Loading...
Symbols:
Authors:

Why I'm Committed to the UltraShort Financials ETF

by: Jimmy Lathrop July 16, 2008 | about stocks: BAC / DAG / DBO / DOW / DYY / FUD / GLD / JJG / RFN / SCC / SDS / SKF / SZK / USO    

Jimmy Lathrop

About this author:
Become a Contributor Submit an Article
  • Font Size:
  • Print

I'd like to take a moment to explain why I am committed to my ProShares UltraShort Financials ETF (SKF) position and why I'm generally bearish on even owning any stocks or bonds for the near-term.

Four percent of SKF is short Bank of America (BAC). SKF has a lot of short positions and swaps for megabanks, I-Banks, Fannie (FNM) and Freddie (FRE), and every type of lending institution that makes up the index. But the bet on BAC is the biggest.

Bank of America now owns between 20 and 25% of the residential mortgage loans in America. It offers credit card accounts in a period of increasing inflation, lower discretionary spending, higher commodity prices and low consumer confidence. It also offers auto loans under the same conditions as the credit card segment except that the default rate is worse, with greater liabilities. Additionally, BoA has a huge amount of revolving credit facilities set up with businesses back when rates were more favorable to the bank but with the Fed refusing to increase rates, these credit facilities eat up space on a balance sheet which could be loaned out at a more favorable rate. And even though the purchase of Countrywide (CFC) was discounted, it had to pay 11.8 billion dollars of Countrywide's debt as well as face possible liability in suits brought by plaintiff's firms and State Attorney General Office's for deceptive business practices. Countrywide's summary under its stock symbol describes a five segment company where at least four segments are obsolete in the falling housing market and tighter lending condition of today. BAC is still digesting its acquisitions of US Trust, MBNA and LaSalle Bank.

And in the middle of this, there is a general lack of faith in a system of securitizing loans, and moving back towards portfolio business, which would increase the cost of lending and be devastating to the public. There are new accounting rules ending SPVs. Not to mention the other three horsemen of the apocalypse - inflation, high commodity prices and still sliding housing market.

There is no talk about how BAC or any other bank can become profitable back to the levels of 2002 to 2007. The bank is not nimble. It can't cut a dividend. There is only a need to recapitalize and dilute shareholders. Thats all it can do for the next four quarters. I have asked BAC stockholders how they intend to rebuild earnings and they have no answer, they just point to a dividend yield. That is an unsatisfactory answer.

I haven't mentioned FNM, FRE, Citigroup (C), Lehman (LEH), UBS (UBS) or any of the other financial institutions which will continue to struggle for many quarters, to say the least. No one has a silver bullet. No one has another gimmick or bubble to catch on. UBS has substantial positions in SKF - calling the insurance broker for your house when you see Grandma fell asleep in the rocking chair with a lit cigarette and now the curtains are on fire.

The most important factor to consider is that the banks are generating three negative feedback loops. The first one is by raising capital that they are diluting their own shares, slashing their own share price. The second negative feedback loop is that they are selling assets of companies which is dragging down the market as a whole. Finally, by selling off houses which are in foreclosure, they are further dragging down the real estate market, making their mortgage default rates increase.

I really don't know if there is going to be a market rally, or if oil prices are going to go down or home sales will pick up again. I have no idea at all. I do know that if any one of those things does not happen, banks will still have to dilute shares, merge, or fail for the next year. I also know that as I try to pick up shares of equities, these financial institutions are unloading them to lower leverage ratios and sell assets so the trends are bearish. But once the commodities come down, and the major indexes show sustained rallies will there be a true buying opportunity. Buying Dow Chemical at 25 a share in three months would be better than buying any mutual fund.

So I would go to Google Finance or Yahoo Finance and watch these 15 symbols. When the 14 funds show continual losses for a month and Dow Chemical [the lamb of God who takes away the financial sins of the world] shows a month-long gain, we are officially out of the woods. But I don't see that happening in the next 52 weeks. Here is my Apocalypse 15. If all of these funds show continual gains for a month, the Angel of Death is knocking on the door.
  • ProShares UltraShort Financials (SKF)
  • ProShares UltraShort Consumer Services (SCC)
  • SPDR Gold Trust (GLD)
  • ProShares UltraShort Consumer Goods (SZK)
  • ProShares UltraShort S&P 500 (SDS)
  • iPath DJ-AIG Grains Total Return (JJG)
  • PowerShares DB Oil (DBO)
  • DB Commodity Double Long (DYY)
  • GAMCO Gold AAA [GOLDX]
  • CMCI Food Index (FUD)
  • DB Agriculture Double Long (DAG)
  • Prudent Bear [BEARX]
  • U.S. Oil Fund (USO)
  • Rydex Inverse 2x S&P Select Sector Financial (RFN)
  • Dow Chemical Co. (DOW)

Disclosure: Long SKF, SDS, DBO, GLD, GOLDX, SZK and DAG.

