Why I'm Committed to the UltraShort Financials ETF

I'd like to take a moment to explain why I am committed to my ProShares UltraShort Financials ETF (SKF) position and why I'm generally bearish on even owning any stocks or bonds for the near-term.

Four percent of SKF is short Bank of America (BAC). SKF has a lot of short positions and swaps for megabanks, I-Banks, Fannie (FNM) and Freddie (FRE), and every type of lending institution that makes up the index. But the bet on BAC is the biggest.

Bank of America now owns between 20 and 25% of the residential mortgage loans in America. It offers credit card accounts in a period of increasing inflation, lower discretionary spending, higher commodity prices and low consumer confidence. It also offers auto loans under the same conditions as the credit card segment except that the default rate is worse, with greater liabilities. Additionally, BoA has a huge amount of revolving credit facilities set up with businesses back when rates were more favorable to the bank but with the Fed refusing to increase rates, these credit facilities eat up space on a balance sheet which could be loaned out at a more favorable rate. And even though the purchase of Countrywide (CFC) was discounted, it had to pay 11.8 billion dollars of Countrywide's debt as well as face possible liability in suits brought by plaintiff's firms and State Attorney General Office's for deceptive business practices. Countrywide's summary under its stock symbol describes a five segment company where at least four segments are obsolete in the falling housing market and tighter lending condition of today. BAC is still digesting its acquisitions of US Trust, MBNA and LaSalle Bank.

And in the middle of this, there is a general lack of faith in a system of securitizing loans, and moving back towards portfolio business, which would increase the cost of lending and be devastating to the public. There are new accounting rules ending SPVs. Not to mention the other three horsemen of the apocalypse - inflation, high commodity prices and still sliding housing market.

There is no talk about how BAC or any other bank can become profitable back to the levels of 2002 to 2007. The bank is not nimble. It can't cut a dividend. There is only a need to recapitalize and dilute shareholders. Thats all it can do for the next four quarters. I have asked BAC stockholders how they intend to rebuild earnings and they have no answer, they just point to a dividend yield. That is an unsatisfactory answer.

I haven't mentioned FNM, FRE, Citigroup (C), Lehman (LEH), UBS (UBS) or any of the other financial institutions which will continue to struggle for many quarters, to say the least. No one has a silver bullet. No one has another gimmick or bubble to catch on. UBS has substantial positions in SKF - calling the insurance broker for your house when you see Grandma fell asleep in the rocking chair with a lit cigarette and now the curtains are on fire.

The most important factor to consider is that the banks are generating three negative feedback loops. The first one is by raising capital that they are diluting their own shares, slashing their own share price. The second negative feedback loop is that they are selling assets of companies which is dragging down the market as a whole. Finally, by selling off houses which are in foreclosure, they are further dragging down the real estate market, making their mortgage default rates increase.

I really don't know if there is going to be a market rally, or if oil prices are going to go down or home sales will pick up again. I have no idea at all. I do know that if any one of those things does not happen, banks will still have to dilute shares, merge, or fail for the next year. I also know that as I try to pick up shares of equities, these financial institutions are unloading them to lower leverage ratios and sell assets so the trends are bearish. But once the commodities come down, and the major indexes show sustained rallies will there be a true buying opportunity. Buying Dow Chemical at 25 a share in three months would be better than buying any mutual fund.

So I would go to Google Finance or Yahoo Finance and watch these 15 symbols. When the 14 funds show continual losses for a month and Dow Chemical [the lamb of God who takes away the financial sins of the world] shows a month-long gain, we are officially out of the woods. But I don't see that happening in the next 52 weeks. Here is my Apocalypse 15. If all of these funds show continual gains for a month, the Angel of Death is knocking on the door.

• ProShares UltraShort Financials (SKF)
• ProShares UltraShort Consumer Services (SCC)
• SPDR Gold Trust (GLD)
• ProShares UltraShort Consumer Goods (SZK)
• ProShares UltraShort S&P 500 (SDS)
• iPath DJ-AIG Grains Total Return (JJG)
• PowerShares DB Oil (DBO)
• DB Commodity Double Long (DYY)
• GAMCO Gold AAA [GOLDX]
• CMCI Food Index (FUD)
• DB Agriculture Double Long (DAG)
• Prudent Bear [BEARX]
• U.S. Oil Fund (USO)
• Rydex Inverse 2x S&P Select Sector Financial (RFN)
• Dow Chemical Co. (DOW)

Disclosure: Long SKF, SDS, DBO, GLD, GOLDX, SZK and DAG.

