Back on the Short Side

Good Afternoon Everyone!

Stocks ended mixed today in a very volatile session. Well, what can i say: I tried to be a bull! I really really tried! Sadly, after reading the constant negative news flow, my bear claws are now growing back.

Guys, the news just keeps getting worse. I have always been more of a long term macro trader based on the fundementals. I reached a point today where I can't just can't continue to sit in denial and go long the market as I watch Rome burn. The bulls still have some momo but its losing stream quickly in my view.

I decided to get back on the short bus. I find it much more comfortable on here because it matches my thoughts on the economy! I also found some entry points that looked very juicy to me. I was hoping to pick SRS back up in the 60's. However, the continuing bad news flow makes me believe that I have a better chance of seeing god before this happens so I picked some up at $85. I look to be a little early here after watching it dip into the late 70's today but that's ok I am patient.

I also flip flopped on the financials and grabbed some FAZ which is a 3x inverse short financial fund. I did this after selling my Citi calls at a profit and i also sold my UYG.

There are a few reasons why I flip flopped to the bearish side today. I spent a long time researching the markets last night and today. Let me layout what I found the last two days followed by some thoughts at the bottom. The first piece was something I picked up on Bloomberg around a formula on stocks that was discovered by Nobel Prize-winning economist James Tobin. Here is the piece:

"Dec. 10 (Bloomberg) -- A global stock slump may have further to go, according to Tobin’s Q ratio, which compares the market value of companies to the cost of their constituent parts, CLSA Ltd. strategist Russell Napier said.

The ratio, developed in 1969 by Nobel Prize-winning economist James Tobin, shows the Standard & Poor’s 500 Index is still too expensive relative to the cost of replacing assets, said Napier. While the 39 percent drop in the index this year pushed equity prices below replacement cost, history suggests the ratio must sink further as deflation sets in, he said. The S&P may plunge another 55 percent to 400 by 2014, Napier said.

“In the long run, stocks will become even cheaper,” said Brian Shepardson, who helps manage $1.9 billion at Xenia, Ohio- based James Investment Research. The firm’s James Balanced Golden Rainbow Fund beat 98 percent of similar funds this year. “There’s a likelihood of some type of rally and further pullback surpassing the lows we’ve already set.”

The Q ratio on U.S. equities has dropped to 0.7 from a peak of 2.9 in 1999, and reaching 0.3 has always signaled the end of a bear market, said Napier, 44, the author of “Anatomy of the Bear,” a study of how business cycles change course. The Q ratio for U.S. equities has fluctuated between 0.3 and 3 in the past 130 years.

Previous Bottoms

At the end of the four largest U.S. bear markets in 1921, 1932, 1949 and 1982, the Q ratio fell to 0.3 or lower, and history is likely to repeat, said Napier. From the 1982 trough, the S&P 500 grew more than 14-fold to the middle of 2000, when Napier says the last bull market ended."


Article #2 Moral Hazard Anyone?

I thought this was a really interesting article in the USA Today. This is a catastrophe just waiting to happen folks. Want a loan modification and can't qualify? Just stop paying the mortgage!

"Are homeowners purposely falling behind on their mortgage payments to qualify for cheaper home loans?

Economists, lenders and other housing experts are concerned that programs to bail out troubled homeowners might have an unintended consequence: encouraging people to miss mortgage payments so they can qualify for a handful of programs that ease loan terms.

"It's a problem," says Mark Zandi, chief economist and co-founder of Moody's Economy.com. "A lot of the programs require you to be at some stage of delinquency, so homeowners say, 'What about me?' and they get delinquent in order to get help."
Many mortgage modification programs require that borrowers be 60 to 90 days late on payments to get a mortgage reworked.

"We speak with homeowners every day that have few qualms about walking away from their mortgage or missing payments as a way to 'get in on' loan modifications and low house prices," says Jeremy Brandt, CEO of 1-800-CashOffer, which buys homes. "The attitude is starting to move toward, 'How can the government help me,' " says Chad Olivier, a certified financial planner in Baton Rouge. "We are seeing it on Wall Street, and now we are seeing it with the public."

It's frustrating for Cara Halstead Cea, 38, of Suffern, N.Y., who last year refinanced into a 30-year, fixed-rate mortgage at an interest rate of 7.5%.

She says she's struggling to make her mortgage payments while others who fall behind get assistance. "I have felt that my husband and I are being punished, in a way, because we put the mortgage first, and we are always on time with payments; therefore, we're not eligible for loan modification. … We would do much better with a lower rate."

