Five Sectors To Consider Shorting

Having picked the homebuilders as potential short opportunities in 2005 and the mortgage lenders in 2006 we protected our model portfolio by hedging our long positions with put options. At this point in the cycle, it may not be prudent to start new short positions or put options on the homebuilders or the mortgage lenders as they could be very close to their bottom. The only homebuilder that has comparatively not taken a very hard hit is Toll Brothers (TOL) and it could be a potential short opportunity. Given below are five broad themes for short opportunities:

1. RV Manufacturers: While a lot of people are focused on Winnebago Industries (WGO) as a short opportunity, I see smaller rival Monaco Coach Corp (MNC) as a much better short opportunity. Even over the last three years while a record number of people were buying homes and feeling flush with cash, Monaco has seen steadily declining operating and net income. Winnebago's balance sheet also happens to be much stronger than Monaco's. Monaco is the BMW of RVs with its cheapest line of RVs starting at almost $100,000 and higher end models crossing the half a million mark. High gas prices make these gas guzzler home-on-wheels highly unattractive even to the rich folks these RVs are targeted towards. While Monaco has been slowing working down its inventory over the last few quarters, it still has $154.97 million in inventory representing nearly half its current assets.

While I had no qualms about picking homebuilders like St Joe (JOE) and mortgage lenders like Countrywide Financial (CFC) as short opportunities, I do feel a little unhappy about picking Monaco as I have personally known people who have worked at Monaco and it is located right outside Eugene, Oregon, a place I love. However emotion has very little room in the field of investing and I was planning on purchasing Jan 2008 or April 2008 $12.50 put options on Monaco but unfortunately there is very little volume on those options and the April 2008 options have not even traded in more than two weeks. Hence to reflect real world trading conditions, I am going to instead short Monaco, even though I prefer put options. Please note that since Monaco has a dividend yield of 1.8%, you will be responsible for paying this dividend in case you short the stock.

2. Furniture Companies: Furniture companies are yet another group that are directly affected by a weak housing. Beyond the commonly known furniture companies like La-Z-Boy (LZB), Ethan Allen Interiors (ETH) and Pier 1 Imports (PIR), you can also look for short opportunities in companies like Haverty Furniture Companies (HVT), Hooker Furniture (HOFT), Italy's Natuzzi (NTZ), Furniture Brands International (FBN) and Cost Plus (CPWM). From my brief analysis of this group of companies, it looks like Haverty (HVT) could fall the most. While most retailers saw same-store sales increase in August, Haverty saw a sales decline of 10.1% at stores that have been open more than a year.

3. Staffing Companies: An interesting event transpired last week when an old SINLetter pick RCM Technologies (RCMT) made a two unsuccessful bids for larger rival Computer Task Group (CTGX). I sold RCMT from my personal portfolio in two transactions at $7 and $8.25 on its sudden ascent to $10 in July. Based on this aggressive acquisition attempt that does not fall under the category of "diworsification" and a P/E of just 12.44, I am tempted to start a position in RCMT once again but am held back by the dismal job numbers and an economic slowdown, both of which bode badly for a consulting and engineering company.

If you think this subprime mess is hurting home builders and mortgage lenders, check out the action on staffing company Manpower Inc (MAN), which has dropped from $92.24 to $63.93 or 30.69% since the end of June. Competitor Robert Half (RHI) has fared a little better with a drop of 17.81%. In the aftermath of the dot com bust, Robert Half lost more than half its value while Manpower weathered that downturn much better. I think there is little doubt that both these companies are likely to fall even more and could be potential short opportunities. Please note that while Robert Half has a rock solid balance sheet with $434.79 million in cash and very little debt ($4.02 million), Manpower is slightly leveraged with $710.8 million in cash and $847.7 million in debt. Manpower also has an astounding billion dollars in goodwill on its balance sheet.