Comments

[TVG]

In order to be successful, you not only have to be RIGHT, but RIGHT at the RIGHT time. I don't think you have that last one "right"!

[jcrash]

Don't bet on the end of the world.

It's a one-time event. If you win, you lose.

[BrunoT]

Yeah, much better to put on a smile and go down with the ship by going long on banks and silly consumer stocks like starbucks and the sharper image (oops, already gone).

[fatcat]

Skf is down $22 dollars as I write...may have to wait a few days before you bite on authors advice...however,I agree with his thesis.

[JohnPseudonym]

If you want to see a bubble, look at the SKF blow up to 200!

That chart screams correction to the down side.

Not that a bull market in financials is at hand, but we're certainly due for a break from the freefall.

[aydnap]

I like your analysis - especially the part where you described the shortcomings of the financial sector as negative feedback loops. As an engineer, I appreciate the analogy - but where/when do you see the cycle breaking? and where/what is the control device?

[CLH]

Whats is always interesting is when someone makes some money and thinks they are smart. SKF has probably topped and its all down now.
Inability to switch sides is the worst of all mistakes.

Only fools bet on the end of the world.

[User 112687]

Dear, continue in your commitment and don't fear the markets. SKF is up for more rallies for at least 3 more months before it flattens. If you want to bet double long, Q209 is your best bet. By then, I am sure you will switch and prove CLH wrong. Only thing is, by the time financials start recovering, the economy will be screaming for help. That's another story I guess...

[DaveW]

Perhaps a wiser move would have been to sell at least half of your position on the deeply parabolic move up past $200 yesterday. Then buy more shares now at $178, or better yet, wait longer and buy cheaper. The market is ripe for a rally, SKF could go much lower before another rise...

[JimmyLathrop]

The SEC's prohibition on naked short selling on certain financial institution has led to a rush to cover these positions before the rule takes effect on Friday. The index is reflecting the buying of actual shares needed to cover the short sells. This will continue up through Friday. As the stocks of those prohibited firms rise from increased buying, the index will reflect gains which have an inverse effect on the ETF. This is a trader driven event. It is not a systemic event. My fellow commuters were not whistling "Who's Afraid of the Big Bad Wolf" on the way to work this morning.

However, while I was reading the Wall Street Journal this morning, I did not see any announcements by any financial institution which suggests an immediate turnaround. On the contrary, things are as bleak as they were yesterday.

If anyone has any ideas how the financial sector will be able to rebound to its previous 52 week heights in the next 52 weeks, feel free to post them. I'm sure some bankers would like to hear them too, as they have their own mortgage payments to worry about.

[seriously ?]

Dear Jimmy,

This is a trader driven event. It is not a systemic event.
Agreed, but if this is the case why do you keep talking about BAC's fundamentals as if they really matter here ? SKF is clearly in a speculative "bull" phase. May be a good short term play, but how much lower can BAC and company go ?

We all know the entire herd can't feed at this trough, especially as it is herd...err.....trader driven ... right ?

[Umm, yeah]

@seriously

Certainly there's a lot of fear feeding more fear, but it's also wrong to say there aren't some serious systemic problems feeding the fear.

[monday1929]

I'm as bearish as they come, but trading is trading, not having a "commitment" to a position. And listing the fundamental reasons now, as opposed to one year ago, why BAC will go down just sounds like a poor trading mindset. Markets do not trade on logic and they never conform to your internal "timeline".
And it is a positive feedback loop(with negative consequences) which is occuring.

[thoroughbred]

I bought and have traded SKF very successfully for the last 4-6 weeks, I originally bought at just under $100, continued buying in $5 increments to $125 and started selling at $160 in $5 increments, sold my last 100 on Thursday at $178 and when news came out about Fannie / Freddie on Sunday I was glad to have been out, expected a big rally, none happened and than it hit $223...but with 15-20 point spreads each day, what a wonderful trading stock in my IRA. I gotta say though, I saw $150 as a top, did not expect $200

[jcrash]

Jimmy, you don't need Financials to hit their 52 week highs. You just need them not to go lower.

If you think you are gonna get ANOTHER 60% haircut on top of the one you already got, you are mistaken.

[vmonter]

Financial shorts are played out imho (based on nothing) and I've my eye on the DB double short commodity fund.

However, playing markets is a lot less fun and more stressful than simply going long on solid companies at good prices.

[E F Nuttin]

After it lost 20% today, now would probably be a better time to commit to this ETF! I wrote a 150 and 165 call for this last week and kinda glad to see it back to those levels, so I can do it again for August. Huge premiums on this Call.

[Solution]

What if the BRIC countries or Arabian starts to buy the financial companies if the price is driving too low ? US will be in deep trouble.

