Bond Insurer Gets a Boost of Capital January 31, 2008 | 4:12 PM
Bond Insurers have been absolutely crushed by the credit crisis. The two industry leaders Ambac and MBIA have both lost more than 80% of their market value in just over a year. These bond insurers are only as good as their credit rating because, in order to provide insurance bonds, they must keep their AAA credit rating. There has been much speculation that these companies are so heavily influenced by the credit market that the rating agencies could drop their ratings, which would be akin to a death sentence. It would not only have affected MBIA but also the $678 billion of securities they insure.
Today, MBIA’s CEO, Gary Dunton spent a four hour conference call squelching rumors that recent write-downs have crippled the company so much that they would lose their AAA rating. MBIA did disclose that the 4th quarter produced a massive $2.3 billion write-down. There were fears that MBIA would not have enough capital to cover their losses. “The effect of these reserving and impairment activities on our capital position will be more than offset by the successful completion of our capital plan, which will increase our capital position by well over $2 billion,” said Gary Dunton in a statement. MBIA aggressively looked to raise capital in order to maintain its strong Moody’s rating.
The company raised $1 billion dollars through offer of surplus notes. In addition, MBIA also brought in a huge investment through a private placement, possibly one of the largest private placements ever. The transaction was negotiated by private equity firm Warburg Pincus, who will purchase newly issued MBIA shares with $500 million right away with an additional $500 million likely in the future. This type of transaction is often referred to as a PIPE or Private Investment in Public Equity. The great advantage of these transactions is that they are quickly executable and generally not very expensive. PIPE investments are becoming more and more prevalent in the post Sarbanes-Oxley marketplace as a way to simplify the act of raising capital.
It appears that MBIA’s chairman was able to assuage investor’s fears today as shares were up almost 7% today with the help of the two large investments. MBIA has a very strong Ockham rating at present, but that is a factor of their steep decline over the last year which make the shares seem cheap in a historical context. However, there is still plenty of uncertainty in the credit market and Ockham cannot advise going long on monoline insurers until there is a more stable market climate, which may take a good while.
Helicopter Ben to the Rescue
January 30, 2008 | 3:41 PM
Two big stories surfaced on the macroeconomic front today. First, the Commerce Department released the fourth quarter GDP results. On an annualized basis the economy grew at .6% which was a disappointment, as the consensus on Wall Street called for 1.2% growth. Clearly, the credit crisis played a large role in slowing growth as did tepid consumer spending--especially important in this quarter because of the holiday season. This has validated recent calls by many economists who have been saying that economic growth is slowing, and it was a fairly steep decline from the lofty 4.9% annualized growth in the third quarter. However, those talking of recession need to hold off, at least for now. As you know, a recession is defined by two consecutive quarters of negative GDP growth, and the U.S. economy has yet to record one recent quarter of negative growth. So, while today’s GDP number is disappointing, it is important to note that it was still positive.
The second big story was a second Fed rate cut in the last eight days. As most expected, the Fed cut the Fed funds target rate by another 50 basis points, totaling 225 basis points in the last 4 months. Clearly, the Federal Reserve Open Markets Committee (FOMC) has chosen to be very proactive in doing all that it can to accelerate economic growth. However, Fed Chairman Ben Bernanke refrained from commenting on inflationary pressures. Inflation is lurking in the background as the dollar continues to weaken and commodity and energy prices remain stubbornly high. Be that as it may, for better or worse, the Fed has whole-heartedly embraced the easing cycle. One projection from IDEAglobal forecasts that the FOMC will continue to cut the real Fed funds rate (accounting for inflation) into negative territory by mid-2008, which would bring the target rate down another full percentage point to two percent.
