Cognitive Dissonance on Wall Street

I have been writing about brown shoots for too long to recount - perhaps since the term green shoots was created by some bull with calls on the S+P - and I have been astounded by the number of analysts, pundits and whatever who bought the argument. Congress is expected to re-write the laws of math but no one else. So why were so many people surprised on Thursday with the unemployment data?

This Thursday's unemployment report should not have been a surprise. I will not waste your time recounting numbers you can see or have seen elsewhere. But the sharp selloff means a) a lot of traders got in on the wrong side of the trade and ran in a hurry and b) there is still a historically high amount of cognitive dissonance on Wall Street. Cognitive dissonance may, in fact, explain the entire rally and is, if you like behavioral psychology, is central to understanding the behavior of markets that fly in the face of economic reality.

To quote part of the Wikipedia definition (a good one, to be found at http://en.wikipedia.org/wiki/Cognitive_dissonance), "Cognitive dissonance is an uncomfortable feeling caused by holding two contradictory ideas simultaneously. The "ideas" or "cognitions" in question may include attitudes and beliefs, and also the awareness of one's behavior. The theory of cognitive dissonance proposes that people have a motivational drive to reduce dissonance by changing their attitudes, beliefs, and behaviors, or by justifying or rationalizing their attitudes, beliefs, and behaviors."

Sounds like the Street to me.

Wall Street does one thing quite well - math, usually reserved for bonus calculations, commissions, fees but occasionally used for analyses - and it knows the consumer is dead and getting deader, suppressing business behavior and employment. But it wants to go long - it longs to go long - and this tension is cognitive dissonance. It removes the tension by reconciling these two ideas with what it really wants--for the market to go up. Otherwise intelligent people go on TV and tell people things are fine with green shoots everywhere - I am not talking about screaming anchors who have traded ideology for intelligence like Larry Kudlow, nor am I referring to corrupted reporters now always optimistic as if they had a patriotic duty to be so - perhaps it is ratings? I am talking about money managers who are mostly long and want to stay that way. They are now telling people to "invest in the second derivative" - a decline in the rate of decline - and their reasoning "green shoots." So if you are going to willfully deceive yourself and resolve cognitive dissonance, you might as well pull some sucker along for the ride.

This optimism extends to individual market segments and companies. In the good old days, pre Bear Stearns, when housing starts hit one million per year it was a "bottom" and time to buy the home builders. We are down to half of that rate with no rebound in sight but pundits are talking up the companies, most of them kept alive by billions in tax rebates that end this year. Not one investment bank, not to mention a major money center bank, has earnings power remotely approaching their capability five years ago but the stocks have risen sharply based on accounting metrics the Street knows are on paper, not the real world. Not to mention all of the money center banks cannot exist without Fed guarantees of their bonds. And within this group, look at Citigroup - worthless balance sheet, some great businesses, but having no real shareholder value and if and when forced to properly (I don't mean legally, what they do with their books is legal) account for assets, they are wroth nothing. And how about GM trading above a buck?

There is another variant to this optimism - honest optimism based on a mis-reading of data. My favorite TV analyst, Ron Insana, a brilliant and painfully honest man, not quite fully pulled back into all of CNBC's mantras about green shoots, thinks we have hit bottom in the market with the overwhelming reason being the amount of liquidity the Fed has injected into world markets. Yet, if you look at the circulation of "new money" - its velocity - how much it circulates - against what the Fed has metaphorically printed you can see the money supply may have actually declined in the past year. No kidding. And even if I am partially wrong, where is the liquidity? It is now showing up in margin accounts of hedge funds or trading desks - it is sitting in bank mattresses, ready to be used to balance out future losses.

So there is optimism from cognitive dissonance, know one thing, think another, reconcile this by sticking with a belief even if you know the belief is wrong. Or you are getting it wrong because you are using historical norms to analyze something far less than normal - today's economy and markets.

I am not complaining - well, I guess I am, sort of, since I live on fundamentals even though I only recommend options position in my service, ChangeWave Shorts - but a day of at least partial reckoning is coming. Either a blow up or a slide that defeats even the hardiest if bulls. And even if I am wrong, based on the history I am trying hard not to use, the economy will inhibit corporate profits and at best keep the market going sideways for several to many years. Even Congress cannot change how the market value corporate profits - and the market is way overpriced based on the next 2-12 quarters of economic and profit growth.

