In April 2009, Bill Ackman of Pershing Square Capital Management said America had suffered "the equivalent of a heart attack, but now we are in recovery, hopefully. It takes time to heal."
Fast forward 13 months and, "yes," America has healed, Ackman says.
Furthermore, "I think the market's not particularly expensive," the famed activist hedge fund manager declares. "Look at large-cap, very high quality businesses today [and] they seem pretty cheap to me. "
Much to everyone's surprise - including Ackman's - those "very high quality businesses" include Citigroup. On Wednesday, the day after Treasury announced the sale of 1.5 billion shares of Citi stock, Ackman stunned Wall Street by revealing his firm has taken a big stake in the big bank.
With theatrical flair, Ackman made the announcement as a throwaway line at the end of his presentation at the 15th annual Ira Sohn investment research conference in New York: "And by the way, we bought about 150 million shares of Citigroup, but I don't have time to talk about it," he said, according to multiple reports.
And by the way, when Ackman and Bloomberg reporter Christine Richard joined us this morning to talk about Confidence Game, a new book about Ackman's public battle with MBIA (and regulators), I just had to ask him about the Citigroup position.
The Bull Case for Citigroup
"If you had asked me a year ago ‘could I conceive of owning Citi 12 months later?', I couldn't conceive of owning the company," he says. "It was hard for me to even look at it in light of a year ago."
Upon further review - and while admitting "there are still question marks" -- Ackman determined Citi was attractive based (in part) on the following:
-- Money Talks: Thanks in large part to the government's conversion of its preferred stake in Citi to common stock in 2009, Citigroup is "probably one of the best capitalized banks today, ironically," Ackman says.
-- Free Money Is Even Better: Because Ben Bernanke has kept the fed funds rate effectively at zero, banks like Citigroup "effectively they've got free money," Ackman says. Furthermore, "it's a great time to make loans - they can earn attractive spreads" because collateral values are down and lending standards are up.
-- Franchise Value: Despite hits to its reputation in recent years, Citigroup still has a "great deposit franchise" and a "very well capitalized balance sheet," the fund manager says. In addition, he notes off camera Citi has less exposure to home equity loans than most of its big competitors.
In sum, "it's really a great time to be in the banking business," Ackman says.
Watch the accompanying video for more about Ackman's take on Citigroup, General Growth Properties and other investments -- and stay tuned for additional segments where Ackman and Richards discuss Confidence Game and the ongoing war against the shorts.
Monday, May 31, 2010
Sunday, May 30, 2010
Five Reasons to Love Bank Stocks
I was practically all alone on March 18 when I gave you five reasons to steer clear of bank stocks , but it turns out heeding that advice would not have been such a bad idea.
The SPDR KBW Bank ETF, which counts Citigroup, Bank of America, Wells Fargo JPMorgan Chase and US Bancorp as its top five holdings, was at $26.01 when I wrote my story.
While it would hit a high of $29.22 on April 21, it touched a recent low at $23.33 Tuesday. Two reasons I highlighted, "Regulatory Threats Resurface" and "European Contagion," look especially smart. So give me an A for insight and a C+ for timing.
> > Bull or Bear? Vote in Our Poll
Now that everyone is freaking out about bank stocks, it may be worth taking another look at the sector, which for current purposes also includes Goldman Sachs and Morgan Stanley. They have been a big part of the recent selloff, and they may have more in common with JPMorgan, Bank of America and Citigroup than any of those three does with Wells Fargo, or certainly US Bancorp.
There are plenty of reasons to be a bull on banks. Here are a few.
5. The U.S. Economy Is Improving
The recent selloff, not just in bank stocks but in global equities, has had nothing to do with any signals in the U.S. economy. It's been all about European countries like Greece, Spain, Ireland and Portugal struggling under heavy debt loads, with a pinch of fear about overzealous regulators thrown in. There may also just be a general fear that equities have come too far too fast and those things provided an excuse for selling.
Meanwhile, things in the U.S. continue to mend. Since hitting a high of 10.6% in January, the U.S. unemployment rate is down to 9.5%. The steep rise in the chart shown here demonstrates that we've already had a historic rise in layoffs and hiring freezes. Employers freaked out, now they are hiring again, and it's hard to think of any single thing that could be more bullish for bank stocks. Sometimes it pays to keep it simple.