It is clear that Bernanke and his gang believe that there is real basis for concern in the U.S. economy. They are attempting to front load these rate cuts before it is too late and the economy is already in recession. The magnitude of these cuts in such a short time period puts this series of cuts in the same class as the cuts of 2001. However, it is troubling that concerns about nascent inflation seem to have been marginalized, taking a back seat to the goal of spurring economic growth. Being the Fed Chairman is a balancing act and Bernanke seems to be shifting evermore to one side over the other. Bernanke will have been Fed Chairman for two years this Friday, and how he handles these volatile times will certainly define his term in office.
Home Depot on the Rise
January 29, 2008 | 10:41 AM
The Home Depot seems poised to break out of its recent disappointing stock performance. When you look at what the market has historically been willing to pay for HD it is selling at a noticeable discount. For example, Home Depot’s price-to-cash-flow currently is about 8.27, which is well below its historical range of 11.07-18.19. The current price-to-sales ratio is a similarly low with HD trading at .73, whereas its normal historical range is .90-1.46. Both of these valuation
measures suggest that HD is unusually inexpensive right now.
The real concern dogging retail stocks at present is that consumer spending will slow dramatically, adversely affecting retailer’s bottom-lines. However, there is no guarantee that the economy is headed for a recession and even with a slight decrease in consumer spending, Home Depot is well positioned to weather the storm. For one thing, Home Depot is a huge and diversified retailer. One of Home Depot’s biggest customers-- home builders--have slowed their production greatly. However, this business will not be down forever and many do-it-yourselfers (DIY) may opt to spend more money on home improvement projects, with the housing market in stasis for the foreseeable future. The DIY market is HD’s bread and butter and an area of increased focus for the company. HD’s 25% return-on-equity (ROE), which has been rising for the last six years, demonstrates that the company is led by an exceptional management team well able to adjust to an evolving marketplace. It may surprise you to know that while the rest of the stock market has been pummeled so far in 2008, Home Depot stock has increased 16% year-to-date.
It is easy to see that HD is cheap right now with a P/E multiple of just 12.05. Ockham had a “buy” rating on the stock at more expensive price levels. Although the market correction may not be over, HD stock appears very attractive at its current price level for long-term investors. Given current earnings expectations for the company, we would expect to see HD trading in the range of $37 to $61 a share in a more positive stock price environment.
Home Builders Take Another Knock
January 28, 2008 | 11:41 AM
To claim that home builders have had a tough year would be somewhat of an understatement. As evidence of this, released today was data on new home sales which was the weakest in 12 years. There were 41% less new homes sold this year than in the prior year. This lack of demand for new homes also pushed the median new home price down 10% for 2007. The credit crunch has definitely hit the housing market especially hard as some of the first signs of distress originated with the sub-prime mortgage mess.
At this time major home builder stocks (Centex, Lennar, Ryland, Beazer, Toll Brothers) have lost anywhere from 50%-80% of their market value because of the carnage in housing. These stocks were inflated during the housing bubble that developed during the boom years from the late nineties until 2006. While, our value investing methodology has a very positive Ockham rating on these stocks, we are not eager to go long on these securities just yet. It is likely that most, if not all, major home builders will recover from this mess, but the housing recovery will take more time than a general stock market recovery. Home builders are clearly feeling a crunch and could be tempted to cut corners in order to cut their costs. If home builders cut costs too deeply and quality suffers then these companies will increase their risk of future litigation from displeased customers. While such worries are speculative in nature, it is a logical concern for investors to ponder before committing capital to this sector of the stock market.
Home builders built more homes than were needed during the housing boom, and now there is little that can be done to resolve the glut quickly. Until housing supply comes into line with demand, home prices will continue to drop and the home builder’s financial picture will be bleak. Ideally, these companies would have invested their profits wisely when the market was booming so that they would have a solid cushion to fall back on in lean times. However, it seems that many builders kept the “pedal to the metal” as the real estate market began to show signs of excess over the past couple of years. This would explain why, despite the fact that new home starts are at their lowest point since 1991, prices continue to fall.
