Michael Shulman's Sell Short

The jobs numbers came out a few minutes ago and even with minimal parsing it is time to go short - or at least get ready to go short. Why? Job losses of 85,000 surprised many people - and were actually much greater as the BLS uses a statistical trick - an accepted one - to add more than 100,000 jobs to the number - as it has since February. The BLS says the birth of new companies creates jobs it misses, bankruptcies kill jobs it misses, and the difference is a net positive, on average in 2009, of over 100,000 per month. In the Great Recession? I don't think so.

At the most macro of levels, the importance of employment, or unemployment, is national income - the amount of money, in aggregate, people have to spend in an economy driven by consumer spending. Ten percent plus unemployment and continuing job losses restrict national income. An average work week that is shrinking or stagnant restricts national income. Stagnant hourly average wages restrict national income. Everyone sees this in part. But the hidden number today was the household survey report which showed a loss of 616,000 people from the work force. This keeps the unemployment rate down - or keeps it steady - but means there are 616,000 fewer people even looking for work which means they are not looking to generate income. Another and a very big hit to national income.

So everything adds up to a hit to national income - which hits consumer spending. And growth - or shrinkage - in the economy. And corporate profits can outpace growth for only so long. So in Q2 or the second half of the year the lack of consumer spending will finally overtake bullish optimism. And that means the time to go short - or at least get ready to go short - is now, if not the indices, selected names.
Start with adult toys - no jokes please. Brunswick (BC), builder of boats. Harley Davidson (HOG), the builder of unnecessary motorcycles with a broken balance sheet. Hovnanian (HOV) another broken balance sheet, a builder of high end homes no one is buying. Blue Nile (NILE), purveyor of diamonds, a great company facing a stagnant or declining market with a P/E north of 60.

Then look at overpriced companies who will blow up the first time they miss an estimate. Blue Nile again; Open Table (OPEN), a front end to a shrinking number of restaurant reservations; Wynn (WYNN), owner of the best casinos in the world with the best CEO in the world but selling at multiples that are unsustainable; and the list goes on.

I maintain, for my subscribers at ChangeWave Shorts, a watch list of potential train wrecks. Do the same for yourself and get ready. The double dip is coming.

Most investors are now focused on the minutiae of earnings -- as if anyone can make any sense of bank earnings or balance sheets. And they are assuming at worst economic stabilization and at best economic growth in 2010. More than three quarters of all analysts have buy recommendations on most large banks and the sector in general. They are not just forgetting the words of the great banking diva -- Meredith Whitney - they are forgetting the macro picture evident in readily available public information. So are public officials. And for this reason -- call it willful blindness, something that can lead to being charged with a felony in may states - another banking crisis brewing - a quiet one, since we all now know Uncle Ben will not let the system fail. Good for him - but not necessarily good for investors.

First, popular revolt against the banks is rising but has not crested on Main Street or Wall Street. The Obama administration and the FDIC - they are different - are both taking aim at changing the rules of the game for banks, in part to keep up with activity on Capitol Hill. Main Street populism against bailouts and bonuses is driving the political calculus - in reality, investors should take note this populism is long overdue and not misplaced - in fact, it is quite muted. To put it another way, if US banks had done to the Russian or Chinese economy what they did here, we would be talking about bailouts for widows and orphans, not banks.

The heart of this populism is the perception the banks - especially the big ones - were treated unfairly - overly fairly - during the bailout days. They were - the issue was systemic risk - six branch local banks do not create systemic risk. Fueling this populism are excessive bank salaries and bonuses - they are - and have been since the first of the great Wall Street partnerships began to go public in the mid 1980s and risk takers were rewarded for increasingly short term behavior using other people's money. And Obama and the FDIC are taking aim at the big banks - Obama is looking at more fees, depending on how big you are and the level of risk you are creating for the banking and financial system and the FDIC is looking at higher fees if the compensation structure at a bank encourages too much risk taking.

Forget Kudlow's screams and Robert Reich's quaint, Depression era editorials - these actions are the direct result of populism that could get out of hand if the government sits back and let another crisis unfold as it is, more slowly than before, in residential and commercial real estate mortgages. Yup, here comes another one.

