Why Its Time To Be A Bear

Financials Slide
Goldman Sachs Group (GS). on Tuesday gave a cautious outlook for Wall Street in 2008 because of the ongoing credit crisis, even as the world’s largest investment bank chalked up another record-breaking year. During Q4, Goldman’s $3.17 billion profit was fueled by higher investment banking fees, one-time asset sales, and surprisingly strong debt trading results. Though quarterly results easily surpassed Wall Street’s projections, for some analysts they lacked the kind of power and finesse investors have come to expect. Goldman said it faced one of the worst Novembers on record, which has only somewhat loosened this month. Goldman’s troubles were taken as something of an ominous sign for other investment banks yet to report results, particularly Morgan Stanley, which reports Wednesday, and Bear Stearns, which reports Thursday.

Lehman Brothers says its Q4 profit fell for the third straight quarter, slipping 11% from a year ago on net write-downs of $830 million on fixed-income trading assets

Home Builders Slumping
Fallout from the housing downturn and an accounting charge helped Hovnanian Enterprises Inc.’s (HOV) fiscal Q4 loss nearly quadruple. Despite the net loss of $469.3 million, the company generated $376 million of positive cash flow from operations in the quarter that ended Oct. 31 and projects that it will have more than $100 million in cash flow from operations in fiscal 2008. Hovnanian reported its 5th consecutive quarterly loss. Its Q4 net loss of $7.42 per share after paying preferred stock dividends compares with a loss of $117.9 million, or $1.88 per share, for the same period a year ago. Quarterly revenue fell 20 percent to $1.39 billion from $1.75 billion in the same period last year. Hovnanian and other homebuilders have been struggling amid the subprime mortgage fallout, as a record number of foreclosures has made it harder to get loans, weakening the housing market. Earlier this month, Toll Brothers Inc. (TOL), the nation’s largest builder of luxury homes, reported its first quarterly loss in 21 years.

Construction Activity Down
Housing construction fell in November and single-family activity dropped to the lowest level in more than 16 years. Construction of single-family homes fell 5.5% to an annual rate of 829,000 units, the lowest level since April 1991, while multi-family construction was up 4.4% to an annual rate of 332,000 units. In a bad sign for future activity, the government reported that applications for building permits fell for the 6th straight month, dropping 1.5% to a seasonally adjusted annual rate of 1.15 million units, the slowest pace for building permits since June 1993. Field sentiment among builders remains at an all-time low for the 3rd consecutive month.

Oil Prices Rising
Oil prices rose ahead of the release of U.S. government data on petroleum supplies expected to show crude stockpiles fell for the fifth straight week. Light, sweet crude for February delivery added 29 cents to $90.37 a barrel.

Worst Year For Municipal Bonds Since 99
Wall Street’s three-year love affair with debt sold by U.S. states and cities is over. Municipal bonds, whose returns trounced Treasuries and corporate debt from 2004 to 2006, are headed for their worst year since 1999. They may remain laggards after securities firms reduced their holdings at the fastest pace in at least 12 years during Q3. Citigroup (C), Goldman Sachs and the rest of the securities industry reduced holdings of municipal bonds in their trading accounts by more than 16 percent, to $45 billion. Securities firms are putting less into state and local debt after about $62 billion of writedowns on securities related to subprime mortgages. Borrowing costs are also rising in part because the housing market is enduring its deepest slump in 16 years. Falling property values may slash tax revenue for states and cities by more than $6.6 billion in 2008.

Inflation Concerns
The Labor Department reported the biggest jump in the consumer-price index (CPI) since September 2005, and the biggest gain in core CPI, which excludes food and energy costs, since January. Higher inflation, along with recent signs of resilience in the economy, could make it harder for the Federal Reserve to justify the need for the additional interest-rate cuts. In a further sign of worries about inflation, investors sold Treasury securities, sending the yield on the benchmark 10-year note to its highest level in a month.

Wholesale prices rose 3.2% in November, their largest monthly gain since August 1973, as surging energy prices raised concerns that inflation is beginning to take a toll.

Retail Sales
Consumer confidence fell for the fourth straight month during November, to 87.30. Following a lukewarm shopping weekend, consumers seem to be postponing more of their buying to the last minute compared to a year ago. To boost sales, retailers plan to expand hours and offer generous discounts. Based on early reports from analysts and malls on Sunday, sales results were generally unimpressive. Consumers, fretting about economic worries, were also delaying their shopping even more this year, knowing there’s a full weekend before Christmas, when the bargains will be even better. Meanwhile, for online retailers, holiday sales didn’t live up to industry’s hopes as lower-income shoppers pulled back on spending amid a housing slump. After a strong Thanksgiving weekend, the official start of the holiday shopping season, business has slowed even more than normal, resulting in mixed November results for retailers and uneven business so far in December. Some 35 million Americans have yet to start shopping for holiday gifts.

Other Indicators

  • Dollar is getting weaker against other currencies. With more rate cuts, the dollar can dive to new lows.
  • Trade deficit is widening
  • Gold has crossed 800$+ and looks to reach 1000$ by 2008-2009.
  • Worst in housing is yet to come. 2008 will be ugly. Foreclosure rates will keep on increasing. Housing prices will slide in most parts of the country.
  • Financials will be posting alot more writedowns in 2008 than 2007.
  • Credit card companies and auto companies will be the next to suffer, once U.S. enters a mild recession.
  • Emerging markets are over-valued and might cool off.

Conclusion: All the above reasons makes me mid-term bearish.

Recommendations: Consider going short on homebuilders (CTX, HOV, SPF, LEN, BZH, DHI), financials (C, MER), retailers (M, MW, BIG), credit card companies (COF, DFS, CIT), others (SBUX, DSL, FED, FBN, AMIE). Consider going long on oil/energy (HAL, SLB, MRO), mining (LMC, SLT, RIO, CMP, POT, TGB), solar (LDK, ESLR, STP, WFR)

Disclosure: Short position in DHI, BZH, CTX, LEN. Long positions in FXP, LMC, SLT, EJ, LFC