The Nightmare Portfolio of 2009

Is it possible for an investor to be losing money in financial markets this year?

With an incredible amount of bad timing and wrong-headed conviction, you actually could have constructed a portfolio on Jan. 1 that would be deep in the red by now -- even as most stocks, bonds and commodities have rallied sharply.

Basically, if you bet heavily at the start of the year on some version of economic and market Armageddon unfolding in 2009 -- and you’ve refused to budge from that bet -- you probably are in a world of hurt.

Though I concede the year isn’t over, and it’s possible that financial Armageddon has only been deferred, here's my idea of the Nightmare Portfolio of 2009:

--- A long-term Treasury bond fund. As 2008 ended Treasury yields had plunged to near-record lows as some investors flocked to the relative safety of government bonds, fearing that the worst was yet to come for the economy and the financial system.

Bad move: Treasury yields began to rebound with the turn of the calendar to January, as the market focused less on the economic meltdown that was in progress and more on Uncle Sam’s massive borrowing needs. When yields go up, bond prices drop.

The 30-year T-bond yield, which fell as low as 2.52% in December, now is at 4.26%. The average total return for long-term T-bond mutual funds this year, according to Morningstar Inc.: a negative 11.6%, as the plunge in bond prices has more than wiped out interest earnings.

--- A bear-market stock fund. With the Standard & Poor’s 500 index down 38% in 2008, and the worst of the recession clearly ahead as 2009 dawned, bear-market funds had huge appeal as portfolio hedges. By using derivative securities or "short selling" strategies the funds are designed to gain if share prices slump.

That continued to be the right market bet -- until stocks hit bottom in early March, turned up, and, so far, haven’t looked back. The average total return of bear market funds year-to-date: a negative 32.3%, compared with the positive 20.5% return of the S&P 500.

--- A strong-dollar fund. If you expected the global financial system to fly apart in 2009 it would have made sense to bet on the dollar rallying, figuring that investors would turn back to the world’s premier currency as a haven. In fact, the greenback rose sharply in January and February as fears of calamity mushroomed.

But once stock markets began to snap back in March the dollar’s allure faded as global investors began to reach for risk again. This month the buck is sliding anew, deepening the losses of funds that bet on dollar strength. Case in point: The Pro-Funds Rising U.S. Dollar fund now is down 9.1% for the year.

--- A natural gas fund. Specifically, the U.S. Natural Gas exchange-traded fund (ticker: UNG). Who knew that, despite the resurgence of crude oil prices this year, natural gas prices would continue to plummet -- to 7 1/2 year lows by early this month?

But there may be hope: Even amid a continuing glut of gas and weak industrial demand, gas futures prices have rebounded 48% since Sept. 3, and the UNG fund is up 30% since then. That may not be much comfort to investors who bought in late last year or early this year, however: The fund still is off 49% year to date.

-- Tom Petruno

Image: The soundtrack from the 1998 movie. (The world was saved in that version, too.)

 

AIG chief offers 'hope' something will be left for shareholders

Another sign that the bulls aren’t willing to cede control of the stock market: Just a vague hint of encouragement from American International Group’s new chief executive today has sent the bailed-out insurer’s shares flying and helped pull up financial stocks in general.

From Bloomberg News:

Robert Benmosche, named this month as chief executive officer of American International Group Inc., said he expects the bailed out insurer will repay its debts to the U.S.

"At the end of the day, we believe we will be able to pay back the government and we hope we will be able to do something for our shareholders as well," Benmosche said in an interview in Croatia. "The government is working with us. They want us to do things that are very prudent."

He hopes to be able to do something for shareholders? In the same way that most people hope they’ll win Lotto?

AIG’s shares were up $4.74, or 18%, to $31.38 at about 12:10 p.m. PDT. It has the feel of a short-covering rally, which would make sense given that the number of shorted shares jumped from 13.1 million at the end of June to 24.6 million at the end of July. There are just 134 million shares outstanding after last month’s 1-for-20 reverse split.