While everyone is focusing on commercial mortgage problems, the more important problem is residential. In the past, in the good old days, when someone fell behind on a mortgage for 30 days, there was a better than 80% chance they would catch up, keep the house and be tortured by their teenage children like everyone else. Today that number is below 30% and falling. Between 1.5 and 2.0 million homes will be foreclosed in the next 18 months adding to the inventory of homes and depressing home prices. Add to his the 600,000 -800,000 homes already foreclosed but not yet listed for sale. Then assume the tax credit for homebuyers is allowed to expire, it is politically unpopular, in April, just as Uncle Ben starts pulling back on Fed purchases of mortgages. Oh, one last wrinkle - after sub-prime mortgages went away, the geniuses in the mortgage lending industry created option ARMS - pick your payment mortgages. According to Fitch (see housingwire.com), only 12% of the 800,000 Option ARMs have re-set to date - and the issue here is not interest rates but terms of the loans which have allowed owners to roll interest into the principal. When they re-set, they will be seriously underwater. At the moment, default rates are north of 40% and climbing - and to date after resets 43% of option ARM mortgages led to a foreclosure. The largest issuer of Option ARMs was Golden West, bought by Wachovia and that bank was in turn bought by industy darling Wells Fargo. Bottom line - another fall in home prices, lots more loan defaults, much higher than anticipated bank write-offs, especially the larger banks that hold lots of mortgage backed bonds.

Why is residential more important to banks and bank investors? First, they are not being discussed y serious people and are not currently factored into bank stock prices. Second, falling home values suppresses consumer wealth and spending, dampening economic activity, and fueling a cycle that will lead to more mortgage defaults. Third, there are no large vulture investors out there scooping up extra housing inventory - and this will not happen.

This mixture of populism and residential mortgage driven banking crisis means more than anticipated bank write offs and a the need to raise more capital and dilute existing shareholders to head off problems with regulators. Bottom line: populism plus the crisis will depress the entire sector and hit selected names very hard as the yea unfolds. A great place to troll for great short candidates.

The double dip is coming - data out yesterday and today showed the climb out was really a crawl that stalled and the descent may even be under way. Turns out the nation did not lose 5.6 million jobs in the last year, it was 6.9 million. Whoops. Turns out retail sales did not go up in December, they went down. Double whoops. And jobless claims stalled at 444,000 last week - triple whoops? Yes - although that does mean we are going to get a triple dip.

But the double dip is in place, clearly. I have been writing in service, ChangeWave Shorts, that I am agnostic and can read third grade math and you don't need more than that to see the second half of the year is going to a great big disappointment to the economic bulls. The market, being a forecasting mechanism, is already sensing this - but has yet to fully grasp the impact on corporate profits of a double dip. And that is why there was such a muted reaction on the Street to day - and yesterday - to some really bad numbers.

Am I overacting? Hardly - this data is small beer compared to the big trauma slated for March and April when the home buying season begins - and doesn't happen. Defaults and foreclosures are accelerating and will do so through the middle of 2011; much of the pig in the python - foreclosed homes not yet listed - will be listed in the spring; the Fed begins shrinking its purchases of agency debt, raising interest rates that have already begun to climb; the tax credit for homebuyers ends and it is unlikely it will be extended as it is very politically unpopular; and the market starts forecasting Q4 and the holidays.

There will be noise about a stimulus plan - something independent voters don't want - but the reality is national economy has a broken engine even a fiscally reckless Congress cannot fix -- home building, home buying, and home ownership, the source of a good deal of employment, a good deal of economic activity and a good deal of national wealth.

What to do? Short the obvious - a continuing fall in national income - start looking at logical shorts based on fundamentals and then check out technical's for the "when." An important part of those fundamentals are balance sheets - as sales stay stagnant or continue to decline, debt service will increase - if debt can be re-financed - as rates rise. Who needs a boat - short Brunswick, decent balance sheet, not great. Who needs a high end motorcycle - short Harley, totally wrecked balance sheet. Who needs more stuff -- short Macys, woeful balance sheet; who needs an expensive home or who can get a mortgage for one - short Hovnanian, surreal balance sheet. And, of course, short Treasuries as tax collections will be less than expended and Congress may actually pass another futile stimulus package.

