A quick clarification

I've received a lot of questions regarding my last post, and I think I should better clarify what I am saying.

To put it succinctly, I still strongly believe we are in a worsening recession which will last the rest of the year. Unemployment will still get worse, earnings will still get worse, GDP will get worse, and equities have a lot of room to fall (you should see what a joke analysts estimates STILL are for S&P 500 earnings).

The reason I am closing my short positions is that next week the President - and no doubt his economic team with Larry Summers standing behind him - are going to make a significant announcement regarding the entire financial structure of the United States of America, and I have little idea what that announcement will be. It could be the right thing to do - which is that we are nationalizing the banks at the expense of the equity holders - but I put a 95% chance on it being the wrong thing, which is that we're going to purposely overpay for toxic crap which will never be paid back. In that case, the worst stocks of insolvent companies will no longer be insolvent as they now have zero risk. Any profits they make are kept by rich shareholders and any losses they have are paid for by me and my future children.

The larger point I am making is that government is constantly changing the rules, and I have no idea what the rules will be in the future. Thus, I cannot make an intelligent investment decision. I want to make sure this is being framed properly: I'm not trying to make a short one-week trade play. I don't do trades, I do investments. I am just out of the market at least until this enormous game-changing decision is announced.

I'll leave you with an excerpt from one of my closest friends, Nemo:

So, the people who made loans to the banks, voluntarily taking on the risk of default, will be made whole at taxpayer expense. The shareholders, who nominally took on even more risk, will reap the profits at taxpayer expense. Sure, the Obama Administration will slap a few executives on the wrist and block the purchase of a private jet or two, because those are things the average person might actually notice and understand. But in the big picture, this is a straight transfer of wealth from you and your descendants to our largest financial institutions.

Did the executives at these banks get wind of this ahead of time? Well, let’s see. Bank of America executives have been purchasing millions of dollars of their own stock in the past two weeks. Jamie Dimon purchased $11.5 million of JPMorgan stock a week and a half ago. So I would have to say “yes”. Behold your tax dollars at work.

If you're interested in finance and economics, I highly suggest you read his blog on a regular basis. The man is brilliant. In fact I would venture to guess that any reader who does will probably start reading him rather than me.

I'm closing all short positions.

I only want money stolen from me once, not twice.

My plan was to close my short positions this June, after the next two quarters of surprise reports saying things like GDP is falling at a -5% annualized rate. However, the Obama administration along with both houses of Congress have signaled that they are not going to do the right thing - which is to nationalize the banks and force the equity holders to pay for the risks they took - and are instead going to steal money from me (and you) and use it to overpay for bad loans which will never, ever be paid back.

Are they going to do clawbacks on all the false bonuses that were paid over the past five years based on false earnings? No. Why would they take from the bankers? They are going to steal from us instead. The government is going to steal from us and transfer that money - in the form of huge dividend payments and bonuses - to the very people who created this mess (oh, and a very rich Saudi billionaire). They've done it before, and they have now signaled that they will continue to do it again and again.

That's right...the government stole money from us, gave to Citi, and Citi immediately paid a huge dividend of the same amount (with much of that going to Citi's largest shareholder -- a Saudi billionaire). God bless America.

Anyway...the point here is that the government has changed all the rules. And I can't keep doing this when the rules keep changing. I'm out of all short positions.

We as investors have clearly made the wrong decisions by living below our means and saving. We should have gotten huge loans far above our means, taken out multiple home equity withdrawals, and pissed all that money away on vacations and boats. The government would then see what bad financial shape we're in and bail us out by renegotiating our contracts.

Oh, and for the record, no one is bailing me out of my student loans. We have $140,000 of student loans and many of them are stuck at almost 7% in a 0% interest rate environment. I've contacted every major lender in the USA and exactly zero of them will consolidate those loans despite having perfect credit. All the bailout money you suckers paid to the banks so they could lend? They aren't lending a dime. They pissed it all away on huge bonuses and dividends. They won't use any of it to actually lend.

Words cannot describe how disappointed I am in the Obama administration. They lied to us over and over again about how we must make sacrifices. Why are the bondholders and shareholders of these toxic companies not having to sacrifice their equity? They got to keep all the profits when times were good but I have to pay all their losses?

I guess he meant the taxpayers will have to sacrifice for the richest people in America.

Congratulations, Sarah!

Sarah had her first day of work today! It only took her 26 years (hehe). Her new job is fantastic; she can work a compressed work week schedule which matches mine, so we'll have all the same three- and four-day weekends. She can work flex hours, and she can go to work on all those lame fake holidays she gets (San Jacinto day?!) and get comp time to use later.

Life is good, but I suspect the pressure will be back on me to provide more globetrotting adventures.