More from Bloomberg:

Benmosche plans to rebuild the New York-based company’s profitable insurance operations as he seeks to repay the government bailout that was required because of losses on derivative contracts tied to subprime mortgages. He told employees on Aug. 4 that he won’t be pressured to sell assets to repay the government, and this week halted the auction of an investment advisory unit.

"My first charge is to get the company to operate at the level it used to operate, being the world’s best," he said. "The fact is we owe the U.S. government a lot of money and we are not going to be able to pay it back just by our profits, so we will sell some of the company off but only at the right time at the right price."

The insurer has announced about $9.3 billion in asset sales since its September rescue and still owes more than $40 billion on a Federal Reserve credit line.

The U.S. bailout includes a $60 billion credit line, an investment of as much as $70 billion and $52.5 billion to buy mortgage-linked assets owned or backed by the insurer. AIG agreed last year to turn over a stake of almost 80% to the U.S. in exchange for the bailout.

What, if anything, will be left for shareholders? Your guess is probably as good as Benmosche's at this point.

-- Tom Petruno

 

BofA stock hits 8-month high after ex-bear buys in

Mega-hedge-fund manager John Paulson, who correctly bet heavily against the banking system in 2007 and 2008, now has become one of its biggest fans.

Or at least he was in the second quarter, when he snapped up 168 million shares of Bank of America Corp. and large stakes in several other major financial firms, according to filings made public after markets closed Wednesday.

News of Paulson’s stake in BofA helped drive the stock up $1.07, or 6.7%, to $17 on Thursday, the highest closing price since Dec. 8.

BofA has soared 441% from its 2009 low of $3.14 on March 6, when some investors were convinced the Obama administration was planning to seize the bank.

Paulson, who heads New York-based Paulson & Co., is considered one of Wall Street’s savviest players. He is estimated to have earned $2.5 billion last year thanks to bets against financial stocks and subprime mortgage bonds. He began shorting subprime securities in 2007 using credit default swaps.

But in the second quarter, with many financial issues leading the stock market’s dramatic rebound, Paulson loaded up. Besides BofA, he bought into Capital One Financial Corp., Regions Financial Corp. and Fifth Third Bancorp.

His 168-million-share stake in BofA as of June 30 made him the bank’s fourth-largest holder. He would have been buying in the second quarter at prices between $6.82 and $14.17, the low and high for the period.

The problem for investors who are piggybacking on Paulson is that it isn’t clear whether he believes BofA still is a buy at $17. His firm isn’t discussing the investments.

BofA’s stock is up 29% since June 30, compared with a 19.8% rise for the average stock in the Standard & Poor’s index of 79 major financial issues.

A much more recent vote of confidence in BofA came from Sallie Krawcheck, who was hired last week to head the bank’s global wealth and investment management unit, which includes Merrill Lynch’s army of brokers.

The 44-year-old Krawcheck, well known on Wall Street and most recently head of wealth management at Citigroup until last fall, bought 63,000 BofA shares Wednesday, according to a required filing she made Thursday with the Securities and Exchange Commission.

She paid $15.96 to $15.98 a share for the stock, for a total of just over $1 million.

But really, the only surprise would have been if Krawcheck hadn’t purchased a chunk of BofA shares to show her support, given that she’s an outsider landing in a position that could put her in line to succeed CEO Ken Lewis.

-- Tom Petruno

Photo: The BofA Tower in Charlotte, N.C. Credit: Chuck Burton / Associated Press

'Short sellers' fled the market in July; we may miss them

Stock market "short sellers" rushed to close out their bearish bets in late July as share prices surged, new data show.

That rush helped drive the market’s powerful advance, just as many analysts had suspected at the time.

The bad news: The removal of so many short bets in a two-week period also quickly burned up potential fuel for a continuing rally.

The number of shorted New York Stock Exchange-listed shares plunged to 14.03 billion as of July 31, down a steep 10.3% from the 15.64 billion shorted as of July 15, the NYSE said today.

