A Long Overdue Correction In Process

I dramatically unwound my portfolio today.  If you want to see the exact steps I took, just look in the comments section of my last post.  As of right now, I am one large batch of NRP away from being margin free.  Since today was the dividend report day I was waiting for, I will almost absolutely sell out tomorrow.  I was betting on another small run up after what I view to be a “hard line monetary policy” bailout of Greece.  The bet worked decently in TLP.  Not so much here.

In general, having betted on a correction for almost the entirety of last month, seeing this plunge down is nothing less than frustrating.  I thought I had finally gotten my mind wrapped around this thing, but, there you have it.  Sometimes, you’re wrong no matter what you do.  The last couple of weeks have that kind of feel to them.  At any rate, I’m down from 25% year to date gains and back into the single digits, predominantly from the shipping companies I’ve accumulated, betting on a sustained global recovery.

There are many kinds of short squeezes, but none seem so brutal as a dollar short squeeze.

At present, $75.5 billion of our national debt is held by Ireland, Spain, and Italy.  This is a severe step down from the amount of our debt that was being held on the other side of the year by these three.  Therefore, on the first level, the default of one of these countries could, directly, spark only as much of a sale as 2.4% of our gross debt.

On the next level, the question becomes, how much do our larger European debt holders depend on these three countries, plus Greece, and Portugal, for premium and interest payments, and to what extent do those payments effect their purchasing our bonds?  We know that Germany banks are large holders of Greek debt, for instance.  I would presume the same holds true for other European countries.  As of right now, I can’t answer that question, as I didn’t have the time today to look for the answer.  I would suspect that many others are in the same boat.  Hence, the panic that we’re getting in the market right now…

However, I would like to lay out a series of scenarios and establish my plan for each one.

The first is what happens if other major European countries begin to default.  In such an event, I see extreme pressure being placed on France and Germany to cave and devalue the euro.  In such an instance, the environment would become strikingly similar to European companies as it has been in the U.S. over the past year and a half.  The one exception being I believe our treasuries would be in higher demand there than European treasuries have been here.  I feel that this step would then hinder the U.S. stock market by enabling cheaper exports from Europe.

If Germany and France refuse, then I see broad austerity measures similar to the ones in Greece being implemented across Europe, although hopefully without the rioting.  In such an instance, we are going to see two things happen: European companies will be dragged down and, again, our treasuries and notes are in high demand.  However, in this case, our companies are also instilled with a distinct advantage thanks to a still strong euro, and so, I think the stock market will go higher in such an outcome.

The second event is what could happen if European countries don’t default, or at least try to fight it, and I think this could be worse for us, if you believe that.  You see, one outcome is that sudden demand for financing in Europe causes pricing to be issued in such a way that all financing is attracted to those distressed countries, effectively drying up the corporate and municipality auctions.  If this happens, that’s when I believe we start to see state governments and some more major corporations defaulting.  Imaging the desperation of the last Greek auction, but compounded by two or three of the world’s largest developed countries.  I imagine this is the nightmare that’s got the market places so spooked at the moment.

That being said, I recommend keeping some cash on hand.  I’ve been advising my friends to hold 20%, in case of a run down.  I intend to hold 10%, but then, I have secured lines of financing and such, which can be implemented.  Also, some of my stocks, like MO, have basically been taking this turmoil to the chest without so much as flinching.  I’m comfortable.

Long term, I still like holding equity on the heavy side.  Ultimately, in every one of these outcomes with the exception of a euro devaluation, I see our government stepping in, when the time comes, and monetizing the debt.  If there’s one thing I’ve observed over the years, it’s that Keynesians are a one trick kind of pony.

Be prepared for a run down, but if you get sucked into the vortex and can hold off, I think you can have faith that within a year prices will return to where they are right now.  Off course, that would mean missing out on a buying opportunity, but you need to do what’s right for you.

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Contagion (con·ta·gion, pronounced \kən-ˈtā-jən\, function noun)

1.  
   1. a contagious disease.
   2. the transmission of a disease by direct or indirect contact.
   3. a disease-producing agent (as a virus).
2.  
   1. a terrible, shapeless demon that devours the wealth of perfectly healthy nations for no apparent reason.

Let’s be clear and start off by saying, I am not mocking those who believe a contagion may take place across the European continent.  Nor am I mocking anyone who is concerned that such disastrous events could potentially spread here.  I am far more subtle than that.

I am not saying that a contagion will not take place.  I am saying, however, that over half of you have absolutely no idea why one would.