The bottom line? Whatever trades you make, they need to be in the face of an economy that is not bottoming and when it does, facing a recovery that could take as much as a decade. And, seriously, take a look at Citi as a short - if they are forced to move their off balance sheet assets on their books, well, lots and lots of these. Check out page 21 of the town hall presentation they half for employees last November. And if you are long Citi, have a drink before you get to that page, and that can be found at http://74.125.47.132/search?q=cache:xSvJ_3VrNX8J:www.citigroup.com/citi/fin/data/p081117a.pdf+citigroup+november+2008+town+hall+meeting+pdf&cd=1&hl=en&ct=clnk&gl=us&client=firefox-a

Posted by Michael Shulman on July 3, 2009 2:28 PM | Permalink | Comments

Shorting the Obama Health Plan

Barack Obama is proving to be a masterful president just six months in office. I am not talking about policy or legislative initiatives - the first role of any president is to lead and he has led the nation from a sense of panic - perhaps panic itself - to calm - real calm. He has been wildly successful, regardless of what the "paid to scream" pundits in the conservative and financial media may say about him.

And now that calm is here, and his policies and proposals are more rather than less important than his ability to re-assure the American people about their own strengths, it may be time to, metaphorically and literally, short Obama. Specifically his health plan, whatever shape it may take. At least some of the profits can be used to pay the extra taxes we are going to pay for next 25-50 years. (For purposes of full disclosure, I voted for Obama.)

The problem for Obama, and why it is possible to develop a short view of his administration going forward, is his loss of control of Congress. Most Senators and handful of Congressmen know something of money, the budget, deficits and markets. But most members of the House do not - and they are showing way too much influence and power in the setting of policy. That means a make believe energy bill/cap and trade bill, because they don't want the cost of energy to go up; too much support for a housing market that would best be left to itself, to correct itself quickly; and a health care bill that has its heart in the right place and its head up, well, this is a family blog - a health care bill that sets the nation on an untenable course.
And that is where it is best to start looking for short and long opportunities - health care. Health care bill will probably pass; it will probably mandate everyone have or buy health care insurance; it will include thousands of pages of regulations that will not work as planned; it will be based on cooked data about cost reductions that will never happen; and when it all gets too expensive, 12-18 months after enactment, medical care for those dependent on the government will be further rationed and medical care paid for by the private sector will become increasingly expensive as private payors subsidy of government programs increases. And then 3-5 years after that, something will blow, led by the need for Medicare to dip into the general tax fund, roughly around 2016.

Short something that will blow up in 2016? No.

But look at short positions in companies that will be first in line to be seriously squeezed - some with merit, others not.

Who will be squeezed? And when?

The squeeze will begin about six nanoseconds after the health care bill is passed and the remaining responsible adults in Washington - there are a few - take a look around and go "omigod." They will be seeing an obese, aging population unwilling or unable to take care of itself hurtling towards government paid health care with frightening speed. And an industry still used to printing money at will with new products or fees and in control of their local Congressman or Senator. And they will go after the unusual suspects first -- and then some not so usual ones.

So, who gets squeezed?

Big Pharma: I follow the industry more closely than most, used to write a biotech letter, Big Pharma was my comic relief whenever I got too serious. This industry deserves to be squeezed if not on economic principles but everyday idiocy and a total inability to match real consumer needs with their business model and product development. For example, if you talk to doctors, the best proton pump inhibitor around is Aciphex (I take it, it changed my life, no kidding). It runs almost $300 a month without insurance while generic Prilosec costs less than it does to feed someone at Chipotle (well, maybe not my sons). If ihad the best product, I would hire the right people and go head to head with Prilosec. Nope - just jack prices and milk profits until the patent runs out. And this is the preferred mode of business in the entire, traditional Big Pharma industry. And Congress knows this as well - so you can expect a big squeeze on drugs that do not directly save lives. For short sellers, this intersects with the greatest, most cost saving patent expiration ever - Lipitor, November 2010 - so take a hard look at Pfizer. They are facing a revenue downturn of up to $9 billion in Lipitor sales within 12-18 months of patent expiration. That would require 9-10 blockbusters to emerge - and they have none in the pipeline worth mentioning. In my book Sell Short, which is about process, not specific recommendations, the Lipitor expiraton and Pfizer are central to explaining how one can find and use great short opportunities. (check out MichaelShulmanSellShort.com for more info.)

Other candidates? I have a personal bias against the frequently overprescribed Aranesp and Procrit (an anemia drug) from Amgen - way overprescribed compared to Europe, where people typically live longer. Mind you, Pfizer and Amgen print cash, they are simply overvalued and it will take a while for the market to catch up with them. Between the two of them, and hundreds of billions in R&D over the past twenty years, they have produced, I believe, one blockbuster in their labs.

