trade

The last three days' happy little runnup of almost 400 points in the DOW has made me antsy to short again. I looked at 5-yr charts from UBS, DB, BCS, LEH, JPM, GS, MER, MS, BSC, MHP, MCO, AIG, MTG, and RDN. I looked at the low, high, and current price. Then I ranked them according to the multiple of current to low price. DB, GS, and JPM came out at the top at 3 times. I decided to short more GS in order to save on trading costs by consolidating.

I wanted to short more ITB (homebuilders' index), but it's not available to short. I'll have to look at options if I want to get any more out of that.

The housing market has transferred trillions of dollars from investors to anyone who sold or borrowed against their home in the last five years. The problem with the transfer is that 90% of the people who got the money spent it on worthless stuff (for example, the homebuilders who have built millions of extra houses), so the money cannot be recovered by anyone else.

The problem that the Fed has right now, is that they set the price of money for banks. However, they cannot control the demand for credit, nor can they control the value that banks put on collateral. Right now we are in a self-fulfilling credit contraction. Banks require more collateral for a loan (no more 100% LTV mortgages) which in turn makes the collateral worth less, which causes banks to require even more collateral or charge higher rates. This cycle will end when people are again able to pay with cash and not credit.

Bottom line: I believe that the Fed can prevent a crash, but not a bear market or a recession. Remember 2000? The Fed cut rates to 1%, giving us one of the mildest recessions on record, but they still were unable to prevent a massive bear market in stocks.

pppppppppppppppptttttttt

Home builders are still building too many homes. Sales came in at 870,000 annualized for July. New home starts came in at 1,380,000. That’s 58% too many new homes being built. Oh, wait! I almost forgot about CANCELLATIONS! Toll Bros. has one of the lowest cancellation rates at 29%. I’m going to use 30%. That knocks that 870,000 down to 609,000. Realistically, the home builders are building 227% more homes than they should.

Shady Deals or Desperate Measures?

The Fed is accepting investment grade commercial paper at discount window.

The Federal Reserve Bank of New York today affirmed its policy of accepting “investment quality'’ asset- backed commercial paper as collateral for loans. (Bloomberg)

Also, the Fed has allowed Citigroup and Bank of America to jeopardize FDIC insured accounts to the tune of $50 billion ($25 B each) in order to bail out their trading desks. See this article.

Wow!

The blind leading the blind!

The DOW is up 80+ today as I write this. What a golden opportunity to short. Yahoo's top financial news is "Wall St. Jumps on Good Housing News". What exactly is this "good" housing news? New home sales came in above expectations. The annualized July sales rate was 870,000 homes. But how many are they still building? New Housing Starts reported on 8/16 tells the truth. The annualized rate was 1,380,000 homes. The homebuilders are still building 59% more homes than they are selling. On top of that, home prices fell almost 4%. Ouch!

Time to short homebuilders some more.

Deflationary pressure still strong.

Deflation is being caused by a collapse of collateral values. Banks are hoarding money. Countrywide is offering 5.5% on CD's because they need the deposits. The credit crunch is still crushing the life out of the system, albeit a little more slowly than last week.

As long as deflationary pressure remains strong, I will be short equities. This gives me a maximum position in cash. In other words, being short equities is essentially the same as leveraging a cash position. It allows me to carry more cash in my account than I could if I was 100% in cash. My actual cash position is 166% of my total account value. I'm not sure how to calculate the leverage on cash of put options, so these aren't counted.

trades

I took advantage of today's rally to do three trades. The ITB index is already overshorted, so I looked at more homebuilders. KBH has rebounded to just over book value. So I shorted that stock at $32.13. I also shorted RIO at $39.62. That's 15% over its lows. RIO is a trading move. If I have to hold it until there's a recession, I will. But if I get a 10%+ profit, I'll take it. The third trade is a bet on a consumer slowdown through the Christmas season. I bought an AMZN Jan '08 50 put for 1.10. AMZN is at $74.66 with a P/E of over 100. If we have a recession, I think the P/E could drop to 50 and the stock could drop to $35.

All these trades have two lines of thought behind them. 1. Debt cat bounce (Winterism). 2. I'm betting that the weekend is likely to bring more bad news than good news. This is the opposite of the late Friday runs on merger-arb speculation earlier this year.

