Going short is not necessarily the answer
A medium or long term approach may be wisest just now, says Katie Hope
Its’ like a grim version of “when I were a lad…” working in the City at the moment. Everyone’s trying to out-do themselves in describing just how bad things have got. Going to school barefoot barely makes the grade in terms of hardship trumps these days. Bank of England governor Mervyn King told us a couple of weeks ago that we’re in for a “difficult and painful year” and said growth would be “broadly flat,” a nice way of saying recession without using the dreaded ‘R’ word.
Then American MPC committee member Danny Blanchflower declared we’ re in a recession already, the unemployed will swell to two million by Christmas and house prices will slump by 30 per cent. Those Yanks do have a way of telling it like it is. But it’s Alistair Darling himself, the very man who’s supposed to be in charge of this whole economy thing, who wins top marks for his comments last week that the economic crisis is much worse than people expected and could be the worst for 60 years.
Summed up, it’s grim out there. Aside from taking the next couple of years off trading altogether, what’s a poor contracts for difference trader (CFD) to do? The obvious answer, and after all more or less what CFDs were invented for, is go short on everything: the Halifax housing index, shares and of course sterling. Basically sell, sell, sell. If it’s going to get worse, things will go down further and you will reap the rewards.
Not Simple
But while obvious, it’s not necessarily that simple. Markets haven’t been sitting around waiting for some book-studying economist to declare after two quarters of negative growth that we’re in a recession. Markets are forward looking and have been busy pricing in this kind of scenario and worse for months now.
An old saying in the City goes: “buy on bad news and sell on good news.” The reason is simple. People buy and sell stocks based on what they think is going to happen in the future. When most people are thinking about a recession stock prices have already been adjusted for it. By then, it’s too late.
“There will come a time when you will kick yourself and say why didn’t I buy at these levels? But whether it will be now or in six months time is still unclear,” says Angus Campbell, head of sales at Capital Spreads.
Possible Upside
But short of Armageddon actually happening, there could be some upside to come from current levels. In fact, some strategists are tentatively suggesting that now could be the time for CFD traders to take some selective long positions.
“The time to look for buying opportunities is when there’s blood on the streets. You’re better off being a contrarian in this doom and gloom market,” says Manoj Ladwa, derivatives trader at TradIndex.
His advice is the judicious use of stop losses, taking short term positions of two weeks at most and using a top down approach, which means starting with the broad macroeconomic environment and then moving on to consider more industry-specific influences on a company’s earnings.
For example, trends in the residential construction sectors are affected by employment and household income (which affects the ability of people to buy houses), demographic factors, the level of rents, the level of mortgage interest rates, and the attitude of investors towards property.
In terms of what kind of sectors or companies to take long positions in, many analysts are suggesting sectors that mere months ago would have had investors running for the hills: financials, construction and housing shares.
Long-Term Opportunities
“It’s a risky strategy, but if you think banks and housebuilders are oversold then they’re a bargain. So long as they don’t go bust you would certainly gain some upside,” says Tim Hughes, head of sales at IG Index.
Mark Stockdale, analyst at UBS, also reckons there are long term opportunities in the house builders. He acknowledges that interim results last week from Bovis, Persimmon and Taylor Wimpey were bad, but says they were no worse than expected.
And with Barratt having successfully renegotiated its banking covenants and Taylor Wimpey on the way to doing the same, he says any risk of bankruptcy has disappeared. He expects them to start generating cash again in the second half of the year.
“Medium term opportunities have arrived in valuations as the covenant issues are being dealt with. However, any fundamental performance is likely correlated to mortgage securitisation or growth which is unlikely before mid-2009 at best,” he says.
French investment bank Societe Generale is even braver, suggesting the banking sector, although certainly not wholesale. In fact, it warns that bank share prices will only start to rise when US house prices start to stabilise. In the meantime it advocates buying Barclays as a safe place to shelter from the storm.
Positive Factors
Societe Generale highlights positive factors associated with Barclays, including its defensive UK banking profile, its international diversification and its investment banking franchise which Barclays has moved to strengthen in light of difficulties facing its peers.
Meanwhile, JP Morgan, which is expecting the second half of this year to have the weakest earnings so far, advocates the traditionally defensive utility sector and the energy sector.
“We believe energy valuations are starting to look interesting, and low bond yields are likely to add some support to utilities,” says Mislav Matejka, a JP Morgan strategist.
Things may indeed be bad, but for a CFD trader it’s wise not to get swayed by all the negative talk into shorting everything. Some judicious long positions could see you trump the doom mongers.