Lordrobot (89.73)

Suicide short sellers air supply almost gone

September 21, 2008 – Comments (5) | RELATED TICKERS: MS , GS , C

A lot of conversation has followed about the Naked Short sellers into the markets. Nobody can explain the new oddly aggressive shorters. Their trades don't make sense. I would call them suicide short sellers. Some have suggested terrorism is behind the shorts. Some Russian hedge funds are speculated to be linked with Middle Eastern or Persian money. One hypothesis that has not been presented is that many small investors may be mindlessly shorting stocks through their brokerage houses from their terminals at home. That would be a frightening thought, millions of minnows tearing the flesh off a cow. In some ways this reminds me of the Caps game.

How to game the caps game is to be a suicide short seller. At the end of every rally, you climb onto your caps page and start listing companies to short. The common knowledge is that in down markets that at least 90% of rallies are met with a sell off. When does it stop? Well nobody knows that but when it stops it kills the suicide short seller and it kills them fast. If you look at our marvelous caps game, you will note that there has been some shifting of the top players down the ladder. Most of these players falling from grace, are the ones that have icons attached to their blogs of hooded images of Death with a cycle or some other evil druid symbolism. They are suicide short caps players.

The big question is whether we have had so many short sellers and such negative market sentiment that the market pattern will shift to one of a rally following every decline with moves to the upside. I can't predict that but I know one thing, there are a ton of shorts in the market that have not cleared, hoping for some down stroke to clear. They have been hurt so badly in the last two days, they are scared. Many of the radical shorting hedge funds will go broke.

I have implied that the suicide shorters have thrown fundamentals to the wind and are just shorting for short sake. This is irrational anti-exuberance. I think they are going to get destroyed in the financials and across the board. 

The stupidest example of shorting last week was Goldman Sachs. Why would I say this? The press clearly doesn't like the investment banker model. It wants a Bank linked to a Broker model. So the suicide shorts attacked Goldman and Morgan. Morgan quickly cried uncle and started talks with Wachovia. Goldman said essentially they would pass on the opportunity to own a bank. So the suicide shorts got their question answered with a Yes and a No. Both Goldman and Morgan stock price went up. Of course that makes no sense if you buy into the new saw that "every broker needs a bank" theory. Goldman should have gone down on short seller conviction alone.

We know the suicide short sellers are not very bright because they never looked at the underlying structure of Goldman. Goldman's float represents a mere 12% of the Goldman partnership. Thus, 88% of Goldman is not owned by shareholders. The book value of Goldman stock exceeds twice the current price. Goldman has assets in excess of 1.3 trillion dollars. The shorts are still sitting in this stock, hoping and praying for a sell off.

On a day like the last two, the short sellers were so busy trying to clear their shorts that they had to clear the emergency stocks first. By clamoring for Morgan to meet their model expectations, they accidentally triggered Wachovia and Washington Mutual to a massive rally and they had to get out of there which left a large number of shorts in Goldman and Morgan at market close. It is a disarray giving some credence to my minnows attacking a cow theory. This happened because they had more pressing matters; the shorts were getting the crap kicked out them. At the end of the first day rally, they shorted again only to be buried then next day. But now clearing suicide shorts out of Goldman and Morgan may be a problem. Especially since Morgan really don't seem to want to merge with a bank either. So now what?

The bailout plan calls for the treasury to purchase bad debt to be sold off by trading firms. It is actually a rather brilliant plan. The traders will manage the portfolios and eventually sell the assets. Some of this business will be going to Goldman, Morgan, and Merrill, and JPM. Further, banks will commence massive M&A activity. Goldman is about the only firm that cannot be imputed with a conflict of interest if Morgan merges with Wachovia. This will be a fast global M&A explosion in the banking and financial industry.

But the real big risk to shorts with Goldman is that Goldman has enough cash to buy up all of their stock float, every outstanding share and go private again. Goldman's current share price is very appealing at half book. Plus again the entire float represents just 12% of the ownership of the firm.

If you look in the new SEC rules there are now provisions for companies to buy back their stock. the new rules permit companies to buy back up to 100% of the average daily trading volume in their stock. So now instead of Goldman sitting quietly on their trading desk and watching the suicide shorts take liberties, Goldman can destroy them at will between bites of a hamburger and coke. That's a good NY hamburger, Kaiser roll, thick juicy, a slab of tomato, an onion... Best of all, the suicide shorts can't reload! They are sitting ducks.

We must remember that every short killed in the market is capital that floods into the market value. The shorts have done this to themselves. They compressed the markets by selling short the stock portfolios of all the financials in an effort to prevent the shorted banks from selling assets at fair market, trying to take the banks out of business. The strategy took out Indy Mac and has pile driven other financials. The problem is that the shorts were suicide shorters and shorted some very good well capitalized companies. Microsoft for example does not need to borrow money ever. They have 48 billion in cash. I am waiting for the naked shorts to attack Microsoft saying they don't like model unless the software giant buys a bank.

No matter which end of the market you trade on, when you lose sight of fundamentals you lose.