Yanked By The Shorts

Right now is a great time to be a pessimist about the markets. There are so many factors helping you out it is unbelievable. The oil price, instability in the middle east, jobless figures, housing markets etc etc. But the best comments I have seen from a pessimist is Albert Edwards, strategist at Societe General in London.

“America is leading the way, diving into deep recession as a collapse in consumer confidence induces the great unwind,” he said. Edwards compares the economy with a pyramid scheme that is poised to crash to earth and interest-rate changes can do nothing to avert it.

He thinks Wall Street and the other main markets have a lot further to drop, and will end up 70% below the peaks of last year. That would imply a level of just 500 for the S&P 500, which was at 1,280 on Friday, and 4,500 for the Dow, compared with Friday’s closing level of 11,346.

The FTSE 100, which closed at 5,530 on Friday, will plunge to 3,000, he predicts. The good news is that he expects the oil price, which was above $142 on Friday, to slump to $60 a barrel. The bad news is that he sees this occurring as a result of “deep” recession in the advanced economies and a sharp slowdown in emerging markets.

Crickey. Shorting just 1 contract for $10 a pop on each of these markets would be a nice $100,000 profit if he is right. But is he the only voice in the wilderness?

Not really, the gloom on Wall Street, where the stock market dropped again on Friday, is almost all-pervading. Veteran banking analyst Richard Bove of Ladenburg Thalmann said there was “an absolute unwillingness among clients to talk about anything other than how bad things are”. Investors wanted to know which bank would be the next to blow up or be forced to raise capital. Even though there were hopeful signs of recovery in the sector, albeit from a low base, many in the market had “lost perspective”, he said.

“The last time loan losses were at these levels was 1934,” he added. “I don’t believe we are going back to a 1930s environment with people living in tents.” Bove predicts bank losses will at least stabilise in the coming months.

However, Scott Anderson, senior economist at Wells Fargo, summed up why the markets are so gloomy. The economy is caught between the twin problems of near-recession and sharply rising inflation. “Consumer confidence levels are at their worst since the early 1980s, we have record oil prices and the Fed will have to react to that and start raising rates by the end of the year if they don’t recapitulate soon,” he said. “That would certainly drag out the housing correction and be a further drag on consumers.”

He has scaled back his forecasts for the end of this year and into 2009. “One half [of Wall Street] is worried about growth, and they are scared,” he said. “The other half are worried about inflation, and they are scared too. Sell in May and go away may have been the best strategy this year.”

A drop in the oil price would be the best remedy for jittery markets and a shaky economy, though it could also cause problems. One fear is that a sharp fall in oil and other commodity prices would bring a new wave of troubles for investment banks and hedge funds. As it is, most have been revising up their forecasts for the oil price.

A survey by Reuters shows that analysts expect the price of American crude to average $113 a barrel this year, remaining around that level next year, before increasing to $115 in 2010. Last year the average was $72.

Some analysts, though, are much more aggressive in their forecasts. Fortis, the Belgian-Dutch financial group, sees crude averaging $125.70 this year, $171.50 next year and $224.90 in 2010. In contrast, Royal Bank of Scotland sees a price average of $86 next year.

So what can you do, as an investor, sit around and wait for Armeggeddon?

I was alkig to a client the other day about the state of the markets and he said that he was staying out of the markets for 'the foreseeable future'. This, from a conservative investor, would be a predictable comment and one which could not be argued with, however, this particular client has been a massive bull ove the years, buying what he ca when he can and he has done very well. However, this bullish attitude was always based on the press he had read, or his feelings on a particular sector. He gets extremely excited about 'things moving by large amounts'.

I pointed out, that if these analysts were talking baout the markets going to the moon, he would be a buyer, he did't disagree. Now that that they are talking about a deep decline in the markets should he be a seller? I suggested.

