1) We don’t like the smell of fish. This rally began with a ‘leaked’ memo from Citigroup announcing a return to profitability and was given legs by banks’ bogus quarterly earnings. Washington has added to the stench with its fudge tests for banks, its PPIP proposal and its active campaigning to relax mark-to-market accounting rules.

2) Much of the buying was caused by short sellers covering their positions (a massive “short squeeze”).

3) “Junk” stocks have been leading the rally. The real winners have been beaten-down stocks with the riskiest outlooks. They generally have had the highest level of debt and the lowest return on equity.

4) Historically, sucker’s rallies are the norm, not the exception. Sharp crashes are often followed by sharp, but short lived, bear market rallies. The 2000–2002 bear market had three, with the Dow gaining an average of 21%. The 1929 to 1932 bear had six, with an average gain of 47 per cent. Even the poor Japanese have suffered their head fakes. The Nikkei has seen about 14 false downs since it crashed in 1991.

5) Generally, bottoms don’t feel like this. Bear markets typically end with a whimper rather than a bang. A recent study by Hussman Econometrics analysed numerous US market bottoms and bear market rallies. It revealed that, with the exception of the 1987 crash, the month before the lowest point of a downturn saw a gradual descent.

6) Stocks are still too expensive. As Yale University professor Robert Shiller says, all four big bubbles of the 20th century troughed at between 5 and 8 times earnings. Stocks did not even fall below 11 times earnings in the recent low.

7) Insiders have been selling the rally. According to TrimTabs, April saw the lowest level of insider buying ever recorded, with insider selling 14 times as high. And companies sold 64% more shares than they bought.

Sentiment isn’t low enough yet for our taste. As Russell Napier says in Anatomy of a Bear , “For the great bear market bottoms, you need a society-wide revulsion with equities. It just doesn’t smell like the big one yet.”

9) The risk of corporate bond defaults is at highs unseen since the Great Depression. Moody’s expects the corporate default rate in the US to reach 14.6% by year end – a near doubling from the first quarter’s default rate of 7.4%.

10) Corporate earnings continue to suffer. Earnings weren’t as bad as expected last quarter. But they are expected to continue to decline until sometime next year.

11) The S&P 500 remains under its 20-month moving average. Every sustainable bull market has been marked by the S&P rising above its 20 month average.

Suffice it to say, we’re sticking to our guns. As Merrill Lynch economist David Rosenberg recently counseled, “For those that missed the big nine-week move, don’t worry. Be patient. The story was right – the tortoise always wins the race.”

Tomorrow’s meeting, which will focus largely on short-selling, follows recent internal discussions in which SEC officials have talked about restoring the so-called “uptick rule,” a fairly straightforward securities regulation that many experts say could have blunted the steep stock-market sell-off that U.S. stocks experienced in late 2008 and early 2009. The uptick rule was abolished in 2007.
U.S. Federal Reserve Chairman Ben S. Bernanke is a proponent of the uptick rule’s restoration.

“If the rule is to be restored, it should apply to all equally, including market makers as well as professional traders and individual investors,” Bernanke said if during a question and answer session with the House Financial Services Committee. “If the rule had never gone away it may have been helpful during this current crisis that we face.”

Rule Replacement Proposals

The old form of the uptick rule that Bernanke referred to basically held that a short-sale transaction had to be entered at a price that is higher than the price of the previous trade.

The rule, which was introduced in the Securities Exchange Act of 1934, was actually implemented four years later. It was designed to prevent short sellers from adding to the downward price momentum of an asset whose price was already under pressure and undergoing a sharp decline. The uptick rule was eliminated in June 2007.

On April 8, the SEC voted unanimously to open a 60-day public comment period and is now seeking investor input “on whether short-sale price restrictions or circuit-breaker restrictions should be imposed and whether such measures would help promote market stability and restore investor confidence.”

The agency developed five new proposals related to short selling and wants the public to file comments. The 60-day commenting period ends June 19, said Mary L. Schapiro, chairman of the SEC.

