Time to Short Financial Stocks - Starting with BofA

Financials have been one of the worst performing stock sectors over the last few months and I think the weakness in the sector is going to continue. The housing market is nowhere close to finding a bottom, the economy and job growth are slowing, and gasoline prices are projected to hit all time highs this summer. All of these things are going to bode ill for financial companies in the form of increasing foreclosures and overdue credit card and loan payments. Consequently, I think it is a good time to short financial companies.

Financial companies rallied earlier this year when the Federal Reserve caved into Wall Street demands and drastically cut interest rates by 1.25 points. However, the rally didn’t last long and the share prices of financial companies are once again dropping quickly. I think you can take your pick of which financial company to short, but I am going to give a recommendation to short Bank of America (BAC).

Bank of America bought Countrywide Financial (CFC) earlier this year and therefore has to deal with problems in the housing and credit markets.

The credit markets are going to continue to see problems for a variety of reasons. Consumers are highly leveraged due to all the easy money that was lent out the last time interest rates dropped to very low levels so I don’t think the current drop in interest rates is going to help out much. At the same time, the prices of commodities are being driven higher and higher by speculators, which will do a lot of damage to consumers. Rising food prices and gasoline prices are definitely going to have an impact on overleveraged consumers’ ability to pay bills.

I don’t see a bottom in the housing market any time soon, either. There is already a huge amount of homes for sale and this will only increase with rising foreclosures. Without economic growth and job creation, the demand for homes is going to decrease. Also, there is no reason for consumers who want to buy a house to leave the sidelines because the prices of homes are going to continue to drop.

I am going to give a recommendation to short Bank of America at Monday’s opening price.

Disclosure: I have no position in BAC

Comments

[Aubie Baltin:]

There is nothing like stating the obvious. Where were you 3 and 6 months or even a year ago. In a letter dated March 2007 called "DENIAL is not just a river in Africa" I stated emphatically that the sub-prime problem was just the tip of the iceberg and that I was shorting Citi anmd Merrill among others especially the Home Builders. I'm still short.

UNCOMMON COMMON SENSE
Dr. Aubie Baltin
[e-mail]

2008 Mar 03 08:41 AM

[User 127483:]

Can anyone tell me if there is an ETF that shorts the bond market??

2008 Mar 03 09:03 AM

[Tom B:]

I think it's time to buy BAC. I think they factored in the Countrywide risks when they snatched it up.

2008 Mar 03 12:31 PM

[LukeHappy:]

They haven't bought Countrywide yet...and it's possible they never will.

2008 Mar 03 01:13 PM

[JSwish:]

If you short BAC, have fun paying that hefty dividend.

2008 Mar 03 01:20 PM

[Pent up demand:]

What a shoddy article. You talk as if BAC is a pure-play to short the housing fiasco. If the deal even goes through, they will be buying CFC at a big discount. There are plenty of more likely suspects in the financial sector. What's a matter, did bad old BAC raise your interest rate?

2008 Mar 03 01:57 PM

[Davis Freeberg:]

Using sub-prime as a reason to short BAC is pretty weak. I like the articles where people give fresh insights into the market instead of entries for the captain obvious award. In response to the commenter who wants to short the bond market, I'd check out the Rydex Juno fund. It's pretty expensive, but if you feel that T's yields are going higher then it would be a way that you could capitalize on the trend.

2008 Mar 03 02:20 PM

[jdubrox:]

I whole-heartedly agree with JSwish, who pointed out the dividend factor. If you do as this article says, and short BAC at today's open/close price, you're then responsible for paying the dividend on that stock. I'm seeing an average dividend right now of $0.64 per share. Pay that each quarter, and you're paying ($2.56/sh/yr over $38.92/share) and there goes 6.58% of your capital. In my opinion, "paying money" and "Bank of America" in the same sentence mean "atm fees" and "mortgage payment", not paying BAC's dividend to someone else who's holding long. Then, if you're right by shorting BAC that the stock will go lower, if it actually does go lower, and BAC keeps the same dividend payout, you're going to be essentially paying any gains you've unrealized back to BAC long shareholders in the form of an ever-increasing yield of the dividend.