Devices: Medical devices routinely get approved by the FDA - when effective - then a hyperactive sales force pushes them onto the market and patients pay for them. The 10% better widget results in a 100% increase in fees to the hospital or center - endorsed by Medicare, who sets the price for the new procedure that is copied and used as a floor by the private sector. Well, according to Bob Dylan, the "times they be a changin." It is easy to see Medicare and then insurance companies balking at new devices that sell well here, barely sell in Europe and do little to actually improve patient outcomes. This includes services for treatment and for diagnosis. Who look ripe for trouble? Medtronic. Unlike Pfizer and Amgen, this is a well managed company with a great product development organization - but they are in the wrong place at the wrong time and their size means they need a great deal of success with new products to move the needle on sales and continue as a growth company. Other losers are the big imaging players - GE, Toshiba and Siemens - but these huge multinationals are so diversified you cannot consider shorting them based on this thesis alone.

Payors: Stay away - long or short - who knows what is going to happen to them.

Providers: Ditto for providers - price pressures will be offset by increased business and reduced or eliminated bad debt - but a lot of their billing nonsense is going to get squeezed - a friend was just billed $26 for one spoon of Pepto Bismol - impossible to say where this will end up.

Biotechs: If you want to go long, look at the great biotech's will real live saving products and start with Gilead Sciences. Bets managed biopharma company on the planet - by a mile. They own the HIV marketplace and are pushing into pulmonary and also have a promising, high risk hypertension drug. They are also a great stock to hedge - very high premiums on their calls. If there is a buy and hold company left on the market, they are it.

Posted by Michael Shulman on July 2, 2009 7:28 AM | Permalink | Comments

Time to Short Brown Shoots

Green shoots has become a tiring term - clichés in the age of new media really run of out of gas quickly - and I recently took a two week working vacation to dig out green shoots for my readers. Data is nice - but you can get that anywhere and it basically starts arguments. So I told myself to take a hard look on the ground? What did I find? Brown shoots everywhere.

The two weeks on the road were spent in very different economies - the "posh" but understated part of Long Island, the North Fork; Hartford, Connecticut (family); Maine (need to eat some serious fresh lobster); Nova Scotia (gorgeous); Maine again (got to get back home); and then four days in New York City including a book part for my new title, Sell Short.

What did I see? There were two or three other guests in my luxury hotel in Greenport, empty restaurants with great food. We had no problems walking in to one of the most popular restaurants in Hartford; ditto for the most popular lobster in Bar Harbor (I copped out and got a small one but I did manage to ruin my shirt); a near empty hotel in Nova Scotia, one of the three luxury resorts capitalized by the Canadian government and the most popular destinations in prior seasons. And in Nova Scotia, same day reservations for a special whale watching exhibition in a zodiac that only holds a dozen nerdy tourists. Driving back through Maine, I stayed at a Wyndham in Portland filled with airline personnel and no one else, across from the very, very empty Mall of Maine. And I concluded my trip at a very busy Hilton in New York - busy, busy you say? - filled with tourists taking advantage of radically discounted priced rooms, buying what was available at the half price theater ticket booth or just walking the streets. We found same day tickets available for almost all shows, including for Mary Stuart (terrific play) and In the Heights (great musical, hottest dance chorus since Pippin, yes, I am that old). All of this during tourist season.

And a book party with guests from all parts of the economy, all discussing an uncertain future and all pulling in their spending. Except for the teacher at a prep school and the television producer working the Bernie Madoff case.

Are anecdotes worth investing in? Just as Peter Lynch - you can start with these anecdotes - but first you must ask yourself why is Wall Street so adamant about green shoots and the "bottom." Simple - Wall Street is congenitally biased to the upside, we were coming off a very sharp decline in the markets and Obama has a great ability to lead, convincing us and then remind us the world is not ending.

So, are we at a bottom? Perhaps - but my concern, my observations are about the lack of a rebound. And the current market is now beginning to look for signs of a rebound. So brown shoots mean a lot as the market starts looking to Christmas and beyond.
The tricky part is the definition of a rebound. I read this morning about the big turnaround in auto sales - they are "only" going to be down 20% at Ford and call option activity is accelerating (I am long, in my service, Ford calls). Turnaround? A year of 55 million in sales with worldwide capacity to make 100 million cars? The auto industry is representative of the debate - we may bottom at 55 million but when will sales support current stock valuations? And that is true for most if not all consumer discretionary stocks, from Tiffany to the Cheesecake Factory.

So, short term, you can play the short term optimism - as I said, I am long Ford in my service - but what about the longer term?
For a longer term trade, assuming you agree with me and the summer will be a bust, so look to short travel related stocks. And if you sense Christmas will see Santa stuck in the chimney, look to short names that people will continue to trade down from - Cheesecake Factory, P.F. Changs, Macys -- - avoid names people will trade down to - Dollar Tree, Wal-Mart, Darden (Olive Garden). Look for real discretionary spending stocks - Harley Davidson, Tiffanys, Coach, Nordstrom - and look for underpriced products that will see increased demand in the winter - natural gas (the UNG).