Related Articles

This article has 57 comments:

  •  
    Jul 16 10:49 AM
    In order to be successful, you not only have to be RIGHT, but RIGHT at the RIGHT time. I don't think you have that last one "right"!
    Reply
  •  
    Jul 16 11:00 AM
    Don't bet on the end of the world.

    It's a one-time event. If you win, you lose.
    Reply
  •  
    Jul 16 11:16 AM
    Yeah, much better to put on a smile and go down with the ship by going long on banks and silly consumer stocks like starbucks and the sharper image (oops, already gone).

    Reply
  •  
    Jul 16 11:33 AM
    Skf is down $22 dollars as I write...may have to wait a few days before you bite on authors advice...however,I agree with his thesis.
    Reply
  •  
    Jul 16 11:42 AM
    If you want to see a bubble, look at the SKF blow up to 200!

    That chart screams correction to the down side.

    Not that a bull market in financials is at hand, but we're certainly due for a break from the freefall.
    Reply
  •  
    Jul 16 11:51 AM
    I like your analysis - especially the part where you described the shortcomings of the financial sector as negative feedback loops. As an engineer, I appreciate the analogy - but where/when do you see the cycle breaking? and where/what is the control device?
    Reply
  •  
    Jul 16 11:52 AM
    Whats is always interesting is when someone makes some money and thinks they are smart. SKF has probably topped and its all down now.
    Inability to switch sides is the worst of all mistakes.

    Only fools bet on the end of the world.
    Reply
  •  
    Jul 16 12:37 PM
    Dear, continue in your commitment and don't fear the markets. SKF is up for more rallies for at least 3 more months before it flattens. If you want to bet double long, Q209 is your best bet. By then, I am sure you will switch and prove CLH wrong. Only thing is, by the time financials start recovering, the economy will be screaming for help. That's another story I guess...

    Reply
  •  
    Jul 16 12:44 PM
    Perhaps a wiser move would have been to sell at least half of your position on the deeply parabolic move up past $200 yesterday. Then buy more shares now at $178, or better yet, wait longer and buy cheaper. The market is ripe for a rally, SKF could go much lower before another rise...
    Reply
  •  
    Jul 16 01:21 PM
    The SEC's prohibition on naked short selling on certain financial institution has led to a rush to cover these positions before the rule takes effect on Friday. The index is reflecting the buying of actual shares needed to cover the short sells. This will continue up through Friday. As the stocks of those prohibited firms rise from increased buying, the index will reflect gains which have an inverse effect on the ETF. This is a trader driven event. It is not a systemic event. My fellow commuters were not whistling "Who's Afraid of the Big Bad Wolf" on the way to work this morning.

    However, while I was reading the Wall Street Journal this morning, I did not see any announcements by any financial institution which suggests an immediate turnaround. On the contrary, things are as bleak as they were yesterday.

    If anyone has any ideas how the financial sector will be able to rebound to its previous 52 week heights in the next 52 weeks, feel free to post them. I'm sure some bankers would like to hear them too, as they have their own mortgage payments to worry about.
    Reply
  •  
    Jul 16 01:31 PM
    Dear Jimmy,

    This is a trader driven event. It is not a systemic event.
    Agreed, but if this is the case why do you keep talking about BAC's fundamentals as if they really matter here ? SKF is clearly in a speculative "bull" phase. May be a good short term play, but how much lower can BAC and company go ?

    We all know the entire herd can't feed at this trough, especially as it is herd...err.....trader driven ... right ?
    Reply
  •  
    Jul 16 01:47 PM
    @seriously

    Certainly there's a lot of fear feeding more fear, but it's also wrong to say there aren't some serious systemic problems feeding the fear.
    Reply
  •  
    Jul 16 01:59 PM
    I'm as bearish as they come, but trading is trading, not having a "commitment" to a position. And listing the fundamental reasons now, as opposed to one year ago, why BAC will go down just sounds like a poor trading mindset. Markets do not trade on logic and they never conform to your internal "timeline".
    And it is a positive feedback loop(with negative consequences) which is occuring.
    Reply
  •  
    Jul 16 02:08 PM
    I bought and have traded SKF very successfully for the last 4-6 weeks, I originally bought at just under $100, continued buying in $5 increments to $125 and started selling at $160 in $5 increments, sold my last 100 on Thursday at $178 and when news came out about Fannie / Freddie on Sunday I was glad to have been out, expected a big rally, none happened and than it hit $223...but with 15-20 point spreads each day, what a wonderful trading stock in my IRA. I gotta say though, I saw $150 as a top, did not expect $200
    Reply
  •  
    Jul 16 02:24 PM
    Jimmy, you don't need Financials to hit their 52 week highs. You just need them not to go lower.