It is important to note that Ockham currently has over 94% of our coverage universe rated positively. We regard this as more of a general market indicator than a reason to go long on all of these stocks. If you were to buy all of these stocks right now, in five years you would probably be pleased with the performance, but there are some stock sectors (e.g. home builders, bond insurers) that although attractively valued, are not yet suitable for investment until a clearer picture of their economic prospects going forward emerges. For an idea of one company loosely related to home building that we do like, see today’s company research report on Home Depot.
Low Hanging Fruit
January 24, 2008 | 12:25 PM
Apple Inc. has enjoyed being a cornerstone of the bullish market of recent history. Between July 2006 and the end of 2007, AAPL shares experienced dramatic and impressive price appreciation from about $50 to nearly $200. However, as is true of the market in general, 2008 has not been kind to Apple. At present, Apple is trading just above $130, an almost 35% drop in just over 3 weeks. This selloff has brought Apple shares back into an attractive enough level that it is now on Ockham’s buy list.
Apple shares were headed down from their lofty levels before the Macworld conference on January 15th in San Francisco.
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The annual Macworld event showcases Apple’s newest products for the marketplace to salivate over. However, this year lacked the kind of epic product that makes investors swoon, unlike last year which saw the introduction of the iPhone. Steve Jobs, Apples’ charismatic, visionary leader has not been resting on his laurels, and the ultrathin MacBook Air was introduced weighing just 3 pounds. It was also announced that Apple looks to take a share of the movie rental business, a service that will be available via the iTunes interface and capable to watch on an iPod as well as TV or computer. Apple also announced updates that will improve already existing iPods, iPhones, and Apple TV which should make these products even more desirable.
However, without the eye-popping headliner that the iPhone was last year, the devoted fan base was not impressed, and neither were investors as the stock continued to drop in an admittedly weak environment. Then on Wednesday AAPL provide earnings guidance that fell below estimates and this initiated another sell off. Even though the revenue target predicted growth of 29% it was still considered well below what Wall St. expected. It is clear to us that analyst estimates were way out of line with reality. It seems illogical, but Apple has set the bar so high, that if they don’t unveil the sexiest product on the market every year then their Macworld showing is deemed a failure.
There are plenty of reasons to be excited about the future of Apple Inc. For starters, the stock is almost 35% cheaper than it was a month ago. Furthermore, Apple has developed a multifaceted entertainment and functionality based empire. iPods have revolutionized the music industry and almost single-handedly pushed the industry into a digital age. And they still control over 70% of the market for digital music players. iPhone is on the same path in the rapidly growing smart-phone arena, and Apple expects to meet sales goals of 10 million units by year end 2008. The Apple OS Leopard is selling quite well and is considered by many to be superior to rival Vista.
To sum it up, Apple has the products that consumers want, and as seen with the newest software updates, they are constantly striving to improve. They have developed a large, growing, and devoted customer base, many of which own several of Apple products. The company, under the leadership of Jobs, is integrating products to do more for the consumer. Jobs will continue to lead, innovate, integrate, and challenge AAPL’s competitors to live up to its products, and he shows no signs of slowing down. The recent sell-off exposes estimates that were not realistic, but AAPL is now an attractive candidate for those looking for a smart buy.
Put Your Money Into Banks
January 23, 2008 | 2:40 PM
Financial stocks, for the most part, are getting a really nice bounce today. Some of the biggest banks have enjoyed a considerable rise today including Bank of America, Wachovia, Wells Fargo, and JP Morgan Chase. It appears that the market is beginning to come to terms with the economic slowdown and is starting to see value in select, down-trodden financials. The financial sector has been squeezed by the credit crisis and fears of recession. It is our opinion that financials have been hit disproportionately hard over the past few months. In effect, the financials have been in a bear market going back for some months, many losing more than fifty percent of their value during this swoon.
