Saturday, March 7, 2009

Shorting to Zero, CDS, and Swords Falling 15 points a Day, Every Day…

Doc and I have been discussing the effects of shorting, naked CDS shorting, and put options as has been the topic of conversation on some blogs and forums lately. We both have come to the conclusion that companies that are legitimately strong will ultimately be able to defend any “attack” that may occur.

For example, let’s look at Boeing versus GE. Two very large companies, both with large and diversified manufacturing bases… Although BA has been hammered all the way from a bubble high of $102 down to $30, they never got deeply involved in trying to finance everything in the world including mortgages. In fact, Boeing doesn’t really as a matter of course finance aircraft sales either. GE Capital is the one who does that.

While Boeing is building aircraft and military hardware, GE is building aircraft engines, electrical controls, windmills, military hardware and many other productive enterprises. So the question is this; can the bad debt within GE Capital really bring a zero net worth to the company? The answer is sure it can! Some people are looking at it like GE Capital is completely separate and that they can be zero while the other components of GE are worth something. No, the financial component can be worth way less than zero, and in this case it probably is. In other words, GE’s total liabilities could very well exceed the value of other components. How do we know? That’s where transparency comes in – we don’t. In fact we’ve learned that GE has only taken write downs on 2% of its total portfolio, much less than the rest of the financial industry.

Now, if I’m writing CDS on GE or BA, since I don’t know what GE has hiding in there, I’m going to want more for GE CDS than I do for BA. Yes, speculators come in and put further pressure on those rates which makes borrowing much more expensive and thus can choke a company off. But guess what? That is exactly what should happen to a business that is overleveraged… rolling over debt should be more expensive. No, no one wants to see any big business fail. BUT, in my opinion keeping them propped up isn’t doing the overall economy any favors in the long run. After this disaster, businesses will look upon aggressive leveraged financing from a completely different light, that’s for sure (at least those who are still around).

And if GE fails, does that mean death for America? Well, let’s see… GE is the ONLY REMAINING company of the original DOW 30 companies from 1928, and America is still America so far. Well kind of…

Here’s Doc’s take on shorting in general and with some amazing bear market stats he calculated:

It just pains me to see total BS. The reality is even if you banned ALL short selling and/or buying of puts the market will still be in roughly the exact same place one year from now as it will be with shorting allowed. Market prices over the long run are determined by long run supply/demand for stocks. Shorting by its very nature is a short-term bet and has zero effect as the shares are always eventually given back (even if it's in bankruptcy court).

And it is impossible to short a good company to zero. If there is value in a stock the market will ALWAYS find it. Every single case in history of a stock being "unfairly" shorted to zero is always proven wrong when the autopsy is done in bankruptcy court. How much was LEH worth again when you got to look under the hood? GE needs to shut the hell up about the share price and figure out how to handle their CMBS book amongst other big problems. Run the business right and the value will always show up over the course of time.

I also have those bear market stats for the end of the week. Thus far the bear market has lasted 514 days with the Dow having fallen 7566 points in that time. That works out to almost 15 points a day, about 2 points every 3 hours. That's the size of the sword you are trying to catch if you are thinking about going long here for the longhaul. 2 points every 3 hours, 24 hours a day, 7 days a week, 52 weeks a year, every single day, even on Christmas and your birthday. And in case you think prices are low and they can't go much lower, the losses have actually been accelerating the last 6 months on both a percent and relative basis. The blade is falling even faster now.

The SPX is now down 56% from its all time high. At this point during the Great Depression stocks were only down 49%. It would take an almost 20% rally just to get back to the pace of the decline of GD I. If we equal the declines of GD I then we still have about 65% more to fall. Total douchebag perma bull Don Luskin actually produced a pretty good chart comparing the declines just today:

Source: Don Luskin’s Blog
Nice chart and stats. Amazing that we’d have to rally that far just to get to the Great Depression decline. I note that a 61.8% SPX market loss will occur at SPX 601ish.

So Doc, what do you really think of Luskin? LOL, that sounds about how I would describe Larry Kudlow who is completely warped, doesn’t understand the situation or math at all, and spews forth as if he is THE market authority… how dare the markets not do what he thinks they should!

And guess what? I found the video of Kudlow and Luskin together. Amazingly that chart is the first coherent thing I’ve seen between the both of them:

The Kudlow Report – March 6, 2009:

Another good chart for updating the big picture is DS Short’s Four Bad Bears:

It looks like Luskin and Short began their timelines from slightly different points, but the net result is pretty close. Luskin is using the SPX while Short is using the DOW.

The remarkable thing about this is the time perspective. We’re only about 18 months into our declines so far. If we only match the time of declines of the other bears (average 30 months when including Nikkei 1990), what will our price level be when we reach THE bottom?

Tell you what, let’s take a poll on where do you think THE ultimate bottom of this bear market will be… Let’s use the SPX:

Vote “funny” if you think the ultimate destination will be above 500

Vote “interesting” if you think the ultimate destination will be 300 to 500

Vote “cool” if you believe we'll be visiting Lucifer at sub-300

(of course the people who read this blog are not biased in any manner ;-)