Bearish News

Occasionally I write about what I’m buying on this site, so thought it would be worthwhile to review my picks and the reasoning behind them.

Note: Performance %’s are from date of post to 03/05/2010. In many cases, I stopped out earlier on losers or sold winners. I provide additional color when possible.

The Bad

Long Gamestop (GME) @ $24.50: Down 26%. A devious value trap, which still looks cheap to me at 7x trailing P/E. But it gets no respect on Wall St. Everyone’s too busy speculating on BAC and the TBTF mafia, over-leveraged REITs, etc. I am still long GME, but it’ll probably be even cheaper soon.

Short Simon Properties (SPG) @ $51: Down 54%. I’ve traded around this position a few times, with total losses of around 25% on it. I didn’t cover my initial $51 short in the $20’s when I had the chance. Got greedy, figuring they were headed to zero just like GGP. Then the Fed/Gov stepped in with more liquidity than God, and raising capital became much easier, especially for a well-connected REIT like SPG.

Expensive lesson learned, covered that $51 short in the high 40’s. I’ve re-shorted since and been stopped out for losses a few times (and am still stubbornly watching for signs that the inevitable and long-awaited CRE shoe is finally dropping).

Long GRZZX (May 2009): Down 49%. I sold this short-only mutual fund for a 20% loss, as the bull market picked up steam and bailout bonanza really got under way. Theory was that it would be nice to have a diversified basket of shorts for the inevitable double dip.

At that point the market had already bounced 28% from lows. The world was ending, and this little bounce was dead-cat in nature. Boy was I early. Not to mention generally naive about the effects of government-mandated recklessness. A few days after I bought GRZZX in May, I wrote The Deck is Stacked Against Shorts. A month earlier I warned bears that More Bailouts and Inflation Loom. Shoulda been bargain hunting or speculating on garbage stocks.

The Good

Long AAPL @ $81 (Jan 2009): Trades at $218.95: Up 168%: Apple was a lesson in how to trade the next panic. When that crazy growth-monster momo stock you lust after (but don’t want to pay a premium for) crashes, BUY IT. Other examples: VMW, GOOG.

I bought more AAPL at prices ranging from $81-$93, and ended up with quite a large position (for me). If I remember correctly,  Apple was trading at around a 16x P/E with screaming earnings growth and $30/share in cash. There really were some bargains there for a while… Still holding around 1/3, house money. Sold the rest from $160-$194. The stock is a beast, no telling where it’ll stop. But I am skeptical of the iPad’s prospects.

Long Palladium bullion @ $250/ounce: (June ‘09) Now trading at $470/ounce – Up 88% (June 2009). I think my thesis was solid, and appears to be playing out. Back then I said, “It may prove to be a good hedge against an inflation-fueled recovery. As the world continues to print money in an attempt to stimulate industry/consumers, demand and inflation could increase dramatically. This may in turn cause commodities like palladium to rise significantly, as governments artificially goose the markets.”

Long PGJ @ $13: (Jan ‘09) Trades at $24.21 – Up 82%. My favorite China ETF. It has minimal financial sector exposure (unlike FXI, where the index is 40%+ finance stocks). Still holding most of this.

Long TRAMX @ $5.66: (May ‘09) Now trades at $6.99 – Up 23%. Africa and Middle East mutual fund. If traditional emerging markets aren’t risky enough for you, you can buy this fund and get exposure to these politically volatile but fast-growing markets. Still holding.

Long EKWAX @ $45: (Jan 2009) Now trades at $73.29 – Up 58%: I love this gold fund. These guys know how to pick winners in the mining space. It’s up 602% over the last 10 years. I agree with George Soros here. Gold may eventually be a bubble, but it’s one that I want in on. And it has not come close to peaking yet, with countries around the world engaged in a currency race to the bottom. Still own it.

Morals of the Story, Lessons Learned

Overall I’m happy with the picks I’ve posted here. They either crushed it or bombed, not much in the middle.

I didn’t have enough long equity exposure in ‘09, but the ones I did have made up for it. I also own gold and silver, which have done well.

