Up and Down: Bernie's Bets

06/18/2004 12:00 am EST


Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Bernie Schaeffer is bearish on the market's long-term outlook and continues to play the blue chips on the short side. Yet, he also sees special situations, which offer opportunity on the upside. Here are some of his favorite upside and downside bets.

"Current anecdotal sentiment in the financial media can only be described as ‘over-the-top bullish.’ So extreme is this optimism that it eagerly incorporates such legitimate concerns as rising interest rates and accelerating inflation and slowing economic growth and $40 oil into a mosaic whose theme is ‘It's all good!’ For example, major business magazines have said such things as, ‘Fed tightening shouldn’t make you tense’, and ‘Yes, prices are rising, but not to worry’, and ‘Why a dose of inflation is good for you.’ This bullishness on the part of Wall Street opinion leaders as expressed in the mass media has very worrisome implications for the stock market.

"Importantly, we would note that a market that is highly vulnerable to a major decline is by no means a market that must crash tomorrow. In fact, such a market is likely to have built up a good deal of upside momentum. As such, new money continues to flow into the market and even investors with concerns and misgivings are reluctant to leave the party too soon. But when it's over, it is likely to be so ugly that it will be a long, long time before investors dare to fall in love with stocks again. However, until it's over, I will continue to look for pockets of opportunity on the long side while taking short positions in select big blue chips.

"On the short side, we would consider Fannie Mae (FNM NYSE) and General Electric (GE NYSE). Despite concerns about the size of its loan portfolio, FNM continues to receive positive comments from Wall Street. This optimism may be a sign that potential fundamental risks are not accounted for. Further, of the 18 brokerages covering FNM, 15 rate the stock a ‘buy’ or better. What's more, short interest plunged by 9% over the most recent reporting period. An unwinding of positive sentiment in the form of added selling pressure should keep FNM firmly planted in its downtrend. For options traders, we'd suggest  Fannie Mae January 2005 70 puts. In addition, optimism is running rampant on GE, as the firm was recently featured bullishly in a major financial publication. Wall Street also favors this blue chip, as 14 of the 18 analysts following the stock rate it a ‘buy’ or better. Further, the number of GE shares sold short plunged 39% over the past month. For options traders, we like the GE December 35 put.

"Meanwhile, on the long side, we like SBC Communications (SBC NYSE) and Krispy Kreme (KKD NYSE). Skepticism remains extremely heavy towards SBC, with the number shares sold short increasing by 24% over the past month. Wall Street is also giving the stock the cold shoulder, as 22 of the 24 analysts rate it a ‘hold’ or worse. Any upgrades could boost SBC higher. We suggest buying the SBC January 2005 20 call. Meanwhile, pessimism continues to grow toward Krispy Kreme, as the number of shares sold short soared 22% in May to a new multi-year high of 16.7 million. This accumulation of bearish bets accounts for almost 30% of the total float. Wall Street is also giving KKD the cold shoulder; four of the six analysts following the company rate it a ‘hold’ or worse. Any upgrades could boost the security higher. We like the KKD November 20 call."

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