4. Regulatory Fears Are Overblown Probably the biggest surprise about the regulatory reform legislation that passed the Senate earlier this month was a provision sponsored by Blanche Lincoln (D., Ark.) that would force banks to spin off their derivatives businesses.
Derivatives are a huge profit center for banks like Goldman Sachs, Morgan Stanley and JPMorgan Chase. It is not entirely clear whether the Senate legislation would eliminate their ability to trade, sell and design derivatives altogether, or merely sharply curtail those activities. In any case, the result would be disastrous, and a JPMorgan report Thursday estimates the Lincoln provision would halve the 2011 return on equity for Morgan Stanley and Goldman Sachs.
Even that dire prediction may be too sanguine. One former Federal Reserve official I spoke with fears the provision would make it impossible for banks to hedge their mortgage portfolios, which would create big problems for home lending in the U.S. It also could raise questions about the ability of multinational corporations in a wide range of industries to hedge against commodity and currency risks.
Many of these fears are, to an extent, priced into stocks, and into bank stocks in particular. If the Lincoln provision becomes law, the stocks will trade down further, but if the impact is really so dire as to shut off home lending, or keep McDonald's from doing business around the globe, Congress will be forced to fix it. More likely, though, is that the provision never becomes law.
The White House downplays it and House Financial Services Committee Chairman Barney Frank (D., Mass.) doesn't seem to like it much. Fed Chairman Ben Bernanke has also opposed it. Lawmakers are essentially just working out a way to kill it without seeming like they are sucking up to the banks. They will find it eventually, and when they do, bank stocks will rally.
3. Low Tax Bills Ahead
As the accompanying graphic shows, many banks won't be paying taxes for a year or, in some cases, many years. That is especially true for banks that lost a lot of money during the crisis, which is to say, nearly every bank! All the potential write-offs mean yesterday's losers reap big savings when they become profitable again, and few industries lost more money than banking in recent years.
Bank Analysis
Five Bank Stock Bargains
Looking at a term called net deferred tax assets is a good way to figure out how much in losses and other items companies can apply toward reducing their tax bills in the future, according to corporate tax consultant Robert Willens. Though banks already count this number as an asset that is reflected in book value, Willens nonetheless believes the issue is poorly understood and may not be fully reflected in companies' share prices.
Not reflected in book value is something called a valuation allowance. That refers to losses banks aren't counting as an asset because accounting rules require them to demonstrate a better than 50% probability they will be able to earn enough to use the loss as a write-off. If earnings prove stronger than expected, banks can release capital they have to hold against that valuation allowance, leading to a rise in book value.
2. Worries About Europe Are Excessive
Fiscally stronger European countries like Germany have made a major commitment to support weaker ones like Greece. This is not a small thing, and it will go a long way to providing stability on the continent. Longer term, you may see some weaker countries drop out of the euro, but that's at least a couple of years off.
For all their size, even the largest U.S. banks like Wells Fargo, JPMorgan and Bank of America have essentially no European exposure when it comes to retail businesses, like credit cards or mortgage lending. Wealth management and business lending is minuscule. Even investment banking and business lending operations pale in comparison to the size of their counterparts in the U.S. and other parts of the world. Even Citigroup, traditionally the most global of large U.S. banks, is far from a major player in Europe.
1. Everyone Is Selling
Though bank stocks, like the rest of the market, have showed some signs of life this week, fear has clearly injected itself into the market. The mantra of Sage of Omaha Warren Buffett that it pays to be greedy when others are fearful and fearful when others are greedy proves itself time and again. The trick, of course, is knowing whether people are going to get more fearful before they start to get greedy again. You can never know for sure, which is why you simply have to add risk compared to where you were when the market was higher a month ago.
The SPDR KBW Bank ETF has roughly matched the Dow Jones Industrial Average in the selloff of the past month, but it has sharply outperformed the Dow since markets rebounded off their lows in March 2009. When the markets resume their climb, bank stocks are sure to outperform.
The SPDR KBW Bank ETF, which counts Citigroup, Bank of America, Wells Fargo JPMorgan Chase and US Bancorp as its top five holdings, was at $26.01 when I wrote my story.
