Traderbill's Financial Markets Weblog

…the myth is busted: shortsellers aren’t always correct! True, there are those who have done their research and believe a stock…or commodity is undervalued…but they are few and far between. Just as investors are prone to run with the herd, so are shortsellers…and while they may not all be hedge funds it is they who, due to leverage, are the problem. Before we shoot all the hedge funds though, remember that others, such as ultra-short ETF’s that have two to five times the exposure to upside risk, are just as culpable. When you have that much leverage and then have rallies of 2% or more, the money you made on the way down evaporates quickly.

 

TB receives Google Alerts on mortgage companies and hedge funds. While the former has been reduced to a trickle and the stories have drifted to fraud and foreclosures, the latter is running strong with information that began two weeks ago talking about returns evaporating…to the worst month in five years…to heavy withdrawals…and now to how hedge funds (as a group) have the worst returns in five years and that is not only on a relative basis to conventional managers but absolute returns as well. In addition, more funds will fold this year than are started…this has never happened before. Meanwhile, pension funds in the UK profess their belief that hedge funds are good investments. Correction, that would be their actuaries (consultants)…the same ones who didn’t suggest they rebalance their equity positions in 2000…not only that increased their exposure to US stocks right after Y2k! Brilliant!

 

We interrupt this to bring you a special announcement…President Bush has just signed the Recovery Act…when the Senate came in on Sunday to vote on it, why did he wait until this morning to sign it? Especially after Monday’s selloff that was negated yesterday. Recall it was his people who blamed delays on the Democrats…who couldn’t bring the bill up earlier or it would have been killed by the GOP! (mea culpa: TB said that there was a provision in the bill that would provide loans to Chrysler. When googling the recovery act, the 2006 bill came up…imagine we thought we needed one then and that was when the GOP was in control of the House…and it was that act, not the 2008 act that had the provision for an unnamed auto manufacturer that bore an uncanny resemblance to Chrysler).

 

Both of the major rallies of the last two weeks were shortcovering rallies and both related to the SEC finally doing something about naked shorts! The first coincided with Wachovia’s miserable earnings report (which brought on short covering of all financial stocks for two days, while the second was triggered by Merrill’s raising $8.5 billion in capital yesterday.

 

Christopher Cox’s SEC has extended the prohibition of naked shorts on the two GSE’s and 17 other banks and brokers…all primary government securities dealers…it was temporary and scheduled to expire Thursday…why he put a date on it in the first place defies reason and logic. Then a week ago he wrote an Op Ed in the WSJ that was a ‘dog ate my homework’ piece, and it was clear he didn’t understand the issues. A Bloomberg top story this morning says it was extended to August 12…again a stupid idea. After all the piling on of shorts destroyed Bear Stearns and Indymac (not that they weren’t headed in that direction of their own volition), and almost took Lehman down. The sole extension, which was an afterthought, is to market makers to allow them to provide liquidity…this shows what a knee jerk reaction the SEC provided when if they had merely enforced existing rules in the first place we would not be where we are today: either in having to take emergency action (sic) or having our entire financial system on the ropes. Since the ban according to S3 Matching Technologies, which matches short sales for three of the top five retail brokerages, short sales decreased by 78% from July 14, the day before the ruling took effect! Pension Funds Worldwide, Inc. which clears trades for more than 250 firms is automating its systems after employees were forced to manually review short sales and work weekends in order to review the trades to insure there was no naked shorting (doesn’t this remind you of when they had to have trading halts on the stock exchanges to process heavy volume and the trading curbs that have been in place since 1987 which require manually entering orders once the market falls more than 2%?)…then last week Cox told Congress the SEC may have to reinstate a version of the uptick rule…a rumor was circulating yesterday during the rally that they would require a 5 cent spread between the bid and ask as well…which may have added to the rally…over 225 million shares traded in the final five minutes on the NYSE and stocks went out at the highs of the session.

 

Do not underestimate the impact of this unregulated shortselling, and allowing naked shorts to go uncovered for months…and in some cases for more than a year…on the US economy, not to mention global stock markets (especially emerging markets), and of course the global economy, which is now faltering under inflation fears even as the industrialized nations rate of growth slows. In virtually every one of the big moves, up or down, in the US markets, Europe has followed suit while the Asian markets have shown weakness that makes the US pale in comparison. While Europe is down year to date a bit more than the US (UK -16%; France -22%; DAX -20% vs Dow and S&P 500 -14%), Asia is in a world of hurt: Hang Seng -18%; Shanghai -46%; Shenzhen -41%; Korean KOSPI -17%; both Indian indices -30%. Note also that with the exception of the Nikkei which is down just 12.7% but only 9.5% in dollar terms…the rest of the world got no currency kick…except Korea that was kicked by devaluing the Won and thus down 23% in dollar terms…that is surprising and shows how long the dollar has been weak and could thus be a play here as it is now showing with the Dollar Index now above 73 resistance for the past two sessions…follow it closely! What is the best global stock index?  Hungary -3.7% and Sri Lanka, Prague and South Africa!…all down 4.4%! Besides Japan here are the only ones not down double digits: Mexico -7.5% (but +9.5% in $), and Brazil -9.2% (+3.2%)…but if oil prices continue to decline so will they.

