but they may not get any sympathy in the current market environment.”

When people lose money they need a scapegoat, and short sellers always top the list. And when there’s a crisis, bureaucrats and politicians can’t help but make more rules, even though it was government meddling that caused the whole problem by granting bankers a blank check to blow bubbles.

The five SEC commissioners must approve the rule, which would be adopted on an emergency basis, for it to become binding. Hedge funds, which are private pools of capital whose managers participate substantially from any profits on invested money, prefer to keep their positions secret to prevent other traders from stealing their strategies.

There are all kinds of legitimate reasons for secrecy, not just to prevent copycating.

The agency’s plan to subpoena communication records will mark the second time the regulator has sent information requests to hedge funds in three months. In July, the SEC subpoenaed hedge-fund managers and Wall Street’s biggest firms seeking evidence they were manipulating shares of financial companies.

These financial companies are insolvent. No manipulation is necessary. The proof is that when Lehman sought a buyer last weekend, with the market closed, nobody offered a dime.

Morgan Stanley, the second largest U.S. securities firm, tumbled the most ever today after a government rescue of American International Group Inc. failed to ease the credit crisis. In a memo to employees, Chief Executive Officer John Mack said the management committee is “taking every step possible to stop this irresponsible action in the market.”

Morgan Stanley

“There is no rational basis for the movements in our stock,” wrote Mack, who added that he was in contact with Cox and Treasury Secretary Henry Paulson. “We’re in the midst of a market controlled by fear and rumors, and short sellers are driving our stock down.”

Does Mack think he is fooling anyone?

Democratic New York Senators Hillary Clinton and Charles Schumer urged the SEC today to impose a temporary ban on short- selling of all financial stocks, saying it would “help restore a measure of stability to our financial markets.”

You can always count on these two to pick up a hammer for the coffin of America.

Commercial Real Estate Shoe About to Drop

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The opportunity to short REITs (or IYR, a REIT-heavy ETF) is fantastic at right this moment. This is about as perfect a short set-up as you could ever wish for: securities of companies in a rapidly deteriorating sector have rebounded to near where they were a year ago when optimism was abundant and the stock market was making new highs. The ETF is actually trading where it was in the first quarter of 2006, the exact peak of real estate prices in the US.

Here is a 5-year look at IYR (I like to take the long view):

Click for sharper view. Source: Yahoo! Finance

There is a heavily traded double-short ETF, SRS, that tracks the opposite of the Dow Jone Real Estate Index with 200% magnitude on a daily basis. My preferred way to short is with LEAP puts, because despite common notions to the contrary, these options are more dummy-proof and safer in some ways than short-etfs, while allowing greater leverage so you can risk less capital on your shorts.

One more thing that makes this such a great short is that, in contrast to financials, there has not been much of a panic sell-off yet. XLF (a popular financial ETF), made a waterfall plunge from June to mid-July, which, while certainly not the final bottom, served to blow off some steam for the short-term.

I haven’t said anything about fundamentals here, but it should be obvious to anyone that commercial real estate, like residential, was heavily overbuilt because of cheap credit readily extended to Joe Blow Developers, Inc. We now have way more shopping malls, office parks and trendy urban condo complexes than we could possibly use at prices high enough allow Joe to cover his debt payments.

As the consumer gets frugal, the corporate sector contracts, and inner cities get scary again, vacancies in the respective developments will soar and rents will drop. And because this game, like housing, is played with leverage, holders of CRE are in big trouble (as are the banks that hold these loans on their books – they will soon be the not-so-proud owners of shiny new rental properties).

It should also be noted that as Treasury rates have fallen (a big red flag for the economy), there has been a little fad to buy CRE or REITS for the slightly better yield, as though they can be compared to Treasuries! Gimmie a break! Holders of this junk are in for a world of hurt, sooner rather than later.

It’s a beautiful day for shorting. My picks: Wal-Mart & Costco

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I wouldn’t be surprised if the market ends down on the week (maybe even the day). This morning’s little bailout* blip just offers shorts another chance to set up some trades we may have missed in the bounce since July. (*For a dissection of the bailout, here’s Mish).

