Michael Shulman

The Obama Bounce Trade: Here Today, Gone Tomorrow

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The Credit Crisis

Resolved, you say? LIBOR coming down means it's over? The Fed backstopping commercial paper markets will do the trick, you say? Don't believe this nonsense. Here's what I and a few others know and understand, unlike most members of the press and Congress.

• When Bear Stearns (BS) took its curtain call, for every dollar in core capital or equity it had assets (loans and debt) of about $33-$35. Historically a bank -- not an investment bank, a real bank with rude tellers -- loans out about 11 to 12-to-1.
  
  
• We have since discovered many banks were actually much more leveraged than 11-12 to one by using "off balance sheet" entities called structured investment vehicles (SIVs) and variable interest entities (VIEs). We have also discovered the Europeans, especially the Germans, levered up as much as 50-to-1. Do I exaggerate? In a very short document filed with the SEC earlier this year, Citigroup (C) revealed it had something like $350 billion in derivatives in VIEs. Yes, billion with a "B."
  
  
• We are now going back to leverage of 12 to 15-to-1. That means the amount of credit available would contract at least 50% even if there were no write downs of capital. Speaking of write downs ...
  
  
• Banks have written down around $700 billion, not all of it replaced by fresh capital. Jim Paulson (no relation to TARP man and Treasury Secretary Hank Paulson) made a few billion last year shorting subprime mortgages. Last week he made a speech and said he expects another $1.4 billion, which is $200 billion more than my own estimate. he Street is gong to be surprised as bank write downs continue apace and continuing problems in mortgages well past 20009 will make these surprises uglier and uglier.

Translation: Bank capital is shrinking just as bank leverage ratios are and the combination means credit available to businesses and consumers will not reach levels seen in 2006 for at least seven to 10 years. There we go with that second Obama term -- maybe that is why he said in his acceptance speech he would not get everything done in his first term.

Am I too bearish? Let me throw in some human behavior -- I know, most people think payers in financial markets are prone to inhuman behavior, but bear with me (pardon the pun). The word credit comes from the Latin cred and credit, words meaning confidence and trust. You think we might have a bit if a shortage of trust and confidence right now? And maybe next year?

And let me throw in new government regulations that uber-analyst Meredith Whitney thinks cold reduce consumer credit card lines by 2 trillion bucks. You add it all up and what you get is a very impaired credit market -- for consumers, businesses and even many nations -- and credit is the lifeblood of everyone's economy.

The Consumer

ChangeWave Research and third-party surveys show the consumer has gone on vacation in a used car badly in need if repairs. Spending has hit a wall and since our GDP is about 70% consumer, this is worse news than simply saying there may be a few less shops to peruse at the mall. I just looked at some MasterCard (MA) data for October and electronics were down 19%, home furnishings 21% and sales of anything more than $1,000 bucks disappeared. And this will only get worse.

• The continuing decline in home prices -- yes, there is a connection -- makes people fell less wealthy, more nervous and more frugal.
  
  
• The recent sharp declines in the stock market -- and the upcoming declines (I am giving away my ending, this is called foreshadowing) will also make people feel less wealthy and for many consumers, reduce their income.
  
  
• Speaking of reduced income -- the recession is already going that and is going to hit much, much harder in the coming months. And as it hits, and spending contracts, the recession begins feeds itself.

Don't despair -- there is plenty of money to be made. Just don't listen to Cramer or those long-only money managers on CNBC who think the term "shorts" refers to either evil men or something they put on every day.

Playing the Un-Bounce

I like fundamentals -- yeah, "momentum" trading is "sexy," telling someone at a party you "read charts" is really cool -- but fundamentals will always bring you victory and profits when combined with patience. And the way to play this lack of an Obama bounce is by playing (or should I say shorting?) the fundamentals.

Shorting? Yes, shorting.

When people ask me if I am comfortable with shorting stocks -- I am … if it is done with put options. I think of a favorite quote from Winston Churchill. "We sleep soundly in our beds because rough men stand ready in the night to visit violence on those who would do us harm."

To my mind, short sellers are those at the ready; touts of stocks, long-only money mangers and pundits with no stake in the game like Cramer are those doing harm to our portfolios.

Which side do you want to be on?