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Wednesday, January 30, 2008

Shorting financials -- again

I woke up this morning thinking that the financials have had their run. The ProShares Ultra Financial ETF (UYG) has moved up about 20% from its recent bottom over the course of just a couple of weeks.

With the Fed decision looming, I thought it best to take profits. If the Fed only cut by 25 bps or didn't cut at all, I thought financials, and probably the rest of the market, would plunge. On the other hand, with a 50 bp cut widely expected, I felt there wouldn't be that much upside. Especially as it may signal that the economy is in worse condition than many thought.

In any case, after the Fed announcement, investors will be getting back to focusing on the economy and the financial state of those stocks making up the sector. And that may not be a good thing.

In terms of the economy, there are so many mixed signals that one can't be blamed for taking a cautious stance.

In terms of the financial companies themselves, most of the major names have reported earnings already. The announcements were dismal at best and guidance amounted to putting good spin on what is expected to be a tough year. The financials are being fingered as the sector acting as a drag on the entire market as their negative earnings growth lowers the aggregate earnings growth of the whole S&P 500.

Some of the developments that set off the recent rally are starting to come under scrutiny and found to be maybe not as timely or as effective as had been hoped. Bailing out the bond insurers now appears to be no sure thing and more complicated and expensive than originally thought. It is now clear that the economic stimulus package will not actually put money in consumers hands until May. That means it will be months before any beneficial effects are felt and there are many economists who feel that the effects will be minimal anyway.

Now we have the FBI investigating mortgage originators and securitizers. Still more shoes dropping in the form of writedowns, with UBS the latest example. Loan loss reserves ratcheting up at most companies portend more defaults and delinquencies on loan portfolios. With the credit card and auto loan segments in focus now it appears that the problem is spreading beyond mortgages. And there are noises starting to be heard about commercial real estate lending beginning to encounter problems.

So I sold UYG in the morning at $38.53 for about a 12% profit. When the market jumped at 2:15 when the Fed released their announcement, I decided to buy some SKF, the ProShares UltraShort Financial ETF. After hitting an intra-day high of $104.69 earlier in the day, SKF dropped like a rock and I picked up a few shares at $97.66, what I would estimate to be a reasonable price and just above the next support level. With SKF finally closing the trading day at $102.70, it so far looks like a good move.

We'll soon see if I have been too clever by half in this trade.

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