Two of the five proposals would involve a market-wide institution of the old uptick rule. The three others would create a “circuit breaker,” which is sometimes also referred to as a “collar.”  These three would set restrictions on trading activity due to a freefalling stock price. As proposed, circuit breakers would be established for when the security has fallen 10%, 20% and 30%.
The five proposals consist of:

Proposal  No. 1: Described as a “market-wide short-sale price test based on the last sale price or tick,” this proposal calls for a simple restoration of the uptick rule that had been in place for 70 years.  This would help prevent short sellers from ganging up on a weak stock and pushing it down as far as they’re able.

Proposal No. 2:  Described as a “market-wide short-sale price test based on the national best bid,” this proposal represents a slight modification to the uptick rule by making it more stringent.

Proposal No. 3:  This proposal is similar to “limit days” in commodity markets.  It prevents short selling on stocks that are enduring severe stress.  If a stock drops significantly in a trading session, then it cannot be short sold for the remainder of the trading session.  This rule would put a halt on short selling and prevent that stock from being pushed down even further – which could have the effect of crippling it, in a sense.

Proposal No. 4: A short-sale price test based on the last sale price of a particular stock for the remainder of the trading session.  This would be imposed for a stock that has fallen a certain percentage during the course of a day.

Proposal No. 5: If a stock falls significantly in a trading session, this final option would call for the introduction of a “bid test.” This would mean that, for the remainder of the day, a short seller would have to place a transaction at the highest available bid.

The Fallout of the Rule’s Removal

The uptick rule (rule 10a-1) was established in 1938 – in the depths of the Great Depression that followed the 1929 stock market crash – during the administration of SEC Commissioner Joseph P. “Joe” Kennedy Sr. Kennedy, the first commissioner of the SEC, implemented the uptick rule after examining what role short-selling played in a 1937 stock-market break.

Short-sellers are essentially betting that a company’s stock will fall in price. They “borrow” the shares from another investor and sell them, reaping the proceeds at what they believe is a “high” price. If the price falls, as they expect, they can buy the shares back at a lower price (which is known as “covering” their short sale) and replace the block of stock that they borrowed.

Their profit is the difference between the proceeds from the initial short sale higher price and what they then had to spend to cover their short sale (as well as brokerage commissions).

With the uptick rule, the objective was to prevent groups of short-sellers from, in effect, ganging up on a stock for the solitary intent of driving it down as far as possible. In such a gambit, the short-sellers hope to create a steep enough sell-off to cause panic selling by the other shareholders, which would lead to a total freefall in the stock price.

Short-selling restrictions were removed from about one-third of the major listed stocks in a year-long study conducted in 2004.  This test was conducted to see how much of an impact there would be from the uptick rule’s removal.

After a roundtable discussion about the results in September 2006, the SEC decided to eliminate rule, which it did the following July. According to the SEC, the uptick rule wasn’t really needed to prevent manipulation and actually seemed to reduce a stock’s liquidity.

“The general consensus from these analyses and [from] the roundtable was that the commission should remove price test restrictions because they modestly reduce liquidity and do not appear necessary to prevent manipulation,” the SEC reported. “In addition, the empirical evidence did not provide strong support for extending a price test to either small or thinly-traded securities not currently subject to a price test.”

However, when the uptick rule was eliminated, the U.S. stock market experienced a massive surge in volatility. Hedge funds took extreme advantage of the ability to not have to wait for an uptick in the price of a stock before they moved to sell it short.

Almost immediately after the uptick rule was abolished, investors began to clamor for its reinstatement. Indeed, throughout much of last year, politicians, investors and other public figures began pushing for the rule to be put back on the books.

In 2008, there was outcry from top public figures such as CNBC-TV’s “Mad Money” host Jim Cramer, as well as such elected officials as U.S. representatives Gary Ackerman, D-N.Y., Mike Capuano, D-Mass., and Carolyn B. Maloney, D-N.Y., as well as presidential candidate and U.S. Sen. John McCain, R-Ariz., who all pushed for reinstatement of the uptick rule.

The heavyweight mergers-and-acquisitions law firm Wachtell, Lipton, Rosen, & Katz may have best-summarized proponents’ desire to see the rule reinstated.

“Short-selling is at record levels,” the New York-based firm said in a statement. “We ask the SEC to take urgent action and reinstate the 70-year-old uptick rule.  Decisive action cannot await a new SEC chairman – there is no tomorrow.  The failure to reinstate the uptick rule is not acceptable.”