[jcrash]

Solution, why is that bad? That is the definition of a free market.

[AmesTiedeman]

The page has turned. The WFC news this morning is a game changer.

[EricPeterson]

"Disclosure: Long SKF, SDS, DBO, GLD, GOLDX, SZK and DAG."

Well then ... I guess this was one of the worst days of your life in the market.

[MarkGillCPA]

Your financial short and commodity long postions have worked well this year. I hope you've taken some profits. The financials are way oversold, over-shorted and already discount a lot of bad news. Both USB and WFC just announced earnings reports that were not as bad as feared. I went long the UYG (Proshares Ultra Financials) this morning. And while I realize there's a lot of short covering going on today, the financials could move another 20% up without breaking their 50-day moving average, which equals a 40% move for the UYG.

[Slimsum]

Wasn't long in SKF until almost closing. And will pick up more on its way down all the way to the weekend. I like your reasoning Jimmy. It may not be correct, but it is more likely than not and worth a small entry into the stock at this time. Hope you are correct.

[JimmyLathrop]

Today's rally underscores the sense of relief that WFF wasn't broken. When was the last time you drove a new car off of the lot and said "Thank God it didn't blow up when I turned the key!" The opaque nature of the banks means that a 23 percent loss in profits is good news? That is pretty pathetic. That is grasping at straws. There have been many comments directed at my article but no one has given the magic incantation which will erase the banking industry's ills.

[Matthew C]

SKF off 20% today.

I hope you had a 5-10% stop loss in place.

Financials and the markets could rally a few more days or weeks, and then back to SKF again. . .

[archman82011]

<<The page has turned. The WFC news this morning is a game changer.>>

WFC simply said they weren't going to "suck as much" as the other banks this quarter. They said firmly that they now have 7 Billion set aside for bad crap thats coming down the pike.

I don't care that they raised the dividend either. Thats called playing Wall Street and Main Street for a fool.

Oh we are going to get a financial rally. No question. For those that are newly long or so pathetically underwater from listening to the cheerleading from the media, atleast you can make a few $$

[simjos04]

Stick to being a lawyer. I think that we have a turning point. Look a the volume on the ETFs for financials on tuesday, at all time highs. Capitualtion with an exclamation. Granted we may need another quarter to move thru the write downs but, as Barrons claims, the real estate is at a bottom. Look for interest rates to rise in october after the focus shifts from real estate/financials. We cant exist without financials!!!!!! All this gloom has affected your judgement.

[fatcat]

I bought Wfc puts this afternoon...I am going to dance with the one that brung me...short financials.

[fatcat]

By the way Jimmy,congrats on getting such a good discussion going.Please post again soon!

[Emerald]

Bear market rally here. I have traded the SKF and recently sold at 164. Wait for this rally to play out and buy SKF around 150. Buying WFC here for the long term is a good bet. Financials will bottom out this fall even though their income statements will struggle though 2009. [long C, WFC, BAC< CS and IBN]. Huge profits in financials if you have at least a three year horizon.

[Wez]

WFC has got to be cooking the books, no way in hell they could be doing this well with their loan portfolio. I smell BS.

[sharp10]

WFC has big exposure in the California real estate mkt. Only time will tell how much write offs they will take. As I already see people stating that today's was a page turner, I'm sorry but when Citi still has about $1.1 trillion in assets off their balance sheet without knowing what kind of losses will be taken going forward, most banks are not a buy. Their business model is broken.

[Ashley D]

Every bear market has a rallies....this is one of them. We'll be A LOT lower in 7 months. In the meantime go long UYG.

[genesok]

Why didn't any of the main media mention that the only way WFC "beat estimates", lousy ones at that, was by changing the way they calculated earnings! Otherwise they still would have been $0.49? Talk about manufacturing good news and no one calls them on it.

[genesok]

The bank said its new policy of writing off home equity loans where payments were more than 180 days late, rather than 120, resulted in it deferring $265.0 million in charge-offs.

Credit - Market Scan
Wells Fargo Fares Well
Miriam Marcus, 07.16.08, 6:35 PM ET


On Jul 16 10:16 PM genesok wrote:

> Why didn't any of the main media mention that the only way WFC "beat
> estimates", lousy ones at that, was by changing the way they calculated
> earnings! Otherwise they still would have been $0.49? Talk about
> manufacturing good news and no one calls them on it.

