New Form of Mortgage-Backed Security Losses Ahead

"The worst is to come…"  
That’s what MetLife’s (NYSE:MET) Chief Investment Officer Stephen Kandarian told Bloomberg this morning.  
He was talking about commercial mortgage defaults. He notes that "[t]ypically there’s a lag between when the economy softens and when the defaults actually occur."  
Bloomberg also cites a study from Real Estate Econometrics LLC that forecasts default rates for commercial real estate may hit 4.1% by the end of the year.  
What does commercial real estate have to do with an insurance company? Plenty… 
*****Insurance companies take in cash in the form of the premiums we pay. They then invest that money in order to pay off claims down the road. As their investment returns compound, they profit. 
But when their investments lose money, trouble starts. And trouble is exacerbated when insurance companies sell guaranteed returns to investors in the form of annuities.  
The promise of annuities forces insurance companies to seek riskier investments to boost their returns. And many have turned to mortgage-backed securities to make more money.  
*****MetLife has a $300 billion investment portfolio. That portfolio lost 23% in the first quarter of this year. Mr. Kandarian freely admits he’s looking for higher returns to make up the losses. And he’s looking at adding securities backed by commercial mortgages, in addition to continuing to originate loans to the commercial real estate sector.  
It reminds me of the gambler, who after suffering a big loss, decides to start doubling down and taking more risks to win his money back. It usually doesn’t end well.  
Of course, what he should do is simply step away from the table. But MetLife and other insurers can’t — they have to make money to meet their obligations. It’s not a sure thing, but I can imagine it ending poorly for some insurance companies.  

It’s Newsletter Advisor day and this week we’re chatting with our good friend Bryan Bottarelli of Bottarelli Research. 