Everyone is projecting changes in the economy; the market, the administration, life on Mars and the New York Yankees roster based on the election results in Massachusetts. The reality is less complicated - the election will make health care reform either very modest or nonexistent, restrain (a bit) the next stimulus package, make financial reform a bit more balanced but still a reality in 2010, and increase the odds the Republicans re-capture the House in the November elections. What are the consequences for investors of this happening?

• If health care reform legislation dies, the hospitals lose - more bad debts, less demand for services and a renewed focus on cost controls, via administrative actions, that restrain prices. The short: hospitals.
• If there is modest health care package the focus will be on voluntary cost control measures and federal regulation of insurers prohibiting the denial or exorbitant pricing of coverage base don pre-existing conditions. It may even include insurance exchanges. Bad news for insurance companies - and the first step in insurers becoming regulated utilities (not a bad thing). The short: the insurers.
• There will be another stimulus once unemployment starts to climb again - March/April at the latest - and the double dip becomes obvious - maybe May/June. It is, after all, an election year. But it will be much more modest than the one passed last year and may even focus on the unemployed rather than unionized and state workers. This will restrain the deficit - good for bonds, good for the dollar, bad for gold - but will also hit corporate profits, as there will be less stimulus money sloshing around, hitting the overall market. The short: short gold, short the S+P 500.
• Financial reform will probably happen in 2010 - even the Republicans favor some sort of regulation and populist resentment at the banks is going to be used by the Dems to put the Republicans in a box if they side too much on the side of the financially wicked. Obama may get his fee; Barney Frank is going to get much of what he wants; the banks are going to take the hit Main Street has wanted to see for a more than a year. The short: the big banks.
• A Republican re-capture of the House will lead to unspeakably divided government, true gridlock, often favored by Wall Street but a disaster given the current economic situation. I like divided government but the current House leadership is economically rigid, politically rigid, out of touch with the needs of the jobless and others on Main Street and bereft of any leadership that is able to work with Dems. In 2010, the prospect of the House turning red may boost the market temporarily and will certainly help the dollar and bonds and hurt gold. The short: gold.

Keep it simple when developing these theses and stick to what us real, not hype or hope. The economy is not recovering if you look at data, not words; the Republicans are not in steep ascent, if Victoria Kennedy had agreed to run she would have won in a landslide; Obama still has a 75% "personal" approval rating and his job and personal ratings are about the same as Reagan's after one year. Simply put, do not overreact.

A few days ago I wrote the banks were the best short opportunity based on fundamentals and political reality as it unfolds in 2010.

This week this opportunity became remarkably clear in a hurry.

This week many large banks announced great earnings, doubtful or weak forecasts and some had loan loss provisions so low as to border on the absurd - Citi actually reduced loan loss provisions, depending on how you look at them while telling analysts consumer loan delinquencies were a cause for concern in 2010. Say what? , Once again they were managing earnings rather than clean up their balance sheet.
And this week Obama bared his teeth with Paul Volker providing the tooth whitener - no more trading guys, not if you are a commercial bank. I find this a splendid idea - more on that in a later column - the proposal not just the result of the financial crisis but a direct shot at banks paying obscene bonuses while 20% of Americans are out of work, underworked or out of the work force altogether. This is after their institutions were saved by taxpayer money. An incredible tin ear, as I have written before. And now it is time for them to get their comeuppance.

So let me re-state why some banks are the slam-dunk shorts of the year.

• Their own earnings announcements show continuing problems with consumer credit, with Wells it was also commercial mortgages, none are reserving enough against future losses, especially Citigroup and all are talking about problems with consumer loans for the rest of the year. Their words, not mine.
• They are worried about consumers due to 20% unemployment and the possibility - I say it is a 90% probability - see my piece Shorting the Double Dip -- of a double dip recession in the real world.
• Hundreds of billions in off balance sheet assets are going to hit balance sheets in Q1. This is particularly true of Wells and Citi. These assets are of an unknown quality - then again, they are off balance sheet for a reason.
• As interest rates rise, profits from a very steep yield curve will shrink.
• And if the Obama/Volker plan goes into effect, no more profits from proprietary trading.
• Oh, yes, don't forget the $90 billion in bank fees.