The groundswell of support for reinstatement of the uptick rule spilled over into the New Year, and even escalated as the markets whipsawed U.S. investors. On Feb. 25, for instance, Bernanke, the U.S. central bank chief, declared his support for the restoration of the uptick rule.  On March 10, the SEC and U.S. Rep. Barney Frank, D-Mass., (and the chairman of the House Financial Services Committee) jointly announced plans to restore the uptick rule.

Source: SEC Studies Restoring Uptick Rule That Could Have Mitigated Bear Market in U.S. Stocks

If I had been writing it, I would have titled it “Not All Of The People In The World Are Stupid!” with the subhead, “There are lots of smart people who are buying gold to capitalize on the sheer stupidity of governments abusing fiat currencies so that inflation in prices will soar as inflation in the money supply soars, until gold-owning people, giddy with greedy glee, will say, ‘The Mogambo was right! Whee! This investing stuff is easy!’”

But I am not here to show off how good I am at coming up with boffo headlines with the subtle undertones so that they offer me a job, at a fabulous salary, to write headline gems like this one; this is about how “On Tuesday morning, gold derivatives dealers, who had sold short in the face of a fast rising gold price, faced a serious predicament. Some 27,000+ contracts, representing about 15% of the April COMEX gold futures contracts remained open” indicating that, as holders of those long gold contracts, they “demanded” delivery of the physical gold “by holding futures contracts past the expiration date.”

The big problem belongs to the short-sellers of gold, who are finding, suddenly, that “long buyers were demanding in droves” – demanding physical gold bars, when, apparently, there were not enough.

Since I am confused as to what all of this means, Mr. Goodman correctly interprets the blank look on my face as puzzlement – if not outright befuddlement – and patiently explains that to keep things in perspective, history has shown that people investing in COMEX futures don’t necessarily want physical gold, and that they are merely speculators, as, “In normal times, very few people do this. Only about 1% or less of gold contracts must be delivered. The lack of delivery demand allows the casino-like world of paper gold futures contracts to operate. Very few short sellers actually expect or intend to deliver real gold. They are, mostly, merely playing with paper” which is the basis of the alleged gold and silver scams, as GATA.org and Ted Butler have long exposed, which gets us talking about how corrupt regulators are these days, as everything is else corrupted these days, which is, of course, just what you would expect at the end of long monetary booms, which doesn’t make it any more palatable.

But back to our story of the almost-default at COMEX… Fortunately, at the last minute, Deutsche Bank delivered “a massive 850,000 ounces, or 8500 contracts worth of the yellow metal.”

This is where I kind of lost interest, as this kind of thing is like blood in the water to sharks, who will soon be looking at the low price of gold and the complete lack of supply of bullion, and they will be hatching plots to squeeze this disparity and make a lot of money, and I was soon fantasizing about how my tiny little stash of gold will soar and everybody else who doesn’t own gold will be busted out, now that the scam has been busted, and there will be people, like cute college coeds, who will be so desperate that they will say they are willing to do anything for money, and I will say, “Anything?” and then they will quickly affirm, “Anything!”, and so I again ask, but with a rakishly raised eyebrow and licking my lips in a lascivious manner, “Anything?” and they gulp and say, but without their former enthusiasm, “Anything”… So you can see how I was distracted.

And anyway, somewhere along the line he admits that it is “circumstantial evidence” that Deutsche Bank was a major holder of short positions, or that “the gold used by Deutsche Bank to deliver and fulfill its COMEX obligations, came directly or indirectly, from the ECB”, which gets back to the headline “Did the ECB Save COMEX from Gold Default?” that we were discussing previously.

All of this, of course, is fraudulently criminal in many, many ways, breaks a lot of regulations in those and other ways, and he calls for investigations and indictments and all of that stuff, which won’t happen because the amount of corruption at the end of long monetary booms is so pandemic that it won’t be allowed.

Now, before I go off ranting and raving about how another bunch of scumbags perpetrated another scam with compliance from government scumbags, let’s concentrate on the important fact that not only are a bunch of guys buying gold and demanding delivery of the actual metal, but now increasing demand has swamped supply! Amazing!

