The Fed Shouldn’t Bail Out Financials

The Federal Reserve has pandered to Wall Street demands and drastically cut interest rates this year. The Fed has also used Depression Era rules to lend directly to investment banks. Now there is talk that the Fed may start to buy mortgage backed securities that other banks don’t want to touch. I feel the Fed has already gone too and if the Fed takes this measure it will send a terrible message.

Financial companies got themselves in this mess by extending way too much credit for their own greed. In addition these companies lent out money without much concern for the credit worthiness of the applicant. Now these loans are turning sour as delinquencies and foreclosures are climbing. Instead of letting financial companies pay for their actions, the Fed has been bailing them out with taxpayer money. This is simply unacceptable.

First, the average hard working taxpayer shouldn’t have to pay for the greed and stupidity of financial companies. These companies own actions left them overextended with bad investments and it shouldn’t fall on the regular person to pay for that.

Second, if the Fed bails these companies out what will prevent financial companies from making the same bad decisions in the future? There will be no deterrent. The message that the Fed is sending is that financial companies can profit from excess risk when times are going good and not have to pay the consequences when times go bad. This is an egregious message to send.

The Credit Crisis and Potential Shorts

Financial companies have seen severe declines over the past year and they still have the potential to go down a lot further. The reason financial companies are on such shaky ground is because the risk of rising foreclosures and loan defaults has resulted in a really severe credit crisis. For those of you who don’t understand the current credit fiasco I will try to explain it and show why financial companies still present good shorting opportunities.

Before I start I want to point out that the stock market surged on the Fed cut just like I predicted and also sold off quickly just like I predicted. If you bought financials yesterday I hope you sold the news and got out quickly. If you did play the short term volatility I would recommend that you take new short positions in financials again. Now I’ll go back to the credit fiasco.

The last time the Fed tried to fight off a recession Alan Greenspan, who deserves some blame for the current credit mess, lowered interest rates to ridiculously low levels. Consequently, there was plenty of easy money to go around. Since interest rates were at extremely low levels banks were happy to provide consumers with just about any type of loan they wanted without much regard to the credit worthiness of the consumer. (more…)

BAC Cover Recommendation

BAC - Bank of America (NYSE) - (Closing Price - $35.96) 

Bank of America is down moderately since my initial short recommendation and I think now would be a good time to cover and take the gain off the table. I still think financial companies are going to see further weakness but they will most likely rally tomorrow when the Fed cuts interest rates. If the Fed cuts by a point, which I have a feeling is going to happen, financials could get a significant short term boost. Instead of holding through the volatility I think it would be wise just to cover.

If you shorted Bank of America when I gave my recommendation you are sitting on a 9.5% gain in just a couple of weeks. That is not an insignificant gain considering the short amount of time it took to obtain it. You could have made an even better gain shorting other financial companies when I gave my recommendation. If you shorted Bear Sterns (BSC) you would be sitting on a huge gain.

If you are a very short term trader and like to trade in and out of stocks it may be wise to consider buying financial stocks tomorrow, especially if the Fed cuts by a point. If financials rally tomorrow I would trade the news but get out quickly.

Disclaimer: I have no position in BAC, BSC, or any other financial company.

Should the Fed Continue to Drastically Cut Interest Rates?

Wall Street pundits are saying the Fed should lower interest rates by a full point at its next meeting. I think such a rash decision would be unwise and the Fed should actually think about keeping interest rates the same or lowering interest rates by a more modest amount, 0.50 at the most.

It seems the Fed has been focusing more on the stock market than the economy. Earlier this year global markets had a huge selloff when the U.S. market was closed for Martin Luther King Jr. Day. The Fed reacted by unexpectedly cutting interest rates by 0.75 percentage points the next day. It was later revealed that the selloff was caused by forced selling by Société Générale as it wound down trades related to its rogue trader Jérôme Kervie. The Fed, which is supposed to be focusing on the economy, overreacted to what the global markets were doing.

Now, with all the turmoil surrounding financial stocks (Bear Sterns in particular), analysts are calling for another huge cut. I think another big cut would be foolish for a couple of reasons and would once again show the Fed is being bullied by what is happening in the stock market. (more…)

PAL and SWC are Good Short Plays

SWC - Stillwater Mining Co. (NYSE) - (Closing Price - $18.37)

The prices of palladium and platinum recently spiked to all time highs due to power disturbances that resulted in rolling blackouts in South Africa. Speculators seized on this news to bid up palladium and platinum prices to ridiculous levels.

The stock prices of North American Palladium (PAL) and Stillwater Mining Co. (SWC) spiked in tandem with palladium and platinum prices and both companies present good shorting opportunities.