Throughout the day, I was so blessed as to watch dozens of infanticide prone maniacs leaping through the internets shouting “boo!” at anyone who would listen.  I can only hope that no new investors were so naïve as to permit these serpents to slip the knife in their backs.  However, judging by the markets bloodbath, I would chance a guess and say that lots of people flipped shit and panicked today.

This is precisely why I so dislike the word and it being used.  Can anyone of you come forward and tell me why the default of Greece is destined to spread to the rest of Europe?  Can anyone of you tell me that some of the other European countries weren’t already doomed to face a funding crisis, before Greece started the party off?  Can anyone of you even tell me exactly what is going to happen to create the contagion effect?

No, I doubt many of you can.

So let me give you a quick lecture as to what exactly is occurring here and the potential outcomes (I say potential because nothing is certain, and much depends on the actions of people who are presently engaged in inaction, particularly Germany and France).

If you are already familiar with the phrase, or just aren’t interested in biblical styled narratives, by all means, stop reading and continue with my next post tomorrow, which will be far more analytical, I promise.

Now, for the young or new investors, a parable:

Once, there were five friends who lived together in a distant land.  Their names were Camriae, Refnac, Myegnar, Pisan, and Ecreeg.  Although of amicable relations, they were not of the same body or mind. 

Refnac was of an arrogant disposition and kept mostly to himself, providing his own needs and maintaining such preserves to hold him through hard times.  Myegnar was a great laborer, and worked tirelessly to create things for the comfort of his living.  And of the five, the three that were most alike in nature were Camriae, Pisan, and Ecreeg, whom labored only enough to claim they had, and enjoyed the spoils of life beyond their ability.

One day, a pestilence descended upon the land, and all the woods around their abodes withered and died, so none could gather freely from the produce of the earth, and each had to them only what they had saved or kept in their care.

So the three friends came to Myegnar, the only who had more than enough, and said, “Give to me some sustenance for my body and mind, or else I will surely perish.”

And Myegnar, being moved, gave them each a little.  The three departed his home, but before they had gone half way, they had each eaten their share already, and began to remorse.

And Camriae, being the first to finish, turned around and went back to Myegnar and begged him to depart with a little more, so that he might survive, and promised to repay, when things became better.  So Myegnar gave more, and Camriae returned home.

Next came back Pisan, who said, “Myegnar, can you not see I’m hungry.  Give me more food, or I will die.  You can’t possibly want that?”  And Myegnar, moved by guilt, departed with more of his wares.  And Pisan returned home, with promises of repayment behind on his lips.

And, finally, Ecreeg, the most ravenous of them all, returned to Myegnar and demanded, “Give me more food!”  But Myegnar, looking into his stores, realized he had given too much away, and could offer only scraps.  Ecreeg left with nothing.

And so, Ecreeg went to Camriae and Pisan, and demanded a share of their borrowed food.  And each separated with a fraction of their own, agreeing they would return to Myegnar’s home the next day; for Ecreeg, being crafty, hadn’t told Camriae and Pisan that Myegnar had no more to give.

And then, Ecreeg ate all that had been given him, and kept nothing, and within a month’s time, he would starve to death.

The next day, Camriae and Pisan returned to Myegnar, who was being consoled by Rafnac for his loss at the hands of those dearest to him; and when they saw those two enter with beggars hands again outstretched and realizing repayment would never be possible, because they would all perish if the status quo continued, he and Rafnac became angry and sent them away, without anything.

Because they had nothing to give, and would give nothing if they could.

That’s basically a contagion in a finite security market.  There’s a lot of borrowing, and then, suddenly, one country can’t make due or everyone needs more than what can be supplied, which puts into speculation the well being of every country that engaged in debt transactions with them.  Pretty quickly, cash flows between the countries seize up or default, and everyone gets driven into the ground as their spending continues onward without the cash flow to back it up.

This has already gone on long enough, so I will leave it at that for tonight.  Tomorrow I will comment on the inter-functioning of our countries and actually give my reasoning for why I’m not too concerned about a contagion and, again, why ultimately I think European dilemmas will assist our equity markets.

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Today, I made good on my word and sold half of my position in GKK for $2.37.  Although certainly in hindsight it is apparent that I should have held off until later, the fact is my bet is stacked so it won’t matter, in the long run.  Either GKK falters and I lose three quarters of my investment, or GKK endures, and it’s a race to $10.  Either way, quibbling over pennies is not a productive use of my time at this point.

