Big Short: the sequel?

The money manager who successfully shorted subprime mortgages is now betting against UK stocks. Should we be worried?

“OK. Sell it all.”

Steve Eisman, money manager at the Neuberger Berman Group, was one of a handful of people who saw the subprime mortgage crisis coming.

He got immortalised on the big screen by Steve Carell in the 2015 film The Big Short, which was based on a 2010 book of the same title.

In one of the final scenes of the film, the audience sees a conscience-stricken Carell (i.e. Eisman) cash in on a billion dollars.

He knows the taxpayers will have to cough up the money for bail-outs. But a billion dollars is a lot of money to pass up on.

Over the weekend, Eisman made headlines again. He may be angling for a sequel to The Big Short after announcing at a Dubai conference that he’s taken another short position.

This time “sell it all” might come to mean “short all UK stocks”. For now, he’s shorting two UK banks but he might not leave it there.

That’s because he doesn’t believe the government can get a deal with Brussels through parliament. He’s sure the markets won’t like what will come next.

Eisman got it right in 2007. Does he know something we don’t (again)?

Not contrarian

“I’m shorting two stocks in the UK.”

When a revered shorter makes a statement like that, it’s getting noticed. Finance websites the world over reported Steve Eisman’s words the minute they had left his mouth.

He obviously didn’t let slip the names of those stocks. For one, because he’s not Santa Claus. For another, because it’s more intriguing that way.

Market analysts had a field day trying to solve the puzzle. They soon worked out that Eisman must have been talking about banking stocks. But which ones?

The four biggest UK-listed banks have all fallen out of favour with investors. Over the past 12 months, Barclays is down 5.66%, HSBC 14.63%, Lloyds 16.47% and RBS 19.17%.

So Eisman is hardly being contrarian here!

Last week it came out Barclays and Lloyds were among the worst performers in the EU’s banking stress tests. That’s two poor looking stocks right there… One and one is two?

Not so fast. Even though Barclays and Lloyds didn’t get top marks, they still passed their exams. All of Europe’s top 48 banks are deemed to have enough capital to weather the fiercest Brexit storms.

The conventional theory is therefore that Eisman’s shorting smaller banks. They don’t have the same financial cushions. Unlike their big competitors, they don’t have big balance sheets and don’t get a lot of revenue from abroad.

Metro Bank and CYBG, owner of Clydesdale Bank and Yorkshire Bank are being named the most. Probably because they happen to be among the most shorted financial stocks in the UK. Metro has 7.9% of its shares shorted, CYBG about half of that.

On the same day Eisman shared his bearish outlook for Brexit, the Sunday Times broke the news that Prime Minister Theresa May had won a major concession from Brussels.

Eisman doesn’t think it matters. He expects the UK to reach an agreement with Brussels, but he’s betting on parliament killing off any deal that’s put to a vote.

Still, the Big Shorter doesn’t think Brexit is actually the biggest threat to the UK…

Like many investors, he fears a real-life re-enactment of Chris Mullin’s novel A Very British Coup more than anything else.

“I’ve got a screen of about 50, and I might short all 50 if I think Jeremy Corbyn is going to be prime minister,” Eisman said.

“Corbyn’s a Trotskyite. Now I know my Trotskyites well, and I know you don’t want to be invested in the UK if a Trotskyite is prime minister.”

Natural antidote

Should we be worried about Eisman’s position?

Not really. Eisman is a money manager and betting against the market is what they do when the odds of something happening aren’t as slim as the market thinks.

Brexit optimism went on a high after rumours about May striking a secret deal with Brussels. The pound rose to $1.30 – which means it’s again making up ground lost on Brexit Eve.

The market may have got carried away a bit. It’s risen sharply on a rumour. Until Theresa May holds a press conference with a high-profile EU diplomat, nothing’s changed.

As the Belgian MEP Guy Verhofstadt noted last month, as long as there’s no agreement on the Irish border “progress is at 0%”.

But the markets react to whatever piece of information they can get their hands on. When they grow too bullish about something, bearish investors will come along to help it find a new equilibrium.

Eisman is the natural antidote to bullish traders, like Japanese bank Mizuho, which is expecting the pound to rise to $1.40 once a Brexit deal gets through the Commons.

For the record, I’m still confident the government will get a deal with Brussels through parliament.

The EU is said to allow the UK to remain part of its customs union until a “Future Economic Partnership” is agreed.

It would allow for an orderly “exit” (because nothing would change) on 29 March 2019. Then it’ll give the government more time to negotiate a Canada-style free trade deal with the EU.

Europhiles will like the first part (keeping the status quo for a few more years), while Brexiteers will feel more for the second part of the plan (Brexit would mean Brexit).

If May’s deal with Brussels doesn’t scrape through on the first try, then I’m sure it will on the second try after a few more concessions.

I don’t think the market’s wrong to be a little optimistic. It’s starting to price in a deal with Brussels, which seems more likely again. Hence the pound’s move upwards.

As for Eisman… Does he know something we don’t? Time will tell.

For our part, let’s hope Steve Carell doesn’t get to star in the sequel to The Big Short with the UK economy as ground zero.

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