Why short leading discount big-box retailers? Although they sell stuff cheaply, they have come to rely on Americans buying lots of cheap stuff. American’s have a habit of viewing low prices as an opportunity** to buy more of something, not to buy the same amount and save the difference. The aisles of these stores are packed with discretionary goods: a myriad of toys, cosmetics, housewares, sporting equipment, and all kinds of footwear and clothing. People’s homes are overflowing with decades worth of junk: enough clothing for a couple of generations, and used toys, tools and appliances galore.

These stocks are priced for perfection, as if the consumer binge will continue in perpetuity and the companies will continue to open new stores in new exurbs. Unfortunately, many of those new developments will be ghost-towns before long, and the stores will be big, empty cleanup liabilities.

Let’s take a look at the numbers:

Wal-Mart: Price: $61; P/E: 18; Dividend yield: 1.6%; Earnings growth, 2005-2007: 6.5%

Costco: Price: $70; P/E: 24; Dividend yield: 0.9%; Earnings growth, 2005-2007: 0.94%

By any Graham and Dodd style evaluation, these two are massively overpriced, Costco more so than Wal-Mart. However, I like the short odds on Wal-Mart just as much because it is so overbought and near a 52-week high in a sort of nifty-fifty bubble (hence, I picked up some puts this morning — I’ve had long-term puts on COST for a while).

Yes, same store sales may be up, but that is largely on account of groceries and gas. The profits are in discretionary items. Over the next 12 months, watch for sales to go flat and margins to shrink, before sales drop outright.

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**People don’t apply this logic to investment purchases, hence the securities and real estate markets are inefficient.

Prudent Bear’s David Tice calls for 5 more years of bear market

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Bloomberg today has an interview of the Austrian-minded founder and manager of the Prudent Bear Funds.

Some take-aways:

  • Policy makers and central bankers are to blame for blowing this bubble.
  • “Institutions and foreigners no longer trust our structures, our insurance, our ratings, etc., therefore we’re in big trouble.”
  • “Over 18 months, this market will be down 50, 60, 70 percent.”
  • This market is like a slowly boiling frog that doesn’t feel the increasing heat.
  • The technology sector is the next big shoe to drop. Multiples are still high and demand will slow dramatically. US demand has slowed and now Asia and Europe are slowing.
  • A global slowdown is in the works, since the world is so dependent on US growth, but 3-5 years out, Asian growth should dominate.
  • Tice is still long precious metals, since the dollar should “decline dramatically” and other currencies should follow in competitive devaluation.
  • He doesn’t think gold has topped, though he did cut gold and mining positions dramatically from what he held past few years. He was surprised by the depth of the sell-off, but thinks this is a “decline that ought to be purchased.”
  • He closed out some home building shorts and some consumer discretionary shorts, though consumer spending should slow dramatically.
  • Commercial real estate is another shoe that is going to drop.

As an interesting aside, Tice just sold the Prudent Bear Fund and his Global Income fund to Federated Investors Inc. for $43 million plus up to $99.5 million in contingent payments over five years. Why sell now if he thinks we are just at the start of a huge bear market that should see great returns and increased interest in his funds? It may be a bit presumptuous of me to venture this guess, but as another ultra-bearish investor, I see his timing as very prudent.

BEARX is US-based and relies heavily on short-selling, so it is subject to the whims of a hostile congress regarding this supposedly nefarious activity. And Tice’s Prudent Global Income Fund faces the risk of exchange controls emerging in a dollar meltdown.

Also, Tice is presumably prudent enough in his personal affairs to realize that the window is snapping shut for serious asset protection in this environment, so he must have felt a great compulsion to get liquid while he could. Just as he would probably not recommend 95% of an investor’s assets in his funds, he was likely nervous going into a depression with so much of his own net worth in illiquid business equity.

At any rate, he and his investors will still benefit from his management of the funds for Federated.