Bearish News

China is one of the few places I want to own stock these days. Why? Because I think their economy is most well-positioned to weather this storm. Chinese ETFs are down over 50% from their high last year. Buying opportunity or value trap? I’m going with buying opp. China is a rising global power, and they can tap significant public/private savings to stimulate their domestic economy during the downturn.

China’s average savings rate is around 50%. Most analysts view this as a point of weakness for China, because people aren’t buying stuff they don’t need with credit they don’t deserve. In China, people usually save to buy things they want. Analysts don’t seem to understand this alien concept. All they know is that it sounds boring, and slow! But there just might be something to it.

The two most popular Chinese ETFs are FXI and GXC. But both of these are very heavily weighted towards financials, 41% for FXI, and 30% for GXC. I already own enough banks in America, courtesy of my taxpayer dollars (poorly-run ones, whose financial results are unintelligible. Hmmm, maybe Chinese banks are worth a look too?). Anyways, I’d rather focus on China’s overall economy, particularly domestic spending and growth.

PGJ is a Chinese index fund that seems to fit the bill. It has only 6% exposure to financials, and has been around since 2004. It’s based on the 102 stocks of the Halter USX China Index. It’s comprised of Chinese companies who get the majority of their revenue domestically.

I’ll be averaging into a PGJ position over the next few months. The bottom line is that I want some more exposure to China, but not to banks and finance. Picking individual Chinese stocks is hard, I only own two: BIDU and AOB. So PGJ seems like a good index if you’re looking for non-financial diversification.

“Good Guy” banks that received taxpayer dollars are under increasing pressure to eliminate or reduce their dividend. Here’s a guess at some of their defenses:

We did not want these billions. We took them against our will, and in the spirit of cooperation. If we refused, our more troubled brethren would have been singled out as possibly “insolvent”.

Furthermore, refusing a big cash injection would have left us at a competitive disadvantage. Besides, we never needed or wanted it. Even though the government’s terms were much better than any private source would have offered to us.

Will they keep paying big dividends while receiving taxpayer money? Mr. Obama has signaled strict, transparent, and less favorable bailout terms. We’ll see how it plays out soon. Next week should be another interesting one for financial stocks.

There’s also the seizure of First Centennial to consider, which was announced after the close Friday. Estimated cost to the FDIC: $227 million. Not a huge chunk, but still worrying. And there’s something… dishonest about Friday-evening press releases that makes me skittish.

Obama’s weekly address contained one juicy nugget about his pledge for transparency. I’m trying not to get my hopes up, but this part of the speech did just that:

Instead of politicians doling out money behind a veil of secrecy, decisions about where we invest will be made public, and informed by independent experts whenever possible.

The information will eventually live at www.recovery.gov. Sounds like a very good plan in theory, but I’ll withhold judgement until we get more details. Will transparency be retroactive, include previous investments, loan collateral, everything? I hope so. After all, Mr. Obama is a constitutional scholar. And nothing so far seems to gel with the constitution.

It’ll be interesting to see how bank stocks react on Monday morning. I think Obama has investors spooked about banks, and rightly so. Disclosing details about these guys could mean some common shareholders get wiped out. That’s what happens in an open, efficient market.

Banks crashed during Mr. Obama’s inauguration speech (related post here). He made pointed comments about greed, accountability, and bailouts. Not good things for common shareholders of banks with anything to hide. His decisions could dictate the future (or lack thereof) for some banks. A few days later banks spiked, after Geithner, who is perceived as a banking-insider, sailed through confirmation. That’s enough for now.

Staying diversified is just as important on the way down. Shorting homebuilders may seem like a sure thing, but crap like government intervention and desperate mutual fund managers can get in the way of a profitable short position.

So I added XOM as a new short yesterday, after hours at $77.95. Exxon has a LOT of meat left on its bones. And I don’t see how they can maintain that valuation with oil demand shrinking and gas stockpiles overflowing.

My basket of shorts is getting more diverse, still needs some work: financials (GS, JPM), homebuilders (TOL, CTX), commercial real estate (SPG), energy (XOM). I don’t have a tech, but am OK with that for now. I also own two bear mutual funds which provide good diversification, as noted here.

