Time to get less long and more short

Think the time has come to step off the offensive accelerator and reduce long exposure and increase short exposure; in other words, position more market neutral. The market is up 20% in a month and extended on a short term basis with many economically sensitive names with poor near term prospects and unclear longer term prospects up significantly. The bulls are out in force and shorts are being forced to cover. The move from 666 to 800 was understandable as cataclysm risks faded when the treasury moved on asset purchase programs and committed to save too big to fail banks equity investors by any means necessary.

Moves to effectively force a preferred for equity swap with a signal that the treasury would also push a move up the capital structure and swap debt for equity as necessary to effectively share the capital burdens between debt and equity investors to keep the banks in the private sector put the screws to the shorts as they effectively changed the game. Regulators also moved to ease the balance sheet pressure levied by mark to market rules.

Clearly positives for equity investors in banks and to the extent that they fostered viability (perhaps regardless of solvency), these moves were a positives and understandable improved sentiment and forced short covering. What these moves don’t do however is make all well and good in the world. Credit markets are still under pressure, consumer spending, incomes, wealth, business spending, capex, and corporate earnings are all still under pressure. European macro fundamentals appear to be deteriorating fast. There is no reason that I can see to believe that consumers or businesses will be in a position to spend more anytime soon. And at some point soon, equities will need fundamental support.

For all those reasons, I’ll be stepping up the short exposure today. I recognize the technical momentum at hand so I’ll do it slowly and expect to deal with a little pain in the short run. The fundamentals, earnings and valuations are my shepherd but the volatility and countertrend moves in an uncertain but hope induced market are a killer so I must continue to adjust market exposure accordingly.

I’m still very bearish on natural gas and still bearish on steel. I let a very nice gain in NUE disappear by only covering half on a terribly negative preannouncement and letting the other half go 10 points against me. That always sucks because I thought about covering the whole thing and putting it back on a few points higher. But I didn’t so that’s spilled milk and some pain in the PA as they say and I’m not going to cry about it. That said, I’m going to short more this morning as the fundamentals have turned from incredibly good to disaster yet hope reigns supreme as investors look to NUE as a play on early cycle macro sensitivity as well as global stimulus related infrastructure. That’s optimistic to put it mildly, naive might be a better description. Anyway you cut it I'm still betting that estimates still have to come down more for the balance of the year and next year and think the shares would be under pressure as that happens because they aint cheap.

I continue to think that NUE is clearly the best house in a bad neighborhood that is going to stay bad for many months to come. NUE’s residential and commercial construction, auto, infrastructure end markets are not coming back nearly as fast as bulls hope. Although NUE typically benefits from scrap declining more than end market pricing, as well as lower energy (natural gas) costs, costs can not decline fast enough to stave off severe margin pressure because volumes have plummeted. NUE and most of its competitors are suddenly operating at 40-45% utilization rates. At such levels, companies like NUE simply are overwhelmed by negative operating leverage. Demand and pricing would have to recover significantly to change the revenue and margin pressure dynamics and I don’t see that happening anytime soon. Pricing might stabilize as the industry has done a great job of making regional and product markets less competitive through consolidation and have now move to shut capacity quickly so inventories don’t balloon. However, volumes need demand to recover in a big way and there are too many end markets under severe pressure to expect that to happen soon. That’s my call on I’m sticking to it.