One of the biggest lessons for me was the difficulty of shorting in an environment like this. The Fed has been pumping liquidity into the system like mad, and outcomes depend more on the actions of a few questionably-motivated creatures (who have abysmal track records) than actual fundamentals. Nothing to be done about that though, from an investing perspective anyway.

In hindsight, it was clearly better to bargain-hunt and speculate than short in ‘09. My best gains of the year were pure speculation or value plays. I didn’t publish two of the big ones here, but I did post them on my old Motley Fool CAPS blog. One was CROX at $1.20 (trades at $7.49 today, 524% gain).  The other was Men’s Wearhouse @ $11.20 (trades at $25.17 today).

Reading hedge fund veterans like Bill Fleckenstein was quite helpful. I’ve been subscribing to his service for a while, and he closed his short-only fund near the market bottom, after a hugely profitable year. His short positions have been burnt by Fed Chairmen past, so he knew what effect all that Fed liquidity would have. He told readers he’d rather be in precious metals and cheap stocks than short.

I learned a lot about government intervention in general, and its impact on markets. Next time it looks like the world is ending, everyone should buy horrible pig stocks that will  benefit from the Feds’ clumsy/corrupt attempts to “stabilize the markets”, AKA bail out politically-connected mega-firms.

Guest post by Mac of SHTFplan.com

There’s a lot of buzz hitting the contrarian financial news circles around the web regarding recent market weakness and the possibility for the end of the rally which began in March of 2009.

Many contrarian investors have been waiting for the crash that is inevitably to follow the largest US market rally in modern history, and this may be it. We caution our readers, however, that over the last year there have been various false signals, and rather than seeing a crash in the Summer of 2009 or Fall of 2009, stock markets continued to push up, despite abysmal economic fundamentals.

Is it the real thing this time?

Bert Dohmen, publisher of the Wellington Letter, says “This is the time for the bears to make money. Sell short any rally attempts.”

Dohmen, who suggested in December 2009 that early January would see a continued rise in stocks, anticipated a down-turn in late January. In his most recent letter, dispatched to subscribers January 21, 2010, Dohmen says that we can forget about the theory that “hyperinflation is right around the corner,” and that deflation and debt implosion is the major problem:

“Market analysts expect 2010 to see a rise in corporate earnings and sales. They are probably correct. But that will be met by further market weakness. You see, that’s what the stock rise of the prior 10 months was all about. Stocks are already priced for the best news that could possibly develop this year. When all the fund managers are positioned for this “good news,” there is no further money to go in. And that’s when the selling gets serious.

The recent news out of China is just what we have been warning about: tighter lending and monetary policies! Economic growth in the last quarter was a blistering 10.7% (officially), which obviously creates worries about inflation. Tighter money dampens speculative fever. And all the sins of the speculative bubble of 2009 will surface.

As a result, the US dollar is now in demand and is soaring. That kills the most important reasons for buying commodities. The dollar rally will be a lot stronger than even the few dollar bulls imagine. There will be a massive rush to close out short positions.”

In our earlier post this morning, Chinese Fed Shuts Down Lending, Capital Flees to Dollar, we suggested that the pullback in Chinese bank lending and stimulus, may force capital speculating in Asian stocks back to safety in the US Dollar. Dohmen seems to agree with this assessment.

J Derek Blain, of Investopedia, also thinks the stock markets may be turning. His view is that not only will the dollar rebound, but we will see equities prices, commodities, and precious metals turn to the down-side in the near term, as more capital flows into the US Dollar. Blain is quite bearish on short-term precious metals prices, so if you haven’t stocked up on gold and silver, perhaps you’ll have yet another opportunity in the near future because Blain says The Big One Could Finally Be Here:

“But here’s the interesting thing – finally, after 5 weeks of watching gold top and begin its bear market decline, and the major stock indexes make new highs, we might have just witnessed the turning point in all “risk assets”.

And that is really one of the keys, and one thing we have been saying for several months now.   Whenever the precious metals are treated as risk assets for the purposes of capital gains, they are not in a bull market but in a false rally.  The psychology that drives this sort of rally is hope-based, completely mood-driven, and ultimately comes unwound like the thread in a poorly knit sweater.