[MARSROX]

I'm with Jimmy that a couple of the negative ETF's are appropriate in today's (toxic) economic environment. I own SKF and watched it dive today, although I wondered if it would rise up "green" during the usual late-afternoon sell-off. Along the way down I considered selling, but I couldn't think of a fundamental reason (besides taking profits and creating a taxable event) behind the bank stock increases. I only have these shares as part of a diversified portfolio so I didn't reach Max Pain levels today. I think it's time to buy more during the next couple of days. Historically, I had traded SKF with stops and have been "stopped out" on 10 point down moves that resolved later in the day back to where it started - or maybe higher. I wish I understood how to hedge with options.....So instead, I accept the volitility with an eye for the prize in the long run, but who would think that for no reason that I can understand, "financials" would have their biggest one day rally in twenty years! I missed the "All Clear" bell ringing for financials. therwise, oil moving down to the bottom of it's Bollinger Bands doesn't seem to me to affect the amount of foreclosures or rising credit card debt being "walked on by debtors". Of course, one positive for banks today was due to the plan to investigate persons instigating "naked shorts" and rumour mongering against the likes of Lehman, Citi and the GSachs. Wouldn't it be ironic if these bad people are found to be employed with ......Lehman, Citi and GSacks?

[Arohan]

Hmmm Mr Lathrop, you talk about fundamentals of the sector but you do not care to discuss valuations. You may be right but only because you have short term outlook. Long term investors might wish to consider this as an excellent opportunity to buy

[Think-About-It]

I'm not sure you are right to reduce their reported EPS by $265M for the reason given because they should have added the $265M to their provision for bad debt during the quarter. The net affect on EPS is zero. They just handled it differently on the P&L

[alexL]

I think this author needs to check his facts. 20 to 25% of the mortgage market? Not. $11.8 billion in debt?? What about the $5 billion in revenue with the synergistic side of the acquistion from layoffs and other reduced expenses. Billions to bottom line. I could go on and on ripping this article apart, but really, check your facts and do a bit more research so you do not have such a 1-sided opinion.

[trader_doug]

Jimmy thanks for the analysis and insight. The answer to your continued questioning is as follows - the wheels of our American system are greased by the prudent operating of banks such as Wells Fargo, Bank of America and the like. For short-term players the current plight of financials is certainly of concern. However, for longer term players, the reality is franchises like WFC and BAC and the brand equity they enjoy isn't created overnight. However, the market in the last two months has voted and brought down these two institutions mightily to a clearly oversold position. Today we saw a flight to quality that recognized the strength of the brands, infrastructure and businesses that have been built. If you believe in America and our power to persevere then you must believe in the power of these brands - WFC and BAC to re-establish themselves at the top of the financials hierarchy. I look forward to the coming months.

[JimmyLathrop]

WFC entire 10Q stated that they are retrenching to offer products to existing customers, which is bank talk for "we don't trust anyone who doesn't have an account with us. WFF, the near and subprime arm, posted losses and is getting out of the auto leasing business all together. Maybe they will get into the hot-air balloon leasing business which has higher profits. But most troubling is that in the last paragraph of the Non-Interest Income section, the bank mentions in passing that they are carrying a 2.1 unrealized loss in securities holdings, up from 500 million the year before. They don't mention what securities these are except that they hint that the unrealized losses come from increased yields on mortgaged-backed securities. Then it is not mentioned again at all.

2.1 b is a big number. What are these securities? Is there a market to sell them? Because if they are auction rate securities, guess what? Those are realized losses because those instruments are worthless. If they are CMOs, how are they valued? Marked to market? Marked to model? At cost? The silence is deafening. Is the bank waiting for the next quarter to "realize" these losses, by saying that they didn't "realize" they couldn't sell these securities, hoping we don't "realize" that these were actual losses, and that their net profit was actually a net loss? I don't know, you don't know, and I suspect the bank doesn't know either. For America's fifth largest bank with an conservative model to be so coy, that is a big red flag. I'm not trying to pull an Einhorn here but to be so vague when you are falling over your self to show the health of the other aspects of the company is not reassuring.

[jcrash]

40% in two days...ouch.

[User 222398]

A theoretical question:

Let's say I bought SKF at May 07,2008 for around $100.
.DJUSFN was at that day at 434.

Today SKF is at $150. And .DJUSFN is at 336.

So far so good.

Let's assume:

I hold onto SKF and .DJUSFN raises to its level of 434 where it was back in May. This means a 30% raise from today's level.

What happens to SKF?

Does it dive to $60!!! (-60% = $90)

And can it go below zero if .DJUSFN double?

Hope you have a answer for this?

Regards

Thomas

[morgan77]

Short-selling the financials because of new SEC regulation and fundamentals? Check out this article- mention C, BA, and WM

www.greenfaucet.com/tr...