Some geek can do the silly math about how much profit will be reduced at each major bank from this and that - the larger issue is long term, most banks will have their ability to generate profit from each dollar of capital lessened compared to the period of 1999-2009. Through reduced leverage and reduced or eliminated trading desks. Simply put, game over. It will take a lot more capital to generate the profits generated in the past. That means dilution or reduced profits per share and that means lower stock prices.

The biggest losers? The real hybrids - Citi, BOA (the proud owner of Merrill Lynch), and JP Morgan. The unscathed or winners? Goldman Sachs and Morgan Stanley, pure investment banks and trading shops.

If you disagree and are fantasizing about a Republican filibuster you are mistaken. Populist outrage is going to drive lots of behavior on Capitol Hill this year, not to mention the proposals have serious merit that some thinking red state types will appreciate, especially in the Senate. And if they do fight the Dems on this, there goes their chance to retake the House and win seven seats in the Senate. Obama and Volker have put them in box.

Last week - déjà vu all over again.

The dollar was rising, so the market fell.

China is pulling back on stimulus, so the market fell.

Obama is going to tax the banks, so the market fell.

Obama is going to regulate the banks more than expected, so the market fell.

Ben Bernanke is not going to get confirmed, so the market fell.

Corporate profits are great but forecasts for 2010 are weak, so the market fell.

Unemployment claims rose unexpectedly, so the market fell.

Housing numbers were worse than expected, so the market fell.

The VIX was very low compared to the last two years, a sign of complacency, and so the market fell. And of course the VIX popped up.

The market breached the key support level of 11278/1128 on the S+P 500, so the market fell.

And, this weekend, everyone took a breath, and as I write this, S+P 500 futures are up more than 16 points or 1.5% in pre-market trading. Is this as reflex rally?

Yes - maybe - who cares? What is important is last week was a continuation of a trend that began in the fall of 2007 - the market responding to the banks or the federal governments and the Fed's actions concerning the banks. Around Halloween of 2007 Meredith Whitney spoke (I was, fortunately, sitting next to her at the time, you cannot imagine what you can learn having make up put on) and the banks began to break. Then Bear Stearns fell on St. Patrick's Day, Lehman in September and the market melted alongside this through February of 2009. Then the fake stress test results came out and the world - the Street - realized Uncle Sam and Uncle Ben would not let the banks fail and the March rally took hold. The rally faltered in late June, Ms. Whitney said the banks would earn plenty for the rest of the year - and disparaged 2010 - and the rally resumed. The banks stocks began to falter in late fall, six months before earnings were seen as potentially weak and as the Fed said they would begin withdrawing stimulus at the end of the first quarter.

Need any more proof? C'mon tell me this is not good enough? You can plow through all the data you want but step back a bit - there are two issues here. The banks themselves see potentially weaker earnings if there is no big upturn in the economy in the second half of the year. Second, the banks own words tell us new proposed federal taxes and regulations will whack profits.

Can a recovering economy counter this trend? What recovering economy? Can bank lobbyists counter the populist trend? Not this year. The double dip is already getting a head of steam - and uncertain banks earnings due to a lack of appropriate loan loss provisions means less lending to consumers and businesses and the important hybrid of the two - small businesses, the engine of job growth. And Obama has moved his campaign people back into the White House - and even many Republicans, catering to the tea party cranks on their right wing, are talking about more rather than less regulation aimed at the banks.

What does this mean for the typical investor? Nothing good despite the reflex rally taking shape this morning. The banks are going to see weak growth and flattening operating earnings - and many have not reserved enough for losses in the second half of the year. Capital One lost 12% on Friday for this very reason, the genius management team took a relatively small loan loss provision and then, in the same voice, said consumer delinquencies were likely to remain at abnormally high levels. Citigroup did the same schizophrenic earnings management routine a few days before. And with weak or uncertain earnings, combined with populist new taxes and regulations about to hit the banks, the bank stocks are going either sideways or down in 2010 and this will lead the market.