Nouriel Roubini’s firm just released a report with this grim title: “Total $3.6T Projected Loans and Securities Losses, $1.8T Of Which At U.S. Banks/Brokers: The Specter of Technical Insolvency“.

It doesn’t exactly roll off the tongue, but it’s the wording of it is fascinating: The Spectre of Technical Insolvency. Not long ago, reports warning of large-scale insolvencies were dismissed. Today people calmly digest them, then react according to how they’re positioned in the markets. Bears urgently gesture to their friends (who could care less), “look! it’s bad, reaaal bad!”. Bulls find some way to refute the analysis with numbers and assumptions more to their liking.

Meanwhile, technical traders shrug and resume charting, thinking “Oh, you foolish fundies. Don’t you understand that this is not an efficient market?“.

Enough nonsense, here are some interesting excerpts:

FDIC-insured banks’ capitalization is $1.3 trillion as of Q3 2008; investment banks had $110bn in equity capital as of Q3 2008. Past recapitalization via TARP 1 funds of $230bn and private capital of $200bn still leaves the U.S. banking system borderline insolvent if our loss estimates materialize. (emphasis mine)

That’s especially worrying, because Roubini’s earlier statements, which were among the bleakest around, turned out to be far too optimistic. It’s worth noting that he has recently erred on the side of caution when issuing negative reports. If the same happens this time, all bets are off.

In order to restore safe lending, additional private and/or public capital in the order of $1 – 1.4 trillion is needed. This magnitude calls for a comprehensive solution along the lines of a ‘bad bank’ as proposed by policy makers or an outright restructuring through a new RTC.

I think Roubini’s analysis is fantastic. But ideas he seems to favor, like “good-bank/bad-bank”, and “give them more capital, and keep it coming”, are ridiculous. Yes, he would probably execute the plans on much better and fairer terms than Bush’s boys did. I may be missing something.

It’s hard to endorse any ideas that reward incompetence and encourage inefficient markets. I think the band-aid approach is much more appropriate: get the pain over with quickly, let the corrupt and worthless institutions fail. Maybe the impact would be too much to handle, I don’t know… But the concept of having open, honest, and healthy banks just warms my heart. It’ll never happen, though.

Source:
RGE Monitor – need a subscription to view the whole article.

When banks crashed on Mr. Obama’s inauguration day, the obvious catalyst (in my mind) was Obama’s pledge for an open and transparent economy. I don’t think banks want transparency. His comments about “the greed of some” couldn’t have helped either. He seems to favor taxpayers over rich bankers… Odd.

His move today to reform the FOIA (Freedom of information act) is a good first step. He ordered the relevant agencies to change their M.O. to favor the taxpayer. According to Obama, these agencies “should act promptly and in a spirit of cooperation, recognizing that such agencies are servants of the public”. Interesting theory.

I like Obama, he was the first candidate I’ve ever donated money to. But my biggest question is this: is he willing to sit down with the fed, treasury, and say “it’s not in American’s best interest to be in the dark, despite what you think. So what exactly have you been doing with taxpayer dollars? We’re going to show everything to everyone.”

I hope so. But with Geithner, a Fed insider, in charge I’m…. puzzled. Transparency means letting us know where our money, not to mention our gold, is.

Trading note – Shorted some GS today at $66.73, new position. I think Obama may reveal information that these big banks don’t want to be public. This is just based on my opinion on Obama’s character, so please don’t trade on it. After all, I’m down 3 pts on this trade so far. Will probably cover around $75 if it gets there. But I just don’t see how those earnings are sustainable.

Remember: the market’s irrationality can outlive your liquidity. Imagine having shorted oil at $80 on the way up, only to see it almost double. The short would have been correct in his evaluation of oil’s true price, but it was an irrational speculator’s market. So he probably covered, or lost a lot of investment opportunity in the meantime.

Trend=friend. I’m being a little stupid here, basing my short on a new president. But it’s kind of a gut feeling, I don’t fully understand the balance sheets of these banks, like everyone else. I’ll cover for a loss if necessary.

Disclosure: short JPM (puts), SPG, GS.