The coolest thing for me though is that she can have two different 401(k) plans at the same time (one is called a 457) and do a max contribution to each of them. That's $16,500 x 2 plus $5,000 in the Roth IRA for a total of $38,000 of tax free savings options per year just from her job alone. Win.

My portfolio

Some folks may have missed my December 30, 2008 post alerting readers that I had altered my portfolio in time for the tax deadline. I dumped all my 2x inverse-leveraged ETFs and instead sold short the 2x ETFs. I did this largely because the 2x inverse ETFs were acting like large put contracts with time decays. By shorting the "bulls" rather than buying the "bears" I get to make all the money from the declining market and also capture the time decay properties at the same time. You can check that post for more information.

My portfolio as it stands now:
Short UCC - the 2x retailer index
Short SSO - 2x the S&P 500
Short TNA - 3X the small caps! - this is a smaller "fun" position. This is the one that will probably have the highest return because it is crazy, but I wouldn't recommend putting serious money into it. 3x funds are dangerous.
March $25 puts on XRT - These are puts on the retailing index XRT. These are contracts that give me the right to sell XRT for $25 in late March. XRT currently sells for $20.30, and I anticipate this going down.

I expect the market to fall quite a bit from here, and I will hold all of these positions until it does. I suspect that sometime around late June, 2009 I will be closing out these positions and finally buying stocks again for the first time in 20 months. Once I do this, I will probably not short anything again for two decades.

Earnings season is here, and it will be bad. It is time to make money. I took a big hit on the bizarre and illogical runup we've had since Thanksgiving, but these positions have already made some of that back. The market had risen 25% since November 24th. It is now only up 16% since then, and I suspect that over the next two months the market will be dismal and these positions will be serious moneymakers. I will have levered gains on the market dropping 25%.

Just as important, all the things I want to buy will fall in price during that time as well, so you get to make money on both sides. You end up owning way, way more stock with more money at a cheaper price than if you simply went long today.

It begins.

I made a lot of money in the stock market today. The reason is because people realized Alcoa was *probably* going to report dreadful earnings, and this is significant - as I mentioned in my last post - because Alcoa is the first company to report in the S&P 500 earnings season. They are something of a barometer for the flighty, never-forward-looking market.

The market didn't get to see Alcoa's results because they didn't report them until after the market closed. The results were, of course, horrid. So horrid as to make analyst estimates a joke. Analysts are so ignorant and crooked, that they predicted Alcoa would somehow profit in the historic credit freeze and collapsed steel market (Alcoa sells steel!). The estimates were that Alcoa would earn 9 cents per share. Close...they actually lost $1.49 per share. The difference between the two represents over a billion dollars. The company lost around 28 cents per share I believe in their operating results, and the rest was writedowns. The media is reporting this as if the writedowns don't count. Almost every one of the 500 companies making up the index will have large writedowns, so they absolutely count.

I'll post my portfolio later today since some folks may have missed that I dumped all my 2x inverse ETFs and instead shorted the regular 2x ETFs.

Why yesterday was significant.

This is a little too short-term for my taste, but it does have implications for the next six months, so I want to post it anyway.

The stock market finally fell yesterday, and fell by 3%. This is very significant to us and bodes well for our short positions (though is very bad news for the market). Here's why:

I wrote in my last post that earnings season begins this Monday. Earnings season is always kicked off by Alcoa a week before everyone else starts reporting. It was Alcoa who - after market close two days ago - warned it was going to report terrible results, fire 13,000+ people, have earnings below already low estimates, and people realized S&P may downgrade their credit. Then Intel came out with its problems. Yesterday's 3% fall is significant, because it tells us that this market is not at all pricing in these "surprises". The news will continue to be just like this starting this Monday and continuing for the 4-6 weeks, as about 99% of S&P 500 companies will report the first quarterly reports, which will capture the meaningful impacts of what happened in September, October, and November in full detail, along with very bad year-over-year comparisons of Christmas. The market will learn that margins have been entirely destroyed in retail and that sales numbers have nothing to do with earnings numbers.

For the next two months there will be surprises and misses and downgrades, and all of it will surprise the market and panic people. Barack Obama will be making a big economic announcement today (or possibly next Thursday, I can't remember), probably saying he's going to try to get a big and meaningful plan through Congress as quickly as possible so it will be ready on day 1. He'll then be inaugurated on January 20th. What these two events do to the market I have no idea, and I don't care. I'm not a short-term trader. What is more important to me is that over the next six weeks earnings results will be terrible, and markets will probably fall on these poor fundamentals.