The stock price of PAL more than doubled earlier this year and SWC tripled. Obviously, speculators sent these stocks up to unsustainable prices and I think they will quickly drop back down.

The price of palladium has been dropping quickly and I expect platinum to drop quite a bit from its record levels. The concern over supply due to power distruptions in South Africa has eased and the momentum has dried up. I expect the stock prices of both of these companies to see significant declines.

You can pick either stock to short but I am going to give a recommendation to short SWC at today’s closing price.

Disclaimer: I have no position in PAL or SWC.

Greed, Fear, and Greater Fools

COIN - Converted Organics (Nasdaq) - (Closing Price - $16.59) 

I have referred to “greater fools” and the term “hope a dope” a couple of times and the company Converted Organics (COIN) is a perfect example of what I was talking about.

I came across Converted Organics on a day trading stock blog a few weeks ago and I have been following the stock out of curiosity. The stock price of Converted Organics has risen from around two dollars to the current price of $16.59 in the past half year. I am not sure what initially caused the stock price to surge but the stock price has continued to go up on sheer speculation.

Essentially people are buying the stock and hoping other fools will continue to buy the stock and send the share price up. The only thing Converted Organics has going for it is the company has an extremely low float (number of tradable shares). That is the major reason speculators have been able to manipulate the share price up. (more…)

Covad Communications: Risk Free Return Update

DVW - Covad Communications (Amex) - (Closing Price - $0.9376) 

A few months ago I wrote a post about a relatively risk free 14% return you could get in Covad Communications. Covad Communications is being acquired by Platinum Equity in an all cash deal at $1.02 a share and the stock price of Covad Communications was only $0.88 at the time.

The deal is getting closer to completion and the stock price of Covad Communications is still trading at an 8% discount to the acquisition price (Covad ended the day at 0.9376). There wasn’t much risk when I originally posted about the deal and there is even less risk now. The acquisition has cleared an antitrust hurdle and stockholders have approved the deal. (more…)

Good Time to Short Financial Stocks: My Pick BAC

BAC - Bank of America (NYSE) - (Closing Price of Friday 2/29/08 - $39.74)

Financials have been one of the worst performing stock sectors over the last few months and I think the weakness in the sector is going to continue. The housing market is no where close to finding a bottom, the economy and job growth are slowing, and gasoline prices are projected to hit all time highs this summer. All of these things are going to bode ill for financial companies in the form of increasing foreclosures and overdue credit card and loan payments. Consequently, I think it is a good time to short financial companies.

Financial companies rallied earlier this year when the Federal Reserve caved into Wall Street demands and drastically cut interest rates by 1.25 points. However, the rally didn’t last long and the share prices of financial companies are once again dropping quickly. I think you can take your pick of which financial company to short but I am going to give a recommendation to short Bank of America. (more…)

Current Market Volatility

The stock market has become very volatile and irrational over the last year. I contribute some of this volatility to the uncertain economic climate. However, in my opinion a big cause of the huge price swings in the market is the tremendous growth of hedge funds and their need to generate short term returns.

Hedge funds make most of their money by being able to generate positive returns (they take a big percentage of the gains they make: 20 percent or more). The investors who accept these large fees expect hedge funds to deliver gains regardless of what the market is doing. Consequently, this puts a lot of pressure on hedge funds to outperform the market.

When the economy is expanding and the stock market is going up every day it is a lot easier to make money in the stock market. A rising tide lifts all boats so to speak. When the economy is heading for a recession and the stock market is going down it becomes much harder to generate positive returns. This is a big reason for the volatility in the stock market and other asset classes such as commodities. Hedge funds and other short term investors are chasing after quick gains in a very tough market. (more…)

Sectors to Buy and Avoid

Small caps and technology stocks have taken quite a hit over the past few months and I think now is a good time to start looking for bargains in these sectors.

There has been a rotation out of these “riskier” stocks with the threat of a potential recession looming but the selloff has been overdone. Some companies that I follow have lost over fifty percent of their value from their highs last year in spite of improving fundamentals.

Financials and home builders have seen quite a rebound from the lows they made earlier this year but I think it is too early to say the worst is over for these companies. I think there is going to be further losses due to the risky lending practices that have taken place over the last few years. The housing market is no where near a bottom and foreclosures are going to continue to increase. I would avoid these stocks.

I would also avoid companies that rely on discretionary income such as retailers and restaurant stocks. Consumers are cutting back on their spending and I don’t see that changing in the near future.

Whatever you invest in you should be more concerned with the fundamentals of the company than the stock price. Over time a company’s stock price will ultimately follow the improvement or deterioration in fundamentals.