It came into my mind today to restructure my portfolio and begin a meaningful attempt to unwind.  Therefore, I took several actions.

I sold runoff of my MO position at $21.26 for an average gain of 24% before dividends.

I sold one third of my TLP position for $29.16.  Those shares can be traced to the price of $28.96, a gain of less than one percent, but with a 2% dividend now guaranteed, to be payable this month.

I sold my entire ASR position at $55.96 for a 6.1% gain.  I don’t believe I’ll receive any dividends from this stock.  However, I became uncomfortable with ASR’s poor accounting practices.  I have no desire to mess around with black boxes in third world countries.

After this decisive round of unwinding, I then backtracked a little and bought more NRP at $24.56 a share, for a trade.  Dividend reports are collected this Wednesday, May 5, and after I will hold the shares until I can get five percent from them.  I like NRP enough to hold, even if a downturn unforeseeably extends my plans.

Meanwhile, the rest of my portfolio ran considerably higher today.  I’m holding MGM, MO, NM, NMM, NRP, TLP, and VZ, in addition to two now very small positions of GKK and FTK.

In addition to equities, I’m considering making another round of silver purchases in a week or so, if things hold up.  At present, I hold a sizable amount of bullion at my home, and would very much like to add one third to my holdings before silver touches $20 per ounce.

Now, ladies and gentlemen, I’m off to have dinner.  You have my best wishes.

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As indicated by the date of this post, I have been awake for many an hour over this past weekend, reading deep into shadowy paperwork such that would make lawyers cringe. My subject of interest: none less than one Gramercy Capital Corporate. Let me start by saying, there is a story here, in all of this; one that could very well be made into a book, when all is said and done.

The stock price tanked twenty percent on Friday, and at first, I was quite baffled as to why. There was seemingly no news to be found, and so I guessed that some larger institutional holder must be unwinding. However, I am rarely satisfied with hypotheses that have no basis, and so, I continued to look out.

Houlihan Lokey is an investment bank that began, during the late eighties, to specialize in handling companies with distressed situations, by advising them in bankruptcy proceedings or bankruptcy alternatives. Their financial restructuring group is one of the best in the country, if not the world, having advised the bankruptcies of Lehman Brothers, Enron, WorldCom and Conseco. I believe they had a hand with GM as well.

As it stands, GKK has roughly just under $6.8 billion in assets. They have an associated, rough estimate of $6.2 billion in liabilities. That puts the shareholder value at just over $550 million. Assuming all favored ownership contracts are converted to standard ownership titles and you can see that the shares are, even now, worth more than $10. That’s after all the shit their CDO portfolio has been taking, with so many of the products being at present written to $0.

Even with Bank of American deserting a large portion of Gramercy’s rental space, continued losses from their loan portfolios, and a looming threat of interest rate hikes, all indicative of continued negative cash flow, the amount of long term damage that can seemingly be done is, at less than $3 a share on today’s exchanges, presumably minimal, you would think?

So what’s the problem? In as few words as possible: Goldman Mortgage Loan. Actually, it’s two mortgage loans, from Goldman Sachs, Citigroup, and a couple other sources, valued at $241.3 million and $553.5 million. These loans, which represent barely less than 12% of all assets, and not even 13% of all Gramercy’s liabilities, set to expire by March 2011, have the ability of completely sinking the company.

How is this possible, you might ask? I know I did. The answer has to due with the nature of mortgage backed securities and, specifically, how these two loans were financed. You see, these loans are not, apparently, backed by any specific property. Rather, they are backed by what I ascertain to be a pool of every property the company owns. Hence, any one of their creditors, however minimal, at the event of default, has the ability to force foreclosure of their entire operation.

Which brings us to the apogee of this little story. You see, Gramercy typically finances itself using a system of CDOs and CMBSs. However, as we’ve all seen, markets for these types of debt financing are, at present, taboo. Thus, GKK has been left to resort to standard debt and equity offering. If you’ve seen their share price lately, or their short term debt maturity levels, then you know this isn’t particularly helpful. But, by itself, it isn’t completely material. Ideally, the company just needs to unwind heavily, leaving behind the five hundred and fifty million of shareholder value in the process.

Unfortunately for Gramercy Capital Corporate shareholders, Goldman Sachs and Citigroup have detected weakness.

They seem to be refusing to restructure the debt, and are demanding repayment by maturity, which means a fire sale of assets would be the only way to repay in time. The haircut that a real estate based company would take in this market is more like a decapitation. And default ends in exactly the same way. So, they are effectively using next to zero exposure as sufficient leverage to force the company into bankruptcy, where, I gather, they will attempt to seize a disproportionate amount of the company’s assets while wiping out as many of the shareholders as possible.