I love my country - the chaos, the hurly burly of democracy, the hard work of quiet people on Main Street, the great big heart, as shown by our private donations to Haiti at a time of near 20% unemployment and underemployment. We forgive wayward politicians, and athletes, let our children make more decisions than virtually any people on earth and unlike other nations, except Britain and its former colonies (I guess we are one) stand for something. A true city on a hill. But right now, the city itself is in political chaos - and a bit broke.

It is time to short the US - for a couple of years - until our crisis gets so severe Congress commits mass seppuku and replacements arrive and get something done. Perhaps Gandalf will come to us from Middle Earth and leads us to better times. I am betting on Gandalf. Yes, I am letting Obama off the hook - you always let rookies off the hook, don't you - and unless Congress changes dramatically his rookie mistakes are going to become sophomore and junior year mistakes and the nation will suffer. I am long the US, long term - I am a Buffett kind of guy and laugh when I think of any truly long term problems in the US compared to other developed nations (more on that in a later column). But short term, well, here are ten reasons to short the US, metaphorically and in the market, in the next 1-3 years.

1. Economic Growth: We will see misleading - and therefore worse than meaningless - GDP numbers on Friday due to flawed data and inventory accumulation. In the real world, we are already entering a double dip recession and once this is over unemployment - real unemployment, which means those who have dropped of the work force, those looking for work and those looking for more than part time work - will continue near the 20% level for at least another two years.

2. Private Sector Debt: The Fortune 500 is borrowing - and no one else. Small business cannot get money, directly or via credit cards, and consumers continue to de-leverage. And will do so for five to ten years - maybe more - as debt levels retreat to those of the early 1990s. De-leveraging drives reductions in consumer spending and asset values. Get used to it. And with this consumer discretionary stocks will stall or take a pounding - including retailers - look at shorting the XRT.

3. Public Debt: Large and rapidly growing deficits and public debt at the federal and state level will eventually lead to a rise in interest rates and to the crowding out of other spending as government services debt - that will not happen for a while but will start near the end of this year or early in 2011. And please, don't blame the Dems - the party of fiscal rectitude, those red state guys, doubled the debt while they controlled the White House and Congress, financing a war off balance sheet, led by a cheerleader in chief who told people to go shopping rather than tighten their belts after 9/11. Historically red staters spend more on their key constituents than the Dems - so if they grab power, nothing will change. Plenty of ETFs around to short T Bills.

4. Housing: Ain't comin' back my friends. The bullishness and optimism on Wall Street about housing is surreal given all the date one needs to forecast housing values, mortgage defaults, foreclosures and new home starts is in the public domain or can be bought with some soft dollars not used for travel and entertainment (excuse me, that would be illegal!). You can find the data somewhere else - or read some older columns - but housing prices are going to fall for another couple of years (nationally) as foreclosures hit 6-7 million in the next 30 months as well as the 600,00-800,000 homes foreclosed but not yet listed are added to housing inventory. Not to mention more than third of Americans would sell their homes tomorrow if the price were right. Add tightened credit standards, no market for jumbo mortgages anywhere in sight, the end of the home buyer tax credit in April, the slowing down of Fed purchases of agency debt in April. This constitutes a witches' brew that creates headwinds that will last until foreclosures peak and those homes hit the market - late 2011 to mid 2012, and foreclosures will not hit historical norms until a year or two fate that date. Avoid or short the homebuilders via an ETF -- the XHB - or an individual company with a weak balance sheet.

5. Consumer Spending: The New Normal is not going to be normal as reduced national income due to unemployment, reduced consumer spending power due to tightened credit, reduced wealth due to falling home and stock market values and reduced confidence due to all of the above create a new culture of a "new Frugal." We have never been good at being a frugal nation - but have been frugal in spurts and we are already seeing the beginnings of one. It would take a thousand words or more plus data to prove the point so just go the mall and ask people questions -I do- or look at your own spending. What to short? Weak retailers and restaurants, either in overcrowded segments (Saks) or weak balance sheets (Macys).