While it would hit a high of $29.22 on April 21, it touched a recent low at $23.33 Tuesday. Two reasons I highlighted, "Regulatory Threats Resurface" and "European Contagion," look especially smart. So give me an A for insight and a C+ for timing.
> > Bull or Bear? Vote in Our Poll
Now that everyone is freaking out about bank stocks, it may be worth taking another look at the sector, which for current purposes also includes Goldman Sachs and Morgan Stanley. They have been a big part of the recent selloff, and they may have more in common with JPMorgan, Bank of America and Citigroup than any of those three does with Wells Fargo, or certainly US Bancorp.
There are plenty of reasons to be a bull on banks. Here are a few.
5. The U.S. Economy Is Improving
The recent selloff, not just in bank stocks but in global equities, has had nothing to do with any signals in the U.S. economy. It's been all about European countries like Greece, Spain, Ireland and Portugal struggling under heavy debt loads, with a pinch of fear about overzealous regulators thrown in. There may also just be a general fear that equities have come too far too fast and those things provided an excuse for selling.
Meanwhile, things in the U.S. continue to mend. Since hitting a high of 10.6% in January, the U.S. unemployment rate is down to 9.5%. The steep rise in the chart shown here demonstrates that we've already had a historic rise in layoffs and hiring freezes. Employers freaked out, now they are hiring again, and it's hard to think of any single thing that could be more bullish for bank stocks. Sometimes it pays to keep it simple.
4. Regulatory Fears Are Overblown Probably the biggest surprise about the regulatory reform legislation that passed the Senate earlier this month was a provision sponsored by Blanche Lincoln (D., Ark.) that would force banks to spin off their derivatives businesses.
Derivatives are a huge profit center for banks like Goldman Sachs, Morgan Stanley and JPMorgan Chase. It is not entirely clear whether the Senate legislation would eliminate their ability to trade, sell and design derivatives altogether, or merely sharply curtail those activities. In any case, the result would be disastrous, and a JPMorgan report Thursday estimates the Lincoln provision would halve the 2011 return on equity for Morgan Stanley and Goldman Sachs.
Even that dire prediction may be too sanguine. One former Federal Reserve official I spoke with fears the provision would make it impossible for banks to hedge their mortgage portfolios, which would create big problems for home lending in the U.S. It also could raise questions about the ability of multinational corporations in a wide range of industries to hedge against commodity and currency risks.
Many of these fears are, to an extent, priced into stocks, and into bank stocks in particular. If the Lincoln provision becomes law, the stocks will trade down further, but if the impact is really so dire as to shut off home lending, or keep McDonald's from doing business around the globe, Congress will be forced to fix it. More likely, though, is that the provision never becomes law.
The White House downplays it and House Financial Services Committee Chairman Barney Frank (D., Mass.) doesn't seem to like it much. Fed Chairman Ben Bernanke has also opposed it. Lawmakers are essentially just working out a way to kill it without seeming like they are sucking up to the banks. They will find it eventually, and when they do, bank stocks will rally.
3. Low Tax Bills Ahead
As the accompanying graphic shows, many banks won't be paying taxes for a year or, in some cases, many years. That is especially true for banks that lost a lot of money during the crisis, which is to say, nearly every bank! All the potential write-offs mean yesterday's losers reap big savings when they become profitable again, and few industries lost more money than banking in recent years.
Bank Analysis
Five Bank Stock Bargains
Looking at a term called net deferred tax assets is a good way to figure out how much in losses and other items companies can apply toward reducing their tax bills in the future, according to corporate tax consultant Robert Willens. Though banks already count this number as an asset that is reflected in book value, Willens nonetheless believes the issue is poorly understood and may not be fully reflected in companies' share prices.
Not reflected in book value is something called a valuation allowance. That refers to losses banks aren't counting as an asset because accounting rules require them to demonstrate a better than 50% probability they will be able to earn enough to use the loss as a write-off. If earnings prove stronger than expected, banks can release capital they have to hold against that valuation allowance, leading to a rise in book value.
2. Worries About Europe Are Excessive
Fiscally stronger European countries like Germany have made a major commitment to support weaker ones like Greece. This is not a small thing, and it will go a long way to providing stability on the continent. Longer term, you may see some weaker countries drop out of the euro, but that's at least a couple of years off.