 

Building on the increased regulation theme, commodities are tanking, especially crude and gold. The fear there must be that the CFTC is awakeing from its long slumber will put limits on banks positions in contracts…same as commercials and speculators. Speculation is a good thing…neglect by regulators is not. It leads to Congress which knows less about the issues then Cox or the CFTC enacting laws to punish speculation which is harmful to market liquidity…hopefully that can be avoided this time. TB’s chief objection to Obama’s plan is his ‘gas tax holiday’/oil windfall profits tax when instead he should just be in favor of eliminating the subsidies to oil companies but it makes for good soundbites and that is what this election is all about: rallying support from two different classes, the haves and the have-nots. Just as with regulation that is not enforced, when one group gains a distinct advantage creating a record wealth gap, the balance will be brought back in line. Remember the late Pat Morita in The Karate Kid? It was all about balance and once he got that point across to his pupil he became a winner…keep the balance and America can again become a winner, but as long as we give enormous tax breaks to the top 2% of Americans…when they already have huge ones in the form of generation skipping etc…the gap will continue to widen. Were we not a democracy TB believes we would be on the verge of revolution now. That is the beauty of our Constitution, despite the efforts of this Administration to trample it in the name of protecting us from terrorism. Terrorism is not the issue…it is a catalyst for change…the wrong kind.

 

Energy Secretary Samuel Bodman was on CNBC this morning railing at OPEC for high energy prices. Obviously he didn’t hear Iran’s President on the topic…nor does he read TB…or he would, rather than say the US must seize control of the energy markets from OPEC, be chastising the CFTC for allowing investors to become speculators in commodities to unprecedented levels and having caused virtually all the increases in oil since January…look at those year to date equity market returns above for emerging markets and tell TB that global demand is driving prices…it is not…purely unrestricted limits on futures. That, TB feels, has changed and since we broke $100 in January he feels that we will go back to those levels…only with an overshoot first, perhaps to the high $80’s…not scientific just TB’s gut feeling.

 

What started as a US subprime mortgage crisis a year ago, morphed into a derivative crisis globally that became a credit crisis by yearend, and due to the banks and brokers price declines made it difficult for all and impossible for some to tap the capital markets. One advocate of unregulated short selling, the woman on CNBC’s fast money, complained yesterday about the SEC not policing CEO’s. How else, she reasoned could Merrill’s John Thane say a week ago after selling off Bloomberg that they didn’t need any more capital yet yesterday rush to issue another $8.5 billion in stock…mainly to the same ones who stepped up to the plate before! When you see this think of what inexperienced investors do: double down…sometimes into oblivion. In Merrill’s case however they will not be destroyed and in fact will prosper but do not confuse this with the Merrill that bottomed out when the execs started buying and turned into one of the best investments one could make…had they sold last August! Even Nouriel Roubini as bearish as he was on brokers and dealer banks last August…and correct he was…did not see bankruptcy in the cards for Merrill or BofA. But the question that keeps haunting TB is still: where will the replacement revenues come from? Certainly leverage will be impaired for years to come…and of course financial stocks were so grossly overvalued that their comeback will be much slower than the bounces of late indicate. 

 

Now that we have covered currencies, commodities and stocks, how about those bonds? When the stock market has been strong they rally modestly…usually but sometimes have been weak along with them. When it is weak the rallies are small in contrast to the down days…especially in TIPS…which is remarkable if you believe inflation is a problem as so many profess…and while earnings for many, if not most non-financial/retail stocks…have equaled or beaten lowered bar estimates. Therefore, TB believes that bonds provide value but you will have to pick and choose. Timing is difficult since on Monday as stocks tanked the long end of bond rallied more than a point and long TIPS nearly two points! But yesterday, just as quickly both declined similarly and despite a bounce from the lows gave back most of Monday’s rally.  they are treacherous so be careful but TB believes once inflation fears are removed (remember that due to sharply higher energy prices TB predicted June was the peak in inflation and it will now continue to recede), and overestimating the timing and magnitude of a US recovery means that by year end bond prices will not be much weaker than they are now (in the long end), and possibly stronger. One caveat is junk bonds and municipal bonds due to credit concerns and deteriorating revenues. But the focus for now will be the stock market which not only could have a major countertrend rally but the floor could be, and probably is, in for financial stocks. Bet some US companies, especially the two GSE’s wish they had back the money they frittered away on buying back their stock and could buy back the bonds that were issued to do so! Shudda, wudda, cudda…

 

Interesting how much hype has been made of Buffett’s investing prowess of late. From 2001 to 2007 Berkshire Hathaway, was the best thing you could have invested in…that was the peak but you could have done better to sell before and move into other stocks. CNBC was asking yesterday of guests if Buffett had every made serious blunder…being shortsighted as most market mavens are, they could not think of one. Well, TB can…his bet against the dollar during the period when TB owned the stock that cost $15 billion and took the stock down…all of his managers performed well except him and to his credit he took the heat for his unfounded decision…just a hunch. Well, look at how Berkshire Hathaway (the nearly bankrupt shoe manufacturer he bought that failed) has performed over the past 12 months: up just 3% and remember, no dividends to reinvest! Year to date it is down 21.5%! Far worse than the major indices! He is far too concentrated in insurance and other financial activities than he should have been…all good companies but he obviously didn’t see how bad things could get either…to his credit he increased his position in Wells Fargo…and TB believes USBancorp…about the same time TB felt they had bottomed. Both of us were wrong. The point is: no man or woman is a guru…all are human!

TB doesn’t expect you to believe everything he wrote but instead hopes it made you think, or rethink your positions at least. That is all any reasonable writer should ask for…if you agree it is a windfall.

Have a great day…the markets willing and it appears they are…don’t forget we get employment Friday! 

TB