6. The Banks: Banks are the kink between financial markets and the Main Street economy. They are also the lubricant - when they are lending - of a growing economy. US banks, using time honored but now discarded accounting standards, are, as a group, insolvent. They are hoarding cash because deep in the recesses of little offices, they know they are insolvent if they had to dump toxic assets on the market. They are also looking at reduced activity due to the economy and new taxes and regulations, therefore lower profits and when interest rates rise - Federal Reserve interest rates - their spreads will contract, also hitting profits. Consumer delinquencies continue to be at historical highs yet this past earnings season the banks managed their earnings and actually reduced their loan loss provisions. And did I mention the rapid rise in defaults in commercial real estate? And Obama is not done with them. What to short? The big money center banks, mot the investment banks, and check out some regionals with huge exposure to commercial real estate.

7. Congress: You could probably short Congress - metaphorically - for a century and never lose money. To steal a line from the movie Charlie Wilson's War (very true to the book by the way), "Why does Congress say one thing and do another?" he is asked and he answers "Tradition, I guess." But even by the low standards Congress sets - and should set, we are a democracy which means they are supposed to react to bad and good news, not create it - this Congress is laughable. Polarization between left and right when all the country wants is some practical intelligence residing in the political middle has frozen the indecisive (most of them) and the cowardly (those up for re-election this year). If you want to read a great piece by an acquaintance, Steve Pearlstein, Pulitzer Prize winning columnist for the Washington Post, check out his column today on the State of the Union address hw would deliver tonight. What to short? Nothing, really. It's just damned depressing.

8. Obama: He has done a fair job for a rookie and given the pile he was handed - two wars with no end game or plan, a he federal deficit and dent, a broken economy, broken financial markets and so on. His mistake? He believed his own campaign promises and some lousy advice from his economic advisors and made the economy a secondary priority after passing a filled stimulus bill that so far has cost us $200,00--$400,000 for every job supposedly saved or created. But he has failed to lead - and will probably do so again - his instinct is to organize and drive, not pull - and we need someone pulling the train right now. What to short? Again, nothing. Or everything.

9. The Market: The market is wildly overvalued given the trajectory of the economy - profits cannot hold up throughout the year - and is being driven by traders. The trade of the day continues to be dollar/commodities/China but more and more individual stocks are being rewarded or whacked based on fundamentals, a good thing for stock pickers but bad for the vast majority of money managers who know little more than the movement of the indices. What to short? Companies with weak balance sheets; the leaders in this market that will lead the market down, the banks; and over a two year period, the market itself.

10. The Doubters: Long term, the US is in far better shape than almost all developed nations except for some of the small British colonies with commodities and reasonable public policy - Canada, Australia, New Zealand. Our population is growing faster than any OECD country; our debt is not half as bad as Japan or some European nations; our higher education system is several orders of magnitude better than all but Britain and its former colonies (trust me, I have twins going off to college this September, have visited 17 and counting); and we have an economic system and culture that lends itself to growth, not stasis. What to short? Short the doubters - go long the companies that do what the good old US of A does best - go long biotech, go long selective chip stocks, go long the great brands and innovators, i.e. Apple.

After the State of the Union address tonight, the blow dried pundits (or the corpulent ones with no real hair) will be screaming at us. Ignore them. Ignore people who doubt our long term future -- craven fear mongers like Jim Rogers, who so admires the Chinese for all their honesty, transparency and dignity they show their own people - ratings hawkers like Glenn Beck, xenophobes like Lou Dobbs, cartoon like ideologues ranging from Robert Reich and Paul Krugman to Rush Limbaugh - ignore them all. The ten and fifteen year plan will work. How? Turn to another movie -Shakespeare in Love - for when crisis seems to overwhelm everything and the producer of the play is confronted with disaster and asked how will things work out, he answers "I don't know, it's a mystery."

What are the best shorts in this flailing market? Depends on whether you do charts or fundamentals - I do fundamentals with a light taste of charts - so this is about fundamentally weak companies that can no longer benefit from tailwinds provided by a technically driven market rally.

Where to look? First, unduly high Wall Street expectations for fundamentals. Second, companies in segments that are going to take a hit when the economy takes its double dip or has meager growth in the second half of the year. Third, companies with weak balance sheets. Fourth, companies inside bubbles about to pop - or ETFs for segments that are bubblicious and ready to blow for any number of reasons.

