Most of us are taught, at an early age, that cynicism is wrong.
Being distrustful of others and believing people are only motivated
by self-interest is a difficult way to approach life. However, as
in most everyday wisdom, there is a dramatic exception to this
rule.
Being a cynic has earnedhedge fund manager Jim Chanos billions
of dollars over the years. He is such an adherent to the philosophy
of cynicism when dealing with the financial markets, he gave his
fund a Greek name for cynic -- Kynikos.
As you can imagine, the $6 billion Kynikos fund is focused on
short-selling. Selling a stock you don't own in an attempt to buy
it back at aprofit when its price declines has cynicism written all
over it. After all, what short sellers hope for is the
worst.
This cynic view of the world has helped Chanos
discoveraccounting frauds and other corporate malfeasances that
generally take stocks nosediving to bankruptcy. This attitude has
enabled him to short Enron right before it imploded in the largest
U.S. bankruptcy scandal of all time. He also made a prescient short
trade on Baldwin United in the months prior its bankruptcy
spiraled.
His most recent high-profile accurate shortcall was
Hewlett Packard (
HP
)
.Shares are down more than 26% since he said HP had fudged the
numbers on itsbalance sheet . Chanos is also a majorbear on China.
Although
I disagree with him
, I can't deny that his favorite Chinese short, the
Agricultural Bank of China (
ACGBY
)
, is down more than 20% so far this year, compared with last
year.
He calls the stocks he shorts "value traps." Here are five
traits of value traps:
1. Accounting issues
2. Cyclical or overdependent on one product
3. Hindsight drives expectations
4. Famous investors/marquis management tout the stock
5. Appears cheap when using management's metric
While shorting individual stocks is a highly speculative
undertaking because of high-margin costs and theoretical risk,
there is a less risky way for investors to profit from Chano's
short calls -- shorting the exchange-traded funds (
ETFs
) that have assets related to those short predictions.
And right now, Chanos is heavily short Brazil, China and Spain.
He says thingswill get far worse in these nations before
theturnaround occurs. So if you share his cynicism, then these
three ETFs follow in his footsteps while providing ahedge against
single-stock risk.
1. iShares MSCI SpainIndex Fund (
EWP
)
ThisETF is weighted at 41% toward the Spanish financial sector.
Banco Santander (
SAN
)
, one of the world's largest banks, makes up almost 22% of the
ETF's underlying assets. Chano recently made a compelling case as
to why Banco Santander is a classic value trap. First, he says the
trouble in Spain's national balance sheet will negatively affect
the bank. Second, the bank's 320- billion euro exposure to the
struggling Spanishreal estate market will continue to pressure
shares.
2. Proshares UltraShort FTSE China 25 (
FXP
)
Chano's global short fund is roughly 20% made up of short bets on
China. If he proves to be right about the future of the
Chineseeconomy , then holders of this inverse ETF will benefit.
Because it's leveraged, it will profit from a decline in the value
of its assets. As such, it's only suitable as a
short-terminvestment .
3. ProShares UltraShort MSCI Brazil (BZQ)
At the Ira Sohn conference on Monday, Nov. 26, Chanos let it known
that two of his favorite shorts are
Brazilian giants Petrobras (PBR)
and
Vale (VALE)
. Together, the federal oil firm and the world's largest iron
producer add up to 26% of this ETF's underlying assets. He is short
Petrobras because the Brazilian government owns 64% of the company,
which is a huge negative since the company is unable to obtain
fullmarket price for oil and gas, because to government
interference. He is short Vale because he thinks iron ore is
currentlyovervalued and the company is too dependent on demand from
China for its business. This means signs of a slowdown in China
will have negative implications in Chinese steel consumption, which
would in turn affect Vale in a big way. In addition, extraction of
iron ore and other basic materials are becoming more costly.
Once again, if Chanos is correct about these companies, then
holders of this inverse ETF will benefit handsomely. Again, this is
only suitable as a short-term investment.
Risks to Consider:
Despite Chanos' stellar record on the short side, he may be
dead wrong about these stocks. Even $6 billion hedge fund managers
don't always get it right. I for one think Chanos is not really
correct on his China short calls. China's new leadership have a
pro-business stance and the country is slowly opening to outside
investment. He's simply too late with his Chinese
bearishness.
Action to Take -->
Having said that, I agree with his calls on Spain and Brazil, given
their current economic slowdown. If you share Chanos' cynicism
andbearish predictions, then shorting the EWP and taking short-term
long positions in the leveraged ETFs FXP and BZQ makes perfect
investing sense. Yes, you could short the stocks listed directly,
but using the ETFs will lessen single-stock risk.