Posted by Michael Shulman on June 30, 2009 8:52 AM | Permalink | Comments

The Great Consumer Head Fake

TARP money was repaid this week - the FDIC said the purchase of toxic assets from banks is on hold - health care reform is now going to be built around mandatory health insurance - Hezbollah was defeated in Lebanon, perhaps foreshadowing a change of tine from Iran - gasoline hit $2.85 a gallon in my neighborhood - national chain store sales fell 4.4% last month - Obama said the stimulus was working too slowly and now he wants to create 600,000 more jobs on top of the jobs that have yet to be created -- mortgage rates climbed a full point over two weeks ago -the Supreme Court suspended, for a bit, the purchase of Chrysler by Fiat - and with all of this the market went sideways, Just another week in The New Normal. The equity markets sighed, then yawned, and action moved to commodity markets - especially oil and gas, - then to government bonds. The markets must have known I am trying to get to London this summer and bid down the dollar against the pound.

Think about it - all this news, any of it mind blowing and market cracking a year ago - and now we accept it, reminding of something a science teacher taught me way back when. If you put a frog in hot water, it jumps out. If you put a frog in room temperature water, and slowly heat it up, the frog stays there and boils to death. The markets are behaving like frogs right now - each week, news gets hotter and hotter, worse and worse about the economy, but it does not seem so bad, so the market either stays put or goes up.

Is the water eventually going to boil? Ask the consumer.

They will tell you - we are broke. And getting broker. And consumers that are broke, feel broke or afraid gong broke do not spend money - or as much money as they used to. Given that 65% to 70% of the US economy depends on consumer spending, the broke consumer means a broken economy.

In the 1970s federal law changed and said banks could charge interest in credit cards up to the rate allowed in the state where the bank ostensibly did business. In a nanosecond the banks found high interest rate states - ever wonder why your Citibank Mastercard is issued in South Dakota? - and the credit boom was on. Fast forward to 9/11 and the president, rather than raise taxes to pay for a war or two, told us to shopping, with credit of course. To buy stuff probably made in China. And by the end of last year the American consumer had amassed more than $13 trillion in debt - or more than 130% of disposable income, on average.

Well, if you don't want to use credit, spend some of your accumulated wealth. What wealth - the recent meltdown in hosing and equity markets has reduced personal wealth by roughly $13 trillion and the number is climbing. The psychological toll is greater - you feel poorer because you are, and you probably feel worse than you really are, and you pull back on spending.

Well, if you don't use credit or wealth, use your current income. What current income? Unemployment is 9.4%; real unemployment, including the discouraged and part timers wanting to work full time, is almost 20%; hours worked per week are falling; and after tax personal income, or the nation, is falling.

Well, get some more credit card and hope for the best. Not an option - banks are on a pace to pull back more than $2.5 trillion in credit lines this year. Re-finance or increase that home equity line. Nope - 67% of mortgage holders have less than 15% equity in their house and that number is falling alongside home prices.

One last note -- gasoline hit $2.62 nationally this week, up a buck in the past 12 months.

OK - no credit, fallen wealth, falling incomes rising gasoline prices. And in the face of all this, what has Wall Street done? The XLY - the Exchange Traded Fund representing consumer discretionary spending -- and the RTH - the Exchange Traded fund representing retailers - are both up year to date. The Street is expecting and pricing in a recovery from the bottom - which we have not reached - and I cannot tell you where they think the consumer will find money to spend.

Think head fake - momentum feeding momentum - and a bear trap if ever there was one. Is there a trade here? An investment? Not yet - the momentum has slowed down but this trade - consumer led economic recovery - is still in play, a game for very short term traders. Stick with fundamentals and wait - when the Street wakes up, there could be a great opportunity on the short side to make money on the whole segment through an ETF or the purchase of puts on the ETFs mentioned, the XLY and the RTH.

Specific names? Look for companies that were in deep yogurt before the consumer went broke. Two come to mind -- classic, long term shorts - Sears (SHLD) -- and the GAP. Been in a Sears lately? Been in a Gap lately? Even a consumer rebound -- the one that is not coming -- will leave these two gasping for air. Sears will spin off or sell K Mart, Gap will spin off or sell Old Navy, in last gasp moves, perhaps one to two years from now and then, nothing.

Among the luxury retailers, check out Coach (COH) -- good managment, too many stores, not one product anyone has to buy.

Posted by Michael Shulman on June 9, 2009 3:23 PM | Permalink | Comments