Short Selling Ban, Part IV: Endangered Species...

During the past few years as the ETF menagerie was populated by increasingly unlikely and exotic creatures many investors never considered how the mechanics of the products they were purchasing would react to the kind of market stress we are facing today.

The Ultrashort Proshares Dow 30 (DXD) is a prime example. Many investors were taken aback today as they saw their leveraged short trade vehicle begin to positively correlate with the underlying index while options trading halt for the name –not realizing that they were receiving a special short term gain distribution due to the fact that DXD (as well as its ultra short siblings like SDS) are not actually holding short positions in the underlying securities, but rather are long OTC total return swaps that provide synthetic short exposure. As the system deleverages some of these winning trades held by these ETFs and others are being unwound and accrued interest is being realized creating extraordinary one time distributions.

I think that ETFS are an excellent way for investors to access the markets and I think that they will remain a popular product, but in the coming years I expect that some of the more exotic species that came to market during the boom will go the way of the dodo.

Andrew Barber

China: Burning Both Ends of Supply Rope?

China has been gaining leverage in sourcing product – that is well known. But now we see an investment in US retail -- perhaps the first step to own both ends of the supply chain?

Here’s a scary thought. Gottschalks (troubled West Coast-based department store chain) announced yesterday that it has received a $30mm capital investment from Chinese based Everbright Development Overseas, to establish an ‘exclusive sourcing and sales partnership’.

So let me get this straight… Values on marginal US assets are justifiably falling due to inability to maintain margin in an environment characterized by weak spending and rising imported inflation. At the same time, factory dynamics in China are dramatically changing in a way that is limiting capacity and giving the large factories long-sought-after pricing power. Then we see the Chinese use this leverage plus stronger FX to invest in said US assets after the initial margin hit?

Under the terms of the deal, Everbright will be issued 5.6mm shares, 29% of the total shares outstanding, and a $20mm convertible secured note that convert at $1.80 per share. In addition, Everbright can acquire up to 60mm shares of Gottschalks common stock at $120mm in cash if shares trade above $6 for more than 60 day and performance thresholds are met. This would be another $300mm payday.

Morgan Stanley: Where are the Evil Doers today?

MS is down -7% from its intraday high and down -3% on the day to $27.11. The stock is being sold by someone, and since John Mack, Chris Cox and Lloyd Blankfein have the shorts banned from playing the game, this leaves the objective mind to wonder who these sellers might be.

From a quantitative perspective, the stock looks like it can easily trade down to $19.18 again. The scariest thing about the Street buying into this evil doer short seller narrative is what happens next.

Now we all know why Goldman Sachs was trading down prior to the short selling ban – they needed capital to survive!

As MLK said, “a lie cannot live”.

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TED spread widening again today...

Below is a TED spread chart since beginning of August. This spread is widening this morning partly because Goldman Sachs is admitting that they need capital, and partly because the duration on the Paulson Plan fix is being pushed out to reality (i.e. not rubber stamped this week).

CNBC has this chart flashing on their screens more regularly now. From a sentiment perspective, this is a positive sign. The consensus fear associated with a psychological bottom is finally in motion.


Eye on Resolution and Trust...

On February 9, 1989 President Bush the first announced his plan to deal with the mounting fallout from the Savings & loan crises. His stated goal was to have legislation passed within 45 days, but the Financial Institutions Reform and Enforcement Act was not actually enacted until August 9th.

Today Paulson, Bernanke and President Bush the second are attempting to get a much more extraordinary piece of emergency legislation passed within a matter of days. This will be a very hard sell, irrespective of the fear mongering you saw yesterday and will continue to see tomorrow.

Investors do not trust this leadership.

Keith McCullough & Andrew Barber
Research Edge LLC


Outside of Stanley Ho’s guesthouse and private marina where several boats and yachts looked to be in pretty bad shape, Macau appeared to escape the direct wrath of Typhoon Hagupit. Unfortunately, we cannot say the same thing for the Guandong province which took a direct hit. But back to Macau, the early assessment is that the casinos and the projects under construction suffered no major damage. I had indicated yesterday that the construction projects were most at risk, but my Macau contacts said the developments survived relatively unscathed. Now if they could just get the visa situation fixed.

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.52%
  • SHORT SIGNALS 78.67%