Why We're Adding to Our Centex Short

We have added to our short of Centex (CTX), the homebuilder. This stock has previously traded below book value, and we see no reason why in this environment it should trade above book.

Centex is also one of the more leveraged of homebuilders which makes its position more precarious, and less a candidate for a leveraged buyout. Leveraged buyouts are the bane of fixed income investors, and also of short sellers, and one does need to assess the potential for a leveraged buyout in shorting stocks. Still, given Centex's leverage, and the instability in homebuilders cash flows, we don't see much of a risk of an LBO currently.

We think the nasty correction in real estate has far from run its course. When consumer and investor sentiment turns negative on real estate it's very hard to change. It will take something dramatic to turn the tide on real estate, like sustained rate decreases by the Fed, which Insight does not see happening anytime soon.

That said, there is much bearish sentiment on homebuilders, and any glimmer of hope in the economic numbers could set off a short-covering rally in the stock. Still, we think there is 10% more downside in the stock, given the stock trades at about 108% of book, and book value may well be overstated given the homebuilders’ use of options on land, which are off-balance sheet.

Shorts now constitute 30% of long positions in our model portfolio, which reflects our cautious view of the US economy. Some of the most severe geopolitical tensions in the past 25 years further buttresses our cautious view.

While too many hedge funds do not truly hedge risk but rather increase it, in our view a truly hedged portfolio composed of longs and shorts can significantly diminish risk in a professionally managed portfolio.

We think Wall Street's current view that when the Fed stops raising rates everything will be ok, is incorrect and pollyanish. The Fed will stop raising rates only when there are very clear signs that the economy is in trouble. And when economies do get into trouble, as Japan has taught us well, an upturn can be a long time in coming.

CTX 1-yr chart:

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