That marked the biggest percentage drop since the 13.4% dive in the second half of September, when the Securities and Exchange Commission stunned Wall Street by banning short selling of 800 financial stocks.

In a classic short sale, a trader borrows stock (usually from a brokerage’s inventory) and sells it, expecting the market price to decline.

If the stock drops, the trader can buy new shares later at a lower price, repay the loaned stock and pocket the difference between the sale price and the repurchase price.

If the stock rises, however, short sellers face potentially unlimited losses until they buy back shares and close out their bets.

The plunge in shorted NYSE shares in late July shows that many bears were scrambling to get out of their trades as optimism blossomed. Better-than-expected second-quarter corporate earnings reports just made life tougher for the shorts.

Their buying to close out their positions added to the market’s momentum: The Standard & Poor’s 500 index jumped 12.3% from July 10 to July 31.

The number of shorted shares also fell at Nasdaq, but not as steeply as at the NYSE. The total Nasdaq short position declined to 6.78 billion shares as of July 31, down 5% from 7.14 billion on July 15.

-- Tom Petruno

Photo: No wonder he's angry. Broady the Bear from "Grizzly Park."  Credit: American World Pictures

CVB Financial, facing doubters, gets OK to repay TARP

CVB Financial Corp., an Inland Empire-based banking company that has been battling "short sellers" who are incredulous about its financial health, said late Monday it got U.S. permission to repay the capital infusion received under the Treasury's TARP program last December.

CVB, parent of Citizens Business Bank, said it would make good on its promise to use the proceeds from a stock offering in July to return $130 million in capital from the Troubled Asset Relief Program.

The bank's shares, which closed at $8.21 on Monday before the announcement, have jumped 40% since the company sold 22.7 million shares at $5.85 each on July 21.

The rebound has confounded short sellers who have bet heavily this year that the Ontario company, with $6.4 billion in assets, would collapse under the weight of bad real estate loans. The number of shorted CVB shares -- stock borrowed and sold, in a bet that the price would fall -- hit nearly 19 million shares in mid-July, up from 12 million in mid-March.

The latest shorted total was equivalent to almost 18% of the company's outstanding shares.

Short sellers have targeted CVB in part for its exposure to Inland Empire real estate loans, expecting credit losses to eventually wipe out its capital -- the recent fate of two of its rivals, Temecula Valley Bank of Temecula and and Vineyard Bank of Corona.

But CVB has so far defied its detractors. The firm reported earnings of $29 million in the first half of the year, down a modest 13% from a year earlier. Problem loans edged up just $3.2 million, to $51.3 million, as of June 30 compared with March 31, the bank said in its second-quarter report.

Chris Myers, CVB's chief executive, said in a recent interview that the company was "really disappointed at the number of short sellers in our stock." He said that although investors perceived the bank to be heavily involved in Inland Empire property lending, just 22% of the firm's total loans were in the Inland Empire. The rest were spread among Los Angeles and Orange Counties and the Central Valley, Myers said.

Some short sellers have expected the bank to renege on its pledge to repay TARP capital, and instead hold on to the cash from the stock sale to offset further loan losses.

But CVB said in its statement Monday that, with U.S. permission now granted, it "intends to complete the [repayment] as soon as possible."

Myers said one reason CVB wanted to return the TARP money was to escape the business and financial restrictions that all banks have faced under the program -- including limits on stock buybacks.

The ability to repurchase shares "is leverage for us" over short sellers, Myers said, because buybacks could offset pressure on the stock from further shorting.

-- Tom Petruno

'Short sellers' in SEC's cross hairs as it votes new rules

The Securities and Exchange Commission today announced plans to shine more light on "short selling" of stocks and to make permanent a rule change aimed at restricting so-called naked shorting.

Still on the agency’s table are much weightier issues -- including whether to bring back the "uptick rule" as a way to curb potential short-selling abuses.