What we are looking for, here at Investophoria, is despair.  Until we see such a thing in the precious metals we cannot recommend buying them.  If we did without it, we would be advising you to get in line and be “the sucker” who is willing to pay a higher price.”

—

“The next leg down in both gold and silver should be very fast and will take many more by surprise who have run to them seeking to make back the losses they sustained in stocks in the last bear-market leg.”

If the global stock markets start to pull back, gold and silver are going with them. While gold is a safe haven asset in times of distress, it is important to note that the broader picture for the time being is that gold has not decoupled from the stock market in general and remains closely tied to the inverse movement of the US Dollar, as was evidenced by gold’s reaction to the Dubai stock market collapse in November 2009.

For traders (not investors) looking to make short term profits, precious metals are just as dangerous as the stock market right now. If you are a long-term precious metals investor, turn off the news and stop watching daily price movement in precious metals, you should be fine when gold does finally decouple from other assets and becomes a safety asset, not because of inflationary fears, but because instability in the public (government) sector.

When this will happen is anybody’s guess, but there should be a floor for gold, because as the price collapses, it will become attractive for large buyers, especially central banks in China, India and Russia. So, there really is no need to run out and sell all your gold bullion to Cash4Gold at 60% less than it is worth. The longer trend for gold is still entact.

The dollar seems to be the beneficiary of recent market mini-panics, as evidenced by corrections in US markets last year, Dubai and now the shift in capital out of Chinese assets.

How can this be, you ask? Isn’t the dollar supposed to be on an unstoppable collapse to a value of exactly zero? Well, yes, it is on a collapse trajectory, but it is important to note that this will not happen in one fell swoop. There are gyrations in the markets, and since the US Dollar remains the world’s reserve currency, regardless of talk from Russia and China, this is where the money will go when everything else is collapsing. We strongly believe that this trend will eventually end and the ultimate safety asset class will become precious metals, but in a paper world, when the SHTF, capital flees to the safest paper around, which ironically, is the US Dollar.

Considering that the US Treasury needs to fund roughly $1.5 Trillion in new debt via Treasury sales in 2010, a global stock market collapse could be the US government’s saving grace, as Graham Summers recently pointed out:

“So how do you create interest? [In US Treasuries]

Simple, let the stock market collapse. The “flight to safety” that would follow would push billions if not hundreds of billions of dollars into Treasuries, soaking up the debt issuance and roll-over with little difficulty.”

It sounds mad scientist sinister, but quite realistic when you give it the consideration it deserves. The Fed, Treasury, Congress and the administrations have continually taken ridiculous, if not criminal, actions over the last several years. What’s to stop them now? It’s really a quite simple plan – pull back on stimulus in the US and China, have the big investment banks rip their profits out of equities and shift into US Treasuries, and leave panicked investors who thought the economic recovery was sustainable scrambling for the exits.

Theoretically, this all sounds quite feasible, but how are we looking from a technical perspective? Tyler Durden of Zero Hedge weighs in on the argument for the dollar:

“The DXY is about to break the 78.449 high last achieved on December 22: at 78.320 we are very close. Greece is helping. When that resistance is breached, look for Europe to start panicking and also all those who still have the dollar short trade on to start rushing through the exits.”

Though it may still be too early to tell, the technical signals suggest that the ingredients for a crash seem to be in place and conditions for a serious down-turn are now more likely than anytime in the last ten months.

Thanks to Mac Slavo of SHTFplan.com for the submission.

VIX is spiking. Rally might actually be done (yes, it’s been said before). I sold most of my remaining AAPL today, from a lucky grab @81.86 here. Also shorted WFC on Monday @28.59.

chart via ZH

Since January of ‘09, Citron Research has been warning about the questionable business practices of Apollo Group (owner of University of Phoenix):

Count on the Obama administration to take a fresh, critical look — as the largest single recipient of Student loans in this country is a for-profit institution whose insiders have sold hundreds of millions of dollars of stock while collecting over 75% of their revenue from government guaranteed loan funds, while delivering an education of questionable value amid a history of unsavory business practices.

Well, after-hours today the WSJ reports that the SEC is investigating some of Apollo’s revenue-recognition practices. The result? APOL down 17% after hours.