Recession coming

U.S. auto sales fell to the lowest for July in nine years, prompting GM, Ford and Toyota Motor Corp. to cut their forecasts for total vehicle demand in the second half. Sales at GM, Lear's biggest customer, plunged 22 percent. (Bloomberg)

The recession is coming soon, probably in the next six months.

trade, thoughts

Trying not to jump on the downslide even more. I have to be content with the profits my position will give me. Last night Fed member Poole said that there would be no rate cuts "barring a calamity" because the financial credit crunch hadn't spread to the general economy. It will. Then the Fed will lower rates. I'm beginning to see why the Fed always lowers rates too late. It's because if they provided liquidity to the market now, they would only fuel inflation. None of the liquidity would go to the mortgage market, instead, it would go to something tradeable that has a recent track record of gains such as oil and other commodities.

Bought 2 NFI Sept. $2.50 puts for $0.65 each. Other than that, everything's too expensive. Options are off the charts, the DOW was down as low as 12,500, and the VIX is pushing 37, it's highest level in almost five years. Maybe I'll do some bottom fishing on CNE, which is down to $13, yielding almost 18%.

trade

I bought a Starbucks Jan '09 $20 put for $1.15. This trade is a bet on recession, and a spreading of economic pain from the Walmart customer to the yuppies. I think this is a great trade for two reasons: first of all, the pain will probably spread, and second, I expect SBUX to trade in line with the overall market. SBUX is at $27.15 right now.

Saved by the ECB...

The ECB has done what the Fed refused to do. In order to return overnight interbank Libor rates to target rates, they needed to inject $215 Billion over the last two days.

What does this mean? I believe that while they may have averted a crash, the liquidity will not prevent a bear market, at least for housing and financial sectors.

Mortgage lenders and homebuilders may not have the noose tightened, but it's unlikely to get any looser. I don't see a market for non-conforming mortgage backed CDO's any time soon. I don't see home prices rising any time soon. I don't see alt-A, subprime, 100% LTV, or jumbo mortgages becoming more available no matter how much money the Fed throws out there. The only way that might happen is if Fannie Mae is allowed to change the criteria for conforming loans, so that they can buy more non-conforming loans. However, that will take time. It also just socializes the losses, with the result that the overall economy will bear the burden of the pain in the mortgage sector.

While my tactical trades (and non-trades) have been terrible, my overall strategy has been pretty clear of major blunders. I need to improve my tactics by taking advantage of opportunities to take profits and enter positions at more favorable times.

For example, I put in a sell order (unfilled) for my WaMu Jan '09 $20 put at $2.15. At that price, it gives me the equivalent annualized return of holding the option to close with WM dropping to $0 on the day of expiration. With the VIX near its yearly high, it's time to look for some profits. If I had had my wits about me, I could've sold it for $2.50 last Friday.

Unhinged Fund Update

Unhinged Fund Alert! spreadsheet.

Unhinged Fund Alert!

25!

Affiliation: Goldman Sachs
Fund: North American Equity Opportunities Fund
Size: $767 M
Leverage: ?
Losses: 15%
Status: Closing
Links: Reuters, TheStreet.com

Unhinged Fund Alert!

22, 23, and 24!

BNC Paribas is the latest bank to announce that it was suffering hedge fund losses. It's interesting how the funds are supposed to be diversified, but they keep dropping in 2's and 3's. That tells me that they're all playing the same game. The lake is drying up and the fish have nowhere to go. They are already eating each other.

Affiliation: BNC Paribas

Fund: Parvest Dynamic ABS
Size: $2.75 B (combined)
Leverage: ?
Status: suspended
Links: Yahoo! Finance

Fund: BNP Paribas ABS Euribor
Size: $2.75 B (combined)
Leverage: ?
Status: suspended:

Fund: BNP Paribas ABS Eonia
Size: $2.75 B (combined)
Leverage: ?
Status: suspended

random thoughts...

First, strategy. I will wait to make another move in options until the VIX gets back down around 15, or if it spikes up to 30, then I'll look to sell a couple of positions if they jump as well.

Here are a couple of general thoughts on inflation and deflation. Inflation is when the value of money shrinks in comparison with goods. Deflation happens when the value of goods falls in relation to money. Deflation can occur because of lack of demand, oversupply, or sharp contraction in the money or credit supply. Inflation can occur because of lack of supply, increased demand, or expansion of credit or money supply.

oopps!

I guess I forgot to take some profits last week. I should have closed 2 positions: Countrywide at $25, and the WaMu Jan 09 $20 put. I should have closed Countrywide because $25 is book value, and also because it would have given me a 40% profit. If it drops another 10%, that's only 6% on the original position. I should have sold the WaMu put because the price spiked on abnormally high volume. I may not have caught the highest price, but at least I could have put in a high sell and tried. Next time, I have to remember to buy low and sell high.

has Cramer been reading my blog?