Every time we pull up a chair with trading expert Bryan Bottarelli, he’s sharing with us some of his most successful – and profitable – trading strategies. Today is no exception.  
In the interview below, we once again ask Bryan the urgent questions what every investor wants to know, like "where’s the market going," and "what’s the best way to profit off it?" Please take a moment to read today’s special bulletin. Trust us, it’ll be well worth your time!
Q: Good afternoon Bryan. I reviewed your 2009 LEAPS track record and found that you’ve closed out 28 trades for the year with 24 of them as winner. That’s a 85% success rate and your average return, including winners and losers, is 58%. So let me ask, what’s your secret? 
A: The secret, in a nutshell, is the ability to play the market’s "sentiment" no matter if you believe it’s true or not. For example, I personally do not believe in the sustainability of the market’s recent 3-month rally. But that doesn’t mean I won’t profit off it.  
Perhaps this sounds counter-intuitive. But in a recent alert titled "Separating Truth From Nonsense," I explained it like this: 
Anyone with a brain and a sharp pencil can connect the dots between the current economic situation and the fundamentals on the current Dow chart. Those who have done this exercise, in my view, have all been short over the last few weeks. That’s where the conflict between reality and outside influence comes into play. 
70% of our countries’ economic growth comes from the American consumer. And right now, we all know that a large number of American consumers are jobless, cash strapped, and without any financial reserves. What’s more, 20% of U.S. homeowners are currently "underwater" on their mortgage, which means they currently owe more on their home than it’s worth and can’t apt into that equity like they did earlier this decade. 
People are just not spending right now, no matter what type of bogus statistics you hear.  
The U.S. government will tell you that unemployment is still under 10%. I say "bullroar!" If you factor into the equation people who have given up looking for jobs – and also factor in those who are currently working a makeshift job below their income generating level just to make ends meet (often called the underemployed), you’ll realize that the "true" unemployment rate is closer to 20%. As a point of reference, unemployment during the Great Depression hit 24%. This is truly a modern-day depression.  
BUT HERE’S THE KEY: The one trump card is the meshing of the Fed, the Treasury, and U.S. Governmental policy. Never before has the line between all three organizations been dissolved by an order of magnitude. 
The fact that the market is being goosed by countless trillions of dollars has now caused a snow-ball effect that has cast major ripples throughout Wall Street. For example, I noted above that anyone with a brain and a sharp pencil can analyze the dire market situation and enter into a short position. Many of the top traders that I know have done this repeatedly over the last two months. The problem is, when the U.S. Government funnels money into the system, those short players are forced to cover their positions. They’re not going long, mind you. But rather, they’re zeroing out their ledger by covering their shorts. 
As a result, this massive "short-squeeze" phenomenon translates into sudden and powerful upside market movements – which has fueled the 3-month upside move that we’ve just witnessed. In other words, the recent rally has been nothing but short-covering induced by outside market influences.  
Now I admit, CNBC will bring on some talking-head with a skyline photo in the background, who tells you that the market is up that particular day because Wall Street is cheering some extraneous piece of news. One recent example was the fact that only 450,000 jobs were lost last month. You’ll hear these talking heads bellow out nonsense like, "losing only 450,000 jobs is much better than losing 600,000 jobs like last month – that’s green shoots baby!" 
Common, give me a break. There’s a vast difference between a market that’s (perhaps) stabilizing – and a market that’s recovering. Right now, we might be in the very, very early states of stabilization. But until we have job growth (as opposed to fewer jobs lost month over month), we’re nowhere near recovery. Ben Bernanke tells us that the worst might be behind us. Heck, after bankruptcies at Countrywide Financial, Lehman, Bear, General Motors – and near implosions at Fannie/Freddie, Citigroup, AIG, and Washington Mutual, that’s not a gutsy statement. But I still refuse to buy into the idea that we’re poised for recovery. 
I apologize for the long rant, especially on your first interview question. But my overall point is this: From a trading perspective, market sentiment now makes up 90% of your success or failure. Therefore, it’s critical that you play the market "tape" while ignoring all of the extraneous garbage. For example, you might not intuitively believe in a certain trend, but nevertheless, that shouldn’t stop you from profiting off this trend (no matter how bogus you believe that it is). This is not easy to do. In fact, not many investors can do it. But in my opinion, that’s the underlying key to successful trading right now – which has allowed us to achieve the strong returns that you referenced above.  
Q: Can you give us a recent example of trading success you’ve had playing market sentiment in this manner?
Sure, our trade from Tuesday, June 3rd was a good example of this philosophy. I personally don’t believe that oil prices will move lower over an extended time frame, but that didn’t stop us from hitting a quick downside winner on the Oil Service Holders (NYSE:OIH).  
You see, the OIH is a basket of oil service companies that includes powerful companies like Diamond Offshore Drilling (NYSE:DO), Halliburton (NYSE:HAL), Schlumberger ( NYSE:SLB), and Transocean (NYSE:RIG). In my honest opinion, this collection of companies represents one of the strongest – and most profitable – sector groups on the entire market. But on Monday June 2nd, I go the indication that the bullish sentiment on the OIH was overdone. After all, the OIH had moved from $95.00 up to $110.00 over five trading sessions, which was a 15.7% move. There was also an upside gap at the $105.00 level. Combining the over-bought sentiment with the technical gap, I noted that the OIH was due for a quick fall. So on Monday, I recommended OIH June 110 Puts (OIH RB) for $4.40 per contract. The very next day, the OIH dropped $5.67, and these puts traded as high as $8.11. That’s an 84% return in one day, simply correctly playing the market’s sentiment.  
Q: Nice trade. But where is the market going and what’s the best way to profit from it?  
Right now, the market internals clearly indicate that the major market averages are due for a fall. But despite these indications, the market has been rallying. Therefore, from a trading perspective, you must throw out the technical readings and play alongside the upside pattern. In the most simplistic tactical advice imaginable, you should buy into the dips. And do this until it stops working.  
In terms of specific companies, I’m currently recommending longer-dated call options on
Coeur d’Alene Mines Corporation (NYSE:CDE), which explores, develops, and mines silver, gold, lead, and zinc properties in South America, the United States, Australia, and Mexico. Much has been made about gold’s recent upside push toward $1,000 per ounce, but not too many investors realize that silver has completely out-performed gold this year. Silver’s year to date gain of just under 50% is far superior to gold’s 12% return. And for less than $15.00 per share, CDE offers you exposure to both sectors. Combine their strong presence in gold and silver with their attractive share price, and you can see why I consider CDE one of the most promising metals plays you can buy.  
Over on the bearish side, I currently own longer-dated put options on United Parcel Service (NYSE:UPS). The rationale here is simple. As I mentioned above, the U.S. consumer is on lock-down. He’s not spending. This reduced the profitability of UPS. At the same time, oil and gasoline prices are rising. That means UPS‘ largest operational cost is also cutting into their profitability. It’s a double-whammy which will eventually lead to lower stock prices. Therefore, in terms of a bearish play, I expect UPS to move lower.  
Thanks Bryan for a great interview and some truly outstanding trading recommendations. I’ll be following up on those myself. 
Bryan‘s got a great track record going and if you have a minute, I strongly recommend that you check out his service HERE.
He’s agreed to cut a break on his subscription rate for Daily Profit readers. Right now, you can get 9 months of service for the price of 6. That’s a $700 savings! To take this special offer, click the link below, and select the special 9-month offer (noted with a red star).  
Before doing that however, use the link below to find out more about the service. Then when you’re ready come back to this email and click the link above. It’s got the special pricing for Daily Profit Readers.

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