Short sellers typically borrow stock from a brokerage’s inventory and sell it, betting the price will drop. If the market price declines, the shorts can later buy stock in the market, replace the borrowed shares and pocket the difference between the sale price and the repurchase price.

Although shorting is perfectly legal as long as traders follow the rules, the shorts got blamed last year for worsening the collapse of many financial stocks. That fueled Congress’ ire and triggered the SEC to take the unprecedented step of temporarily restricting shorting in hundreds of financial issues.

Since then the agency has been under intense pressure from Congress to do more to rein in abusive shorting.

"Today's actions demonstrate the commission's determination to address short selling abuses while at the same time increasing public disclosure of short selling activities that affect our markets," SEC Chairwoman Mary Schapiro said in a statement. The full text of the agency's announcement is here.

In one new move the SEC said companies and investors would be able to see the aggregate volume of shorted shares for each individual stock each day. That would let a company know if bearish bets on its shares suddenly were rising. The New York Stock Exchange and Nasdaq currently disclose twice a month the total number of shorted shares for each listed company.

In another decision, the SEC voted to make permanent penalties it imposed last year in cases in which short sellers sell shares they haven’t yet borrowed and then are unable to promptly deliver the stock to the buyer. The penalties are imposed on the brokerages that short sellers employ for their trades.

Shorting without first borrowing the stock is known as naked shorting. For reasons related to normal market function, the practice isn’t illegal. But the SEC imposed the prompt-delivery rule last year to keep short sellers from driving down a stock’s price without any intention of actually borrowing shares for sale.

Since the rule was put in place the number of cases in which traders failed to deliver shares has tumbled 57%, the SEC said. That presumably means that many abusive short sellers were pushed out of the market (although not everyone is so convinced).

Lastly, the agency still hasn’t decided whether to bring back the "uptick rule" as a way to further limit the potential for abusive shorting.

The rule historically had been a barrier to rampant short selling by banning short sales on "downticks" in stock prices. Instead, a short seller would have to wait for a stock’s price to move up at least slightly before shorting it. The idea was to prevent a cascading effect by short sellers that could drive a stock mercilessly lower (a so-called bear raid).

The SEC got rid of the rule in 2007 after finding that it hurt liquidity in the market (by keeping some traders away) and wasn’t necessary to prevent manipulation of stocks.

But the uptick rule still has a special place in the hearts of investors who hate short sellers and want to make their trading as difficult as possible.

-- Tom Petruno

Photo: SEC Chairwoman Mary Schapiro. Credit: Jay Mallin / Bloomberg News

As hopes rise, altitude sickness sets in for some stock bulls

Have those economic "green shoots" already grown into a rose garden? So soon?

Stocks today surged worldwide after the government wrapped up its "stress tests" of major banks, and on news that net U.S. job losses in April were smaller than expected (though still huge, at 539,000).

Investors who wouldn’t go within two miles of a bank stock a week ago today found them irresistible.

Case in point: PNC Financial, the big Pittsburgh-based lender. Last week the stock plunged 12.5% as some investors backed away ahead of the stress-test results.

Today, after regulators ordered PNC to raise a relatively modest $600 million in fresh capital, the stock rocketed $8.61, or 19%, to $53.08. Its gain for the week: 40%.

How could the market get it so wrong on PNC last week? Or is it getting it wrong this week?

On the heels of the stress test results, all 24 bank stocks in the BKX index of major lenders rose today. The index jumped 12% and was up 36% for the week.

The rebound in the banks has the scent of "short covering" by bearish traders, but that can’t explain it all. There is, of course, legitimate optimism in the stock market as economic data continue to come in better than expected -- or at least, less worse than feared.

The employment data suggest that "the economic downturn has hit bottom and the recession is all but over if it is not over already," said Christopher Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi in New York.

If he’s right, the stock market has done its job: The spectacular rally since March 9 has told us that the world wasn’t ending, even though, early on, few investors believed it.