In conclusion, let me say that if people don’t buy gold, in spite of the overwhelming historical evidence to do so when the money supply is set to double (and then double again and again!), in spite of gold’s gains for the last decade, in spite of the sight of people suddenly taking delivery of physical gold in unprecedented amounts, and in spite of me telling them right to their faces to buy gold, then there is something very, very wrong with them, which ought to give them something to think about as they are idly scratching around in the dirt looking for bugs to eat, because this economic mess caused by a Congress constantly deficit-spending and a Federal Reserve constantly creating the money for them to do so is going to get Really, Really Nasty (RRN), and I am scared for me and for them.

But I am not as scared when I have gold, so at least I have that going for me! Whee!

Source: Golden Shorts in an Economic Winter

Las Vegas Sands stock hit a daily high of $10.97, before paring back to close at $8.91 with an 80% gain of $3.96 each.

The Singapore Tourism Board stopped short of pledging financial support for the project, but said it would “facilitate the success” of the project under construction in downtown Singapore.

“The Singapore Tourism Board is monitoring the situation and is aware that the current uncertain economic climate may give rise to concerns,” the agency board said in an e-mailed statement, Bloomberg News reported. The tourism board said it was “working closely” with Las Vegas Sands’ Singapore unit, Marina Bay Sands.

Las Vegas Sands Chief Executive Officer Sheldon Adelson has been desparate to raise cash as his company’s shares have plummeted more than 91% year-to-date. The gaming industry has been hit hard by dwindling disposable income.

Las Vegas Sands shares have a 52-week high of $148.76, but prior to yesterday’s rise were hovering close to their 52-week low of $4.32.

Adelson has gone so far as to invest $475 million on his own money into the struggling casino company whose flagship properties include The Venetian Resort Hotel Casino (The Venetian), The Palazzo Resort Hotel Casino (The Palazzo) and The Sands Expo and Convention Center (The Sands Expo Center) in Las Vegas, Nevada, as well as The Venetian Macao Resort Hotel (The Venetian Macao) in Macao, China.

While the news of the Singapore government’s support certainly helped to boost Las Vegas Sands stock, some analysts believe the stunning 122% intraday surge can be attributed to short-sellers scrambling to cover positions after the stock’s initial rise.

A similar situation unfolded earlier this week with Volkswagen AG (OTC ADR: VLKAY). [Please click here for a related story in today’s issue of Money Morning on the recent Volkswagen share movements.]

“Gaming is a heavily shorted sector in need of a catalyst,” Todd D. Jordan, a managing director at New Haven, Connecticut-based investment-research firm Research Edge LLC, said yesterday in a note to clients, Bloomberg reported.

Source: Las Vegas Sands Shares Soar After Singapore Deals Itself In

Pop quiz: The biggest company in the world? Nope, not Exxon Mobil, not today anyway. Would you believe…

Oh, how twisted the markets have become.

In European trading this morning, shares of Volkswagen AG leapt 93% when word leaked that Porsche would be upping its stake from 49% to 75% — a controlling stake of the company. Buyers rushed in, short sellers were squeezed (big-time) and, for a moment, VW’s market cap crested $370 billion — greater than the beaten-down value of the world’s most profitable company, Exxon Mobil.

The moment was fleeting, but for a moment there, VW was the largest company on Earth… the Leper King during the worst of credit epidemics.

The short squeeze on VW was so extreme today the automaker was momentarily trading for 100 times projected 2009 earnings. Rumors abounded that Goldman Sachs was caught up in the short squeeze… which it quickly denied. Still, the stock fell over 10%. Morgan Stanley dropped over 12%.

The London interbank offered rate (Libor) — the rate at which banks lend to each other — is down again today. The introduction of the Fed’s new Commercial Paper Funding Facility (CPFF) helped the three-month Libor fall another 5 points yesterday, to 3.47%.

The mist rising off the frozen credit markets is still causing a heavy fog, but there’s hope the sun may come out again and burn it away. Coupled with some more European Central Bank injections this morning, the Libor is on track to have fallen 13 days in a row.

Still, according to the Bank of England today, global credit crisis losses now exceed $2.8 trillion. In its semiannual Financial Stability Report, the BoE reported global banks are financially unstable and losing money. Really.

