Friday, August 8, 2008

Markets and Spades Playing

Back to that time of year. Time to put on blinders to the markets and play spades. What is going on is as stupid as it was back in April. The bulls will argue valuations have bottomed (you don't see many bulls arguing anymore that the economy is going get better anytime soon, the argument is changing). Whatever, sounds great, your right, let's talk in 3 more months.

I am currently really proud of myself and disappointed with myself. I am proud of myself because yesterday it was very tempting to short. The news was death and fundamentally it added to the compelling case of shorting some more. Well all day I talked myself out of it because it didn't look like anything was different in the markets that it wasn't just a natural pause before more bad news would be bought. On the disappointment side, I had decided that if we get the natural pull down I wanted to sell some covered puts on my short. Well the news was so bad yesterday I couldn't bring myself to do it. So I missed the opportunity.

Today news flow while not as bad as yesterday is also bad. Of course this is the type of market where bad news is bought and horrid news is quietly sold. The Fannie Mae news was not good today. No matter how you slice and dice it there are some financials that should be declining today based on the FNM earnings release. If you read their conference call it is interesting how much they discussed how bad July was. The other interesting thing was in their press release which calculated risk actually pointed out.

[Fannie will be] ramping up defaulted loan reviews to pursue recoveries from lenders, focusing especially on our Alt-A book. The objective is to expand loan reviews where the company incurred a loss or could incur a loss due to fraud or improper lending practices. To achieve this, we are increasing post-foreclosure loan reviews from 900 a month in January to 4,000 a month by the end of the year, expanding our quality-control reviews for targeted products and practices, and are on track to double our anti-fraud investigations this year. We expect this effort to increase our credit loss recoveries in 2008 and 2009.

Basically in everyday English they will seek money to make them whole on loans that went bad made by other banks that Fannie bought from the banks. Basically a put option back on the banks meaning losses for banks that they didn't think they would have because the loan they made and sold went back forcing them to take the loan back. I don't know what kind of dollar numbers this is talking about but this likely flows back to Countrywide which then likely flows back to Bank of America (Countrywide was the biggest seller of loans to FNM). Bank of America has been on an absolute rocket going from 18 to 34 (now 32.50) in less than a month. It seems like the most insane of all the bank rallies.

So what is going on? Why the big rally? Besides the obvious reasons, you also have to understand Wall St. From mid May to mid July energy was on a tear while financials got killed. What that means is that investing companies that follow an asset allocation strategy saw the percent of their portfolio in financials decline substantially and the percent in energy increase substantially. Well at some point they decided enough was enough and it was time to rebalance. This starts a domino reaction and so everyone rushes to rebalance their portfolios based completly on asset allocation targets, not on fundamentals. So you have money leaving energy flowing into financials and other areas of the market regardless of the fundamental aspects of the trade. This has obviously not run its course and could continue awhile. That is why even if you know a financial is overvalued, it is a really hard short and it is probably better to wait to try to pick your timing better.

Need to play some spades. Only one more hour of this nonsense for a couple of days.

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