What do REITs think they’re doing at 2005 prices?

IYR is an ETF loaded with commercial and residential real estate investment trusts:


At 4.44%, you can get almost as much yield from a 10-year Treasury note (3.8%). Why mess around with these debt-laden monsters?

SRS of course is the 2x inverse of IYR, and URE is the 2x bull version (not a bad way to short, IMO).

A blast from the past

I haven’t talked much about SRS and SKF in over a year, since I ditched my monster positions in them in late September ’08. I had good reasons in the shorting ban, counterparty risk (seen when some London-listed ETFs with AIG swaps were halted), and the compounding issue.

Now, inverse ETFs are nasty, nasty instruments that can wreck you if you hold them too long or don’t use stops. That said, they do have their place as convenient tools for a market timer without an options or futures account, which for better or worse, means most traders out there. But if you’re thinking about inverse ETFs and you are trading with more than 25k, ask yourself why you don’t have a futures account.

For a pure short position, there is nothing better than futures — you can put on an unlevered position or use as much gearing as any sane person could want, with no slippage, no fees and tiny commissions. Say you have a 100k trading account and you don’t want to risk it all. That’s fine, just short a single e-mini contract.  With today’s index prices NQ (Nasdaq 100) is worth 37k; ES (S&P500) is worth 56.5k; TF (Russell 2k) is worth 63.5k and YM (mini Dow) is worth 53k. Some people who will put half their account into a 2x ETF think that is safer than futures. What nonsense! 50k in SDS (-200% S&P) is like selling two 2 ES contracts, except that you pay fees to ProShares and lose money if the market doesn’t fall immediately. You even lose money if the market trends sideways — how nuts is that?

Now, a 100k account could easily be blown to bits if you decide to go all-in and short a cool million worth of S&P contacts (which you can do), but then those 3x ETFs can do the same thing to you. At least with futures you know exactly where your account is going to be at any given SPX level. With ETFs, the way the market moves is as important as where it moves.

Ok, now you know what I really think. But here, for the brave or foolish or IRA-bound, is a chart of SRS and SKF:

Source: Yahoo! FInance


I’m not saying I’d do it, but their underlying equities (as seen by IYR for REITS and XLF for financials) are some very overbought and tiring debt-addled zombies:


If what goes down in the next round of credit panic is worse than 2008, and it very well could be, the counterparty risk in short ETFs will be very much an issue. If the markets do crash again and these ETFs soar, it could be prudent to just take the money and run on the first hard leg down.

5th Avenue blues

Hat tip Evilspeculator

They counted 48 vacant properties (I presume mostly street-front) from 59th to 14th Streets on 5th Avenue in Manhattan. I don’t have any stats to compare this to, but it is clear that times are not so good for landlords (and their banks) in NYC. I used to live on the same block as one very large storefront shown here, and I happen to know that that particular property has been vacant for over 18 months, ever since its former tenant, a nationwide retail chain, went bankrupt.

I have noticed that many of the “for rent” signs you see in Manhattan bear the name of Vornado or other such REITs. That sector is still doomed, though traders seem to have forgotten to ask, “where’s the equity?” I suspect that in most cases, an honest accounting would reveal that net of debt and marked to market, there is none at all.

With every new low in the VIX, I buy more puts

Still in favor are Dec 2011 SPY LEAPS of various strikes, and today I’m eying market darlings Apple and Goldman. The chatter on these two being recession-proof is reaching a fever pitch, and while there is a kernel of truth to that story, their stock prices leave no room for error at these levels. Actually, even if these companies continue to prosper, their stocks will deflate as the market assigns lower multiples to the earnings of its strongest as well as weakest components.

REITS (proxy IYR) can’t hold up much longer either, their short-squeeze having run out of steam while rents start to plummet in earnest.

The question of the summer is how high this market will go while the global reprieve in mood lasts. That the NASDAQ is leading the pack reminds me of late 2007, when the market had started to roll over but the “tech horsemen” (AAPL, RIMM, AMZN, GOOG) kept on rising, against all reason. The fact that it has already reached such heights is a big warning sign. It has almost filled its October gap, a very nice target for a corrective bounce.

Above chart from google finance. BTW, check out wikinvest if you get a chance. It’s got a lot over google and yahoo’s stock pages.

Elliott Wave theory holds that corrections move in three waves (impulse moves in five), so this current push could be viewed as the C-wave in an A-B-C move. When it exhausts, a sea change may ensue, not just a minor reversal. With no fundamental support above SPX 400 (and weak support there), just such a paradigm shift is very much on the table.

Unfinished business: Financials, REITs, small-caps.

These three categories have only begun to really break down in this plunge. Let’s look at some charts. In a crash like this, you want to see deep new lows in all the vulnerable sectors before you can consider things complete.

Here are financials. These stocks are just revisiting July’s lows, yet to make a solid break to lower levels. XLF is our proxy:


Next, REITs are finally breaking down, but they have a long ways to go, considering that an honest accounting of real estate prices would probably reveal that many of them have negative equity. IYR is a REIT-laden real estate ETF:


For small-caps, we’ll switch to a 10-year shot of the Russell 2000 to show the magnitude of the bubble in crappy stocks since 2003. The Russell is making new 3-year lows, but like REITs, it has defied gravity since last year so there is a lot of air underneath these levels. (PEs on the Russell are infinite, by the way, just like the Dow.)


May as well throw in an update on Wal-Mart for good measure. I shorted them a few weeks ago, not because they were horribly overvalued (they are, but less so than most junk out there), but because they have been boosted by a nifty-fifty “defensive stock” mania, and therefore the puts were dirt cheap. 2-year view:


The fact that these laggards are just now breaking down, along with the lack of a meaningful bounce today, suggests to me that this plunge is not out of steam.

Commercial Real Estate Shoe About to Drop

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.