Playing the Market as Delinquencies Continue to Rise

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I'll let the picture do the talking here. Taken from Calculated Risk, we see continued rising delinquencies across the board in Residential Real Estate, Commercial Real Estate, and Consumer Credit cards.

How to play it:

• Short Commercial Real Estate [short CB Richard Ellis Group Inc. (CBG), short General Growth Properties (GGP), long UltraShort Real Estate ProShares (SRS)]
• Short Credit Card Companies [short Capital One Financial Corp. (COF), short Discover Financial Services  (DFS)]
• Short banks with lots of leverage, lots of derivative exposure, and lots of residential/commercial real estate exposure [short HSBC Holdings plc (HBC), Washington Mutual Inc. (WM)]

One caveat with all those picks: You've got to monitor your positions like a hawk. The slightest bit of positive news can send these things skyrocketing due to short covering. Use stops, use your brain, and be swift.

Disclosure: None

Comments

[Ishortyou:]

wow what a nice and detailed study of the situation, thanks!

2008 Sep 01 08:21 AM

[Menachem Be...:]

Those who fail to discern that not all derivative contracts are created equal are investing with their eyes closed. In fact a short position is also a derivative contract. Interest rate swaps and derivatives based upon AAA rated municipal bonds for instance have risen in value across the broad market. When opinions regarding derivative exposure are offered without detail the reader should beware. Those that suggest a bank is " over exposed " to derivatives ( such as HSBC, which I own ) based simply upon the cumulative value of outstanding contracts have failed to do their homework.

2008 Sep 01 08:31 AM

[tilut:]

Despite general consensus of negativity on financials , I would not short most of them and certainly not DFS which is undervalued and could spike from 6$ to10$ in one minute if it annouces a favorable settlement with MA and V.

2008 Sep 01 08:40 AM

[CLH:]

Folly--Your post is bad advice with almost no data behind it. Smart investers will disregard it.

2008 Sep 01 08:55 AM

[Serge:]

How is a short position a derivative contract? That's like saying that a long position is a derivative of a firm's free cash flows.

2008 Sep 01 09:13 AM

[kkin365:]

Good advice. The problem is, as an outsider, one does not have access to info as those on the floor of NYSE.

2008 Sep 01 10:18 AM

[Menachem Be...:]

Heres the definition of a derivative from investopedia.com ( a great site by the way )....
" In finance, a security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage.
Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Because derivatives are just contracts, just about anything can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region.

Derivatives are generally used to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using American dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into euros. "

When analysis of derivative positions held by institutions is performed one cannot make a judgement on its true value without knowing the underlying article of value. Is it a sub-prime mortgage or ton of gold? Is it based upon bonds from Exxon or Washington Mutual?
The word " derivative " has been used to scare investors like the word " bogeyman " was used to scare children.
I have been buying HSBC and LLoyds TSB. My analysis is correct.
Folks should do their own homework.

2008 Sep 01 10:44 AM

[tipalia:]

HE /SHE is either right or wrong time will tell ,but shorting a lot things at the beginning of September does not need a lot of homework if history repeats itself . it s like throwing cooked dice and always ending up with a winning hand every single hand.
TIPSTER

2008 Sep 01 10:53 AM

[bear9:]

Uh, Tipster, the critical phrase in your post is "if history repeats itself." You claim that your recommended course of action guarantees a winning hand. But any statement starting with the word "if" cannot end with a guarantee -- it is by definition contingent. Think about what you post.

2008 Sep 01 11:01 AM

[Richard Col...:]

It's dangerous to short any strong corporation when there price is low. You never know when or why they can explode and go straight up. There are just too many good companies to invest in so why play with fire.
Daniel Kowkabany

2008 Sep 01 11:08 AM

[Tom Lindmark:]

Of course, we don't know when or if the SEC might decide to float another short sale rule and blow the whole strategy up. Too much chance of government interference with the markets at this point to be taking excessive risk.

2008 Sep 01 12:01 PM

[ain't no fo...:]

And don't forget the FED and Treasury are allied 100% with their friends the large investment banks and money centers.. FED credit and liquidity agendas are designed to keep the markets stable through the election so as to keep their republican sponsors in charge, that is what their interest rate and discount window activity has been all about.

So the institutions will make big $$ off the volatility, but they will try their hardest to keep the markets pretty steady here... they've received hundreds of millions of taxpayer money to trade with, profiting on both sides, but we can't have the indices tanking right before the election now, can we, for that would be the end of the republican party's hopes.