The financial sector has improved it’s relative ranking to the other sectors tracked by Ockham since last week. This means that the valuations for financial stocks have improved sufficiently to rank 1st out of 10 total sectors. We review all individual securities along with their peer groups to identify improving and declining valuations. To compute our sector ranks, Ockham Research takes all of the component companies within each sector and weights their Ockham ratings by the market capitalization of each company. These capital weighted ratings are then averaged to arrive at our sector ratings. We sort all of the sectors from most favorable to least favorable and report on their movements relative to other sectors.
It’s no surprise to us that financials have become the most attractively valued of all stock sectors. The S&P 500 is currently off more than 16% from its October 9, 2007 high and is nearing what is traditionally termed a bear market (defined by a 20% decline). However, the financial sector large cap index (XLF) is down almost 40% from its peak. Whether or not this drop is justified remains to be seen, for some financial institutions clearly did have too much exposure to risky debt and derivatives. The credit crisis is going to play out and those that took on too much risk will pay the price. You can be sure that financials are particularly averse to unnecessary risk right now and for the foreseeable future.
Financial stocks have come through a very difficult bear market. When you consider both their lower valuations and the fact that government fiscal and monetary policy relief is imminent, financials appear to have increasing appeal at present. Everyone hopes that these policy adjustments will spur economic activity, and we at Ockham believe that the financials will benefit. We may not be at the end for the bear market in financial stocks but many indicators point to that possibility.
A Day to Remember
January 22, 2008 | 3:36 PM
The day began with the announcement by the Fed to substantially cut rates. The announcement came in the wake of markets around the world suffering sizable losses on Monday as U.S. markets were closed for Martin Luther King Jr. Day. In anticipation of U.S. markets diving in sympathy with plunging global markets, the Fed cut the fed funds target rate 75 basis points to 3.5% in an attempt to offset the worldwide gloom. The rate cut was the biggest single-day cut since 1982. Furthermore, there was concern that disappointing earnings reports from Bank of America and Wachovia would drag down the financial sector. As the market opened this morning it was down, way down.
The market has endured a bumpy ride since that terrible start, and seemed to changed direction half a dozen times! The good news is that it bounced soon after the market opened and has recovered to sustain more manageable losses. The morning plunge was either a reaction to recessionary fears that echoed around the world yesterday or it was a reaction to what can be interpreted as the Fed having to act to bail out the economy with another big rate cut. Either way, it seems that the 400+ point drop in the DJIA in the first few minutes of trading signaled capitulation to investors. After about five minutes of panic this morning, stocks began their climb back and it appears that the main US indexes will finish the day only down .5%-1.5%, hardly a nosedive.
What does this say about the greater market trend? Our analysis at Ockham Research is that the US equity markets have fallen awfully fast so far this year and are oversold. From a valuation standpoint, stock prices are reaching exceptionally compelling levels. The price-to-peak earnings multiple has been steadily declining to 14.9x this week, which is a reasonable level. That measure had been holding steady above 18x for nearly two years. Furthermore, investor sentiment is rarely as pessimistic as it is right now with just 15% of NYSE stocks selling above their 30-week moving average.
When you see both value and sentiment indicators line up like this, historically, it has been a good time to buy selectively. Obviously, you should stay away from those companies most affected by the turmoil in the credit markets, but there may now be real value in financials that have steered clear of that mess. All of our indicators are turning bullish and those indicators are based on historical norms which have proven to generally be correct. The market may not be at the bottom, but it could very well be a minor bottom, as the smart money realizes that undervalued securities exist in almost any market, especially one that has dropped so rapidly.
The Time for Value is Now
January 18, 2008 | 1:25 PM
The stock market continues to suffer losses in the early part of this year. The government plans to step in with a stimulus proposal to head off an economic downturn. Both fiscal and monetary policy relief are going to be used in an attempt to aid the economy in short order. We hope that the politicians will get it right this time, and balance the need for consumer spending with the ever rising deficit and inflationary pressures. Whether the tax rebate is used for consumption, investment, or paying off personal debt, hopefully the increased economic activity will stave off recession.
