Whitney Tilson Wears a White Hat

Whitney Tilson is a nice guy, and an Amigo through and through. But he is not very Street smart:

To the extent that the SEC has evidence that naked shorting is going on, then more power to 'em to try to put an end to it (but if so, why limit the new regs to only 17 stocks? Get rid of all of it!). I'm somewhat skeptical, however, that naked shorting is widespread and had much to do with the declines in the stocks of the 17 companies.

This belief is rooted in the fact that not only have we never naked shorted -- our prime broker I'm sure wouldn't allow it, even if we wanted to -- but in nearly ten years in this business, I've never known of or even heard of a case of naked shorting.

But maybe I'm just naive or only hang out with honest people, given that the stocks of these companies have jumped probably an average of 30%+ in the past two days. It was a classic short squeeze, and there are a number of possible explanations for it. Seeking Alpha

Much like Whitney, I spent part of last week pondering what was the biggest catalyst for the ramp in the financials. Given that the the Agency debt of Freddie and Fannie had a bad end to the week, as evidenced by the poor showing of the Pimco Total Return Institutional Fund (PTTRX), I quickly eliminated Hank Paulson, not that I would ever give him the praise Abby Cohen heaped on him recently.

Wells Fargo certainly has to be given partial credit for lighting the candle; but ultimately the regulator's move to clamp down on naked shorting has to be given the lion's share of the credit.

While Whitney might hold himself out to be as pure as the driven snow, not everyone on Wall Street is. Some folks were probably short, and naked, and did not even know it, although their prime brokers might have been scrambling behind the scenes.

And while Wall Street’s prop desks might have been short, independent prop traders, who can leverage up their equity to intraday ratios (20 x 1)that would make Jimmy Cayne blush, have certainly been behind part of the beatdown. It was not until recently that order entry software from firms like Merrill Lynch’s Trade Speed routinely blocked naked short sales. With thousands of fast money traders clearing Merrill alone, I would imagine many intraday beatdowns were the result of momentum traders piling on, given the trend and newsflow, and the fact that they don’t fight the tape.

But the back office staffs of prime brokers and professional clearing organizations will now slow the traders down, forcing them to locate stock and reserve a borrow, as John Tabacco of Locatestock.com noted last week:

July 15th

Yes, Whitney is right about financial stocks being oversold, but nobody was willing to buy until a catalyst appeared. Buying stocks based on historical trough valuations has not been working either, and low-price to book strategies have been gotten crushed across multiple sectors, and not just financials.

Whitney might spend his free-time comparing notes with the other Amigo’s, but he had better realize their is an army of independent prop traders out there who control the day-to-day action on the Street.

They are good traders, and vote early and often, while folks like Whitney are more weighing machines.

Yes, the prop traders read the tea leaves, and jammed financials up and to the right at the end of last week. Some covered shorts, and others, who go home flat, saw an easy trade and went for it.

Whitney is right about one thing. He is naive; and has probably been short, naked, at times in the past without knowing it. Given the competition between prime brokers I doubt they located stock each and every time Whitney went short. Multiple shorts on the same inventory has been the order of the day at prime brokers and clearing firms, and even Caesar’s wife has probably been naked short at times.

Prop traders eat what they kill, something Whitney probably cannot comprehend, given that his 3-year performance would likely leave him starving in a world where absolute returns rule.

Calling momentum traders nitwits is laughable given Whitney’s performance. Yes, his numbers are beginning to turn. And if the worm has turned Whitney will find himself smiling by Labor Day as valuation comes back into vogue. But there are more ways to skin a cat than value. And based on Whitney’s Focus Fund numbers I have to wonder if he knows how to skin a cat.

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Yes, financials are cheap.

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The SEC’s Campaign Against Naked Shorting: Misguided or Right On?
Seeking Alpha

Never Have So Many Short Sellers Made So Much Money With Stocks
Bloomberg

Prime Brokers Scrambling to “Locate a Borrow”
1440 Wall Street
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The content contained in this blog represents the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author. No Positions

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