However if there is one stock I would want to short in this area, it would be Monster Worldwide (MNST), the company behind the job website Monster.com. The stock has fallen hard in recent weeks from a high of over $50 to its current price of $33.50. Beyond a weak job market Monster also faces tough competition not only from traditional job websites like Dice.com and Yahoo's HotJobs but also from Craigslist.com and increasingly from social networking websites like LinkedIn. LinkedIn is favored by professionals and I am beginning to see several "LinkedIn exclusive" jobs. A friend of mine who is looking for equity research positions also landed an interview through LinkedIn. I tried using Monster a few months ago and my experience was terrible. Not only was I inundated by ads every step of the way, I also received a lot of spam from people exploiting monster by posing to be employers. Please note that Monster is as much an internet play as a staffing play and the company has tons of cash and investments with very little debt. Since Monster Worldwide is a highly liquid stock and the options are available, I am going to purchase Mar 2008 $30 put options for $2.05 per contract instead of shorting the stock.

4. Retailers: Consumers inability to use their homes as an ATM machine combined with falling consumer confidence, high energy costs and a drop in non-farm payrolls certainly spells trouble for retailers. Even retailers like Costco (COST) and Gymboree (GYMB) have seen their stocks drop in recent weeks. One potential play would be to short stocks of companies like Bebe Stores (BEBE) and AnnTaylor Stores (ANN) while simultaneously buying discount retailers like Ross Stores (ROST) and TJX Companies (TJX), which operates the stores T.J. Maxx, Marshalls, and A.J. Wright in the United States. Beyond a few retailers, I do not follow the retail sector very closely and hence do not plan on initiating short positions in this sector.

5. The Russell 2000 Index: With the exception of the last few months, small cap stocks as represented by the Russell 2000 index have handily outperformed large cap stocks over the last four years. The recent downward trend of the Russell 2000 is likely to continue as small companies are hurt the most in an economic downturn. Office Depot (ODP) blamed small business spending while announcing that third quarter earnings will decline by double digits. The stock has lost almost half its value since early June. I am going to use the UltraShort Russell 2000 ETF (TWM) by ProShares to short the Russell 2000. Since this is an ETF, it will not show up under "short positions" in the portfolio. If you are not familiar with how the UltraShort ETFs work, check out this article.

Note: Shorting stocks or purchasing put options is a highly risky strategy with the potential of losing your entire investment and then some. I only utilize it to hedge a portfolio consisting of long stocks and use very small positions. A half point fed rate cut may also make the markets go up in response and this short-term event should also be kept in mind.

Comments

[omooc:]

I had held positions in QID, but had a hard time finding out the companies represented in that ETF. I also had difficulty in finding a correlation between moves in NASDAQ and in QID. How can one read into TWM holdings and correlations? omooc

2007 Sep 11 10:00 AM

[Asif Suria:]

It looks like QID achieves its leveraged shorting of the Qs through swaps and options as you can see from its daily holdings here

www.proshares.com/fund...

You can find additional information from their prospectus here

media.proshares.biz/do...

The inverse correlation between QID and QQQQ is quite apparent when you look at the following one year chart comparing the two

finance.yahoo.com/char...;range=1y;compare=qqqq...

Similarly the inverse correlation between TWM and the Russell 2000 is quite apparent when you look at the following 6 month chart comparing the two

finance.yahoo.com/char...=^rut;range=6m;compare...

2007 Sep 11 04:32 PM

[Asif Suria:]

It looks like QID achieves its leveraged shorting of the Qs through swaps and options as you can see from its daily holdings here

www.proshares.com/fund...

You can find additional information from their prospectus here

media.proshares.biz/do...

The inverse correlation between QID and QQQQ is quite apparent when you look at the following one year chart comparing the two

finance.yahoo.com/char...;range=1y;compare=qqqq...

Similarly the inverse correlation between TWM and the Russell 2000 is quite apparent when you look at the following 6 month chart comparing the two

finance.yahoo.com/char...=^rut;range=6m;compare...

2007 Sep 11 04:32 PM

[flstearns:]

Often ETFConnect will pub, the top holdings by volume.

2007 Sep 13 01:39 PM

[Drew Robertson:]

Also XLB XLI XLY and XLK....

2007 Sep 11 11:04 AM

[Uncle Bill:]

"We protected our model portfolio by hedging our long positions with put options" is a misleading statement. While your fundamental analysis is solid as can be, your timing and application of options leaves something to be desired.