We are optimistic about the future, and our value investing approach is rarely as bullish as it is right now. In our coverage universe we have over 80% Buys, which we have not seen since the end of the dot-com bubble. It is logical for a value-oriented investment methodology to find more “buys” as stock valuations fall in a bearish market phase. Furthermore, stocks are becoming increasingly attractive when compared to other asset classes. Bonds are expensive, and likewise commodities have become expensive partially due to the softness of the dollar. Real estate is the riskiest of all assets right now as its downturn will likely continue well into 2008 and likely beyond.
We have plenty of faith in our long term approach, and for good reason, it works! But sometimes being a contrarian can scare the daylights out of you. There is so much volatility in the markets right now, and to couple that with the uncertainty of the credit crisis continuing to play out, there is plenty to be wary of. But before you resign yourself to putting your money under the mattress, consider that for a long term investor these down days yield buying opportunities. Valuations are in reasonable territory and we may see a bounce due to the likely Federal Reserve Open Market Committee rate cut expected at the end of the month. It will be extremely interesting to see what the result of the economic stimulus plan will be, as it could be a much needed injection of life into a slowing economy.
Bernanke Bail Out?
January 17, 2008 | 3:28 PM
Fed Chairman Ben Bernanke spoke today before the House in support of implementation of a temporary fiscal stimulus plan. He covered himself with the caveat that it must be implemented quickly yet it must be properly constructed to gain his full support. His prepared testimony before the House Budget Committee this morning was not received well by the stock market, as the Dow dropped quickly after a minor morning rally. The Fed Open Market Committee will meet at the end of the month, and Bernanke added that the Fed is "prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability." Read: half point rate cut forthcoming.
While the expected rate cut would likely give the market some much needed positive momentum, a rate cut is not nearly sufficient to heal the wounded credit market. Rate cuts do not provide the banking system hundreds of billions of dollars liquidity that is discussed so often, but they do provide a psychological lift to traders. As noted by John Hussman Ph.D., considering the $12.7 trillion currently in the U.S. banking system, the total amount of liquidity added by the Fed’s actions since March 2007 equals just $16 billion. Furthermore, all of that $16 billion has been drawn out of the banking system as currency in circulation through repurchase agreements. So, the effect of the Fed Open Market Committee meeting is certainly more psychological than fundamental.
So, when the Fed likely does cut rates later this month, the stock market will likely get nudged upward; that is assuming that the rate cut is large enough to warrant excitement. It would not be a surprise however, to see the markets tumble back down soon after the euphoria wears off and investors realize they have been duped and realistically little has changed. After all, Ben Bernanke can cut rates all he wants but that wouldn’t address the solvency of the credit market that has been the biggest drag on the economy thus far. If he were to abstain from cutting rates the market would surely protest. Everyone is looking to him for the answer, and there are no easy answers. He cannot be blamed for the circumstances that he inherited, and we wish him luck navigating a way out. Perhaps a well crafted stimulus plan would restore solvency to the credit market, but I wouldn’t hold my breath for politicians to pull it together in a timely manner.
Government Stimulus Proposals: Political Lip Service
January 16, 2008 | 12:24 PM
Someone with even a cursory interest in politics would almost certainly have encountered one of the presidential candidates discussing ways to revive the U.S. economy. Many potential voters have listed the economy as one of the most important issues facing America, and many of those voters see that the potential for recession is real. Thus, where there is a potential to find votes, you will soon find a politician pontificating. The various plans they have detailed thus far each have their unique qualities, but there is a sense that the government needs to urgently undertake the task of fixing the economy. Are the stimulus plans necessary and would they work?
For simplicity sake, I will boil down the plans to the basic but key elements because I am not an expert on the topic. Senator Clinton’s stimulus package targets relieving the housing debacle, increases unemployment benefits, and subsidizes energy costs for low-income families. There is no doubt that slowing consumer spending gives her concerns, and so she is taking a populist approach to lessen the impact of a downturn on the “little guy”. However, she and other Democrat candidates have not mentioned the potential expiration of the Bush tax cuts, which if they expire in 2010 it will have the effect of a huge tax increase. Also, the one year “band-aid” that kept the Alternative Minimum Tax from taxing the middle class which the populist movement claims to protect will expire after this year.