Undue Street Expectations: The Street is overly fond of the banks - yes, the stocks are flat or have dipped for the past three months but Wall Street profit estimates - and target prices - are out of line with reality. Not to mention $1.5 trillion in toxic assets seem to have been forgotten. I agree with uber analyst Meredith Whitney - I have since she turned me onto the problems with the big banks in the green room at Fox Business in the fall of 2007 - that bank profits will disappoint in the second half of the year due to economic stagnation, increasing consumer credit defaults, increasing foreclosures - one analyst sees up to seven million in the next 30 months, mostly from prime borrowers, and decreased trading profits.

Over the past few days earnings announcements - notably Citigroup's (C) and Capital One's (COF) - made it clear the banks are again managing quarterly earnings instead of doing whatever they can to shore up balance sheets. Both reserved less than they had in the past yet also expressed serious concern about the quality of consumer credit throughout the year. Wells Fargo (WFC) also did not reserve as much as it should have given the rapidly deteriorating quality of its commercial real estate portfolio.
My concerns are independent of the factors that have hit bank stocks recently - potential new fees ($90 billion) and tough regulations that will restrict leverage, the scope and operations and certain profitable activities such as proprietary trading. Banks are also being forced to take some of their off balance sheet assets and put them on the balance sheet. Wells has to do this with more than $100 billion in assets - don't cringe just year, they have more than another trillion, with a T, off balance sheet. Capital One surprised itself and analysts by the amount of off balance sheet assets they needed to put on.

One last wrinkle - and this will hit Bank of America (BAC), purchaser of Countrywide Financial, and Wells Fargo, purchaser of Wachovia which had purchased Golden West - that comes from the Freddie Mac and Fannie Mae. They are now gong through the documentation of mortgages that have fallen into default - and forcing banks to repurchase these mortgages. Freddie Mac hit banks for back $2.7 billion in the first nine months of 2009, Fannie Mae $4.3 billion. 2009. This is gong to accelerate the next eight to twelve quarters, a big drain on earnings.

The Impact of a Double Dip/Low Growth Second Half: Retailers and many consumer discretionary stocks outperformed the market last year - and are still seen by some as holding great value. Sure, right. Consumer spending from 2000-2008 was driven almost 100% by expanding credit - incomes were flat, spending went up, and a couple of trillion of spending power came from credit cards and home equity loans. We now have declining national income - not to mention declining household spending - and trillions in credit lines have been pulled back. Without job growth - big time job growth that lifts national income - the consumer will not be back enough to justify current valuations.

The key here is not the statistic always bandied about - the unemployment rate - but the actual number of people working multiplied by their average wages in a week. This, plus interest income and some other items constitute national income. You may read the country lost 450,00 jobs and the blow dried pundits now paid to be smiling and optimistic will say that is lot better than six months ago. True. But the real number that impacts national income and spending is that number plus the number of people dropping out of the work force. When you put these numbers together you have more than thirteen million people not working who were working a couple of years back. And that is a lot of lost spending power.

While many turn to the retailers as the biggest potential victims, sorry folks, it is the high end adult toy makers. No jokes please - I mean boats and motorcycles and spas and high end clothing. That means companies like Brunswick (BC), Harley Davidson (HOG), Steiner Leisure (STNR), Liz Claiborne (LIZ) and Saks (SKS). And in 2011, many of the people who typically buy products from these companies face higher taxes. The weak balance sheets here...oh, I am getting ahead of myself.

Weak Balance Sheets: There are some frightening balance sheets out there and companies yet to issue new shares, roll over debt and in still in need of a lot of financing are facing major problems in 2010. Morningstar put out a list of "low cushion cash flow" stocks based on debt, cashflow and the need to refinance soon. The leader on their board with a B- credit rating is Royal Caribbean (RCL) - and no one needs to take a cruise, do they?

Finding weak balance sheets is easy - matching that problem with creditor reluctance to provide new financing and weak cashflow is the next step. You can a whole slew of these weaklings among the home builders. These dogs have been held up unconscionable federal tax rebates - multiple billions over the past three years - and the days of this largesse is over. Arguably the company in the worst shape is Hovnanian (HOV) for they also concentrate on high end homes that can be built but are not selling due to a lack of demand and virtually no jumbo mortgages to be had.
Lennar (LEN) also has a scary balance sheet.

