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

[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

2008 Jul 16 11:42 PM

[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.

2008 Jul 16 11:48 PM

[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.

2008 Jul 16 11:50 PM

[Jimmy Lathrop:]

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.

2008 Jul 17 08:44 AM

[jcrash:]

40% in two days...ouch.

2008 Jul 17 09:45 AM

[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

2008 Jul 17 12:38 PM

[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...

2008 Jul 17 05:00 PM

[omooc:]

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

2008 Jul 17 07:52 PM

[Kunst:]

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

2008 Jul 18 01:39 AM

[gofigr:]

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

2008 Jul 19 10:53 AM

[Ames Tiedeman:]

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.

2008 Jul 19 01:44 PM

[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

2008 Jul 20 12:11 PM

[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

2008 Jul 20 03:03 PM

[Eric Peterson:]

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 :)

2008 Jul 21 09:57 AM

[Eric Peterson:]

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.

2008 Jul 21 10:01 AM

[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.

2008 Jul 25 04:56 PM

[Ames Tiedeman:]

Financials will continue to trade south until housing stabilizes.

2008 Jul 29 07:10 AM

[Ames Tiedeman:]

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.

2008 Jul 29 07:13 AM

[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...

2008 Aug 05 02:53 PM

[OctoberFaith:]

ow.

2008 Nov 03 04:19 AM