Wednesday, July 23, 2008

Whither Financial Orgy?


Roughly a week ago, I wrote about how financial stocks were technically oversold and due for a bounce. And boy did they bounce hard off their lows. I track a number of them every day and I was amazed to see the volume and the ferocious moves up. Depending on which financial dog you bought (Fannie and Freddie come to mind), you could have easily doubled or tripled your money in a fews days if you were brave enough to buy those lows.

I couldn't help chuckle watching all the Wall Street cheerleaders parading on CNBC and CNN, telling us that the earnings from banks are positive and that the worst is behind us. One of them cited the increase in Wells Fargo dividend yield to 10% as a "sure sign" that the economy isn't as bad as the media portrays it to be.

I got nothing against Wells Fargo and I know Warren Buffett owns a good stake in that bank. Nevertheless, I can't shake this feeling in my stomach that the Paulson-SEC-Wall Street machine is throwing everything but the kitchen sink to talk up stocks, especially financial stocks.

Before you jump on the buying bandwagon, however, I highly recommend you read John Mauldin's latest Outside the Box comment. Mauldin surveys a few articles from authors that are skeptical of the sustainability of this short covering rally.

I quote from Spencer Jakab's The Mother Of All Short Squeezes May End Badly:

Is it possible though that Cox's actions, however unnecessary, marked the ultimate bottom for banks? They do seem cheap by historical measures, but the widespread euphoria last week looks more like a bear market rally than classic capitulation.

And this editorial from the Economist:

Bear markets often involve bare-knuckle fights, but it is still a shock when the referee starts punching below the belt. The Securities and Exchange Commission (SEC) has intervened in the epic struggle between financial companies and the hedge funds that are short-selling their shares...The SEC's moves deserve scrutiny. Investment banks must have a dizzying influence over the regulator to win special protection from short-selling, particularly as they act as prime brokers for almost all short-sellers...

The SEC's initiatives are asymmetric. It has not investigated whether bullish investors and executives talked bank share prices up in the good times. Application is also inconsistent. The S&P500 companies with the biggest rises in short positions relative to their free floats in recent weeks include Sears, a retailer, and General Motors, a carmaker. Like the Treasury and the Federal Reserve, the SEC is improvising in order to try to protect banks. But when the dust settles, the incoherence of taking a wild swing may become clear for all to see.

And John Mauldin's thoughts:

Deciding to actually enforce a rule already on the book is not going to make the profit picture at banks and other companies any better. They are still going to be shorted as soon as the dust clears. This just gives them (mostly banks) more room to fall. As noted two weeks ago, there may be as much as $1 trillion still to be written off by banks, brokers, insurance companies, pension funds and sovereign wealth funds. This is going to be ugly for at least a year. Those hoping for a bottom should look for it when the quarterly bleeding stops. Bill Gross said today that for Fannie and Freddie to raise capital it will need the help of the government. My side bet is that this will not be good for equity holders of Fannie and Freddie.

I am sitting patiently on the sidelines waiting to jump back into the Ultrashort Financials Proshares (SKF). If it falls near or below its 200 day moving average, I will start buying it back slowly. Why not make money as financial shares head back down?

Finally, you must read Jim Bianco's comment from Naked Capitalism on the possible role of Semgroup's bankruptcy on the oil price drop. I quote the following:

SemGroup, the US physical oil trader, on Tuesday filed for bankruptcy as it acknowledged trading losses of more than $3.2bn in different energy markets after betting this year that crude oil prices would fall. Its collapse came as oil prices plunged to their lowest levels since early June. West Texas Intermediate crude oil fell to an intraday low of $125.63 a barrel, down $5 on the day. Traders sold oil futures as news emerged that tropical storm Dolly was set to miss oil and natural gas installations in the US Gulf of Mexico.

Oil traders said SemGroup could have exacerbated the spike in oil prices this month, when the market experienced unprecedented swings of more than $10 a barrel, as the company was buying back some previous bets on lower prices.
The bankruptcy of SemGroup, which describes itself as the fourteenth largest US private held company, affects approximately $3.1bn of debt, according to court filings.

My advice is to tread carefully in these markets because the only thing that is a "sure thing" is more volatility. Despite the correction in oil prices, I would remain underweight financial shares and even look into initiating outright shorting positions and/or buy the SKF if they rally further from here.

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