Cheers, mates, thanks for the update.

“It’s a great contraction,” notes Chris Mayer, “a historic liquidation in the stock market and a mad dash to grab cash wherever you can get it. Across the world, the goal is to build up cash reserves and cut back. The Financial Times reports that 5-10% cuts in capital spending are common. In the commodity world, it’s more like 10-20% — as mines shut down and projects freeze. Most expect more cuts of one kind or another. As the FT opined, ‘The hoarding of cash is likely to intensify.’

“This slowdown also comes with a complete shutdown of the credit spigot. It’s tougher to raise money no matter who you are. If you a smaller miner or resource company, forget it. A lot projects that looked good at higher commodity prices are just bleeding money at current levels. Yesterday Russia’s Ufaleynickel, the third largest producer of nickel in Russia, said it would shut down nickel production entirely. It costs it $26,000 to produce a ton of nickel that it can sell for $8,000.

“And so the commodity markets begin to correct. Some will correct more quickly than others. The survivors on the other side, though, stand to make fortunes. I think we’ll have a bunch of those, but it certainly looks bleak today in a big-picture sort of way.”

“The ability to generate new earnings off net tangible assets,” Dan Denning adds from down under , “is what you’re after in this market. Alcohol, tobacco, farmland, food… all these are good, recession-insulated businesses for the future. But more importantly, run properly, the capital structure of these businesses means you’ll get increased earnings, despite tighter access to credit in the global economy.”

For Chris Mayer’s play on Saskatchewan farmland, be sure to read your latest issue of Mayer’s Special Situations.

The S&P/Case Shiller continued its swan dive in August, the group reports today. Annual declines in home prices are down by another annual record, 17.7% for its 10-city composite, 16.6% for the 20-city.

Nine of the 20 regions report record annual declines. The last region to report a positive change in annual home prices was Charlotte, in April.

But we must admit, the housing picture in August isn’t looking as bad as previous months. The two composites were only slightly worse than their July scores, and the chart is starting to look like the very beginning of a bottom. But until we start seeing some data for October… we’re reserving judgment.

Is anyone (with a brain) surprised to see consumer confidence plummet in the first half of October?

Oh wait, some were. Pundits on CNBC exclaimed, “WOW!” when they reported the Conference Board’s latest reading today, which showed consumer confidence had been effectively cut in half over the last three weeks. Wow? Really… sometimes we wonder if we’re covering the same market as these guys.

The Conference Board’s gauge of confidence crashed to 38 in October, from a score of 61 in September. That’s just a bit worse than the 52 mark economists expected, and easily the lowest score since the report’s inception, in 1967.

The Dow ended down Tuesday, nearly 2.5%. We’d love to say there were compelling reasons to buy and sell stocks Tuesday, but really… it doesn’t seem like anyone knows what the hell they’re doing, day to day. The index traded in another 400-plus-point range during the day and crossed between positive and negative territory 60 times.

The VIX remains above 80, just shy of another record high.

Either way, at 8,175, the Dow put in a new five-year low. Any blue chip investments you’ve made since April 2003? Probably gone.

Nevertheless, and true to form, the stock market is rallying today. The Dow opened up over 200 points. We’ve yet to see any shockingly putrid news this morning. And since the markets have been getting decimated all week… can you blame traders wiping away debris looking for value?

“Most of the rest of the world’s stock markets also tumbled to new multiyear lows,” notes Eric Fry of yesterday’s market. “Many of the year-to-date declines look like misprints: London’s FTSE is down 53%, Hong Kong’s Hang Seng Index is down 60%, Russia’s RTS Index is down 76%.

“Down 76% is more than just a bad year; it’s a disaster. ‘That’s not going to happen here!’ we tell ourselves, as we cross our fingers, knock on wood and light a candle to St. Martin of Tours. ‘The U.S. is not an emerging market, after all.’

“More than likely, the beleaguered Dow Jones industrials’ 38% loss year to date will not ‘do a Russia’ and double to 76%… at least not immediately. But the line between ‘developed markets’ and ‘emerging markets’ has become very blurred. Nearly every stock market in the world has become a ‘submerging market.’

“When will this global financial trauma come to an end? Probably not for many years. At least that’s our guess.”

