Sunday, April 5, 2009

Now is a pretty good time to short stocks.

We're doing that thing again. You know, that thing where we ignore all the bad news coming out and only focus on how the recovery is here. As Professor Roubini has been saying, the bull market rallies have predicted six of the last zero recoveries. I'd also like to point out that the market isn't responding to news that things are getting better, only that things are getting worse at a slower rate than before. But even that news is temporary.

For the most part, all of the good news is now out. We've suspended mark-to-market accounting and replaced it with mark-to-fantasy, and we've come up with version 10 of the same plan the Obama Administration has been leaking for two quarters now, which is that the U.S. Government is going to purposely overpay for toxic assets in a giant gift to the banks. In this latest rendition, we are injecting a middle man so that "Joe the Plumber" types don't get angry. With this new plan, we can make it sound like private firms are buying the toxic assets, when in reality it is the taxpayer (you'll see what I mean when those assets start having ever higher default rates).

There are two important things for you to know going forward. The first is that Alcoa reports results tomorrow, which kicks off earnings season for the major companies. As I've written numerous times - including before the last big crash - earnings season tends to slap optimists in the face. We have this cycle where a lack of earnings reports allows people to think the recession is over, and then earnings season hits and panic sets in. The second is that at the end of April we will have the results of the bank stress tests. The government is going to try to hide the results (by now their proclivities are entirely predictable), but they are going to leak out anyway. The results are going to show that the largest banks (specifically Citibank and Bank of America) are insolvent even after the bailouts and after mark-to-fantasy accounting. It is important to understand that the latest bailout package absolutely does not preclude nationalizing Citibank.

There are only so many ways the Fed and FDIC can keep "gifting" such large chunks of money to banks. When the Administration has to go to Congress, they're going to find that lawmakers have bailout fatigue (a polite way of saying the constiuents are really getting pissed).

So we now have a bad earnings season starting (the YoY changes in quarterly earnings are really going to screw up those P/E ratios people pull up in Yahoo Finance!), bad stress test results, and the possible nationalization of Citi and/or BAC and/or GM. It is good time to short stocks.

Oh yeah, one more thing. Housing prices are only a little past half way finished falling. Perhaps I should change my WBuffettJr handle to DrDoomJr.


Walter said...

Rick, I have a question. Thinking ahead, when the economy resets and begins to gain traction again, and the market does the same, would it be a good idea to short the ultrashort ETF's - for the longterm? Over time, those funds are going to be aimed in the wrong direction, and the fees add a sizable anchor dragging them further down.

Won't they be certain losers during a long period of expansion?

Konrad said...

Would the opposite premise be suggested as well? Market is going down, so you want to short the ultrapros?

ada said...

anyone who went for FAZ took a major beating today

Rick said...

Answer to both of the first two comments is yes. Konrad, shorting the ultra pros is exactly what I am doing now. It is preferable to going long the ultra longs, because the volatility kills these funds.

To Walter, yes, you can short the ultra shorts and do well in a recovery, but remember the most you can make in a short position is 100%. Those ultrashorts will do worse and worse and worse, but unless you keep piling more money into them, they will just keep approaching zero without ever getting there, so your return will be limited. In a growing economy I would much rather own a growing business that can compound 25% annually for ten years. But yes, shorting something like FAZ will probably earn you a lot of money very quickly once the real recovery kicks in.