Joining Whitney in the Bearish Camp

11/25/2009 12:00 pm EST

Focus: MARKETS

Michael Shulman

Editor, Short-Side Trader

Michael Shulman, editor of ChangeWave Shorts, says he agrees with banking analyst Meredith Whitney, who recently expressed bearish views on the banks and the markets.

I believe this momentum- and liquidity-driven market has taken on the characteristics of a bubble, and I got support for this view [recently] from none other than über-analyst Meredith Whitney.

In an interview with Maria Bartiromo on CNBC, she said she was the most bearish she has been in a year. In her interview, using data—not ideology, historical patterns, or charts—she reiterated that housing is the problem for the economy and banks, and there will be a "W"-shaped recession.

Whitney is good at what she does because she's an agnostic and fundamental-driven analyst. Given time, fundamentals drive stocks and markets.

We're in the evolving stages of an equity bubble, because fundamentals are not getting better and are getting worse in many cases. In her interview, Whitney pointed out well-known facts that are ignored on Wall Street:

Consumer credit continues to contract, with credit lines down $1.5 trillion, and the contraction is accelerating again and will have a demonstrably downside impact on consumer spending this holiday season and in the future.

The Federal Reserve is now the mortgage market, as it is the only buyer of mortgage-backed securities (MBS). When the Fed ends its program (which is supposed to happen soon), rates will go up and there will be far fewer buyers.

The value of bank stocks will go back to tangible book value, and that is not going to be nearly as high as expectations on Wall Street due to a weaker-than-expected 2010. Also, banks need to raise capital to cover future losses, with banks exposed to the consumer market at highest risk.

Whitney, like I, can't see how the Fed can take its foot off the liquidity gas pedal, and hinted that although the Fed said it would ease out of the MBS market, it probably will not—certainly not in an election year with rising unemployment.

But someday, the Fed must stop and the economy and the market will take a hit. With the unemployment and underemployment rates now approaching 20% combined, times are tough and are getting tougher for many Americans.

Whitney's comments in July caused the market to rally even though she said that only the second half of 2009 would be good for the banks—not 2010. She further said that unemployment would hit 13% or more and no one listened.

So, we likely have a rising market for the rest of 2009 as it stands increasingly separated from the real world. In early 2010, we could see the market go even higher, but the higher it goes, the further (and harder) it will fall when reality sinks in, the "W" takes shape, the Fed reduces liquidity, or all three of these things happen.

So, stay long where appropriate and play the current best portfolio shorts in 2009, but be prepared to go harder on short positions in 2010.

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