Apollo Group Inc. said the Securities and Exchange Commission has launched an informal inquiry into its revenue-recognition practices.

Apollo, whose University of Phoenix is the country’s largest private college and has benefited from the economic downturn, reported fiscal fourth-quarter results Tuesday that beat Wall Street estimates. But news of the probe, its second this year, sent its shares tumbling in late trading.

Finance Chief Brian Swartz said in a conference call with investors Tuesday that the company believes “that our revenue recognition policies are appropriate and in accordance with GAAP.” He added that it didn’t have “any further insight” into the probe.

For-profit colleges have come under fire numerous times for their methods of recognizing revenue, most of which is derived from government loans. Apollo received a letter from the SEC’s Division of Corporate Finance related to its revenue recognition in February and said in its conference call that, “to our knowledge,” it answered all of that division’s questions. The current probe comes from the SEC’s Division of Enforcement.

Apollo said that it took an $80.5 million charge in its fourth fiscal quarter to cover the costs of a possible settlement of a whistleblower’s suit pending in U.S. District Court in Sacramento, Calif. The suit alleged that Apollo owed the government refunds on billions in financial aid funds because it allegedly paid recruiter incentives based on the number of students they enroll. Federal education law bars such incentive payments.

Disclosure: Short APOL

Homebuilders: Short or Steer Clear?

KB Homes missed big today, reporting an $.87 per share loss. Their outlook on the market wasn’t rosy either. They dropped 8.5%. Builders appear to be a good short candidate. But like most industries, one needs to consider government interventions before shorting.

Major HB names are still up more than 100% from their 52-week lows. Kinda makes the S&P 500’s rally look meek:

1. Meritage Homes (MTH) up 307%
2. M/I Homes (MHO) up 198%
3. KB Home (KBH) up 145%
4. Ryland (RYL) – up 111%
5. Toll Bros (TOLL) up 47%

Government Crutch

Since last Fall, when a depression seemed imminent, builders have clearly benefited from government-support. The big question is: How long can this last? The Fed claims to be planning their exit strategy. But they always add a disclaimer, “not too soon“. Meanwhile, the fundamental side has changed little.

Cheap mortgages are here to stay for an extended period. Bernanke and Geithner have made this clear. They will do all it takes to prevent (or postpone) a depression. Cheap rates will buoy builders, but enough? This is where the homebuyer-tax-credit comes in, acting as another gross distortion of markets. Think about those people who bought a day/week/month before the credit passed. “Oh, gosh. You bought your home yesterday? Too bad.”

$8,000 Credit: Double and Expand It, Please

The first-time home buyer credit is scheduled to expire in November. But lobbyists are fighting hard to get it renewed. Congress seems likely to bite, despite our huge deficits. These market-interventions will largely determine the direction of home-builder stocks over the next year plus.

Sen. Johnny Isakson of Georgia, an ex-realtor, has proposed not only extending the credit, but expanding it to a max of $15,000. And he thinks everyone should be eligible in 2010; not just first-time buyers (WaPo). Bailouts and moral hazards don’t show any sign of abating.

So while the administration is under (a little) pressure to shrink deficits, more bailouts will probably pass. Our economic leadership views these market-distorting actions as victimless. Everyone benefits from rising home prices, right? Wrong. What about the millions of renters who are going to face higher taxes, due to drops in tax revenue? And what about responsible savers who have been waiting for homes to drop into their price range? They get screwed.

The Dreaded Spillover Effect

There would be a spillover effect on the broader economy if housing prices dropped. But do we really want to return to the days when houses were ATMs? Clearly that’s not sustainable. And despite falling prices, house valuation ratios remain out-of-whack. In a recent piece titled Falling House Prices Are The Solution, Not The Problem Patrick Killelea wrote:

It’s still much cheaper to rent than to own the same size and quality house, in the same school district. On the coasts, yearly rents are less than 3% of purchase price and mortgage rates are 6%, so it costs twice as much to borrow money to buy a house than it does to borrow (rent) the house itself. Worse, total owner costs including taxes, maintenance, and insurance come to about 9% of purchase price, which is three times the cost of renting. Buying a house is still a very bad deal for the buyer on the coasts, but it does make sense to buy in Michigan and some other places where prices have fallen into line with salaries and rents.