As you might expect, for the Republican candidates making the tax cuts permanent is key. Most, if not all, Republicans are trying to talk up the Reaganomics supply-side tax cuts as well. They are also fond of taking tough about cutting spending. These are positive things, that I am in favor of, but there is little example of concrete, immediate stimulus. I happen to agree that Americans are overtaxed and overregulated, and the current model will not work in perpetuity. However, potential benefits from these plans being enacted would be down the road, and ineffective at containing the immediate housing and credit crises.
Surprise, the presidential candidates are most likely given lip service in exchange for votes. The candidates are sticking pretty close to the safe answer. For Dems, help the “little guy” as soon as possible with less regard to the long term inflationary effects of a bailout. Republicans also stay close to the vest, invoking the name of Reagan whenever questioned about how they would govern. The question of, what would you do, is informative to see how the candidate thinks, but a lot will change in the next year before one of these people is actually in the White House. Furthermore, once the President is elected it will take time to enact their plans and even more time for households and businesses to adapt. In that time, the economy could be on the way back from recession, and stimulus could over correct into inflation issues. Economic stimulus is for now up to President Bush to decide what to do, or do nothing at all which could be the best alternative.
Rationality in an Irrational World
January 15, 2008 | 11:24 AM
This morning the market is off by a decent margin, and most are pointing to the news of disappointing retail sales in December and another massive write-down by Citi. This $18 billion write-down ranks as one of the largest write-downs related to the credit crunch thus far, and by the largest U.S. bank by assets. Scrambling to save face, Citi unveiled plans to raise $14.5 billion through a cutting their dividend 41%. This is by no means good news, but it is important to understand that disappointments like this one are sometimes necessary to bring prices into line.
Until recently, the U.S. economy had prospered for the most part uninterrupted since the technology bubble burst in 2001. CNBC’s Larry Kudlow is fond of calling the performance of the American economy, “The greatest story never told.” For some time, people were acting as if the “goldilocks” economy would continue unabated forever because of the changing nature of the increasingly global economy, but during this time of prosperity prices were inflated to unsustainable levels. Now that disappointing earnings reports or announced write-downs have replaced “goldilocks,” we are beginning to see stock valuations come into line with historical norms.
The point of this discussion is to look at this from a very “macro” view, and thus avoid superfluous noise. Based on our research, the market was out of line with historically normal prices for the last few years. We have believed that a decline was coming at some point, and it would take a fairly decent drop to make us excited about buying value again. On days like today, where stocks are down a good bit and negative news reels play on repeat, just keep in mind that this is great for value investors. It is all part of a cycle that makes studying the financial markets so entertaining. The key to beating the valuation cycle is remaining rational in the face of an irrational marketplace.
Is the Market Nearing a Bottom?
January 14, 2008 | 3:27 PM
Investors are optimistic about a positive start to the week as IBM announced this morning earnings well above Wall St. estimates. IBM’s announcement spurred the market rally this morning with tech stocks and basic materials as the main beneficiaries with fairly heavy trading volume. Among today’s leaders are IBM, Nokia, and Intel.
It is well known that the market started the year on a downward trend. It is statistically the worst start to the fiscal year of the last 25 years. In the second half of last year, we believed that the market was overbought and overvalued. However, after the significant sell off we are now on the other side, as an example we have a buy rating on over 80% of the almost 3000 stocks that we cover. We have not been so bullish since the end of the dot-com bubble in 2002. In hindsight, we actually timed the bottom of the market quite well. Obviously, we do not want to advertise ourselves as market timers, but it is an noteworthy concurrence.
