Over the past few days I have been involved in a number of heated discussions on some of the financial websites and with my friends and colleagues, about the near term expectations for financials and the two ETFs that inversely track them, FAZ (triple leveraged inverse financial ETF) and SKF (double). Many traders that have been actively trading FAZ (and very profitably until a few weeks ago!), bought into what I believe to be a faulty logic, that FAZ just can't go below $35-$40(was a damn good support for FAZ). Some of these traders are saying now that the FAZ is just too 'cheap' below $20.
I beg to differ. The problem is that for now, the FAZ train has 'left the station' and it ain't coming back to $35-$40, barring a complete near term collapse of our financial system, which I don't see happening. Notice, I am only talking about the near term, which I define as several weeks to several months. I sure appreciate all the problems that we will likely experience down the road, but for now I am NOT betting against Financials.
Below, I tried to summarize my position in 10 short points.
1) The Q1 results for financials and in general are expected to be pretty dismal. Having said that, it seems that the trends, at least in January and February were better. Not great, but less bad. March, according to JPM's CEO Dimon, was a bit more challenging. Still, with expectations pretty much in check, we may escape the bloodbath in financials during this earnings period.
The operating earnings could be even better than expected at some of the key banks, JPM, BAC, SST and even C. Brokers like MS and GS should do better too. The upside may come from the contributions from trading , while the pick up in refi's and fee income will help some regionals. We may actually see banks make money this quarter, according to Meridith Whitney! Yes, the extent of the write downs is still a big X-factor (and will likely remain so for some time) , but many investors have already braced for the worst. If the commentary from the top 5-6 institutions is even marginally better, we may actually see another rally in financials.
The action in these 5-6 financial institutions is what really matters for FAZ/SKF performance anyway.
2) We may get a gift from the SEC, possibly as soon as this Thursday, in a form of modified short sale and uptick rules. Yes, this could be significant, as it will reduce the appetite and opportunities to short financials and other stocks. Additionally, I believe financials are still one of the most shorted groups, and any short covering as a result of changing these rules could provide additional support both for financials as well as the market as a whole.
3)The institutional investors that are currently long financials, are not selling here, as they believe it's too late to sell and are taking a longer term approach. I agree, considering where these stocks have come down from. I am just not sure there is an attractive risk/reward for selling financials here..Of coarse, another 10%-20% rally in financials will result in some selling, but by then FAZ will likely be a single digit midget.
4) Most analyst ratings on financials are still neutrals and underperfoms. But there are signs that the sentiment is approaching an inflection point in the near term. I would expect that after Q1 results, more analysts will review their ratings...perhaps we may even see some upgrades, but I doubt we are going to see more downgrades. Case in point, Dick Bove initiated BAC with a buy this morning..he is is a well followed bank analyst with a very good reputation on the street. He was the one to make a pretty bold call that financials have bottomed and to buy BAC at $3-$4 a few weeks ago. I am not saying that he is right, just pointing out that he is considered a thought leader in this space and may lead to a change in sentiment towards banks. Similarly, Meridith Whitney was on CNBC today, also sounding a bit more upbeat on banks than in the recent past and specifically said that shorting financials is no longer a good idea. "Lay off on shorts, and don’t buy into selloffs," Whitney said. "The fundamentals are not getting any better but capital ratios should get better." However, Michael Mayo, another reputable bank analyst is out with a negative report today on banks. The report reads pretty ominously, but for the most part, his points are fairly well understood and hardly bring anything new or shocking to the light.
5) The fear of of wholesale nationalization of banks is no longer at the top of the investor concerns. Yes, there is still a possibility, that more banks will get taken over by the government, especially after the stress tests at the end of the month. But, unless you believe there is a strong possibility of major banks being nationalized, stay away from FAZ and SKF.
6) Geithner and the FED, are on the hook to show some success with their "financial engineering". They will continue to "assist" in whatever way they can to 'save the financial system'. I am not betting against the FED.
6) M2M - we can debate whether its just a band aid and smoke and mirrors, but what is important is that it will obscure the true balance sheet information and will artificially help banks report stronger results, even if its only an optical illusion. Whitney explained it well today in her interview on CNBC. Bottom line it will help improve a tangible book value, a key metric on which banks are valued, as well as improve a sentiment towards banks..
