Don’t Bank On The Financial Sector Rallying For Good Quite Yet…No Matter What They All Say Tuesday, July 22, 2008
The Smart Profits Report Issue #542
by Marc Lichtenfeld, Sr. Equity Analyst, Smart Profits Report What They’re Saying About The Financial Sector Sounds Nice… As I was running to catch my early morning flight on Saturday, I grabbed a copy of the New York Times and Barron’s. I looked at the Barron’s cover and figured that I must not have gotten enough sleep and was still in dreamland. Right there in big capital letters was the advice to buy banks, with the caveat that you should do it selectively. And no, as it turns out, I wasn’t dreaming. The article argues that valuations are low and the companies still have significant earnings power. Last week’s sharp rally in the financials gave investors some hope that the banks were done cratering. And many took Wells Fargo’s (NYSE: WFC) strong earnings report as a sign that we’ve seen the worst in the sector. …But The Worst Isn’t Over Within Financial Investments The way I see it, this magazine cover reinforces the idea that the bottom is nowhere in sight. Now I’m not a conspiracy theorist, despite my belief that the 1985 NBA draft was rigged so that the Knicks would—thankfully—get Patrick Ewing. Nor am I a Chicken Little, as I believe any of my regular readers can attest to. But while I’m not about to say the sky is falling, I do believe bank stocks will for a while. This is not a stance I take lightly, especially considering that Mt. Vernon Research Investment Director Karim Rahemtulla, is well-schooled in picking and choosing from the financial sector. In fact, using his deep in the money covered call strategy, he has actually racked up gains on companies like JP Morgan, Wells Fargo, and US Bancorp. (If you are going to get involved in financial investments, you really should only pick the stocks and strategies that Karim recommends in Xcelerated Profits Report.) If anyone can pick winning stocks in a losing sector, it’s Karim. But you have to look at it this way: if some of these banks needed to raise money and were offering bonds at a competitive rate, would you help finance them? Would you buy a Lehman Brothers (NYSE: LEH) bond maturing in 2017 with a yield of 6.3%? I sure wouldn’t. How about a Fifth Third Bancorp (Nasdaq: FITB) 4.9% yield maturing in 2018? Thanks but no thanks. A Key Corp. (NYSE: KEY) bond maturing in 2014 paying 5.6%? Ummm…No, I think I’ll pass. If I’m not certain that a bond will be paid back, why would I want to own the stock? After all, the bond owners get paid before the stock owners. It’s my contention some of the banks and brokers don’t even know what they own on their balance sheets. The mortgage products and derivatives were so complex that the average CEO can’t explain them. And these guys aren’t dumb. They may have made some poor decisions, but stupid they ain’t. We may get a lift for a while, but there’s going to be a lot more pain in the sector as companies are forced to continue write downs when they realize the value (or lack thereof) of the garbage on their balance sheets. Zig When They Say Zag Furthermore, the magazine cover indicator has been a fairly reliable predictor of stock movements. It was even proven by academics at the University of Richmond. The professors examined headlines from three major business publications over twenty years and compared the stock performance to the bias in the headline. The study concluded that positive stories were typically published after periods of strong out-performance and negative stories after underperformance. In other words, these stocks had already made their strong moves. Stocks with negative stories outperformed the overall market by nearly 13%, while positive story stocks outperformed by 4%. The most famous example of a magazine cover as a contrary indicator is the August 13th, 1979 cover of BusinessWeek magazine which proclaimed, “The Death of Equities”. Of course, we know that the market is up well over 1000% since then. Magazines tend to be late to the party for several reasons. Their job is to sell magazines. So they will often only publish a story—and especially a cover—when they know that the topic is already well into the public consciousness and is being talked about. When was the last time you received a good investment idea, that everyone was already talking about? Similarly, a stock often only catches the attention of a journalist or editor after it’s made a big move. Many of them are writers first and stock market mavens second, which means they’re going to put emphasis on the writing instead of analysis. Where was the financial media calling for a bottom earlier last week when shares of Washington Mutual plunged 35%, Wells Fargo dropped 11% or Bank of America (NYSE: BAC) slid 15%? Only after everyone was already talking about the remarkable comeback of the sector at the end of the week, did the writers at Dow Jones declare the bottom in bank stocks. Why? It’s what everyone wanted to read after the crazy events of the past five days. I guarantee that a cover that stated bank stocks are headed lower wouldn’t have sold as many copies. In fact, I’m certain that a cover like I just described would not have made me pause long enough to pick up a copy, in my dash to the plane. The bottom line is this: Covers that everyone wants to read sell magazines. They don’t accurately predict the stock market. Hoping your longs go up and your shorts go down. Marc Lichtenfeld
Today’s Smart Profits Notes: And speaking of banks, Fannie Mae and Freddie Mac are still capturing the unwanted spotlight. With the government likely to back them up with much needed funding, they might be able to pull through with this crisis with their businesses at least intact, though their reputation might not be able to claim the same. Together, they own or guarantee over $5 trillion in home loans.
Wachovia felt the pressure this past quarter, with a just-reported loss of $8.86 billion. All told in the April-June period, it lost approximately $4.20 per share. But they seem to be taking responsibility for the poor numbers, if Chairman Lanty Smith’s comments are any indication. In an effort to build themselves back up, they’re taking action, including leaving the wholesale mortgage lending business altogether.
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