Shorting WaMu

[davelj]

[I’m going to try to answer some of the various questions posted to me here.]

Poway, you wrote: “So what is your take on shorting WaMu? Please, instead of writing about me, which is very boring to everyone, could you add something tangible to the discussion?”

I already answered this question above: “Having said all that, do I think WAMU’s stock will be lower at some point over the next two years than it is today? Yes. But it’s not a bet I’m willing to take.” Since that wasn’t clear enough: No, I don’t think it’s a good idea.

(By the way, Frank is right. If you’re really worried about option ARMs/neg am loans FED is a better short. But, personally, I wouldn’t short FED either – trading isn’t my business and I religiously stick to those very few areas where I have a large competitive advantage.)

A quick note on trading in large cap stocks. I’ll use WAMU as an example. I could pick up the phone right now and find two equally smart, well-informed analysts/traders who have taken opposite positions in WAMU, one long and one short. They could each wax poetically and convincingly on all the reasons they are on the “right” side of the trade and why the other side of the trade is wrong. After hanging up the phone, I might be swayed more by one than the other based on my preconceptions, but it would be a tough decision. My point is that as an individual you’re making a decision based on 1% of the information and analysis that these guys have, and as a GROUP they’re STILL conflicted. What’s the takeaway? Your odds of a successful trade in WAMU are the same odds as a coin flip. There are many reasons that WAMU’s stock could rally despite the fact that it has a lot of these toxic loans on the balance sheet (and it’s stock may ultimately fall): market perceptions that the Fed will lower interest rates faster than previously believed, WAMU discovers some exotic way of hedging their loss exposure to the ARMs on its balance sheet, the company sells a subsidiary for a huge premium that the market believes will offset any losses from ARMs… I could go on and on and on. My point: your success or failure here will likely be random. That’s the nature of large-cap stock trading unless you have an informational/analytical advantage. And I’m biased about all this as an investor – I don’t do any trading and really don’t do much with publicly-traded stocks. (Finally, if you invest on the belief that the other market participants are stupid and that the people that run these companies are stupid, you’ll be disabused of that notion eventually. They’re not stupid – but they are impatient, and that’s your arbitrage opportunity, as I’ve explained previously.)

Poway also wrote: “I think most of those option ARM borrowers will default.”

This is precisely the sort of baseless outlandish prediction that delegitimizes otherwise legitimate claims you might make. What you’re saying here is that 51% or more of all option ARMs are going to default. I have an extraordinarily bearish friend who’s hoping that 20% default (that’s by far the highest informed prediction I’ve heard). My understanding is that, in very rough terms, about a third of all option ARM users have very good credit and won’t have any problems at all; another third have decent credit and a small percentage will hit the wall; the other third will feel the pain, but even a lot of those people at the bottom will find a way to stay solvent – they always do. If you would like to take a $100,000 (or more) position in betting that 51% or more of option ARM borrowers will default over some specified period, I will be happy to have my legal counsel structure a product so that I can take the other side of that deal. We can definitely do business. Just let me know.

HereWeGo, if you want to lend your shares to Poway you can draw up a simple legal agreement and give her your stock certificates. The premium you should expect for the loan is dependent on your estimation of Poway’s credit. Also, you’d want her to replace your dividends. Broker’s Call Rate is typically a few points above LIBOR, which is the price most retail investors pay for borrowing on margin. Obviously, stocks with big dividend yields are very expensive shorts once you factor in the dividends and interest.

[powayseller]

Another point for shorting WM. WaMu’s move to Europe bonds worries Merrill’s Bernstein

“Washington Mutual Inc.’s issuance of bonds covered by U.S. mortgages in European credit markets, and potential follow-on activity by other U.S. financial institutions, carries risk should the dollar fall as expected, Merrill Lynch market strategist Richard Bernstein said in a note….

“We were accordingly somewhat startled,” by WaMu’s move, Bernstein wrote. “Cheaper financing by issuing in stronger currencies: Isn’t this the financing road many an emerging market has unsuccessfully traveled?”

[rseiser]

I think this is a very relevant comment. It just shows that banks are getting desperate and try to borrow money cheaper wherever they can, no matter the risk. This is the same as when interest rates are low and everybody buys junk-bonds because they have a higher yield. This is the wrong move, since they are also more risky, especially in these times. Just because interest rates are lower in Europe totally overlooks the higher risk. In interest rates one has to look at their level compared to the equilibrium level. If a country keeps its level artificially lower than the market would demand, then it would be a good deal to borrow, since the rates are low AND their currency will lose somewhat due to the credit created. But Europe might not be in that situation. They might have interest rates low, because they are justified by the market, i.e. less money printing and lower trade deficits. In that case it might be better to borrow in the U.S. Does it matter for WM? Maybe. $20 billion seems like a large amount, and if they just lose 1% annually that would be $200 million. Quite significant compared to earnings of $3 billion.
Good luck with your short Poway. I haven’t gotten enough information on this, but the long-term chart sure looks like bearish flag if it cracks. Wonder what ChrisJ has to say to this.

[powayseller]

Chris suggested that I wait to short until a pullback off the low, i.e. past $43.50. It’s short term oversold now, so I need to wait for a little bounce. He himself is not interested in this stock. Why do people say the sky is the limit on short losses? You can put a limit on the short, just as with a long.