After peaking at a remarkable 87.8 yesterday,more than a 2-year high, the dollar index has backed off a point this morning. As we write, it’s back to around 87 even.

Oil is taking a break from the norm today by rallying a buck to $64 a barrel. It fell as low as $61 yesterday, a 17-month low.

Gold is up, too… a mere $10, to $740 an ounce.

This morning, we have further proof this is not the time to be in the newspaper business. As if you needed any.

Combined circulation of all 507 daily print newspapers tracked by the Audit Bureau of Circulations fell 4.6% last month. Combined circulation of all those rags averaged about 38 million in the six months ending in September, down 2 million from the same period in 2007.

“Mr. Wiggin, that was a bit harsh for a reply to a subscriber,” writes a reader of yesterday’s issue. “I know The 5 Min. Forecast is a free publication, and I also have a number of paid subscriptions to various Agora services through a number of their companies. Even high-priced ‘premium’ ones… and think subscriptions might even provide some of your cash flow.

“I did listen/watch the Webinar and got much the same opinion, that it was an advertisement. So much so that I hit delete when I received the e-mail pertaining to the Strategic Short Report. These are trying financial times for many of us: rich, moderate or poor. They have left me poorer than I was. How about you? Is it possible that the other subscriber that you referred to has been badly hurt?”

“Sounds to me like your Agora Reserve member is a little ticked,” suggests another, “about their lost principal and took it out on those who could be trusted the most with such emotion… your team!

“I would like your readers to know that I phoned in after the Webinar and was honestly told that purchasing Strategic Short Report was not in my best interest, due to my personal circumstances, and was advised that perhaps a subscription to Outstanding Investments was better suited for me. I appreciated that I had a conversation with an understanding person who was not just interested in getting my credit card number. I am a current subscriber to Strategic Investment and will be forever thankful for having found you a year ago. My situation is too complex to go into, yet I want you to know that the philosophies of Agora Financial resonate with me so well.

“In fact, in September 2007, I had just placed my home on the market and ultimately took it off in November 2007, after studying your newsletters. I remember distinctly telling my real estate agent and her mortgage broker that we were ‘in for a global meltdown of epic proportions,’ based on what I had learned. They looked at me like I was crazy, especially since we live in Seattle, a city considered to be removed from the rest of the country’s economic pains (Ha! Can you say WaMu?). I wonder what they think of my comment today? Because of all you do, I am one single mother of six children, who is still a current homeowner and continuing to make positive changes every day because I have read and taken heed to all you share…

“I saw the movie I.O.U.S.A. and was amazed that I was only one of seven in the theater. I have full faith in the integrity of your company. My future and that of my children’s is and will continue to become more beautiful and abundant because of Agora Financial. Thank you.”

The 5: You’re welcome.

When you begin an e-mail “I dare you,” what kind of response do you suppose he’s expecting? We’ve noticed when people write by e-mail, they dispense with civility a lot faster than they might if they were to speak to us in person.

Regarding the film: The economics of releasing a documentary about the national economy — even during an epic financial crisis — are rather complicated. We’re releasing to 35 additional markets starting this Friday, but most of the push is being funded by the Peterson Foundation , rather than high attendance numbers.

Still, our experience with the film has been extremely positive. We just finished a stretch of media in screenings in Toronto and New York City. They were all well attended and the conversations that the film provoked are exactly what we wanted to see happen. As happened after our screening before the National Board of Review yesterday at the Disney Screening Room on Park Avenue, the audience wants to know immediately what we’ll be doing to get the film into high schools and universities. “We’re working on it,” we reply. The film is now in the hands of the foundation. They’re setting up programs to help teachers screen the film and conduct discussions with their students.

Source: Senseless Markets, Companies to Consider, I.O.U.S.A. on DVD, and More!

This is a remarkable read and re-enforces my view that we are in a “sell in May and go away” summer. This is really a great Outside the Box. Enjoy.

Joining the dark side

It never ceases to amaze me that whenever a major corporate declines the short sellers are suddenly painted as financial equivalents of psychopaths. This is madness, rather than examining the exceptionally poor (and sometimes criminal) decisions that the corporate itself took, the short sellers are hauled over the coals.

