Summarizing the Case for Long Term Short Positions

As technicians, fundamentalists (and I am not talking about religious types) and almost anyone else will tell you, the market is trading by its own internal logic that is pretty hard to elucidate. Let me try.

First, Wall Street sees a bottom at yearend and an upturn in Q4 GDP. The seriously foolish see this as a real bottom and a real upturn in GDP; the savvier fools see this as a statistical bottom they can trade and have done so for the past two months. This latter group is not really made of fools - they have just cost my subscribers a lot of money and I am mad at them.

Second, technicians and historians are using past market performance to say we hit a certain bottom, we are going through a retracement to his and a return to that. All based on rational history. Then you ask them about corporate earnings and the multiple of the market and they ask have you seen a good ball game lately. You then ask them if equity markets have ever risen in the face of rising interest rates and they cough and ask you to leave.

Third, the market is now behaving like on great day trading pit - a piece of news, let's rally or slide and let's hang on, if you get in before the pop, collect your winnings before the window closes and get ready for the next horse race.

But all of this would not hold and would to push the market up as fast and as fast as it has - if people did not want to believe in a good news story and want the market to go up - the history of the Street since trading was actually conducted in the street. Independent of your politics or how you view his initiatives, Obama has proven to be a remarkable, no, an extraordinary leader with outstanding ability to calm people - even those who dislike or hate him - and make them feel better about the future.
This may explain the current market. Now let me present the summary for the bearish view. It all begins - and will end - with housing.

Point Number One for the Great Short Trade: The feel good part of Obamanomics has people investors, traders, pundits and politicians believing housing will bottom this year or early next. Maybe in 2012 - just do the math on foreclosures (they are rising), unlisted and empty housing (as much many as 13 million units according to the New York Times), recent Case-Shiller data shows the worst decline in housing prices ever with more to come. When Americans feel good about the value of their home and can get a home equity line, they spend money. When they don't, they don't as much - and in this recession, they do not and will not. And as consumer spending goes, so goes the economy. And within that economy, good bye to any growth or serious profits from direct beneficiaries of residential and commercial construction (more on that later) - think Sherwin Williams, Whirlpool, Louisiana Pacific, other suppliers.

Point Number Two: The housing bubble was really the tail end of a credit bubble that is over for between a decade and a generation. Do I exaggerate? The nation's banks are on the way to pulling in two and a half trillion in credit lines via credit cards. Two thirds of people with a mortgage on their home had less than 15% equity in that home as of the end of last year so at the rate the Case Shiller index is going that will mean two thirds of all mortgage holders will have not equity in their homes by this time next year. Almost all increases in consumer spending were fueled by credit expansion since 2001 - remember, the cheerleader in chief did not ask for new taxes to pay for the war on terror, he told us to go shopping? That's leadership.

Point Number Three: The banks cannot lend more vigorously as they are, for the most part, based on real world accounting standards, broke and getting broker. For the next twelve quarters, at least, they will be carefully managing down existing toxic assets - anyone read anything about the PPIP program lately? - and using profits to offset write offs for these and newly made toxic assets. The new wave in toxicity will come from more mortgage meltdowns - worse than subprime according to many analysts - commercial property write downs - did you know Wells Fargo has almost $350 billion in commercial property loans - and private equity disasters - every here of Chrysler? Well, Chrysler has many smaller cousins. And as some banks disappear, Uncle Sam will use funds to prop up the FDIC and the longer we keep the zombies in business, the more expensive this will be.

Point Number Four: The bottom line is corporate profits are going to take a hit - Stephanie Pomboy, credit and market analyst extraordinaire, in an interview with Barrons, spoke to the big rise in corporate profits since 2003-2003 as being directly linked to the radical expansion in consumer and other credit. Contracting credit means contracting profits.

And - markets always regress, for some period of time, not just to the technical mean but to the mean of corporate earnings. Moderate analysts put S+P earnings this year at $55. This gives the market a current multiple of 18-20 - a multiple appropriate for a 3.5% plus growth economy. Put a recession multiple - 9 to 11 - and, well, you can do the math. Of course, I think corporate profits will be lower but even at $55 you get an S+P of 600 at best. Or a 33% decline from where are right now.
Bulls argue with interest rates so low there are no historical comparisons - the same bulls who use historical comparisons to support technical arguments. I guess we now know why bulls are called bulls.

So I, the great agnostic, believe the rally could last quite a while but the market cannot escape the economy and the economy cannot escape consumer spending and the banks and consumer spending and the banks cannot escape housing. And every time I make this argument I become persona non grata at yet another meeting or party.

Anything specific to short?

First, check out, and check the technical's and whether manic sentiment has left, the suppliers to new housing and remodeling - Whirlpool , Sherwin Williams - and some dodgy home builders like Toll and KBH.

Second, there are some banks still overvalued you can short - take a look at Wells Fargo, it selling at multiples well above the segment, has (or had at the end of last year) roughly $90 billion in option ARM mortgages and almost $350 billion in commercial property loans. And I still think Citigroup will break itself up and shareholders could get the shaft.

Third, the ultimate consumer discretionary stocks - luxury and unnecessary, companies like Tiffanys, Coach, Harley Davidson. HOG has just rolled over, it deserves special attention.

Last point - if you don't think housing will take at least two more years to bottom and want to write a comment - please do so - but please, prove your case. Mine is based on the dates mortgages were let, their dates for being re-set, which are in the middle of 2011, and given that defaults and foreclosures happen 3-6 months after re-sets, and then the foreclosed house hits the market - well, maybe it is 2013 after all.