Sunday, May 21, 2006

Shorting Countrywide Financial (CFC)

The bounce finally came on Friday, but a rather weak one. It was widely anticipated and the market rarely does the majority’s bidding. Friday was also options expiry so the high volume didn’t necessarily indicate conviction. I have been reading a large number of usually bearish experts stating that this may be only a 10-15% correction and the “big one” won’t come till the fall. It may well be the case, but the apparent readiness for traders to short into any bounce makes me wonder if the market will once again do the least expected. Looking back to the daily candlestick chart of the S&P in year 2000, I can count 22 red candles out of 28 (79%) as the S&P declined 200 points from 1530 to 1330, or 24 out of 32 (75%) counting from 1530 to 1306. On the weekly chart, that makes six consecutive red candles. It didn’t stop there, by the middle of December the S&P was at 1254. In comparison, from May 9th, we have had six down days out of eight (75%). Surely seems we are on pace, doesn’t it?

The home builders continued to be weak. Even though I’m still concerned with Monday’s debut of CME housing futures, I didn’t add to my shorts in home builders. By the way, the two names I’ve been looking at were PHM (Pulte Homes) and DRI (DR Horton).

I have to thank ContraryInvestor.com for the tip on Countrywide Financial (CFC), the largest independent mortgage underwriter in the country. ContraryInvestor.com provides excellent economic commentary but don’t have any specific stock recommendations. The regular newsletter is by subscription only but they do publish a free letter monthly. At any rate, in one of the recent newsletters, there was a discussion on the divergence between CFC which broke out of a trading range a couple of weeks ago and the home builders which are making new lows almost daily. The situation may be analogous to the GM and Ford which have money losing manufacturing arms but quite profitable financing units. It’s another testimony to the financial economy in the current cycle, but it begs the question, how long is it going to last?

The daily chart of CFC (not shown) is not yet oversold, while the weekly chart below features bearish indicators and a possible failure of the break out. Failed break outs are worse than no break out in the first place as traders who were suckered in provides more selling pressure. Insiders sold 40% of their holdings in the past six months and the short interest is only 3% as of last months.

While I’m fairly confident with the ideas behind the trade, the execution left much to be desired. I initiated a 200 sh short position at $39.15, which was the size I had in mind. For some reason, I had another 200 sh stop limit order at the low of the day, not suspecting any funny business given such a heavily traded stock. Well, the market maker simply scooped up my order before ramping up the stock. So I now have a 400 sh short position at an average price of $38.965. I’m usually very hawkish regarding new positions, so if my fear about the housing futures doesn’t pan out on Monday, I’ll cover half of the short position as soon as possible.

As always, this is not investment advice. Please do your own diligence and be safe!