Wednesday, July 9, 2008

Dow 10,000? I've seen that movie before.

I have a hard time wondering why this economy continues to take the media-christened experts by surprise, but I'll be damned if it doesn't keep doing just that. There is no turn around. There is no rebound. The way I see things, we are roughly half through this massive recession. And I should emphasize I don't mean half through the losses or half through the pain, I just mean half through on a time line. The worst losses are yet to come, and the large bank failures have yet to begin. Bear Sterns was providence for anyone willing to listen. None are. It was also fantastically profitable given my recent purchase of Lehman (LEH) puts striking at $50. Lehman dropped to $24, resulting in a jaw-dropping 680% return in just four days. I and my clients are both still short Lehman, which now sits at just $18 per share.

How should you be investing? Well you shouldn't be long anything, I can tell you that. If you've never shorted a stock, I think we should either learn how or pull out our money for the year. All you need is to ask your brokerage for margin. Then you just place sell orders for stocks you don't own.

The way I see things, we easily have a recession lasting through 2009 at least. From there my crystal ball doesn't work any better than anyone else's. I survive by calling the easy shots, and since last October the economy in decline was (and is) an easy shot to call. Who knows that can happen past 2009. President Obama will dump $150 billion into creating a new green energy bubble (the next He'll put another $60 billion into infrastructure at home including revamping the power grid. And the last (and worst) of the bubble homeloans will finally be blowing up and hitting the foreclosure market.

But for now, this is the greatest investing environment I have ever seen. There are several companies that are obvious zeros. Fannie (FNM) and Freddie (FRE) are in huge trouble, and who knows how low you can ride them down before we spend our tax dollars to bail them out. Lehman Brothers (LEH) which gets the honor of being my most hated bulge bracket bank will continue to have trouble for the next year. And bond insurer MBIA (MBI) is still heading to zero. I have shorted them since October, and let me tell you hell hath no fury like a message board poster who is long financial companies when someone comes in and suggests perhaps they are insolvent. It amazes me that MBIA is still a billion dollar company. Even though its shares are only $4.50 each, that is still a massive market cap, and there is still a very long way to fall. Rival Ambac is only worth about $250 million, and MBIA is a worse company.

You want to find another zero where the market has only begun to recognize it? You'd do well to read David Einhorn's new book on Allied Capital (ALD) called "Fooling Some of the People All of the Time: A Long Short Story." Allied is a zero. I'm heavily short this company via its stock and via January 2009 puts going from $15 all the way down to $7.50.

Short anything here and you're going to have a very happy 2008.


Anonymous said...

"All you need is to ask your brokerage for margin. Then you just place sell orders for stocks you don't own."

Rick, I have never fully grasped options trading. Is shorting different from buying puts? The same?

Thanks, Walter

Rick said...

Hi Walter,

Shorting is indeed different from buying puts, although they both make money from stocks going down. When you short stock, you simply sell stock you don't own. If the stock falls $1 per share, you then make $1 per share in profit.

With buying puts, you are trading a derivative. You are buying a contract that says you can sell your stock at a specific price in the future. The more the stock falls, the more your contract is worth. It makes you a lot more money than shorting stock, but you can lose it all too.

Let's say there is a stock that trades for $9. You own a contract (a put) that lets you sell it for $10. You contract is worth $1, right? Now let's say the stock drops from $9 to $8. You contract is now worth $2! A 100% increase! Because the stock dropped 11% (from $9 to $8) you made a 100% gain. This is what we mean when we say it is a derivative. It trades as a derivative of the stock price. Be wary though...if the stock goes from $9 to $10, your contract is worth nothing. You have lost 100%.