    If you think you are gonna get ANOTHER 60% haircut on top of the one you already got, you are mistaken.
    Reply
  •  
    Jul 16 03:00 PM
    Financial shorts are played out imho (based on nothing) and I've my eye on the DB double short commodity fund.

    However, playing markets is a lot less fun and more stressful than simply going long on solid companies at good prices.
    Reply
  •  
    Jul 16 03:39 PM
    After it lost 20% today, now would probably be a better time to commit to this ETF! I wrote a 150 and 165 call for this last week and kinda glad to see it back to those levels, so I can do it again for August. Huge premiums on this Call.
    Reply
  •  
    Jul 16 03:48 PM
    What if the BRIC countries or Arabian starts to buy the financial companies if the price is driving too low ? US will be in deep trouble.
    Reply
  •  
    Jul 16 04:05 PM
    Solution, why is that bad? That is the definition of a free market.
    Reply
  •  
    Jul 16 04:06 PM
    The page has turned. The WFC news this morning is a game changer.
    Reply
  •  
    Jul 16 04:08 PM
    "Disclosure: Long SKF, SDS, DBO, GLD, GOLDX, SZK and DAG."

    Well then ... I guess this was one of the worst days of your life in the market.
    Reply
  •  
    Jul 16 04:27 PM
    Your financial short and commodity long postions have worked well this year. I hope you've taken some profits. The financials are way oversold, over-shorted and already discount a lot of bad news. Both USB and WFC just announced earnings reports that were not as bad as feared. I went long the UYG (Proshares Ultra Financials) this morning. And while I realize there's a lot of short covering going on today, the financials could move another 20% up without breaking their 50-day moving average, which equals a 40% move for the UYG.
    Reply
  •  
    Jul 16 04:29 PM
    Wasn't long in SKF until almost closing. And will pick up more on its way down all the way to the weekend. I like your reasoning Jimmy. It may not be correct, but it is more likely than not and worth a small entry into the stock at this time. Hope you are correct.
    Reply
  •  
    Jul 16 04:58 PM
    Today's rally underscores the sense of relief that WFF wasn't broken. When was the last time you drove a new car off of the lot and said "Thank God it didn't blow up when I turned the key!" The opaque nature of the banks means that a 23 percent loss in profits is good news? That is pretty pathetic. That is grasping at straws. There have been many comments directed at my article but no one has given the magic incantation which will erase the banking industry's ills.
    Reply
  •  
    Jul 16 05:01 PM
    SKF off 20% today.

    I hope you had a 5-10% stop loss in place.

    Financials and the markets could rally a few more days or weeks, and then back to SKF again. . .
    Reply
  •  
    Jul 16 05:14 PM
    <<The page has turned. The WFC news this morning is a game changer.>>

    WFC simply said they weren't going to "suck as much" as the other banks this quarter. They said firmly that they now have 7 Billion set aside for bad crap thats coming down the pike.

    I don't care that they raised the dividend either. Thats called playing Wall Street and Main Street for a fool.