Retailers, in general, are very tightly managed and have great flexibility in reducing costs through inventory and staff reductions. That being said, Macy's (M) balance sheet is almost surreal given its cashflow - and Macys is at the top end of the full purpose department store segment, a weak segment at the best of times.

Bubblicious Companies: This is easy - China is one big asset bubble driven by state banks lending as fast and furious as possible, building unwanted condos, unneeded steel mills and so on. Where to start? ETFs that track the domestic companies, not the exporters - the most liquid is the PGJ - and the entire segment of Chinese solar companies such as LDK Solar (LDK) or First Solar (FSLR). They are all overvalued, who knows that they are really selling versus booking versus shipping, and the renewable energy bubble is, well, a bubble. Combine a China bubble with a renewable energy bubble and you get double bubblicious.

The discussion and debate about winners and losers created by the iPad is amusing - the Street has already identified the suppliers and is focusing on Amazon as a potential loser. Sorry, wrong victim. In fact, Amazon is a big winner in the announcement of the iPad.

Amazon (AMZN) wants to be the intermediary between a customer - a reader - and the writer/publisher of a book or other material. They started by enabling writers to self-publish, on demand and even bought a company to help them with the process. Then the Kindle. Then Kindle for the iPhone. And after that, Kindle for Windows. Last piece of first generation Kindle is software for the Mac. The money to be made is the 65%-70% Amazon keeps from the sale of a Kindle book, magazine or blog. Not in designing, manufacturing and selling a piece of hardware. Those are the kind of margins that will increase Amazon's overall gross margin; more and more sales of Kindle hardware will reduce gross margin.

Amazon's move was brilliant - jumpstart the market, force others to compete. And now the most recognized consumer technology brand in the world - a company that does not waste space by putting its name on signs above its stores -- Apple (AAPL) - is piling in and on. Which is great news for Amazon. Why? Apple is not in the publishing business - other than some exclusives for iTunes - it is in the hardware business, using iTunes to generate customers for the iPod, the iPhone and the Mac. So Apple really wants Amazon to be a successful publisher while Amazon really wants the iPad to be successful, that will sell a lot of books.

So, loser Amazon is winner Amazon.

The second loser that is actually a winner is a whole segment - textbook publishers - one of the purest publicly held plays being McGraw Hill (MHP). Kindles are not textbook friendly - no color, no serious graphics. iPads are and will be. Won't this displace traditional? Yes - but not traditional textbook publishers. The biggest cost in textbook publishing is the cost of printing the books. That can go away. The biggest problems in publishing textbooks is the need to update them, especially in science, to keep abreast of change. This is a major hassle - and expensive. But not for an electronic text. Best thing about e-publishing textbooks? No used textbook market - if you update a book every year, and a book is trapped on a dedicated device, there is no used textbook market. Go Steve Jobs go --- that is what the folks in the textbook industry should be yelling, right now.

Another sets of losers are actually winners - the textbook guys.

Anybody else? Any loser really a loser?

Yes - Barnes & Noble (BKS), Books a Million (BAMM) and Borders BGP)- they are not financially or culturally built to compete against digital titans Amazon and Apple with their own readers. And Apple's entrance into the market will accelerate the shift away from hard copy books, and traditional book retailers has the most to lose. I expect Borders and Books a Million will disappear and Barnes and Noble will be the last large book retailer standing. The Nook will do little to help B&N - ChangeWave surveys show there is extreme interest in the iPad and a multi-use device that is also a very good book reader will crowd out most if not all alternatives.

Bottom line: the iPad is not bad for publishers, it is good for them. The iPad and electronic distribution of books - especially expensive to produce textbooks - because it is a cost dis-intermediator. The iPad is not bad for Amazon, rapid sales of hardware will increase demand for Kindle books sold via the existing iPhone app that will work on the iPad - I hope so, I am publishing two novels as Kindle and print on demand books in the coming months - and for Amazon, publishing and distributing is where the margin is, not in selling hardware. Yes, the iTunes store will put a dent in Amazon sales but Amazon can match Apple keystroke for keystroke as a simple interface to buy intellectual property and there is more than enough room for both.