We hesitate to say that this is the very bottom, especially with so much uncertainty ahead. However, it is quite possible that this a minor bottom for at least the near future. We employ a value investing methodology, and now seems as good a time for long term value buying as we have seen for 5 years. The economy still has many issues yet to be satisfied; how far will the credit crisis spread, is consumer spending slowing too fast, are corporate profits drying up, etc. All of these factors are present in the psychology of the investing public, but we see reasons for optimism as well. For example, the S&P 500 average P/E level has finally crossed below the historical average of 16. Continue to be on the look out for earnings estimates, and realize that even disappointing results are a normal part of prices coming into line.
Starting about nine months ago, we advised caution when buying because the market was at an unsustainably high price level. We must have sounded like a broken record telling our readers that the market is overvalued. It took a few months after we became bearish for the market to begin to sell off. So, our recommendation is to consider buying because there are many resilient, blue-chip stocks that have crossed into deep value territory, based on historically weighted normal price range. When you buy a good quality stock at a discount it may continue to decline for a bit, but sooner or later it will again rise into those normal price ranges.
Stocks Flail Beneath the Mighty Consumer
January 11, 2008 | 3:17 PM
The stock market is headed south again today as consumer spending concerns have investors nervous about a recession. Holiday sales were expected to be a little bit slower this year, but they fell below even those modest expectations. One of the main catalysts for the sell off today appears to be the 4th quarter profit warnings issued by American Express. AXP will take $440 million dollars of profits to cover credit card defaults. Normally known for having relatively high-end customers, one might have thought that Amex would be guarded against such card default issues. Apparently, no card company is safe as Capital One issued a similar warning today, but its stock recovered quickly compared to AXP who is down about 12%.
A slowdown in consumer spending is bad news for the stock market, as it can be a key to determining the direction of the economy. We can hope that this is just a bump in the road and not a sign that credit issues have spread into a wide range of sectors. It makes me wonder whether a tax hike, heralded by many democrat Presidential candidates as an economic panacea, will come from the money that the private sector plans to save or spend?
The day began with the confirmation of the rumor about Bank of America coming to the “rescue” of Countrywide Financial (the topic of yesterday’s Razor’s Edge). Bank of America had already put some $2 billion into Countrywide in the form of preferred stock, and $1.3 billion of that has already been written-off as a paper loss. The news gave a lift to the financial sector as there are hopes for further acquisitions. However, BoA’s offer for the distressed mortgage lender was at a discount to yesterday’s closing price, and both of their stock prices are off today.
As an interesting side note, Bank of America is making this deal with the understanding that it will be able to use financial losses incurred by CFC to offset its own tax liabilities. We do not know how much that will actually account for, but it is likely to be in the billions of dollars. So, not only did BoA acquire the nation’s largest mortgage lender at about 12% of its market value 8 months ago, but it seems that they will be using Uncle Sam to finance the deal!
Keeping in Perspective: Bank of America and Countrywide Financial
January 10, 2008 | 6:37 PM
The stock market had a nice afternoon advance amidst rumors surround a Bank of America buyout of mortgage giant Countrywide Financial. Yes, the same Countrywide that just eight months ago was trading in the low $40s range. It opened the day at just a bit over $5, but after the rumor leaked CFC recovered some to $7.76 per share.
As the nation’s largest mortgage lender, Countrywide has obviously taken a heavy beating in the wake of the credit crisis. So, this rumor was a rare bit of excitement in the mortgage industry. While it is a rumor, at this point, the buzz surrounding the deal fueled the stock market to a late day rally. It gave hope to some that maybe the worst days are behind CFC if Bank of America was willing to give it a much closer look. We hope that those speculations are correct that the worst is in the past, but we do not place much faith in speculation, after all, it is just a rumor. Even if the buyout were to take place, it would not magically make the risk of debt default vanish. It will simply put it on the balance sheet of a company that could soften the blow somewhat.
