Lewis Leaving: Time To Short Bank of America?

Ding dong, the witch is dead...a familiar reprise to many of us of a certain age. The first witch to go was the wicked witch of the East - John Thain of Merrill Lynch. Now the wicked witch of the west - Ken Lewis - is gone. West? Bank of America was built in California, I needed to make this work somehow.

And Lewis leaving means it is time, once the charts are on your side, to short BOA.
Lewis, the second best cry baby among the bank CEOs (John Stumpf of Wells Fargo is in a class by himself), is leaving not because he wants to re-grow his beard or get out of the spotlight. He is leaving because the bank faces years, not quarters, of trouble ahead.

• A weakening balance sheet due to bad loans and more bad loans - more on that in another post.
• Continuing government ownership via TARP funds - I may be wrong but given their balance sheet issues, deteriorating loan quality and he size I do not see them getting permission to pay back their government money soon.
• Lawsuits and investigations related to Merrill Lynch bonuses and the Merrill Lynch acquisition.
• A future - one to twenty quarters - of declining or stagnant earnings, depending on how much they want to legally cook their books. In the real world, earnings will be troublesome for three to five years.
• A need to raise capital that puts the CEO in the spotlight answering too many of the wrong questions with the wrong answers.

These are all reasons to avoid the stock. Many investors - well, traders - have bought in, due to the charts and a consumer franchise second to none. That too is taking a hit. Up until six months ago I cold easily say BOA had the best customer service of any company I dealt with other than Amazon - I was and still am a BOA Premier Banking customer. I am leaving -- they kicked me out of the Premier Banking Program by form letter and assigned me to a Merrill Lynch broker, saying I cold stay in with a quarter of a million brokerage account and getting rid of my private banker for fifteen years. A Merrill Lynch broker is not the guy or gal you want to talk to when discussing mortgages or home equity lines of credit. Bad move, that - an indicator of things to come.

Why short the stock? Most big banks are getting by on government largesse and legal but bogus accounting - totally unfriendly and opaque to investors - and 2010 will see the end of one offs, such as mortgage refis and the sale of assets, that boost earnings. Real earnings, declining home values, more than 10% unemployment and the other parts of the Great Recession will take center stage. More home equity lines will default, more commercial mortgages, more regular mortgages, more credit cards - and this will hit the income statement as reserves are set aside. And for BOA, it will also hit the balance sheet as write downs increase, making it necessary and expensive to raise capital, diluting shareholders.

So, if you believe fundamentals eventually take over the movement of a stock, watch the charts - when BOA turns it will be a good time to consider shorting the stock.

How to Short the Coming Double Dip

The double dip has begun.

Statistically, we will see a rise in GDP in Q3 and in Q4. This is anticipated and meaningless data, but the numbers will hit headlines.

In the real world, the double dip has begun. Here is why - no one seems to be willing to pull things together in one short argument, perhaps for fear of being bored by a bull wearing green shoots. Simply put, all the core factors in driving an economy upward are broken other than pundit comments talking about "it must turn upward base on historical data." My historical note - we exited the Depression due to Hitler and Tojo, not a return to historical norms.

Unemployment: The reported unemployment number is 9.8%; real unemployment is 20% if you include those who have stopped looking and part time workers wanting to work full time. And the labor force participation rate is at a 23 year low.

National Income: Wages are falling and work hours are stagnant, according to this morning's jobs report, and combine these data with a shrinking work force and rising unemployment and you continue to have a sharp downturn in national income.

Consumer Spending: National income drives consumer spending, which is contracting due not just due to falling national income but rapidly contracting credit lines and a near 40% loss of accumulated wealth in the property and equity markets. And while consumer spending ostensibly is 70% of the economy, this includes spending on health care - love those government statisticians - so contraction has an incredibly outsized impact on consumer discretionary spending - luxury goods, travel, restaurants, unnecessary goods, expensive goods - anything you can trade down from to a lower level of price with equivalent functionality.

Credit Contraction: The credit contraction has been ferocious for consumers and small businesses as noted this morning by uber analyst Meredith Whitney (one of my favorites) in the Wall Street Journal. Depending on how you slice data, almost all increases in consumer spending since either 2002-2003 or 1997 has been due to credit. Trillions have been withdrawn and Ms. Whitney postulates another $1.5 trillion dollars will disappear in the coming months due to banking caution and changes in regulations. Given the total lack of credit to small business, and this segment is 38% of GDP and 50% of new job creation, there cannot be a recovery until credit begins to flow.

Zombie Banks: Nothing has changed with toxic assets and zombie banks - nothing, and even the IMF said this - and another $1.5 trillion needs to be written down, at least. Just because these assets are not in the headlines, and the Fed, the Treasury and the FASB faked stress tests and changed accounting rules, this does not mean the banks are or will be lending in a meaningful way in the near future. The Fed prints money, the banks sit on it to shore up busted balance sheets.
Business Investment: There are too many factories around the world, too many shopping malls an stores, too much commercial real estate - and at levels beyond all historical norms or comparisons. The first several legs of a rebound needed to absorb this capacity before we see any uptick in business investment that materially helps the economy.

The End of Stimulus: The buy gold and build a bomb shelter types have been screaming about the Fed printing money - what the Fed did was print enough money (they added a trillion to their balance sheet) to replace what was lost in the shadow and real banking systems - but not enough to replace what will be lost in the next 12-24 months. That being said, there is no political support for more stimulus. Deficits and a Congressional election preclude another stimulus package next year and the Fed and Uncle Sam have already said they are definitely pulling back, beginning November 1. We saw what happened to auto sales after Cash for Clunkers ended; ditto for home sales data in the coming weeks as the $8K tax credit expires. The bottom line: the economy will be much on its own next year.
Corporate Earnings: Corporate earnings follow the economy and they may be all right for Q3 and perhaps Q4 but they are going to disappoint the Street in 2010, big time. You can only cut costs so much - you need some top line growth - and it is only going to be there next year.

Markets: And one historical norm I like is the regressing of markets to the mean of corporate earnings. Translation - the market should be coming down next year or perhaps in 2011.

What to Do: If you like to short, consider the following - short the S+P (puts on the SPY), long term; short consumer discretionary spending via puts on the XLY; short the companies making stuff know one needs, like Harley Davidson (HOG) and Brunswick (BC); short companies making things no one can get credit to buy, such as new homes, via puts on the XHB ETF; short business spending via travel companies, the first thing to be cut in a business cutback, via puts on Avis (CAR); short retailers with terrible balance sheets, notably Macys (M).