The Dow industrial average rose 164.80 points, or 2%, to 8,574.60 today, bringing its gain for the week to 4.4% and its gain since the 12-year low on March 9 to 31%.

The broader Standard & Poor’s 500, up 2.4% today, has surged 37% since March 9.

The story is much the same, or better, around the globe. Measured from their March lows, the German market is up 34%, Brazil is up 42% and Hong Kong is up 53%.

True, stocks remain far below their record highs of 2007. Even so, for some bulls, altitude sickness is beginning to set in.

"I’m actually getting nervous here," said Larry Adam, investment strategist at Deutsche Bank Private Wealth Management in Baltimore. "I think we’ve come too far, too fast."

Steve Hochberg, chief market analyst at Elliott Wave International in Gainesville, Ga., was pounding the table for stocks in early March, predicting a "huge bear-market" rally -- in other words, a short-term rebound, but a big one.

Now, he believes the rally is "maturing." He notes that a daily Wall Street poll of short-term traders shows 80% are bullish, which he says is "the most extreme reading since October 2007" -- the month the market peaked.

Yet even those analysts who are advising caution concede that they may be too early. What we don’t know is how many investors and traders remain poised to rush into stocks after even a modest pullback.

With 2009 and 2010 corporate earnings just a huge double question mark given uncertainty about the economy, it’s sheer emotion, not fundamentals, that is driving the market.

And in that kind of environment, anything can happen . . . and probably will.

-- Tom Petruno

Post-stress test, bank stocks hit the afterburners

The only stress some bank-stock investors felt today was from being unable to buy in fast enough.

Financial issues rocketed as major banks met with early success in their efforts to raise capital following the less-onerous-than-feared results of the government’s stress tests.

Wells Fargo & Co. and Morgan Stanley raised a collective $15.5 billion this morning in stock and debt sales amid robust investor demand. Regional banks such as Fifth Third Bancorp in Ohio soared on analyst upgrades and expectations that they’ll also be able to raise the mandated capital.

Wall Street clearly was thrilled that the financial industry found private investors eager to provide new financing, a crucial first step toward eventually weaning the banks from government assistance.

"The biggest sense of relief is that there are sources of private capital and ready sources of private capital," said Nancy Bush, an analyst at NAB Research in Annandale, N.J.

Just as important, some professional investors increasingly are worrying about being left behind as the financial-sector rally keeps going. The BKX bank stock index surged 12% today, bringing its advance since March 6 to 135%.

"Everybody feels, ‘I just missed a four-bagger on Bank of America-- I have to get in,’ " said Joshua S. Siegel, managing principal at StoneCastle Partners, a New York asset-management firm specializing in bank stocks.

Half of the 24 stocks in the BKX index rose more than 10% today. Fifth Third zoomed 59% and Huntington Bancshares soared 34%. Wells Fargo rose 14% and JPMorgan Chase added 10.5%.

Dave Rovelli, head of trading at brokerage Canaccord Adams in Boston, said he believed much of the buying today was by "short sellers" covering their bearish bets, and by day traders looking for a fast buck.

As for long-term investors, "I think you’d be crazy to get into the banks at these levels," he said.

Bush and Siegel, too, fear investors are getting ahead of themselves, given that the banking sector still faces daunting obstacles, including mounting commercial real estate woes and credit card defaults.

"It’s gone from a meltdown to a melt-up," Bush said. "We don’t know when normalized earnings are going to get here. Probably not until 2011 or 2012. Wall Street is doing what Wall Street does, which is justify a move after the fact."

Jim Glickenhaus, portfolio manager at Glickenhaus & Co. in New York, agrees that "we are ahead of ourselves and we’ve been ahead of ourselves for a couple of weeks," referring to bank stocks in particular and the market in general.

"Having said that, you can never tell what the public’s going to do. It can keep going up from here."