I should mention something else very important for us to understand. Up until now, I have only been talking about poor operating results. And when I predict S&P 500 earnings per share of $50, those are operating earnings. I haven't even mentioned the enormous write-downs that will come in on top of earnings and cause massive losses. Everything from heavily underfunded pension liabilities which now have to see payments increased, to credit default swap markdowns, to whatever. The writedowns will be enormous, and it appears by yesterday's markets around the world that no one is pricing in writedowns either. With writedowns, you could see S&P 500 earnings of perhaps $42 per share. This means that analyst estimates of earnings for 2009 are A FULL 100% HIGHER THAN THE WILL ACTUALLY BE.

I've had to endure a painful 25% rally since Thanksgiving which I believe had absoultely nothing to do with fundmentals and everything to do with misplaced hope in the incoming administration to save people from their mistakes. This next several weeks will likely be the largest earnings season analyst screw up in the history of the stock market. I can't imagine stocks staying high in those conditions.

You can't predict ignorance.

Last summer, I had to sit back and watch helplessly as ignorant people poured billions of dollars into the financial sector sending stocks sky high and costing me a fortune. I was eventually vindicated, but it was so frustrating to see so many people so ignorant -- and to have that costing me so much money. This was AFTER all the bad news was coming out, but you go to CNN or CNBC or the Wall Street Journal or any other permanent bull and all you would read is all the reasons why the credit crises is over. Note the date of that article -- and there are thousands just like it.

Today, I do the same thing I did last summer; I sit dumbfounded that there would be enough ignorance with enough dollars left to send stocks up 25% since November 20th. 25% because Obama won? Everything that happened in 2008 will happen again in 2009 just with a different name. This time it is commercial real estate and alt-a mortgages.

Consider this graph of ALT-A mortgages Tilson recently sent out in an e-mail. ALT-A mortgage ratess start resetting in 2009.

ISM just released the worst manufacturing report it has ever seen in its existence. Far worse than economist expectations. And stocks went up 3% on that same day. More ignorant people will justify this by saying the markets already priced it in. Really? Were they pricing anything in last summer when the sent financials sky high? The market isn't pricing anything in. It is setting itself up for enormous losses. It is pricing in that Obama will save us all, even though he can't.

How long it can last I have no idea, as I can never predict the timing of human emotion and certainly don't try to when investing. I can only invest according to the fundamentals and wait. If I had to guess, earnings season starts around January 12 with Alcoa. Then most other S&P 500 companies follow suit shortly after. The market will soon learn how silly analyst predictions are of $82 per share S&P 500 earnings! Try $50 per share.

I pulled S&P's estimates for the 500 off their website again yesterday. Would you believe they expect earnings to actually be higher for Christmas season this year compared to last? Not just flat, or a slight decline, but higher than a year ago. By this stage, I do believe it. Nothing surprises me anymore.

It seems to me that ignorant people send stocks much higher during lulls in the earnings reports, only to have earnings season slap them in the face with reality. Wash, rinse, repeat. Some day they will be right that the recession is over and they will have bought at the bottom, but not before losing their money over and over and over again. I'm thinking this earnings season will do the same thing as the last one, although we have an Obama inauguration to contend with, so who knows how long people can continue to ignore reality.

All I know is that this is the time to profit if you can get your hands on a little extra cash. This is where you dollar cost average in. Last summer in this exact same situation is where you could buy $7.5 ALD puts for $0.15 each...which now sell for $6.

Predictions for 2009

It will be just like 2008.

Only this time it will be commercial real estate that collapses, which no one sees coming. We will have panic, scared people and institutions, more de-leveraging, major declines in stocks and in house prices. We will have frequent and large bankruptcies (starting with the retail sector). We will have deflation. We will have more bailouts to the same banks we bailed out in 2008 because they refuse to change their business models.

That's my favorite part of this whole mess...no one is learning any lessons. The banks all claim that they don't need to change. This is just a cyclical problem, not a structural one. The CEO of Goldman actually came right out and said that. "We don't need to change."

Stocks will fall. I can't emphasis this enough. People keep throwing money at stocks because perma-bull CNBC tells them to and because people are operating on the investment thesis that Obama = Jesus. Obama isn't going to save you from recession. It can't be done. He will save you from Great Depression 2. People will find this out soon enough, but not before we endure this sucker's rally. The Obama election sent stocks up 20% in December, which gives us a great opportunity to make lots of money by shorting at these highs.

Again; too many people are saying "maybe stocks are cheap." When people are saying "I will never invest in the stock market again" is when we buy. I'm thinking about six months.

It is going to be really ugly in 2009 and the recession will not end this year. But at least we can have faith that things will be getting better in the future rather than worse, which is more than we can say about the past eight years.

Happy New Year!

Well, in all honesty it probably isn't going to be a happy 2009, but I wish you all a safe and healthy 'nother spin around the blue marble. This will be the most dynamic year of my lifetime thus far, I'm sure. It will be fun to watch the major changes taking place.