Shifting to a non-supported housing market too quickly would have negative effects. But we need to let housing prices fall much more than we have. It’s important to remember that we are fighting fundamental market forces here. Even the US government can’t really “win”. Something’s gotta give, someone has to lose. Let banks take the hit. They benefited from low interest for long-enough.

In short: For the immediate future, I won’t be shorting homebuilders. Too risky while all this cheap money is flowing. But I’ll be watching them, especially MHO, KBH, and MTH.

Disclosure: No positions in any companies mentioned
Disclaimer: None of this information should be treated as investment advice. Always consult a professional.

Do fundamentals matter?

David Tice doesn’t see this rally lasting more than six months. Part of me wants to agree with the legendary bear, who founded the Prudent Bear Fund (BEARX). He thinks equities are overvalued, and I couldn’t agree more. Bloomberg:

‘The economy is in really, really bad shape’ Tice said today in an interview with Bloomberg Television. The Federated Prudent Bear Fund that he founded returned 27 percent last year as the S&P 500 plunged 38 percent, the most since 1937. ‘So many people are trying to be optimistic. We’ve gone from oversold to overbought.’

But this irrational rally has legs, and could continue for a year, maybe even a few. Our current leadership seems determined to goose equity markets and sacrifice the dollar. Until the Fed starts contracting the monetary supply (if they ever do), I’m avoiding large short positions. Events over the last six months have caused me to rethink many aspects of US equities. In April I wrote:

Companies with horrific balance sheets are a dime-a-dozen these days. Fundamentals of the economy are bad and getting worse. Seems like a short-seller’s’ paradise, right? Not necessarily. Inflation and bailouts may be the factors that ultimately decide the battle between Bull and Bear.

Being in foreign assets, precious metals, and select equities may prove safer than shorts. The free-market side of me detests this, because US equities are incredibly overpriced. Being short makes a lot of sense, but as Keynes said “the market can stay irrational longer than you can stay solvent“. How ironic that current irrationality is due in part to his disciples.

It’s important to focus on what is likely to happen, taking into account political and economic realities, not what should happen. There’s too much manipulation, Fed-pumping, quant funds, and distortion to make bets based on logic and fundamentals. Not to mention suspicious short-squeezes.

Am I hedging my statements here? In a way. The direction of this market depends on the actions very small group of people. Gotta stay flexible, since we don’t exactly what they will do. What I’ll be watching most is interest rates. If the Fed tightens, that would be a very negative catalyst for US equities.

S&P 500’s Real P/E Ratio: 129

As I have noted multiple times, US equity valuations are ridiculously high. The real P/E of the S&P 500 is currently 129x. Don’t believe me? Check S&P’s site for yourself. Why is this different from P/E numbers you see, like the 20x number used in the Bloomberg piece on Tice? Two reasons:

1. Changes to accounting rules, allowing banks to sweep losses under the rug (FASB-157-4 in particular).
2. Increased use of “operating earnings” to hide losses. This is a relatively new phenomenon. See chart below and this post for a detailed rundown. The MSM and analysts use these “operating earnings” in their bull-cases, despite the fact that they don’t conform to Generally Accepted Accounting Principles (GAAP).

I don’t like this contrived rally any more than Mr. Tice. But I’m not nearly as confident in a major correction as he is. It’s certainly possible. If The Fed starts tightening, for example, it’ll be time to reevaluate. But the existing power structure will do everything possible to keep the party going.

Note: Prudent Bear is arguably the best long-short mutual fund out there. They maintain long positions in cheap stocks and gold miners to hedge against inflation, smoothing returns. Since January of 2000 (as far back as Google Finance goes) the fund has returned 49% compared to the S&P 500’s -25%.

Related:
Flaws in the Deflation Case (June 22nd 2009)
David Tice Interview with Bloomberg TV (Sept 22nd 2009)

Updated 9/23/09 for clarification

Disclosure: No position in any companies or funds mentioned. Nothing posted here should be considered investment advice. Always consult a professional when making investment decisions.