Bearish News

Plan accordingly. See last month’s post “Watch Out Bears, Inflation and Bailouts Loom”. I exited most shorts in March, and April hit most other stops. The shorts I still do hold burnt me like a scalded chimp, as Jeff Macke would say. But good longs have absorbed that damage. As I wrote then:

That’s the problem with being short this market, it’s completely dependent on the whims of Geithner, Bernanke, and whoever else is whispering in Obama’s ear. Some might even describe the situation as akin to stabbing Adam Smith’s invisible hand with a rusty screw-driver. But investors have to deal the cards we’re dealt, so we’ll move on…

I dipped my toe back into short funds last Friday, as noted here. Fundamentally the market is extremely overbought and overvalued. We all (consumers, gov, corporations) are bloated with debt. That has to be resolved, eventually. And there will be some serious pain. There are really only two ways to take care of this debt: higher taxes (and less consumer spending), or massive inflation.

Inflation is much easier to pull off politically. Nobody likes sky-high taxes. Inflation is makeup for a crap economy. That’s why I’ve been bullish on gold/silver. The inflation argument has thoroughly won me over.

On that note, I bought some Goldcorp (GG) today. Balance sheet and valuation look good, and Bill Fleckenstein likes it. I have a feeling there’s a lot more Quantitative Easing coming, and gold is arguably best hedge available. Silver’s good too, and platinum, and palladium (though the last two are exposed to car manufacturing).

If Geithner gets canned, watch out below

#1 – If Geithner gets fired and replaced by a realist, or someone who understands the dangers of moral hazards, watch out below equities. Sometimes it’s necessary to take pain in the short term to have an honest long-term market. Right now our economy is corrupt and skewed. For now, Obama has been taken in by the bankers. He’s supporting their destructive mission. But if his belief in their crooked ways falters, and I think it might, watch out below.

Update: After extended-hours trading was closed, the WSJ reported ‘Banks Won Concessions on Stress Tests’. Looks like the sources I quoted in this post were dead-on.

We finally got the worthless and leaked stress-test results. People are abuzz about capital ratios and Treasury’s ridiculous new acronyms. But of all the capital measures, which is the most important for a bank’s success? Their political capital, of course. I am slightly mangling the accepted use of political capital here, but that’s necessary for this play on words to work. Think “influence with politicians and Fed officials”.

Banks with sway over Treasury were intimately involved in designing the stress test. They were able to influence the general strategy of the tests, ensuring they weren’t very stressful at all. They also made sure the tests would not focus on areas that may expose their weaknesses (derivatives, for example).

Unfortunately many small banks will not survive, and don’t have unlimited government guarantees. Who will be there, willing to scoop them up for next to nothing? The best of breeds, of course. Of course they’re the strongest, how can small banks compete with unlimited government-backing? They can’t.

And now, let’s hear from some more credible voices than mine. This statement from William Black, former head of the Office of Thrift Supervision, speaks volumes:

Bottom line: there were no real examinations. Banks continue to overstate asset quality. The bankers pressured Congress, which extorted the Financial Accounting Standards Board, which gutted the accounting rules on loss recognition.

…We know that Treasury used a “one size fits all” stress test that grossly understated derivatives risk — the primary risk that the largest banks face.

Politically influential banks played a major role in shaping the stress tests. And they got to negotiate their results. What? Yves Smith of Naked Capitalism says:

First, they were administered by the industry based on scenarios provided by the industry… Even worse, banks got to use their own risk models, the same ones that got them into trouble.

Second, the industry got to negotiate the results. This is simply unheard of. That suggests both a lack of confidence in the process and a lack of belief on the part of the key actors

The above quotes are from this great collection of comments about the stress test. Their charges should be answered by Geithner and the boys, but they won’t be. So we need to make sure two things happen:

1. Geithner gets fired, ASAP. Please replace him with William Black, a realist and a smart man. Simon Johnson would be another good choice.
2. The Fed gets audited. Passing Ron Paul’s Federal Reserve Transparency Act is imperative.

If your Congressmen hasn’t signed on as a co-sponsor of Ron Paul’s bill (HR 1207) please write them now. With these bank cronies in power, we’re never going to make any real progress.

Standard and Poors is dedicated to their clients. No one can deny them that. I’m talking about the clients who pay them for ratings and services, not guys like me who indirectly pay for their worthless research via Etrade, of course.

S&P has reiterated their “Strong Buy” position on Simon Property Group (SPG) no less than 8 times in 6 weeks. And even though Simon has $8.4 billion in debt maturing by 2012, according to Bloomberg, S&P isn’t worried. This is their deep thinking on the matter:

Although the company has sizeable debt maturing, we think recent equity and debt offerings enhance SPG’s liquidity.

ZING! Nothing about maturity schedules, increased costs of borrowing, plummeting property values, property bankruptcies, etc. They are either morons, lazy, or in the pocket of Simon. I don’t know which, and have no proof of any impropriety.

But Simon has $19b of debt on-balance sheet, and another $6b or so off-sheet. And they act like these guys have a strong balance sheet?