As the New York Times recently reminded us, vilifying short sellers is nothing new.

In the days when square-rigged galleons plied the spice route to the East, the Dutch outlawed a band of rebels that they feared might plunder their new-found riches.

The troublemakers were neither Barbary pirates nor Spanish spies — they were certain traders on the stock exchange in Amsterdam. Their offence: shorting the shares of the Dutch East India Company, purportedly the first company in the world to issue stock.

Short sellers, who sell assets like stocks in the hope that the price will fall, have been reviled ever since. England banned them for much of the 18th and 19th centuries. Napoleon deemed them enemies of the state. And Germany’s last Kaiser enlisted them to attack American markets (or so some Americans feared).

Jenny Anderson, NY Times, 30 April 2008

Last week, Albert Edwards took our equity weighting down to its minimum (see Global Strategy Weekly, 8 May 2008), and my own bottom-up valuation work finds little opportunity for investment at the moment (see Mind Matters, 28 January 2008). This suggests to me the main opportunities may lie on the short side in the current market. So I guess I am joining the ranks of the dark side!

This remains anathema to analysts. As the chart below shows the percentage of sell recommendations remains pathetically low. Indeed, the other day my head of research showed me the second chart below showing that SG had the highest percentage of sells amongst investment banks – it makes a pleasant change to see SG at the top of a list on a positive note!

All of this got me to thinking about how to identify potential short candidates. In keeping with my first note for SG (on limited information – see Mind Matters 3 December 2007, I want to focus on just a few key measures that stand out to me as sources of poor underperformance.

Valuation

Most obviously (and unsurprisingly given my value bias) one of my primary sources of underperformance has to be high valuation. There are myriad methods of valuing a stock, of course. However, from the perspective of a short seller, one of the most useful is price-to-sales.

Focusing upon high price-to-sales stocks allows us to hone in on story stocks – those stocks that have lost all touch with reality. During periods of investor enthusiasm there is often a marked tendency to move up the income statement in order to try and keep valuation multiples ‘low’. Indeed during the dotcom years, things were valued on measures such as average revenue per user, clicks and eyeballs!

Times of crisis such as these provide some choice examples; HBOS plc, one of the UK’s largest banks, for one.

The banking and financial services giant, with some 72,000 souls under its wing, saw its shares crippled one morning in a bear raid stoked by rumours of funding problems. Those behind the whispering were deemed to have a cynical vested interest at heart. No, really? It certainly riled the regulator against the short sellers. Whatever the motive the impact of rumour on professional market minds turned feverish in mad markets was briefly impressive. A 20% fall at one point in a morning.

Fear got the better of Bear Stearns too thinks CEO, Alan Shwartz. He laid the blame for the sudden demise of 85 years of investment banking on “short sellers and “market manipulators” as it “suffered an evaporation of confidence fuelled by falsehoods,” according to a Guardian report. Though some, ourselves included, might point to the fact they were up to their necks in the subprime swamp might have had something to do with it. Whatever the reason, the Bear died on a single fateful day when the lifeblood was leeched out of it. On March 13, $10bn was sucked from the company by panicked investors. At the end of the raid over $12bn in cash resources had dwindled to $2bn. It proved a mortal blow.

“As an observer of the markets, it looked like more than just fear. It looked like people wanted to induce a panic,” Schwartz told a senate finance committee in Washington.

So there’s fear…and there’s its exaggerated form: panic. I guess it’s one grade of emotion to see a tsunami coming from a distance. A more intense one when it crashes on the beach and you’re still in the sun lounger. The fight then is not one of rational avoidance but visceral survival. At such times the pin stripe suit and the Ivy League finance MBA provide little protection as normally civil behaviour reverts to something more primal.

Continues below …

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Even the proverbial Man on the Clapham Bendy Bus has noticed. Mortgage and remortgage deals are either getting more expensive and restrictive or, worse, disappearing altogether. The Bank of England warns that almost half of the UK’s lenders are preparing to “ration” mortgage deals over the next three months, reports the Telegraph. Middle England is cutting back on spending as recession fears take hold, reports a survey by insurance group Axa; as credit reference agency, Experian, warns more than 5m people could run into serious financial difficulty.

