What Keeps Me Up at Night

It's well past midnight here in Oklahoma, and I'm having some difficulty sleeping. I've been thinking and re-thinking my positions as we go into what is likely to be an eventful week in the markets.

I suppose I could have more serious problems keeping me up. Lady Macbeth (pictured) sleepwalked because of the guilt of having the King of Scotland's blood on her hands.

I suspect that my subconscious somehow knows when I've left myself overexposed, and won't let me relax until that exposure is dealt with. So I'm going to think through my positions yet again . . .

First, I worry that I could be overexposed against the dollar with my substantial gold position. I bought gold as it broke out above $700/oz, but as we run closer to gold's all-time nominal high reached in 1980 of $850, we should hit some pretty stout selling. Additionally, pessimism is rampant, and I'm not comfortable staying in a crowd that is this committed to one side of the trade.

I have to determine whether I'm going to be happy with a quick 20 percent or if I'm willing to put up with some turmoil in order to see gold through above $1000/oz, which I believe is on the way. My current stance is to stick it out and hang on, but that view will take a lot of stomach if a gold decline pulls back into the $600s. It isn't fun to see a perfectly good profit disappear on principle.

. . .

I'm also concerned about the very sizable short position I have against US financials as they appear to have started breaking down . . .

I've been bearish on financials for some time, and remain so. My research convinces me that the credit downturn has much further to go, and that people who think that banks can write down $300 billion in assets and then continue on their merry way frankly haven't done their homework.

Credit crises are crises of faith. When people stop believing in the value of an asset, whether it is the US dollar or the value of a mortgage derivative, they don't just begin believing again.

Particularly strange to me are the "value investors" who are piling into the financials they now call "bargains." I have no idea how these people, many of whom quote Warren Buffett and Ben Graham like scripture, have determined the asset values of these companies when even the companies themselves don't know what they're worth.

I would urge buyers of financial stocks right now to really think their purchases through. The analyst consensus for EPS growth at Citigroup (C), for example, is 8% over the next two years, just 2 points below the growth rate of the last five years.

Exactly where is all this growth going to come from, particularly since the i-banks are in the process of dismantling one of, if not the highest-growth areas, the packaging and selling of derivatives?

I believe that even 8 percent growth is too optimistic. Like the tech stocks in 2000 and like the homebuilders in 2006-2007, the financials' growth rates will not just slow, they will go negative. The investment banks are going to go into the red, and the 7 P/Es will, like those of the homebuilders, balloon out into double digits as the earnings denominator shrinks while the price numerator declines more slowly.

For these reasons, I've avoided financials for some time (Berkshire Hathaway being the main exception), but the apparent breakdown in the form of lower highs and lower lows is finally giving me reason to act against them aggressively.

However, as I look more closely at the chart, I realize that could have been more patient. I should have bought half of my position at current prices and then waited for the rally that should be here next week to retrace to 33 or so, where I could sell the rest short.

The volatility of this ride isn't going to be fun either, but I would be surprised to see the financials make new highs here.

That said, I accept that it could happen. If they begin a new uptrend, I'll get out.

Don't let the bedbugs bite.

The painting of Lady Macbeth is by Henry Fuseli, German-Swiss painter who was from Zurich.