Good luck with that one.

2008 Mar 03 03:05 PM

[RW:]

Aubie Baltin, is C going into the teens? I am also short on it. I think if we see autos repoed in large numbers, then credit card defaults will be quick to follow and C will drop close to $10. Do you see any way it will go that low?

2008 Mar 03 03:13 PM

[User 159681:]

Let me see if I understand the logic of shorting BAC. Dividends still in tact, possible purchase of another financial institute at a drastically reduced price, the housing market showing some signs of closing in on the bottom of its slide, the FEDs ready to again reduce interest rates if necessary, and unemployment numbers remaining at reasonable levels. I do not think shorting BAC makes good financial sense. By the way, I own BAC and appreciate the dividends.

2008 Mar 03 03:48 PM

[vitaminc:]

BAC is a bad short because of the dividend factor as stated above.

Unless you have convictions that BAC's dividend would be cut - which I don't believe it will be true. BAC is a commercial bank and their debt security values on the books does not have to be marked to market every quarter (compare to investment/mega banks that do). Correct me if I am wrong though.

2008 Mar 03 04:22 PM

[Gaucho:]

I was already shorting BAC and was about to back out of my position when the CEO decided to buy CFC. Well that told me that those boys still do not get the severity of the housing market or the economy as a whole. They were thinking that this problem will turnaround in a couple of quarters. They were also underestimating the animosity towards CFC resulting from the lending practices and the media’s coverage of those practices.
All of the above leads me to believe that the management are a bunch of overpaid, well connected, the world owes me something, ivy league morons.

2008 Mar 03 05:06 PM

[whisperonth...:]

I'm staying in.

2008 Mar 03 07:12 PM

[No Moss:]

Yeah, I'm wondering why you'd short BAC. It has more pain in store, but it'll make money from the Visa IPO, and it has made a ton from its investment in China Construction Bank.

The risks involved in shorting BAC include finding a bottom in home prices and their raising their dividend. Both are possible by the end of the year, the dividend increase pretty much a foregone conclusion in my mind. The mother of all risks would be Congress lifting the cap on deposits, which would be a huge lift for BofA.

The stock is sitting at about 55% of its Morningstar fair value ($70).

2008 Mar 03 08:45 PM

[User 159829:]

shorting BAC is going to be your biggest mistake for 2008.

2008 Mar 03 11:45 PM

[User 159829:]

Mr. Phillip Lyon, you are all wrong in telling people to short BAC. Maybe you are a short yourself and try to bring the stock lower only to cover your A*SS soon ?

i'm buying more BAC tomorrow for its dividend.

2008 Mar 03 11:51 PM

[STR:]

It's fine to say 'short it', but that doesn't tell us for how long or to what target price.

2008 Mar 04 12:44 AM

[Bhakta:]

If you like to short the banks, then buy a XLF put. Your risk is limited and gains are substantial if you are right. I have been listening to Mish Shedlock for a while, and he recommended buy XLF puts 6 months ago, which are all profitable 50% or better. I purchased more this week, as I agree the financial s have not reached bottom, but I hesitate to select one only.

2008 Mar 05 02:27 AM

[Richard Shi...:]

BAC is a short in the $40s not in the $30s. Better to short the entire financial sector rather than the obvious survivors, unless you believe there will be no bank alive in 5 years. Plus there is the dividend and they have expressed a committment to it. And yes, they can and may walk on the CFC deal-if they do, can you say "short covering rally." BAC too many upside risks, much better shorting options out there.

2008 Mar 05 11:06 AM

[prsblue:]

Shorting is not smart. Learn how to read the financials carefully, including understanding accounting rules. They have to recognize potential losses immediately, and they accrued big hits to their outstanding loans in 2006 and 2007. Translation: their reported income already factors in many more losses than have occurred to date. So when the "sky is falling" mentality stops earning ratings for the media and the market pulls out, they'll do very well. One more thing: people will need banks and houses in the future right? Good - if you must short, short Google. Online ad revenue is the next bubble to bust.

2008 Mar 06 01:01 AM

[Ker:]

what a bunch of morons. good call Philip

2008 May 29 05:32 PM