For all their size, even the largest U.S. banks like Wells Fargo, JPMorgan and Bank of America have essentially no European exposure when it comes to retail businesses, like credit cards or mortgage lending. Wealth management and business lending is minuscule. Even investment banking and business lending operations pale in comparison to the size of their counterparts in the U.S. and other parts of the world. Even Citigroup, traditionally the most global of large U.S. banks, is far from a major player in Europe.
1. Everyone Is Selling
Though bank stocks, like the rest of the market, have showed some signs of life this week, fear has clearly injected itself into the market. The mantra of Sage of Omaha Warren Buffett that it pays to be greedy when others are fearful and fearful when others are greedy proves itself time and again. The trick, of course, is knowing whether people are going to get more fearful before they start to get greedy again. You can never know for sure, which is why you simply have to add risk compared to where you were when the market was higher a month ago.
The SPDR KBW Bank ETF has roughly matched the Dow Jones Industrial Average in the selloff of the past month, but it has sharply outperformed the Dow since markets rebounded off their lows in March 2009. When the markets resume their climb, bank stocks are sure to outperform.
For Patient Investors, Another Window to Buy
The correction that made such a brief appearance two weeks ago has returned, this time apparently to stay. For me and anyone following the Common Sense system, that means opportunity.
Last week, the Nasdaq dropped convincingly below the Common Sense buying threshold, which is a 10% decline from the most recent high reached on April 23. The S&P 500 also dropped more than 10% from its peak, putting both major averages into an official correction, the first since the bull market began its rise on March 10, 2009. The Dow Jones Industrial Average dropped below the 10% correction threshold Thursday, returned above the line Friday and fell back below it again Monday. The Common Sense approach calls for buying on corrections of 10%, and selling after rallies of 25%.
Just two weeks ago I fretted that a buying opportunity had come and gone so fast I was unable to take advantage of it. The $1 trillion rescue plan unveiled by the European Union and the International Monetary Fund had triggered a huge rally, and it looked like the bull market was back. I needn't have worried. European sovereign worries have returned with a vengeance. Not only did the market's plunge renew a buying opportunity, but indexes fell so rapidly last week that the Nasdaq Composite was well below the 10% threshold on Thursday, when I made some purchases.
This is yet another reminder to remain focused on the long term and not get caught up in the minute-by-minute or even daily gyrations of the stock market. I've said for months that eventually there would be a correction, and not just one lasting a few minutes.
Having gone through three successive selling opportunities during the past year, I had ample cash at my disposal. (I generally sell roughly 10% of my portfolio at each selling opportunity and spend about 20% of my cash at each buying window.) In deciding what to buy, I simply followed the advice I've offered in recent columns. One strategy was to add exposure to commercial real estate, a sector I'd shunned as overvalued but recently concluded showed promise. I'll give a more detailed report on my real estate strategy in a future column, but one component was simply to buy a diversified exchange-traded fund, the Vanguard REIT Index Fund.
For stocks, I focused on some of my own recent recommendations in the technology sector. Despite generally solid earnings, the tech sector has corrected more severely than the broad market. I bought long-term Apple calls at only a modest premium to the current price (I already have a position in Apple shares), as well as the PowerShares QQQ exchange-traded fund, which approximates the performance of the Nasdaq. I've been impressed recently with strong earnings from big technology concerns like Intel, Cisco Systems, and Oracle, which account for three of the fund's top 10 holdings.
I also raised cash by selling some Google puts. This is the first time I've sold puts in over a year. (Selling puts means you agree to buy shares at the strike price if they're trading below that price when they expire.) It's a strategy I recommend when option prices are high (such as when the VIX has jumped, as it did last week) and when I expect shares to rally. If you really hope to own the shares, I find you're better off buying them outright or buying calls. I wouldn't mind owning Google at the strike price, but since I already have a substantial position, I'm also happy to simply keep the cash should the puts expire above the strike price.
I did all these transactions last Thursday afternoon, as the Dow Jones Industrial Average was heading toward a 376-point one-day loss. With the previous brief correction fresh in my mind, I moved quickly in case the window proved fleeting. I needn't have; stocks were still in correction territory this week.