[rseiser]

One of these days I am gonna write a summary on my shorting experience. But regarding setting a stop-loss, you have to practice this and see if you can do it. It is not easy since you might lose 80% of the time just because of short-term volatility. That means you have to make really good gains on the winners, which is not easy either in an inflationary environment. If you miss your stop and it goes against you, where do you pull the trigger? At 5%, 10%, 20%, 50%? I for one am completely useless in that regard as I have proven to never cover unless I admit that my fundamental analysis was wrong. And that’s a guy talking who shorted TOL years ago at $25 and again at $40 just to see it go to $50. I guess I finally made some money now, but this was not for the faint of heart.

[masayako]

PowaySeller,

Thanks, but no thanks. I’m not a speculator, not good at it, and don’t want to speculate with my life saving. I am not good at shorting(guessing) and it does not fit my investment strategy. Like Buffett said, in short term, no body can tell the stock price. It’s more like guessing with wishful thinking.

After getting out from the housing bubble(with big gain), I just don’t plan to jump right into another stock speculation.

Good luck and thanks anyway. =)

Masayako

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

My whole point with this entry is that do not be in too much of a rush to short something based on a fundamental reason. You can be right on fundamentals and take alot of heat on a trade. This is why you have to have a good bar pattern on top of the fundamentals. When trading bear flags or bull flags from my experience it is wise to look for symmetry in them. Look at the last one and how much it pulled back against the trend, then wait for a similar bounce which in this case was about $2/share. Today had a good sized move down so just wait until you get about a $2 bounce off the low. This is just a general rule for novices and not how I would enter the trade. The point is location in terms of price on your entry is important.

There is no reason that just because an individual or institution determines that a stock is a good short, that it will just cascade downward the minute you are in. The market could care less who or who is not in. Choose your points with discipline and do not fall in love with your idea. If it goes against you x amount get out and admit you were wrong.

In general trading flag patterns does provide an edge and you should be able to hit over 50% of them. One rule I used to use with them is that once 3 occurred I pass on the ensuing ones, because all trends come to an end. Three continuation patterns on average is what I used to see before they start to shake the tree a bit. ( This means come after the weak hands ) Just look at Jan 06 in this stock, you had three consolidations leading up to that, then they shook the tree a bit for awhile getting all the weaklings out before moving up again.

There is no need to fear unlimited losses in shorts, I have stated this in this forum over and over. In a highly liquid stock you will be filled at your stop probably with just a few cents slippage. Set your stops and ALWAYS honor them.

RS – I told you when we talked at the get together that you were playing with fire on the short sale exits you were doing.

[powayseller]

Chris, some people had posted that you can’t set a stop loss on a short, so you could lose to infinity (an exaggeration), as the price of your stock soars. Obviously, that is a misunderstanding, as you can set a stop loss.

Now here’s a reason NOT to short WM. From Bill Fleckenstein today

“Q: Your views on mortgage lenders and regional banks are clear. Which I totally agree with, by the way. Do you have any views on the big money-center banks: C, WFC, WB, WM, etc.?

• They should all be hurt to some degree– who knows what is really on their balance sheet. I think WM is the most vulnerable… but supposedly it’s takeover material, so I have stayed away.”

BTW, Bill Fleckenstein also wrote today that he expects the housing and stock market to crumble beginning this month. When I asked him about a fall rally, he said definitely not. Chris, do you consider him inflexible too?

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

Yes I do consider him inflexible. He runs a bear only fund, short only. How is that a fully flexible market view. He never goes long, why would you ever expect him to call for a rally?

[powayseller]

Great answer, LOL.

[powayseller]

WaMu sold 71% of its Option ARMs. What happens to the neg-am income they’ve recorded? Do they keep it, or sell it too?

[davelj]

WAMU has been selling 71% of their option arm PRODUCTION, not their portfolio. This has no effect on the loans they keep on their balance sheet; they’re still responsible for all of the neg-am implications for the loans they portfolio.

As with virtually all large thrifts, WAMU owns a subsidiary mortgage company. This mortgage company generates loans, some of which the thrift keeps on its balance sheet (portfolio) and others it sells either in flow, bulk or securitized form into the secondary market. WAMU sells these loans because either they (a) don’t have the capital to portfolio all of the production, (b) don’t want credit exposure to all of the production, or (c) the economics on the premiums they receive for selling the production are better than the economics of keeping the paper on balance sheet.

The loans on their balance sheet, however, they’re basically stuck with for the short term (although they can always try to sell them at some point). And those loans typically fall into two bifurcated tranches: (1) the loans they’re really comfortable with which probably have low LTVs, high FICOs, etc. (the majority) and (2) the stuff they couldn’t package up and re-sell – higher LTVs, lower FICOs, etc. – because the market didn’t want them (the minority). This is the case with most large thrifts. Obviously it’s the second group, the nasty stuff, that people are really worried about.

[sjk]

Powaysellar,

Fleck is also a “dead fish”, when it comes to silver. He was wrong big time, from 1995-2000 on stocks as well, and lost big money.

Regards,

[powayseller]

davelj, that’s a gem of information. I wouldn’t have figured that one out. Yet, the takeover rumor does worry me from a shorting perspective.

[powayseller]

These last exchanges between me and my friend Chris led me to questions the usefulness of economic forecasting for making money.

How useful is economic forecasting to investors? Look at people like Chris, who have made a living off trading, and who doesn’t give a darn about recessions. It’s not even in his model. He can make a bundle without ever looking at unemployment, recessions, or consumer spending. It seems to me that a good trader beats a good economist any day.

I think economic forecasting is important for businesses, government, and long term buy and hold investors. I use it to measure the business cycle, and know when to get in and out of the stock market.

Do most traders beat most economists at investing?

What do you all think?

[Author]

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