Article #3 The Fed to Issue its Own Debt?

No link here but an interesting read to say the least. It was in today's Wall St Journal:

"* DECEMBER 10, 2008, 12:00 A.M. ET

Fed Weighs Debt Sales of Its Own
Move Presents Challenges: 'Very Close Cousins to Existing Treasury Bills'
By JON HILSENRATH and DAMIAN PALETTA

The Federal Reserve is considering issuing its own debt for the first time, a move that would give the central bank additional flexibility as it tries to stabilize rocky financial markets.

Government debt issuance is largely the province of the Treasury Department, and the Fed already can print as much money as it wants. But as the credit crisis drags on and the economy suffers from recession, Fed officials are looking broadly for new financial tools.

The Federal Reserve drained $25 billion in temporary reserves from the banking system when it arranged overnight reverse repurchase agreements.

Fed officials have approached Congress about the concept, which could include issuing bills or some other form of debt, according to people familiar with the matter.

It isn't known whether these preliminary discussions will result in a formal proposal or Fed action. One hurdle: The Federal Reserve Act doesn't explicitly permit the Fed to issue notes beyond currency.

Just exploring the idea underscores many challenges the ongoing problems are creating for the Fed, as well as the lengths to which the central bank is going to come up with new ideas.

At the core of the deliberations is the Fed's balance sheet, which has grown from less than $900 billion to more than $2 trillion since August as it backstops new markets like commercial paper, money-market funds, mortgage-backed securities and ailing companies such as American International Group Inc.

The ballooning balance sheet is presenting complications for the Fed. In the early stages of the crisis, officials funded their programs by drawing down on holdings of Treasury bonds, using the proceeds to finance new programs. Officials don't want that stockpile to get too low. It now is about $476 billion, with some of that amount already tied up in other programs."

Bottom Line:

Lets talk a little bit about this stuff. The Q ratio article is quite startling with a prediction of 400 on the S&P. I thought this made a lot of sense. The Q formula is dead on when it comes to predicting how the Fed would react to this mess. The Fed is fighting deflation just as they described.

What you saw today in the markets was a reflation trade as the Fed continues to drop $8 trillion out of helicopters. As a result, oil, gold and energy stocks all went up today. This is why we closed green. This is a foolish long term trade because deflation is inevitable. Dennis Gartman was on Fast Money last night describing tankers filled with oil that have no where to go because there is no demand.

The Middle East continues to pump it in order to pay the bills. All of their economies are based on $80 oil. They now have a major problem. The more they pump the lower crude goes. If they reduce production they can't pay the bills. Hmmm....and I thought we had problems. Dubai? Can you say biggest bubble in history? I sure as hell wouldn't want to be peddling property in that city. Is it just me or was building millions of $5 million homes in the middle of a desert a bad idea?

Financials

The financials did nothing today and the risk around our banking system is increasing on a daily basis. Look at the last two articles above. The loan modification article was startling to me. This is what the Fed gets when it tries to meddle in the free markets. Once you set precedent and bailout a bunch of homeowners who made poor financial decisions, everyone then wants the same deal! Why would anyone continue to pay a mortgage without getting a loan modification.

I can't say that I blame anyone who stops paying their mortgage in order to qualify for their own piece of the TARP. Maybe the Fed will learn a lesson from this once most of the country stops paying the mortgage. They should have never ever ever done this in the first place.

Gee, do you think this might happen again if the automotive industry gets their bailout. Who will be next? The hotel industry? Airlines? Home builders? Tech?

Where does it end folks? Once one industry gets a piece of the Treasury pie, everyone will want a taste. Like the auto industry, every other consumer driven sector is suffering as the consumer caves like Oscar Delahoya did on Saturday night.

Regarding the last piece on the Fed issuing debt, WTF? Are they now going to sell their own debt and compete with treasuries? The fact that they are even considering such acts tell you that they don't have anywhere near the money on their balance sheet that they need in order to prevent this massive debt bubble from collapsing.

If they do this, overnight it will turn our banks into walking zombies(like they aren't zombies now!) with absolutely zero chance to make money going forward. I don't see this ever happening, but its another sign that the Fed is running out of ammo and is in dire straights.

Folks I woke up today and drank a big tall glass of reality juice.

The ship is sinking fast and we are running out of lifelines.