But as the UK consumer braces for hard times, the clouds seem to be lifting a little for some in the more forward looking financial markets. Edward Menashy, economist at Charles Stanley, feels “definitely less gloomy” as credit markets have “recovered somewhat”. Well, LIBOR has now dipped a bit under 6%, according to Bloomberg, but there looks to be some way to go…

*** Back to basics. Commodities. That commodity prices have continued to rise as the US has headed into recession “makes no sense to me” said Unicredit economist Marco Annunziata yesterday. He sees prices stabilising from here. Meantime the long commodity price boom for everything from industrial metals to agricultural staples is giving rise some quirky economic side effects.

“Some homes are worth less than their copper pipes”, reads a Reuters headline. It reports an emerging trend of thieves ripping up the plasterwork in derelict homes to steal the valuable metal.

Closer to home, a new kind of robber alchemist (turning lead into gold?) appears to be at work on English churches. With the price of lead having risen sevenfold in the last six years, the churches’ lead roofs have become popular targets for thieves. One church in Leicestershire found itself with 100sq ft hole in the roof, reports the International Herald Tribune.

Meanwhile for resource-rich countries, the bounty of ‘Chindia’s’ industrialisation is helping transform economic fortunes. One time banana republic Peru has just had its foreign currency debt rating upgraded by Fitch to investment grade on a par with India and Croatia, as commodity exports including oil, copper, gold, zinc and coffee boost revenues and strengthen its ability to repay debt. Peru’s improving fortunes are old news to any adventurous investor who has been keeping tabs its stock market in recent years. The Lima General stock index has risen about ninefold in the three years to mid 2007.

Finally, ex-media mogul and so called “Mouth of the South” Ted Turner, who set up CNN, knows how to make the news.

If we don’t get a handle on global warming says the billionaire “we’ll be eight degrees hotter in 30-40 years and basically none of the crops will grow. Most of the people will have died and the rest will be cannibals.”

And there we were worrying about a trifling credit crunch.

Regards,

Rob Mackrill
The Daily Reckoning

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Let me see if I get this right. A week ago, Lehman was running around reassuring everyone it had enough cash to stay in business. Not exactly high cotton. Investors are worried about a bank run, and insiders think it might be too small to qualify for a Fed bailout should it fail.

On top of this, claims that nasty short-sellers are spreading false rumors are making rounds—the company denies the rumors, but they persist, and the company has not showed anything strong enough to stop them cold.

This sale of preferred stock was supposed to raise capital to put the rumors to rest and show how strong the company is. But why does it need this new massive new capital transfusion this very moment, and at such high cost, if it really doesn’t have a money shortage, as it claims?

The company has cut employees by almost 20% already—which hardly signals growth going the right way, does it? It got into trouble with debt, too. It just wrote down $1.8 billion in bad mortgage assets in its recent quarter. If it does that again, everything it raised in the convertible sale will be eaten up by the write-offs.

The preferreds carry a 7.25% yield, which will cost the company an extra $290 million a year to pay. When converted to regular shares, they stand to dilute earnings per share by about 15%. All I can think is that analysts who stand too close to Lehman’s shadow on Wall Street need to step back for a bit of light.

The rally comes despite heavy writedowns from Swiss banking giant UBS.

The uncertainty about the markets’ direction reflected the fact that stocks rose after another round of bank writedowns and capital-raisings – developments that might have been expected to send prices lower.

However, UBS added to the previous session’s 12 per cent advance sparked by news of the departure of its chairman. The Swiss bank said Marcel Ospel was standing down in the wake of $19bn of new writedowns and plans for a SFr15bn ($15bn) rights issue. Its shares rose a further 0.4 per cent to SFr32.9 on Wednesday.

In New York, Lehman Brothers, the US investment bank locked in a battle with short-sellers betting on its demise, surged 18 per cent after it said it was increasing Monday’s $3bn capital-raising by $1bn.

Forget the big bank, says Steve Sjuggerud. Small banks are where the profits are at.

“The good part about the small banks is, they generally stick to their knitting – taking deposits and then making loans. They simply earn a spread… They charge more interest on the loans they make than they pay out as interest on their deposits.

“Small banks are generally not like the big banks. Big banks do try to get fancy, with derivatives trading, massive leverage, and such.”