To postulate that this will mark a turning point in the credit crunch is probably wishful thinking. Many analysts have used the analogy of a baseball game in the 3rd or 4th inning to estimate how far into the crisis we have come thus far. Many financial companies have yet to confess just how much risky debt they have yet to bring out of the coffers. However, perhaps the stocks of mortgage companies have dropped so far, so fast that they may be worth the considerable risk, especially for a behemoth the size of Bank of America.
For the individual investor, there is no way to know just how bad the credit meltdown will be. There is still amply reason to be cautious about buying stocks expected to be hugely effected by the credit market. Any investment in stock has some amount of risk, but in this climate it would be unwise to take risks in excess of what is justifiable. I know that my personal balance sheet looks nothing like that of Bank of America’s!
The Comfortable Contrarian?
January 8, 2008 | 3:57 PM
As of the time of this posting, the Dow is about to close another trading day down triple digits. This is unwelcome yet familiar news for investors in recent weeks. Most everyone is aware of the multitude of reasons for the dismal performance of the stock market recently: notably the credit crisis, the weakness of the dollar, record-breaking oil prices, etc. So, it may come as a surprise that we are actually quite positive from a long term perspective.
Our research covers about 3000 stocks and more than 60% of them are currently rated in the “Buy” or “Strong Buy” categories. Prices had been inflated during the “Goldilocks” period that just ended and were due to pullback, as our newsletter readers are well aware. The rapid drop in stock prices has definitely strengthened our long term valuations. So, while the network and print financial news outlets are mainly selling doom and gloom of an impending recession, for a long term investor these down days are a necessary return to valuations that are in line with historical norms. Another increasingly bullish indicator is the fact that only 28% of NYSE listed companies are trading above their 30-week moving average. This simple indicator is a superb way to measure investor sentiment broadly across many sectors and industries.
Our investing philosophy is heavily influenced by the brilliance of Benjamin Graham. He was quoted as saying, “I have every confidence in the threefold merit of this general method based on (a) sound logic, (b) simplicity of application, and (c) an excellent supporting record… it is a technique by which true investors can exploit the recurrent excessive optimism and excessive apprehension of the speculative public.” It is always wise to avoid speculation, which is more akin to gambling than investing. We would prefer to be logical and true to our methodology rather than to get wrapped up in the noise that sells the newspapers.
While we always recommend caution to our investors before making any substantial changes to their portfolio, from the long-term perspective, we are pleased with the direction of the market to more reasonable valuations. What will be particularly interesting to watch in the coming quarters will be the amount and magnitude of earnings revisions by both reporting companies and the Street Analysts dedicated to following them. Looking ahead, if these revisions are substantial, increased caution will follow suit. So while we are not saying “BOTTOM” by any stretch, we are saying that there is no such thing as a “comfortable contrarian”.
Happy New Year! Have a Cup of Optimism...
January 2, 2008 | 2:52 PM
Happy New Year! It has already been an interesting first trading day as the market is experiencing some fiercely negative factors today. With the Dow down about 220 points at the time of this posting, weak factory data and $100 barrels of crude are receiving the blame.
While the last week continued to see weakness in the market, and the indexes today are heading lower, we have seen some improving valuations overall. Today's market action, while unfavorable, is actually assisting in bringing those valuations further into a "proper range" as far as we are concerned. With the percentage of our coverage universe receiving "buy" ratings still hovering right around 40%, that continues to demonstrate that from our perspective, there are lots of stocks to be cheerful about!
One that jumps out at us, due to its increased negative price action is Starbucks (SBUX). Downgraded this morning by Bear Stearns, that is the third downgrade in the last two months by Wall Street Analysts. For a stock that has fallen from $35 to $19 over the last year, those downgrades to Hold ratings, really wouldn't have helped much, while our sell ratings going back to 2005 would certainly be paying off at this point. But in our estimation, much like other must-have products, Starbucks will avoid the cyclical nature it is now being branded with. It's only real problem recently was its valuation. Look at its sales, doubling in just 4 years! And now it is trading in a reasonable price range. Besides, with expansion overseas and into China, we see their opportunities only increasing further.
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