My reaction illustrates the persistence of psychological factors, even after years of investing. Why was I so concerned this correction would be brief? After waiting more than a year for a buying opportunity, the rising market has conditioned me to expect more of the same: a brief correction followed by the return of the bull. I was eager to put money to work and get it out of low-yielding money-market funds. And yet I realized my eagerness should have been tempered by the likelihood that this may not be the last correction. If history is any guide, the fact that there hasn't been a correction for so long increases the chances that there will be another 10% decline.
So I still have cash in reserve. As usual, I'm making no short-term predictions about the direction of the market. My goal is simply to be prepared when opportunities present themselves, as they did last week.
Last week, the Nasdaq dropped convincingly below the Common Sense buying threshold, which is a 10% decline from the most recent high reached on April 23. The S&P 500 also dropped more than 10% from its peak, putting both major averages into an official correction, the first since the bull market began its rise on March 10, 2009. The Dow Jones Industrial Average dropped below the 10% correction threshold Thursday, returned above the line Friday and fell back below it again Monday. The Common Sense approach calls for buying on corrections of 10%, and selling after rallies of 25%.
Just two weeks ago I fretted that a buying opportunity had come and gone so fast I was unable to take advantage of it. The $1 trillion rescue plan unveiled by the European Union and the International Monetary Fund had triggered a huge rally, and it looked like the bull market was back. I needn't have worried. European sovereign worries have returned with a vengeance. Not only did the market's plunge renew a buying opportunity, but indexes fell so rapidly last week that the Nasdaq Composite was well below the 10% threshold on Thursday, when I made some purchases.
This is yet another reminder to remain focused on the long term and not get caught up in the minute-by-minute or even daily gyrations of the stock market. I've said for months that eventually there would be a correction, and not just one lasting a few minutes.
Having gone through three successive selling opportunities during the past year, I had ample cash at my disposal. (I generally sell roughly 10% of my portfolio at each selling opportunity and spend about 20% of my cash at each buying window.) In deciding what to buy, I simply followed the advice I've offered in recent columns. One strategy was to add exposure to commercial real estate, a sector I'd shunned as overvalued but recently concluded showed promise. I'll give a more detailed report on my real estate strategy in a future column, but one component was simply to buy a diversified exchange-traded fund, the Vanguard REIT Index Fund.
For stocks, I focused on some of my own recent recommendations in the technology sector. Despite generally solid earnings, the tech sector has corrected more severely than the broad market. I bought long-term Apple calls at only a modest premium to the current price (I already have a position in Apple shares), as well as the PowerShares QQQ exchange-traded fund, which approximates the performance of the Nasdaq. I've been impressed recently with strong earnings from big technology concerns like Intel, Cisco Systems, and Oracle, which account for three of the fund's top 10 holdings.
I also raised cash by selling some Google puts. This is the first time I've sold puts in over a year. (Selling puts means you agree to buy shares at the strike price if they're trading below that price when they expire.) It's a strategy I recommend when option prices are high (such as when the VIX has jumped, as it did last week) and when I expect shares to rally. If you really hope to own the shares, I find you're better off buying them outright or buying calls. I wouldn't mind owning Google at the strike price, but since I already have a substantial position, I'm also happy to simply keep the cash should the puts expire above the strike price.
I did all these transactions last Thursday afternoon, as the Dow Jones Industrial Average was heading toward a 376-point one-day loss. With the previous brief correction fresh in my mind, I moved quickly in case the window proved fleeting. I needn't have; stocks were still in correction territory this week.
My reaction illustrates the persistence of psychological factors, even after years of investing. Why was I so concerned this correction would be brief? After waiting more than a year for a buying opportunity, the rising market has conditioned me to expect more of the same: a brief correction followed by the return of the bull. I was eager to put money to work and get it out of low-yielding money-market funds. And yet I realized my eagerness should have been tempered by the likelihood that this may not be the last correction. If history is any guide, the fact that there hasn't been a correction for so long increases the chances that there will be another 10% decline.
So I still have cash in reserve. As usual, I'm making no short-term predictions about the direction of the market. My goal is simply to be prepared when opportunities present themselves, as they did last week.
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