"We have met the enemy and he is us."

Pogo nailed it. In the last two decades, I've never seen so much activity over so little data. Oh sure, we have much to read and more to hear from the folks whose paychecks are dependent on you listening to them. But the words being spread are so innaccurate the authors are teetering with irresponsible reporting. 

The financial sector has a liquidity problem. Interestingly there are few other problems. Interest rates are low, unemployment (while rising) is historically quite low and much lower than the global average. Mortgage default rates are higher but not necessarilly "high". Well under 3% of mortgages have been foreclosed. But such a low number is boring so reports use words like millions and 40% increase to give listeners something to "ooh" about. And I suppose it would be too much to ask to hear a little about the billions in profits that are being booked shortly after purchases of these so-called "toxic" assets. I wish I would get an offer from my mortgage holder letting me purchase my own mortgage for how little they are potentially selling it for. One report had a private equity fund paying 22 cents on the dollar for mortgages from struggling banks. That sort of fire sale covers the buyer if 75% of the loans are worthless. The financial crisis is an accounting issue more than a fiscal issue. We've created an environment where according to regulations assets (loans to you and me) are being sold for prices based on prior recent sales rather than standard present value calculations. If a bank can't sell a performing loan package for a present value of the loan, what's the point of selling it at all? If they can't sell loans they don't have the cash to make future loans and the credit cycle clogs up. BUT NONE OF THIS IS BEING REPORTED! So, the market takes an emotional plunge because the Congress won't pass a liquidity bill. It isn't a bailout or a rescue. It's probably profitable to the taxpayer over time and I don't particularly like it because Congress has no business on Wall Street anyhow. 

OK, so I've vented on the ignorance of the people we're supposed to be getting our guidance from. Now, what to do about it. Well, some say I'll lose my shirt but I'm buying XLF (the S & P Financial Index) at anything under $18.50 because it's a bargain. Then I'll sell some covered calls to make some short term gains, probably in excess of 10%. Oh yeah, and if that doesn't work I'll pocket the premium and teh 4% dividend while I'm waiting for the recovery. If you can hold your hand steady, there is a lot of money to made right now. 

Ignore the press, check your emotions, and go with the math...

Will All the Banks Fail?

The list of market problems just seems to keep getting longer. We're down two Macs (Indy and Freddie), a Fannie, a Bear, and the Brothers Lehman. With a partridge and a pear tree we would have a little diddy. 

Are we doomed to repeat the 1930's? Is the mattress safer than the depository? Will we all be destitute by Christmas waiting in a communal soup line?

While some individuals may be hit so hard personally that the end appears near, the broader picture is nowhere near as bleak. It does make for good drama, though. And the market will continue to roller coaster on each verbal slip from Ben, deal from Hank, and the various jetsam from Congress. Don't expect to see calm seas anytime soon. 

That said, I must reiterate my buy signal for those willing to sift through the rubble. Even in the days of sky high commodities and the mergers and acquisitions that follow such a run, we will soon find financial M & A activity to be more voluminous than any other sector. The global financial market is exhibiting Darwinian theory at its best. While it seems a shame to see a bank falter, why should a competitor prop it up when the pieces will be half price after the fall? We've already seen several acquisitions of opportunity including Merrill Lynch and Countrywide both purchased by B of A. Several Sovereign Wealth Funds have invested in various institutions at fire sale prices. Chase and Wells Fargo are both positioned well to profit handsomely from a pending train wreck. The system isn't as broken as it appears if the strong are swallowing the weak. 

While consumers spent too much on credit, banks lent too much without cash assets. Both parties will now suffer the consequences while those who didn't participate look on with only temporary hits to their savings. 

I'm not saying that one can avoid the calamity, but keep avoiding the news and focus on the fundamentals. Buffett just announced a 5B investment in Goldman. While Mr. Buffett may offer his personal fortunes to philanthropic ventures, his Berkshire Hathaway company is ALL about profit. And Goldman isn't getting a handout. What we are witnessing is the savvy investor preparing a solid investment that will outperform the market in only a couple year's time. 

For those of you with the inclination, it is time to follow the Sage to the Market. The Blue Light Specials are plentiful and one's mattress will not offer a similar return. For example, Wells Fargo is one of those pesky financial firms that seem to be the root of all evil right now. But alas, they've not fallen foul as others have. Their fundamentals indicated strength while the financial sector dragged the stock down. With a balance sheet of 46B, the company was trading at less than 2 times their asset value in July. Since then, the stock is up 75%. What a handsome return. Now let's look at a potential acquisition target, WAMU. While they are likely to throw in the towel to a suitor, they are not in the exact same situation as one of the investment firms such as Bear or Lehman. This company has over 20B in net assets and is trading at a market cap of less than 6B. While it is certainly possible that WAMU files bankruptcy, it is highly unlikely because this bank as billions of cash in deposits and a tremendous credit card business. If they are acquired at a 50% discount, the stock will almost double. Hmmm...

But let's not look at fish bait, how about some solid positions for our 401K? Are there any financial firms still making money? While certainly off their highs, there is a company that still pulled over 6B in gross profit last quarter with an operating profit of 600M (one quarter folks). Maybe we shouldn't leave home without some American Express stock. If something smaller is your flavor, how about Apollo Investments (AINV). Their portfolio was beat up a bit from the turmoil, but they don't hold any mortgage securities and if you'll give them your money, they'll give you 12% in dividends. Oh yeah, and their stock is trading at barely 1 times their balance sheet. 