-- Walter Hamilton and Tom Petruno

Photo: What the bank rally felt like today. Credit: European Pressphoto Agency

Bank bears flee as the stocks soar ahead of 'stress' results

If the torrent of leaks on the big-bank "stress tests" was aimed at somehow hurting the banks, it has had the complete opposite effect.

If the leaks were meant to skewer traders who have "shorted" bank shares -- betting on lower prices -- they’ve worked beautifully.

Bank stocks rocketed today on the latest stress-test rumors, in what many analysts described as a massive short-covering rally: Traders who had borrowed bank shares and sold them, expecting the stocks to plunge again, were rushing to buy and close out their trades as prices surged.

"They’re taking the shorts out feet first," said Jon Najarian, co-founder of trading firm TradeMonster in Chicago.

Overnight, it looked like Bank of America Corp. would lead a sell-off in bank shares today, on media reports that BofA would need to address a capital shortfall of up to $35 billion when the government announces stress-test results on Thursday.

Instead, BofA soared $1.85, or 17%, to $12.69, bringing its three-day advance to 46%.

The market already knew that the government wasn’t going to allow any of the major banks to fail. Now the verdict seems to be that, whatever the institutions have to do to bolster their capital, it won’t result in the kind of stock dilution that would warrant another crash in the common share prices.

Naturally, the banks rumored to be healthy enough not to need more capital also were up big-time today -- including JPMorgan Chase, up $2.40, or 7%, to $37.22; and Bank of New York Mellon, up $3.05, or 11%, to $30.46.

Trading volume in the bank stocks was heavy, another sign of capitulation by the bears, Najarian said.

BofA traded 920 million shares, up from 551 million on Tuesday. And trading in BofA call options (bets on a rising stock price) also soared, Najarian said.

Wells Fargo & Co., which surged $3.62, or nearly 16%, to $26.84, traded 256 million shares, more than double last week’s daily average.

Citigroup jumped 55 cents, or 17%, to $3.86 on volume of 862 million shares.

For a taste of what has happened to the short sellers, check out the Direxion Shares Financial Bear exchange-traded fund, which is a bet on falling financial-stock prices. The fund dived 20% to a new low of $5.24 today.

-- Tom Petruno

Photo credit: Justin Lane / EPA

'Sell in May and go away' idea haunts stocks' spring rally

For some Wall Street denizens, the idea of a May Day march is a time-honored tradition: March right out of the stock market on May 1 and don’t come back until Nov. 1.

This is the famed "sell in May and go away" investment strategy. It’s based on the market’s historical tendency to post much bigger gains in the six-month period of Nov. 1 to April 30 than in the other half of the year.

On average over the last 58 years, the Dow Jones industrial average rose 7.6% from Nov. 1 to April 30, according to the Stock Trader’s Almanac.

The average gain in the May 1-to-Oct. 31 period, by contrast, was a mere 0.6%, a number dragged down by the many steep sell-offs in the period over the years.

Obviously, the strategy doesn't always work. Nor is it practical for most investors who still have long-term time horizons. But this time around, market bears believe the seasonal issue is at least a good reason to eschew chasing the spring rally.

Joe Saluzzi, a principal at Themis Trading in Chatham, N.J., says investors ought to do a reality check: The rally has lifted key market indexes between 25% and 50% since March 9, "But ask yourself, what has changed?" he says.

He concedes that some economic indicators have been less dire than in preceding months, but says there is no sign that a true recovery is at hand.

Perhaps more worrisome, Saluzzi says, is the mindset of many of the buyers whom he sees pushing stocks higher. "The problem is that this now is a momentum market," he says. "The money coming in is from aggressive traders, not the buy-and-hold investor."

Momentum traders don’t care which way the market is moving, he notes; they’ve been buying over the last eight weeks because the trend has been up, but they’ll be "shorting" stocks as soon as the trend reverses, Saluzzi says.

And when it does, "I see nothing to tell me that we aren’t going to retest the market lows of March, or even go lower than that," he said. . . .