7) Lastly, the overall market sentiment is improving and we are seeing signs of money beginning to trickle back into the market. Much of it will find its way into brad market indices, like SP500. The index funds, that have ~10% weight in financials will need to allocate at least $10 of every $100 into financials. Well let's examine today. We had a very negative start to the day: 1) a very negative (and downright scary) report on banks from Mayo, 2) the nervousness about the upcoming earnings season, 3) looming stress tests for banks, 4) the selloff in commodities, 5) and oh yeah, some comments from Geithner yesterday about a possibility of removing more management teams at the banks that received gov't aid, and 6) comments from TARP watchdog, Warren, about possibly wiping out the common equity at these banks.
Last week and today there were several attempts to sell this extended market and scare some investors into locking in their gains following one of the most impressive rallies ever. But after all that, the broad market and financials were able to recoup most of the losses by the end of the day. All things considered, the financials held up OK and didn't get decimated as would have been the case just a few weeks ago. If you examine the action during the last 30 minutes of the day over the last week or so, you will clearly see some strong buying into the close. Draw you own conclusions. Don't fight the tape!
8) Now let's examine FAZ itself. FAZ is not an investment. Numerous articles examined the performance of these highly leveraged ETFs and concluded that their performance doesn't correlate to that of the underlying. Its more of a trading volatility tool which was very is helpful over the past few months to bet on a volatile and usually one-way trading in financials. Great for day traders that are good at volatility trading. Poor choice for investors.
9) Don't confuse NOW with LATER. Later, many of the problems that have been infecting our financial system over the last 25 years, will resurface. The extent of these problems and the unintended circumstances that our government is creating by trying to 'fix' our financial system at all cost, is still unknown. It will manifest itself again in the future. But for NOW, over the near term, we are likely to see some improvement in both fundamentals and investor and analyst sentiment toward banks.
10) Finally, in order for FAZ to move back up to $35 (more than 100% from today's close), financials would likely need to sell off to a tune of 30-35%. Which means BAC back to $5-5.50, JPM back to mid teens and GS back to mid $80's. It would take just as much of a meltdown as we saw last year, when the problems with finanacials just began to surface and they were all still trading at pretty lofty levels. Is it possible, yes, but not likely,
There will be time again to bet against financials. But NOW is not the time to be betting a farm on FAZ.
Last week and today there were several attempts to sell this extended market and scare some investors into locking in their gains following one of the most impressive rallies ever. But after all that, the broad market and financials were able to recoup most of the losses by the end of the day. All things considered, the financials held up OK and didn't get decimated as would have been the case just a few weeks ago. If you examine the action during the last 30 minutes of the day over the last week or so, you will clearly see some strong buying into the close. Draw you own conclusions. Don't fight the tape!
8) Now let's examine FAZ itself. FAZ is not an investment. Numerous articles examined the performance of these highly leveraged ETFs and concluded that their performance doesn't correlate to that of the underlying. Its more of a trading volatility tool which was very is helpful over the past few months to bet on a volatile and usually one-way trading in financials. Great for day traders that are good at volatility trading. Poor choice for investors.
9) Don't confuse NOW with LATER. Later, many of the problems that have been infecting our financial system over the last 25 years, will resurface. The extent of these problems and the unintended circumstances that our government is creating by trying to 'fix' our financial system at all cost, is still unknown. It will manifest itself again in the future. But for NOW, over the near term, we are likely to see some improvement in both fundamentals and investor and analyst sentiment toward banks.
10) Finally, in order for FAZ to move back up to $35 (more than 100% from today's close), financials would likely need to sell off to a tune of 30-35%. Which means BAC back to $5-5.50, JPM back to mid teens and GS back to mid $80's. It would take just as much of a meltdown as we saw last year, when the problems with finanacials just began to surface and they were all still trading at pretty lofty levels. Is it possible, yes, but not likely,
There will be time again to bet against financials. But NOW is not the time to be betting a farm on FAZ.
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