    Oh we are going to get a financial rally. No question. For those that are newly long or so pathetically underwater from listening to the cheerleading from the media, atleast you can make a few $$
    Reply
  •  
    Jul 16 05:52 PM
    Stick to being a lawyer. I think that we have a turning point. Look a the volume on the ETFs for financials on tuesday, at all time highs. Capitualtion with an exclamation. Granted we may need another quarter to move thru the write downs but, as Barrons claims, the real estate is at a bottom. Look for interest rates to rise in october after the focus shifts from real estate/financials. We cant exist without financials!!!!!! All this gloom has affected your judgement.
    Reply
  •  
    Jul 16 06:23 PM
    I bought Wfc puts this afternoon...I am going to dance with the one that brung me...short financials.
    Reply
  •  
    Jul 16 06:26 PM
    By the way Jimmy,congrats on getting such a good discussion going.Please post again soon!
    Reply
  •  
    Jul 16 08:12 PM
    Bear market rally here. I have traded the SKF and recently sold at 164. Wait for this rally to play out and buy SKF around 150. Buying WFC here for the long term is a good bet. Financials will bottom out this fall even though their income statements will struggle though 2009. [long C, WFC, BAC< CS and IBN]. Huge profits in financials if you have at least a three year horizon.
    Reply
  •  
    Jul 16 08:24 PM
    WFC has got to be cooking the books, no way in hell they could be doing this well with their loan portfolio. I smell BS.
    Reply
  •  
    Jul 16 09:19 PM
    WFC has big exposure in the California real estate mkt. Only time will tell how much write offs they will take. As I already see people stating that today's was a page turner, I'm sorry but when Citi still has about $1.1 trillion in assets off their balance sheet without knowing what kind of losses will be taken going forward, most banks are not a buy. Their business model is broken.
    Reply
  •  
    Jul 16 09:27 PM
    Every bear market has a rallies....this is one of them. We'll be A LOT lower in 7 months. In the meantime go long UYG.
    Reply
  •  
    Jul 16 10:16 PM
    Why didn't any of the main media mention that the only way WFC "beat estimates", lousy ones at that, was by changing the way they calculated earnings! Otherwise they still would have been $0.49? Talk about manufacturing good news and no one calls them on it.
    Reply
  •  
    Jul 16 10:24 PM
    The bank said its new policy of writing off home equity loans where payments were more than 180 days late, rather than 120, resulted in it deferring $265.0 million in charge-offs.

    Credit - Market Scan
    Wells Fargo Fares Well
    Miriam Marcus, 07.16.08, 6:35 PM ET


    On Jul 16 10:16 PM genesok wrote:

    > Why didn't any of the main media mention that the only way WFC "beat
    > estimates", lousy ones at that, was by changing the way they calculated
    > earnings! Otherwise they still would have been $0.49? Talk about
    > manufacturing good news and no one calls them on it.
    Reply
  •  
    Jul 16 10:45 PM
    I'm with Jimmy that a couple of the negative ETF's are appropriate in today's (toxic) economic environment. I own SKF and watched it dive today, although I wondered if it would rise up "green" during the usual late-afternoon sell-off. Along the way down I considered selling, but I couldn't think of a fundamental reason (besides taking profits and creating a taxable event) behind the bank stock increases. I only have these shares as part of a diversified portfolio so I didn't reach Max Pain levels today. I think it's time to buy more during the next couple of days. Historically, I had traded SKF with stops and have been "stopped out" on 10 point down moves that resolved later in the day back to where it started - or maybe higher. I wish I understood how to hedge with options.....So instead, I accept the volitility with an eye for the prize in the long run, but who would think that for no reason that I can understand, "financials" would have their biggest one day rally in twenty years! I missed the "All Clear" bell ringing for financials. therwise, oil moving down to the bottom of it's Bollinger Bands doesn't seem to me to affect the amount of foreclosures or rising credit card debt being "walked on by debtors". Of course, one positive for banks today was due to the plan to investigate persons instigating "naked shorts" and rumour mongering against the likes of Lehman, Citi and the GSachs. Wouldn't it be ironic if these bad people are found to be employed with ......Lehman, Citi and GSacks?
    Reply
  •  
    Jul 16 11:32 PM
    Hmmm Mr Lathrop, you talk about fundamentals of the sector but you do not care to discuss valuations. You may be right but only because you have short term outlook. Long term investors might wish to consider this as an excellent opportunity to buy
    Reply
  •  
    Jul 16 11:42 PM
    I'm not sure you are right to reduce their reported EPS by $265M for the reason given because they should have added the $265M to their provision for bad debt during the quarter. The net affect on EPS is zero. They just handled it differently on the P&L
    Reply
  •  
    Jul 16 11:48 PM
    I think this author needs to check his facts. 20 to 25% of the mortgage market? Not. $11.8 billion in debt?? What about the $5 billion in revenue with the synergistic side of the acquistion from layoffs and other reduced expenses. Billions to bottom line. I could go on and on ripping this article apart, but really, check your facts and do a bit more research so you do not have such a 1-sided opinion.
    Reply
  •  
    Jul 16 11:50 PM
    Jimmy thanks for the analysis and insight. The answer to your continued questioning is as follows - the wheels of our American system are greased by the prudent operating of banks such as Wells Fargo, Bank of America and the like. For short-term players the current plight of financials is certainly of concern. However, for longer term players, the reality is franchises like WFC and BAC and the brand equity they enjoy isn't created overnight. However, the market in the last two months has voted and brought down these two institutions mightily to a clearly oversold position. Today we saw a flight to quality that recognized the strength of the brands, infrastructure and businesses that have been built. If you believe in America and our power to persevere then you must believe in t