I couldn't have put the Hedge Fund situation better myself.

Unhinged Fund Alert!

19, 20, 21 !!!

Three more! All from AXA.


Fund: Oddo Cash Titrisation
Affiliation: AXA
Size: $1 B combined
Losses: 3% - 20% ? (enough to close)
Status: Closing

Fund: Oddo Cash Arbritrages
Affiliation: AXA
Size: $1 B combined
Losses: 3% -20% ? (enough to close)
Status: Closing

Fund: Oddo Court Terme Dynamique
Affiliation: AXA
Size: $1 B combined
Losses: 3%-20% ? (enough to close)
Status: Closing

copied in its entirety...

To Deflation
by Andy Xie
Morgan Stanley
http://www.morganstanley.com/GEFdata/digests/20050610-fri.html#anchor
4June 10, 2005

The current business cycle is inching towards a deflationary ending. Excessive increases in leverage and capacity in this cycle could turn disinflation into deflation during the coming downturn.Property speculation has been at the heart of demand creation in both Anglo-Saxon consumption and Chinese investment — the two drivers of the current business cycle. While commodity prices are still high, the excess capacities downstream are already causing the first wave of deflation. The vanishing profits among downstream industries would take down upstream commodity prices. These forces are likely to bring down inflation and increase the cost of money for speculators. Excess capacity in property itself is also closing in on property speculation. Declining rents and rising property prices are frequently observed among Anglo-Saxon and Chinese cities. This trend also increases the cost of speculation and makes it more difficult to continue. Global property speculation is nearing its end, I believe. The US housing market is in its final frenzy. Other markets have already peaked out. When speculation cools, demand will also slow, which could bring down prices and reinforce the deflationary forces from excessive leverage and overcapacity. The risk for deflation is highest in East Asia where most economies have current account surpluses and most overlap with China’s capacities. The risk is lowest among Anglo-Saxon economies that have large current deficits that allow deflationary pressure to vent through currency depreciation.The Speculation-led BoomGlobalization and technological progress have given birth to a low inflation world; the average inflation rate has averaged about 2% over the past 10 years among China, Europe, Japan and the US, which together account for two thirds of the global economy. The average bond yield in these economies has declined by over half during the same period. The low interest rate environment has given birth to the age of speculation, I believe.Speculation has played a dominant role in the current business cycle. It began in 1998 when the US Federal Reserve lowered interest rates and the BoJ increased money supply in response to the Asian Financial Crisis (see Who Wants Asia’s Surplus Savings and Goods, 4 June, 1998). The deflation shock from the Asian Financial Crisis turned into a tech bubble. The tech bubble led to excessive investment. When it burst, it was another deflation shock and the Fed and other central banks responded by cutting interest rates and increasing liquidity again (see Think Before You Stimulate, 1 October, 2001). The stimulus led to a property boom with a weak dollar trade and an Rmb revaluation trade along the way to increase liquidity further and prolong the boom.I call this cycle a speculation-led boom because demand creation has been based on unrealistic asset prices. Anglo-Saxon consumption has been dependent on decreasing savings or on borrowing on rising property prices, which has caused big trade deficits among these economies. Rising property prices have been driving the profit expectation that supports China’s investment boom. Speculation has been the most important force behind the rising property prices, I believe.This cycle resemble those in the 19th rather than 20th century. The foundation for a speculation-led cycle is lack of inflationary pressure due to either surplus labor or technological progress. The world has experienced plenty of both. After the high inflation period in 1970s, the central banks around the world believe that their main job is to balance inflation and growth, not to fight speculation. In the 19th century when insufficient demand was the main challenge, speculation was the main constraint on liquidity expansion. What has occurred in this cycle is that the major central banks in the world did not see the structural change in the monetary environment.Cyclical Deflation AheadThe Anglo-Saxon consumer debt and Chinese overcapacity will likely become the main factors in causing cyclical deflation as the current cycle turns down. Ironically, Anglo-Saxon consumer debt would mainly exert deflationary pressure on its trading partners. Because these economies have huge current account deficits, they could export deflation through currency depreciation. Cutting interest rates is effective in pushing down currencies for economies with current account deficits, as foreign investors are less willing to buy their assets.The economies with big current account surpluses and export exposure to these Anglo-Saxon economies would be at more risk of experiencing some cyclical deflation. Most Asian economies fall into this category. In addition, they compete against China. As China’s overcapacities push down its domestic prices, their export prices could follow.China may be most vulnerable to cyclical deflation. It faces overcapacity in manufacturing, infrastructure, and property in addition to the risk of declining property prices. It is still too early to calculate accurately China’s overcapacity. What we know is that China’s fixed investment has risen from US$343 billion in 1998 to an estimated US$1 trillion in 2005.Liquidity Will Remain StrongAs the cycle is reaching a deflationary ending, interest rates are likely to remain quite low. In a ‘normal’ business cycle, it ends when central banks fight inflation with aggressive rate hikes. Hence, a downturn would be associated with rapidly contracting liquidity. The demand downturn in this current cycle stems from declining profitability and asset prices due to overcapacity. The central banks are not under pressure to raise interest rates quickly.This is why liquidity is still so strong so late in the cycle. Financial markets have been resilient despite deteriorating business prospects. The situation could change when corporate earnings turn shockingly bad and the demand for risk assets drop as a result.One justification for strong markets is that money has to go somewhere. But it doesn’t have to. In a speculation-led cycle, asset prices tend to move together. Hence, diversification does not work well. The right strategy should be ‘buy low, sell high’. The most important investment decision is to hold cash when the cycle turns down and to decrease it when the cycle turns up, I believe.From a macro perspective, the above investment strategy would imply changing money velocity. Indeed, in a low inflation and interest rate environment, money velocity is unstable and depends on sentiment. Unless central banks keep liquidity tight, there is no stable equilibrium. It all depends on sentiment.The Risk of Secular Deflation RemainsIn addition to the risk of experiencing some cyclical deflation ahead, the risk of secular deflation remains (Cyclical vs. Secular Deflation, 11 October, 2002). Secular deflation could be due to: (1) rapid technological progress; (2) declining population; or (3) a competitiveness shock. The first type of deflation is of course good. The IT sector has been experiencing rapid deflation for years, benefiting consumers and producers alike. When enough industries in an economy behave like the IT industry, it will suffer secular deflation. This is why I believe that central banks should tolerate deflation during a period of rapid productivity growth. Indeed, fighting this type of deflation by increasing liquidity only leads to asset bubbles, which is what Anglo-Saxon economies have done.The second type of deflation is similar to a chronicle overcapacity challenge. For example, property prices are likely to drop when population decreases, ceteris paribus. In general, the capital stock per capita rises with a declining population, which translates into chronicle price weakness. Both Europe and Japan seem to fall in this category.The third type of deflation could be solved through restructuring. When a labor market is flexible, an economy could adjust against a competitiveness shock by redistributing resources to where there is still competitiveness. The adjustment may involve some currency weakness also. However, if the labor market is not flexible, the competitiveness shock would be born by decreasing prices and lowering returns on capital. This did occur in Japan and it may spread to other Asian economies.In summary, the risk in the global economy still tilts towards deflation rather than inflation. Central banks should change their policy objectives and view containing speculation as a central task.