I looked back, and your post on Dec. 11 last year said you were buying the July 42 1/2 puts on Countrywide (CFC). That day, the stock closed at 40.48. The day you posted and said your July puts expired, the stock closed at 36.17. So your puts were worth 6.33 at expiry (42.5 - 36.17). But the options were nearly 2 points in the money when purchased, poiints you had to pay when you bought. That leaves 4.33 points, minus the premuim -- a couple points? -- you paid to hold those for six months. So you made maybe 3 points on the trade in six months. Then you were naked long the stock again in your model portfolio. Right before it tanked.

You also said you missed out on buying protective puts in New Century (no symbol). If you made a fundamental decision to hedge, why didn't you buy those on the offer?

It's important because of your final statement: "A half-point Fed cut may make the markets go up in response." When dealing with options, timing and application is more important than fundamentals.
impliedrisk.blogspot.c...

2007 Sep 16 11:40 AM

[Asif Suria:]

Since you seem to have done the research on my past trades, I would love for you to show me when and where I was "naked long the stock again in my model portfolio". As most of my subscribers know I have been nothing but bearish on Countrywide since 2006. When those options expired I suggested that my timing was a little unfortunate ( I *only* made a 66.67% gain in 6 months as a "couple of points" on a $2.46 put option works out to a tidy gain) and it may be a good idea to roll them into new put options. While all my current positions are listed in the model portfolio, every single trade done in the past is listed in the Historical Trades section of SINLetter.com

www.sinletter.com/hist...

2007 Sep 16 01:58 PM

[Uncle Bill:]

I didn't research your past trades, I just looked at your posts.

Here's what you said on Dec. 11: "A little over two weeks ago I placed an order to buy May 2007 puts on another mortgage lender New Century Financial (NEW) but unfortunately my order was not fulfilled. New Century Financial was mentioned in my November article, "Hedging The Economy", and is already up 44% since we added it to the model portfolio. As an alternative to New Century, I picked up the July 2007 $42.5 puts for Countrywide Financial last week and after the analyst downgrade on Friday, these puts are already up 27%." I thought you meant you missed out on New Century puts to cover the New Century stock that was up 44% in your portfolio, so you went to Countrywide puts instead. I guess you're saying you sold New Century and went short the industry by buying Countrywide puts. OK.

So you used puts on Countrywide to hedge a tech-stock portfolio, made $1.64 on each put and tell us that "we protected our model portfolio by hedging our long positions with put options."

My point is that your hedges had expired by the time the underlyig moved down. Your portfolio was exposed at exactly the time the mortgage sector was experiecing its worst moments.That's why I say your hedging claims are misleading. You're lucky the tech market hasn't gone down yet.

2007 Sep 16 08:34 PM

[Asif Suria:]

If you did not research by past trades, take a look at my current model portfolio or even the portfolio from November 2006 when I initiated four naked put options to hedge the long portion (not specific long stocks) of the portfolio. Two of those four puts (a trucking company YRC Worldwide and a homebuilder St Joe) are still in the portfolio wth gains of 111.43% and 161.54%.

www.sinletter.com/port...


www.sinletter.com/arch...

As for the "tech-stock" portfolio, I would hardly call a portfolio that contains an Israeli generic drug manufacturer (TEVA), a travel company (EPAX), an oil drilling company (DO), an entertainment company (BBI), an Indian auto company (TTM) and consumer non-discrenary companies (PG and UL) a "tech-stock" portfolio.

If using multiple naked put options, using selective short positions and diversifying long positions across asset classes and countries is not called hedging your risks, I have no idea what is.

2007 Sep 16 11:31 PM

[Uncle Bill:]

One more comment. You are not hedging your $180,000 long-stock portfolio, which is heavily tech-laden, when you buy a few thousand dollars worth of puts on the home-mortgage sector. To mask the relative ineffectiveness of the "hedge," you focus on the percentage gain in the option. People should always be wary when profit/loss on options is listed in terms of the option price rather than the stock price.

2007 Sep 16 09:56 PM