[omooc]

Where may one find out SKF's mainly holdings? The volatility is simply too high.

[Kunst]

I bought SKF today at 140. Of course I look back and see that last time I had it, it was at 110.

[User 85797]

How do you feel about the BAC short which is up 50% since you posted this article. Wish I hadn't read it, got out of my losing position fearing it would get worse. Screwed myself out of a $30,000 recovery in just the last two days. Nice call

[AmesTiedeman]

SKF is a now a buy or near a buy. The financial mess is not over. A 85 point pullback in SKF is enough for me to get long SKF. This thing moves like a tornado. Watch it move vs. UYG. When UTG moves down 10 cents this thing moves up over $50 cents. Amazing.

[flashrob]

...notice SKF on the chart...last two days...

The only reason for the "financial sector" being UP this week is due to the SEC interfering WHILE THE GAME WAS IN PLAY...with THE SHORTS...

ESSENTIALLY FORCING THEM TO BUY STOCK AND PROTECT AND DRIVE UP THE FINANCIAL SECTOR...

this is SETTLING DOWN NOW...as EVIDENCED BY SKF hovering near 135-140 the LAST TWO DAYS...

AS THE "SHORT COVERING BASED RALLY OF THE FINANANCIAL SECTOR" PETERS OUT...and the Pros and Big Money ARE NOT STUPID ENOUGH TO THINK

THE FINANCIALS HAVE GOOD INVESTMENT POTENTIAL...

SKF will RECOVER and GO EVEN HIGHER!!!

looks like we HIT BOTTOM...unless the Fed/Sec or someone CAN PULL ANOTHER RABBIT OUT OF THE HAT.

SKF should start GOING BACK UP!

finance.yahoo.com/q/bc...=

flashrob

[flashrob]

add this from CBS over the weekend...

www.cbsnews.com/storie...

flashrob


On Jul 20 12:11 PM flashrob wrote:

> ...notice SKF on the chart...last two days...
>
> The only reason for the "financial sector" being UP this week is
> due to the SEC interfering WHILE THE GAME WAS IN PLAY...with THE
> SHORTS...
>
> ESSENTIALLY FORCING THEM TO BUY STOCK AND PROTECT AND DRIVE UP THE
> FINANCIAL SECTOR...
>
> this is SETTLING DOWN NOW...as EVIDENCED BY SKF hovering near 135-140
> the LAST TWO DAYS...
>
> AS THE "SHORT COVERING BASED RALLY OF THE FINANANCIAL SECTOR" PETERS
> OUT...and the Pros and Big Money ARE NOT STUPID ENOUGH TO THINK<br/>
>
> THE FINANCIALS HAVE GOOD INVESTMENT POTENTIAL...
>
> SKF will RECOVER and GO EVEN HIGHER!!!
>
> looks like we HIT BOTTOM...unless the Fed/Sec or someone CAN PULL
> ANOTHER RABBIT OUT OF THE HAT.
>
> SKF should start GOING BACK UP!
>
> finance.yahoo.com/q/bc...=
>
> flashrob

[EricPeterson]

The article was posted the morning after SKF made its all-time high above 211. Now it's trading 3 days later at 131. Have to have a strong stomach to ride it down $80 a share. Next time I might use this author's article as a contrarian signal :)

[EricPeterson]

Ames Tiedeman wrote: "SKF is a now a buy or near a buy. The financial mess is not over." The question is not whether the financial mess is over yet. The question is, will it be worse than people expect it to be. People already expect it to be pretty bad. The expectations are already in the stock prices.

[sf94127]

I was in SKF in 130's, out in 170's a few weeks ago. I count myself luck, this stock is as much a bet as the slots in Vegas or other ETF's like USO and DUG. Its just betting. SKF is fighting the FED and the Congress and the banks who are working their way out of this mess.
Ask someone who recently bought skf at >130 and ask them if they are happy.

[AmesTiedeman]

Financials will continue to trade south until housing stabilizes.

[AmesTiedeman]

Eric,

You are completely wrong. The expectations are not built into the financials. The rally you watched in BAC and WFC and the rest was a false start. Earnings will deteriorate for some time to come. This will equate to lower stock prices for these issues. We are a long way off from a stabilizing housing market in the U.S. This will only help to create more uncertainty in the financial sector. Your claim that all of this is built into the stock prices is a false claim. You are wrong.

[junk-random]

banks will continue to go down... not enough expectations are built in for the mess that banks still haven't come out yet... more provisions to come... at least according to my own observations in the bank, plus speaking to my peers at other competitors...