I suppose the folks in the 30's didn't see a light at the end of the tunnel but if history teaches us anything, it is that business will always survive and prosper... ultimately. A little research will find some very nice diamonds in this rough and the diligent will inherit this earth's cash while the meek will find their stash full of dust mites. 

Cry From the Hilltops, Jump From the Roof

OK, maybe I'm being a little dramatic. But probably not by much. Since the close of the market last Friday, we've seen a 7% drop in asset value (over 800 points) in three days. Obviously such a pace can not continue, but the volatility is certainly enough to give the stoic some pause.

The message this week: don't watch the news, cancel your subscription to the Journal, don't dare open up any financial website, and stop talking to the lady down the street who seems to always be walking her dog. If you sequester yourself, you might actually keep your nerves from fraying out of control.

The market will recover, it always does. In the meantime, only check your stock prices if you intend to purchase more. There are some amazing bargains out there and I don't mean the major risky shares such as AIG. Stick with the fundamentals, the following points might help some:

1. Timing doesn't work, dollar cost average into your holdings
2. Only invest in sound companies with strong balance sheets and profits to count on
3. Dividends are the answer to all problems, but the added cash flow is reason to consider companies that provide dividends
4. Never hold more than 5% of your portfolio in a single issue
5. Never, never hold more than 10% of your portfolio in a single sector
6. Tend toward EFTs if you want to invest but don't know where: SPY, DIA, QQQQ, etc

Surely, the next post will bring better tidings...

Down Come the Giants

I'm not sure if Monday will go down as another "black" day, but certainly the last hour of trading on 9/15/08 will make all but the most stoic shudder. A 200 point drop in 60 mins ended the session at over 500 points off the opening mark. Are we done with the bad news on financial firms and their massive mistakes? Probably not, however...

I shall tangent and remind the readers of what has transpired to introduce this storm of a market. I'm not a conspiracy theorist so if you're looking for a smoking gun, you've come to the wrong blog. The issues are much simpler than many would have you believe. And my mediocre assessment would blame the following culprits:

1. New-ish homeowners that don't seem to understand that assets don't always appreciate. (I blame new-ish homeowners because anyone who purchased in the 80's knew that property values don't always rise)
2. Mortgage lenders who relax their standards to increase volume without measuring the risk of their actions. Most lenders were just plain greedy, some were unethical in their positioning of ARM's and teaser loans but most explained the risks to the borrower and the borrower still swallowed the hook whole.
3. Construction related companies and individuals who milked the property boom just a bit too much.
4. Consumers who can't seem to keep their credit card balances in check.

OK, so we're all to blame. Notably absent from my target of suspicion is the Federal Government. As a general rule, superflous laws cause more harm through unintended consequences than good. Our politicians are typically some of the worst financial advisers this side of the Vegas strip, so anyone looking for their protection deserves the exposure. If the aforementioned parties had shown a modicum of restraint this particular asset bubble would not have occurred. Further, if consumer credit balances weren't so high, the risk associated with falling property values would have been much diminished. So the dominos looks like this: home buyers and consumers look to borrow too much; lenders oblige; the secondary market scoops up the debt and then freaks rather than servicing largely performing assets; lenders over correct on credit issuance; asset sales after write-downs don't generate enough cash to support historical operating practices; big banks crash and the general public freaks.

So here we are. Now what to do with freaking companies, a freaking public, and a government that loves to pontificate on how to cure the well freaked. For starters, go spend your money on what you need but not what you don't and certainly don't pay for anything that you can't afford. If consumer spending doesn't continue, a recession may pop from all this. That's right, I said MAY. Up to this point, we've not been in a recession and if you disagree please lookup the word recession on Wikipedia rather than arguing the fact.

In the meantime, there are a few investment opportunities that look interesting. If you've followed my ramblings prior to this blog, you know that I've been bullish on the general markets. Short term volatility considered, when interest rates are cut dramatically the market will typical rise over the next 12 months. Count on it. I think the Nasdaq in better shape than the NYSE due to the proportional difference in construction and financial companies between the exchanges. Going long on Q's is probably a very lucrative position right now. Regardless, the other indexes have been so beaten up that Spiders (SPY) and Diamonds (DIA) are probably near cyclical bottoms at this point.

On a more specific nature, I'm very bullish private equity. I'm not sure if the Berkshire will keep up pace with the Sage looking to exit his amazing career. That said, other private equity firms are probably in position for a nice up tick if they weren't vested heavily in real estate related products.

Energy will continue to fall, but other commodities may still show surprising resilience. A portion of your cash portfolio in something like a GLD fund is probably not a bad hedge for stock market volatility. I'm not a big futures fan for the average investor so stick with ETF's.

I've long been a fan of the FRO and SFL family. I think SFL is going to struggle for liquidity over the next several months and I've personally held or distributed my holdings. FRO on the other hand will see a drop from falling energy prices (oddly enough since they have to consume the stuff) and pressure from lack of leveraging capabilites for new builds. However, much of this has been built into the stock and there will be some significant price support in the low $40's. I'm personally accumulating shares under $45.

Retail will have some difficulty this holiday season but they are always the first to emerge from slowing economies so keep an eye on healthy subjects. I'm still fond of CHKE. While they don't make their products, they seem to have a good feel for what consumers like in clothing and they reward their shareholders with healthy dividends.

Finally, keep your idle cash in high interest products such as ETrade's checking accounts, Bank of Internet checking accounts, ING checkings accounts, etc. Don't let your idle cash gather dust from banks that don't value your business. They certainly need you more than you need them at the moment.