I am not looking forward to the coming months, where this stock is concerned. Although my exposure to GKK was only a couple percent of my portfolio, it is a couple percent I don’t want to lose. I will be taking steps, at the first opportune moment, to let go of half of my shares. I’m going to keep the other half, in a fit of denial that the bankruptcy option will be exercised or at least the hope that the subsequent trial will be light on affliction to shareholders. If the company should weather the storm, and go to fair value, then I will break even. If things turn south, at worse I’ll lose a conservative estimate of 75% my original investment (I’ve already lost half). I suppose that’s indefinably better than getting completely wiped out.

However, Houlihan Lokey being forced onto Gramercy by the banks is an ominous sign. While my head tells me that restructuring this company should be a viable option, my heart tells me that we are now long past such simple reason. The men of Goldman and Citigroup are armed, their spears sharpened, and they are looking for blood. Houlihan Lokey is a warning shot. If I were you, I’d stay the hell out of the way.

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As many of you know, today marks the end of my month as King of the Peanut Gallery.  I would like to sincerely thank each and every single one of you for being loyal readers and giving great feedback.  Even if some of you have not agreed with me all of the time, you have been great to interact with here.

At the risk of repeating myself from last night, I would really appreciate your support in my candidacy to become a tabbed blogger on iBC, whenever The Fly chooses to hold an election.  I have worked extremely hard these past few months to add value to your trading strategies and market outlook.  I think iBC is a terrific website with great prospects, and I think I have earned the opportunity to help contribute to that.  Of course, without you guys, none of that would be possible.  So, again, THANKS!

The $SPX closed down 1.67% to finish at 1186 today, as the bulls lost the initiative from yesterday’s rally.  Not only did the bulls give up the psychologically important 1200 level, but we are now below the 20 day moving average yet again.  Moreover, the bearish volume on the down days has been consistently overpowering the bullish volume on the up days for quite some time now. We closed today not only on the session lows, but also near a key support level at 1185. If we lose that price next week, I expect that to inspire even more selling.

As I discussed last evening, one indicator worth looking at is the RSI, at the very top of the chart above.  Bull markets typically stay above 50 on the RSI, with 70 being an overbought reading.  If the RSI drops below 50, as it did in late January and early February of this year, it is usually in the context of a fairly sharp correction–more than a mere 2-3% pullback.  In our current market, we bounced off of the RSI 50 level the past two days, only to close slightly below it today.  Keep an eye on that 50 level next week, to see if we continue to weaken below it. As far as the other indicators are concerned, the MACD is sloping downward and giving a clear sell signal, and the stochastichs are signaling a bearish bias as well. Please keep in mind that these indicators are far from conclusive, but they are useful instruments to get an idea of how robust the market internals are.

My daily updated chart shows that we are still working our way through a broadening channel, which is basically the reverse of a symmetrical triangle.  This pattern, especially after a strong rally, is often referred to as a “megaphone” because of the higher highs, but lower lows.  The pattern reflects the increased volatility and struggle in the marketplace between the bulls and bears. Usually, the megaphone is a bearish topping formation and is ultimately resolved sharply to the downside.  After a strong move up, bulls want to see a quiet period of consolidation.  However, what we are seeing now is anything but quiet and orderly.

Thus, my short to intermediate term bets have become more bearish.  I added more short exposure today in the form of $QID and $SKF, shorting the technology and financial sectors.  I still have a very large cash position, and my top long is the stellar $SWHC. Keep in mind that my short exposure is less than 17% of my overall portfolio right now, so I am not advocating an all-in short strategy.  I am merely placing some money where my analysis is, given the charts above.  Anecdotally, I am seeing many traders who have become so accustomed to buying the dip that it seems as though they have ruled out the possibility of a steep correction. Given the evidence that I see thus far, more caution than that is warranted.

I may post something else later this evening, but I would like to leave you for now with something that I have been thinking about lately. Never call yourself a bull or a bear. Being a trader is the only label that you need.  Sure, you can place bearish or bullish bets at any given time, but you should allow yourself the mental freedom to change your mind at a moments notice, if your analysis tells you to. There are no awards for Bull of the Year, nor for bears, so just focus on making money based on the market that you SEE, not the one that you want to see.

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I made a video just now for you, which should put the broad market into context on a relatively short time frame.  CLICK HERE

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