This then became a discussion about shorting the markets using various instruments and my client is now intent on doing just that. I guess it is just a case of whaht perspective you have. In our business, if the markets are falling... short them... if they are going up, go long. A simplistic view, I know, but I was always taught that volatility is our friend. It is when the markets are going sideways that we should worry...

As a follow on to this, this was an article in the Times that showed up some shorts on the market with new rules implemented by the FSA:

THE HEDGE FUNDS THAT ARE SHORTING UK PLC

A NEW RULE came into force last Monday obliging hedge funds to disclose short positions they had taken in companies that were raising money from shareholders, writes Kate Walsh.The rule, announced by the Financial Services Authority on June 13, lifted the lid on the funds that were betting against companies such as HBOS, Bradford & Bingley, Johnston Press and UTV Media.

Going short involves borrowing shares and selling them straight away - in order to buy them back later at a lower price.

The names that came out last Monday included well-known fund managers such as Lansdowne, GLG, Fidelity Investments and Odey Asset Management alongside the not so well-known Oceanwood Global and Steadfast Capital.

These were the main positions disclosed last week and the men behind the funds. Harbinger Capital: 3.29% short on HBOS Harbinger’s Phil Falcone, the so-called Iron Man of the New York hedge-fund world, is renowned for making a fortune out of others’ misery. Early last year he had determined that the American housing market was on the brink of plunging and shorted nearly 60% of his $20 billion (£10 billion) fund on sub-prime-backed bonds. The bet paid off and he subsequently paid himself $1.7 billion for a good year’s work. This year, Falcone bought a stake in The New York Times, where he is calling for a radical shake-up.

Lansdowne Partners: 0.58% short on HBOS Lansdowne partners Peter Davies and Stuart Roden are regarded as among the best in their field. They have worked in tandem for well over a decade and left the asset-management division at Merrill Lynch in 2001 to take over what was then a $2 billion fund; it now has $19 billion under management. Lansdowne has a reputation for being cautious and is known for the thoroughness of its research - for example, it is believed to have taken a short position on Northern Rock some four years before the bank’s crisis began.

Meditor Capital Management: 0.3% short on HBOS Talal Shakerchi, born in Birmingham but of Kurdish descent, is the main force behind Meditor. Even within the hedge-fund community little is known of Shakerchi other than that he is an aggressive fund manager who does very well in bear markets. He left Old Mutual in 1998 to set up Meditor after poaching his entire former team. Last year, Meditor was one of the hedge funds, along with GLG, that was fined by France’s financial watchdog for allegedly misusing information in a convertible bond issue by Vivendi. Meditor said it didn’t breach any regulations.

GLG Partners: 4.14% short on B&B The founders of GLG - a fund with $24 billion under management - are Pierre Lagrange and Noam Gottesman. They are among the highest-paid hedge-fund managers in Britain and their lifestyles reflect it - the pair are leading lights on the London social scene. GLG made headlines this year when its star trader Greg Coffey resigned, forsaking $250m of shares. Industry sources said that Coffey was a “sizeable” trader on the short side although his main focus was emerging markets.

Odey Asset Management: 0.28% short on B&B When Crispin Odey quit Barings in 1991 to launch his own fund-management firm he admitted he did not even know what a hedge fund was. Early backing from the billionaire George Soros and Lord Rothschild quickly turned Odey into one of the first hedge-fund stars.

In 1993 he paid himself a £10m salary but the abrupt turn in the world’s bond markets in February 1994 hit the fledgling fund hard. Last year, Odey’s $4.9 billion fund made a killing on wheat, though he is always on the prowl for distressed assets or, in his words, “the company that has no chance in hell of meeting the market’s expectations”.

Funds that disclosed short positions in Johnston Press were Lone Pine Capital, Trafalgar Asset Managers, Fox Point Capital Management and Valinor Management. Old Mutual Asset Managers revealed it had taken a short position in UTV Media.

Scary stuff for the housing market...interesting opportunities for the short trader....