new trade

Short DSL at open tody: $53.24

Nothing new here. They had bad news (earnings down 40+% last quarter) and they will continue to fall with credit tightening. My current positions are as follows:

Long equity: 30%
Short equity: 60%
Cash: 10%
Options: 3 put positions

CDS

Credit Default Swap sellers are making a killing. Just look at this deal:

Sellers of Beazer credit-default swaps are demanding $2 million upfront and $500,000 a year to protect $10 million in bonds, according to CMA Datavision in London. (Bloomberg)

No wonder hedge funds that invest in corporate bonds are going belly up. In fact, anyone who uses leverage is probably going belly up. "Safe" bonds are not safe if you use leverage. Everyone who was caught on that side of the market is losing to the people who are selling swaps to hedge default now. The problem is that hedging costs almost as much as has been already lost. Liquidity is going to dry up as people pull their money out of the market.

consumer rolling over.

Auto sales data from Bloomberg: Toyota down 7.3% yoy. When Toyota's down, you know that the consumer is rolling over.

Unhinged Fund Alert!

18

Funds: Macquarie Fortress Fund.
Affiliation: Macquarie Bank
Size: $186 M combined
Leverage: 6x
Losses: 25% +
Status: liquidating

The most telling thing about this is that the fund "has no direct exposure to US sub-prime mortgages" instead, the fund invests in "senior loans" of which "there have been no defaults in the portfolio" but which have declined "four percentage points" since June 29. That's great! Throw in 6x leverage and you get "deterioration in NAV for 31 July 2007 of approximately 20-25 cents" (out of $1.02).

p.s. Everyone is still calling this a "subprime mortgage" problem. It's not. It's a systemic problem with most mortgages written from 2005-2007, prime included.