2008 Sep 01 12:43 PM

[Shawn Ayromloo:]

Very poor advice to short WM around $4. Where was this great analyst when WM was trading around $40 - less than 12 months ago. At this time a wiser move is to accumulate WM on non-margin basis, that way those who short will not have access to your shares to cover. Then wait for a slightly good news.

2008 Sep 01 01:38 PM

[DaveW:]

Folly,
Can't you just cut ishortu's sarcasm with a knife? I don't blame him.

I do agree with your advice here, SRS and most others are at a good entry price after a minor/modest bear rally. More importantly, fundamentals support more downward movement in said stocks/sectors. However, to let a single graph do all the talking is a bit lazy and undermines your credibility as a SA author (as you can see form most comments above).

So, rather than having to formulate new diatribe on an old topic you could instead provide links to some of the more excellent overview articles already in the SA archive supporting your investment thesis.

2008 Sep 01 02:55 PM

[GaryD:]

Can you short a company that trades at less than $5 per share?

2008 Sep 01 02:57 PM

[Muzie:]

"The slightest bit of positive news can send these things skyrocketing due to short covering. Use stops, use your brain, and be swift."

I find it amusing that the strategy you're suggestng is exactly what's causing the short covering in the first place. What makes you think your stop will better than anyone else's?

These are the types of stocks I would avise AGAINST using stops. If the thesis holds they will trend down, but they will whipsaw the whole way.

If you can't rely on your fundamental analysis and have to use stops to make up for your lack of conviction, then ultimately you are guaranteed to lose money, even if these stocks ultimately go down.

2008 Sep 01 06:35 PM

[Market Folly:]

dave,

haha i know i love sarcasm though so its all good. unfortunately, i cannot control which pieces from my blog seeking alpha decides to publish. they did not publish the various other posts i made previous to this one where i linked to articles about the credit crisis explained in plain english and simple terms. so, playing on that theme, i was dumbing down everything with this post and kind of mocking the whole situation.

thanks for the feedback though. i guess from now on i'll have to include links in all my entries so that in case SA picks one piece out of context, it will at least make sense if people follow the links.

2008 Sep 01 07:48 PM

[tipalia:]

my poor bear9 I am sorry to let you know that you don t know how to read between the lines.You didn t understand what I was trying to say and won t waste my time trying to explain my message. Sorry if I am at another level than yours.

2008 Sep 01 09:15 PM

[garygaryny:]

Shame of you, Folly, for your manipulating and self serving just because you hold short position.

Good job, keep cheating, manipulating and misleading until you get short squeeze.

2008 Sep 01 11:44 PM

[Ermilo:]

I personally find this article interesting. I agree with the Federal Reserves chart, and it is apparent that the general American consumer is in debt. However because of the elections, the marekt in general will probably not fall like others have stated. However, the REALITY is grim for the USA.

Markets are not rational, and I don't care what a candlestick or Stock chart says.....fundamentally... are in a big crisis, this is slowly unraveling. The rich get richer (using derivative investments) while the middleclass losses their assets (stocks,bonds, and real estate investments) and the poor just lose money (C.D's, Saving accounts).

I wish you all the best.

2008 Sep 02 11:32 AM

[buyitcheap:]

Gary D - you can short below $5 sure, but as a point of interest, I came across a study a year or two ago that said you had a higher probability of a successful short by shorting stocks over $100 in price. Something about the greater likelihood of a 30% decline, or 50% decline in a shorter period than with a $5 stock. I will try to find a link - it may have been on google scholar.

2008 Sep 02 02:38 PM

[John C. Lee:]

It doesn't matter where you short, the % decline for a $100 stock applies for a $5 stock. Short price limits vary with each broker.

2008 Sep 02 08:27 PM

[1worldcurrency:]

An option or futures contract is a derivative position. A short sale is merely a short sale, of the underlying asset itself.

2008 Sep 03 05:17 AM

[SeekingTruth:]

To wpdragon. I agree completely. Similar thing happening on oil prices. i.e. bring it down to $100 bbl. (at least) before the election. The geopolitical influence on markets now greater than ever esp. during election seasons. This makes shorting even riskier during these periods, so only the greatly experienced need apply.

2008 Sep 03 12:14 PM

[tropaz:]

If you've been watching it like a hawk, you'd of seen me make about 40% on DFS from $13 to $17

This post was MUCH more relevant Sept 1st 2007 than Sept 1st 2008
Since last september
DFS is down about 50%
Banks are all down huge...

I actually went Long DFS at under $14. I started Selling at $17.00 yesterday. Maybe good for a short trade, but not shorting like there was last year. Too late to short commods/oil? Where's the next short?
BRIC's? Most of those are already way down too.

2008 Sep 03 09:04 PM