Even if you look at competitors, the “relatively strong balance sheet” doesn’t hold up at all (maybe if you compare them to GGP, but that’s it). Guys like Realty Income Trust (O) have much much better balance sheets. That’s why I’m long O against my Simon short. O has debt/equity of .86x and pays a CASH DIVIDEND. Simon has debt/equity of 6.0x and pays an almost entirely STOCK DIVIDEND. It’s insane.

Here’s the tiny disclaimer at the bottom of S&P’s “research report” on Simon Property:

S&P and/or one of its affiliates has performed services for and received compensation from this company during the past twelve months.

Previous and related:

• Are S&P ratings biased towards clients?

disclosure: short SPG, long O

Feed Me Seymour!

Has the economy turned a corner? One big enough to justify the gross overuse of the term greens shoots? Doubtful. And despite pleas from the cliche-swamped masses, media continues to bombard us with this overly-optimistic (and early) catch-phrase.

Exhibit A: Just today Forbes published an article called The Street Eases, But Green Shoots Abound. Really? They abound? Call me skeptical.

I think this post at ZeroHedge provides a more realistic picture. It argues that those Green Shoots are more like Venus Fly Traps. I’ve expanded the metaphor further, to a nastier plant: Audrey II, the man-eating crooner from Little Shop of Horrors.

Why so skeptical?

Because there is only one thing propping this market up – government intervention. And the scale of it is awe-inspiring. Bailouts have been arranged (directly or otherwise) for banks, commercial real estate, homebuilders, automakers, and insurers. What would happen if the Gov withdrew their support? Zerohedge sums it up well:

The problem is that despite what Bernanke is saying right now, that he doesn’t view government stakes in banks as long-term propositions, there is really no way to extricate the government without suffering the kinds of economic tremors on par with the Lehman collapse.

Roubini: We Can’t Subsidize the Banks Forever

A new WSJ piece by Nouriel Roubini and Matthew Richardson shines more light on the issue. It’s an absolute must-read. Among other things, they out-gloom the IMF’s recently-doubled loss estimates with their own:

the International Monetary Fund has just released a study of estimated losses on U.S. loans and securities. It was very bleak — $2.7 trillion, double the estimated losses of six months ago. Our estimates at RGE Monitor are even higher, at $3.6 trillion, implying that the financial system is currently near insolvency in the aggregate.

But Roubini wasn’t featured by mainstream media outlets today, despite his solid track-record. CNBC and others were laser-focused on pumping Ben Appleseed’s message that “All will be better in Q4 (unless something bad happens), and gosh, look at all those Pretty Green Shoots!”  Bernanke’s track record should give pause to anyone tempted to listen.

Messrs Roubini and Richardson also highlight the fallacy of these so-called Stress Tests:

For example, the first quarter’s unemployment rate of 8.1% is higher than the regulators’ “worst case” scenario of 7.9% for this same period. At the rate of job losses in the U.S. today, we will surpass a 10.3% unemployment rate this year — the stress test’s worst possible scenario for 2010.

Why is the Fed so wrong, so often?

By now it should be obvious that we can’t trust predictions made by the Fed or Government. It’s clear that Greenspan and his Reserve blazed the trail to bubbledom, and that Bernanke is following along wholeheartedly. But why? I see 3 possibilities:

1. They are simply academics in over-their-head, reliant on faulty models and trusting of crooked bankers
2. They understand the problem, but think deceiving the public is a necessary evil, in order to provide a “soft landing”
3. They are doing everything their power to rescue their buddies, and they justify this to themselves in any way that makes at the time

But their intentions really don’t really matter, for now. We should focus on their actions, which only prolong and exacerbate the inevitable pain. Many amateur  investors, who tend to buy high and sell low, are destroying their portfolios because of the extreme volatility we’ve experienced. This volatility is largely due to government intervention, and possible manipulation via proxies in equity markets.

What’s really sprouting up? Moral hazards, like weeds.

We’re creating a new financial system, one more dependent on the government than ever. Banks and others can start taking ridiculous risks again, assured that the ol’ reliable taxpayer will bail them out if anything goes wrong. Weaning the market off the taxpayer-teet will be extremely difficult.

My only advice is to stay flexible, and prepare yourself for various outcomes: inflation, deflation, stagflation. It all depends on the whims of the Federal Reserve and Government, and the politicians that (kind of) watch over them.

I see bigtime-inflation as the most likely outcome, by far. But who knows? My beliefs regarding inflation are largely based on the writings of Bill Fleckenstein, who is fond of saying, “In a Social Democracy with a Fiat Currency, All Roads Lead to Inflation.” His message has become more emphatic as the Fed has gotten more radical and increased quantitative easing. I’ve read the deflation arguments, and they don’t make sense to me, other than in the near-term. How to prepare for possibly nasty inflation? Precious metals and cheap stocks with good cashflow, among others. I’ll go into this more in upcoming posts. This one has already dragged on too long.

Disclaimer: None of this information is investment advice. I am not a financial advisor. Always consult with a Financial Professional when making investment decisions.