Misty Water-Colored Memories, Dirt-Cheap Stocks, and Patient Opportunism
Looking at forward earnings estimates, buy recommendations, and numerous explanations once again as to why "stocks are cheap" I am left wondering (to paraphrase Barbara Streisand) "Can it be that it is all so simple now? Or has time repeated every lie?"
Looking back, all that's left from the housing crash is "misty water-colored memories" of opportunities to cash out at the top (or dreams of not buying in the first place). The same can be said of the Nasdaq technology bubble that peaked at 5132 in March of 2000.
12 years later, the Nasdaq has managed to crawl back to 3000. Will it be another 10 years before the Nasdaq again hits 5000?
"Dirt Cheap" says Analyst Dick Bove
In 2000, in 2007, and again recently, we have heard many misguided explanations as to why "stocks are cheap". Some use forward earnings estimates, others tortured rationale such as "stocks are cheap compared to bonds", and still others use historical P/E estimates as if recent history is a guide to repeatable earnings.
Recently, analyst Dick Bove said Bank Stocks 'Dirt Cheap' as Image Starts to Turn
The Rochdale Securities vice president of equity research has long held that big banks have been most hampered not by their balance sheets by rather by negative perceptions - from Washington, Wall Street, and individual investors.
But as positions improve and policy makers begin to indicate that some of the more onerous new regulation proposals could be eased, that in turn presents opportunity, Bove said.
"What we're looking at is the complete change in attitude towards this industry from what it's been over the past three years," he said in an interview. "What has killed this industry over the last three years has been the negative psychology. It's not negative any longer."
"If you take a look at this industry based on any historical comparison to what the true value of the companies would be, they're dirt cheap," Bove said. "They remain dirt cheap, and the fact is that either you've got to come to the conclusion that the industry will never get back to the multiples it had in the past...or that it will get back to where it was in the past, in which case these stocks are still very, very cheap."
Warning: A New Who's Who of Awful Times to Invest
Please compare the analysis by Bove to that presented by John Hussman in Warning: A New Who's Who of Awful Times to Invest
The FDIC Quarterly Banking Profile for the fourth quarter of 2011 was released last week. The headline: "Banks earned $26.3 billion in the fourth quarter, an increase of $4.9 billion (23.1%) from the same period in 2010." This FDIC report was quickly picked up by news articles as a sign of clear recovery in the banking sector.
The details: "Earnings benefited further from lower provisions for loan losses. Insured institutions set aside $19.5 billion in provisions for loan losses during the fourth quarter." The amount set aside for loan losses declined $13.1 billion (40.1%) from the fourth quarter of 2010. Actual net charge-offs of $25.4 billion exceeded loss provisions of $19.5 billion. As a result, total loan loss reserves declined by $6.3 billion (3.2%), falling for the 7th consecutive quarter. Meanwhile, full-year net operating revenue declined for only the second time since 1938 (the only other decline occurred in 2008).
In another widely reported sign of recovery, the number of insured institutions on the FDIC's "problem list" fell from 844 to 813 during the quarter. Of course, 18 insured institutions actually failed last quarter, and so are no longer on the list. Nearly 1% of insured institutions were merged into other institutions during the quarter, likely accounting for much of the remainder.
Similarly, banks enjoyed their largest quarterly increase in lending since 2008, which was hailed as a sign of resurgence in economic activity.
A good amount of bad debt has been written down, but the remaining bad debt still needs restructuring. Notably, non-current assets and bank-owned non-foreclosed property ("other real estate owned" or OREO) is actually a larger percentage of bank assets today than in 2008. Restructuring generally means reducing the interest spread or writing down a portion of the principal, and this process is likely to siphon off earnings in the financial sector for years. Despite their preferred status as "risk on" speculative assets, I continue to view financials as a minefield.
Bubbles Are Not Reblown
To Hussman's distinctly sobering bank forecast, let me add a couple of thoughts. For starters, the last bubble is not re-blown.
Consider the "4 horseman" of the internet boom: Microsoft, Intel, Dell and Cisco. Where are they now? Sure there are some new leaders like Google and Apple, but the old ideas have languished.
Consider the housing bust: In spite of every trick in the book used by Congress and the Fed, housing prices make new low after new low.
Consider the banking sector: In spite of every effort by the Fed to get banks to lend, banks simply are not lending.
I suggest the financial sector will be dead money (at best) for years, perhaps decades, just as waiting for the return of Intel, Cisco, or Microsoft has been.
Is there going to be another credit lending bubble?
Take a look at excess reserves parked at the Fed for your answer. The same can be said for reserves piling up at the ECB. So where's that earning's growth going to come from? Mars?
About That Increase in Lending
Analysts went gaga (a continual state of affairs actually) over recent increases in bank lending. For example, consumer credit expanded by $19 billion in December of which $11.8 was non-revolving credit.
I took a look at non-revolving credit in Consumer Credit "Demolishes Expectations" Really? No Not Really! The "Non-Bounce" in Non-Revolving Credit and noted that $8.8 billion of that is growth in federal government loans (which just happens to be where student loans are parked).
Non-Revolving Loans Minus Government Loans
Non-Revolving Loans Minus Government Loans Detail
Note that the year-over-year "bounce" has not even gotten back to the zero-line in spite of exceptionally easy comparisons.
Eight Reasons Banks Aren't Lending
- Banks are capital impaired
- New Basel may require banks to hold more capital
- Few credit-worthy businesses want to expand
- Banks can park trillions of dollars at the Fed and make .25% interest risk-free for doing nothing.
- Demographics: Retiring boomers are scaling back purchases
- Real wages are declining
- Banks are sitting on massive amounts of real estate, SIVs, and off-balance sheet garbage still not marked to market
- Banks simply do not like the risks
Are U.S. Stocks (In General) Dirt Cheap?
Still think bank stocks "dirt cheap"? Heck, are stocks in general dirt cheap? Let's return to Hussman for an opinion.
Last week, the estimated return/risk profile of the S&P 500 fell to the worst 2.5% of all observations in history on our measures. This is not a runaway bull market. Rather, it is a market that again stands near the highs of an extended but volatile trading range. I am convinced that the breakdown of the market from this range has been deferred only through repeated and extraordinary central bank actions.
Importantly, the market is again characterized by an extreme set of conditions that we've previously associated with a "Who's Who of Awful Times to Invest." The rare instances we've seen this syndrome historically are reviewed in that previous weekly comment. They include the 1972-73 and 1987 market peaks, and several instances since 1998.
Arguments that stocks are "cheap on the basis of forward operating earnings" fail to adjust for the record high level of profit margins (about 50% above their historical norms), and also apply bubble-era norms for price-to-forward earnings multiples. This is the same argument that analysts made in 2007, and it is dangerously wrong.
Hussman has made those kinds of arguments before and so have I. If anything, I think Hussman may be an optimist. Indeed, I believe there is a decent chance of "Negative Returns for a Decade"
- February 07, 2011: Negative Annualized Stock Market Returns for the Next 10 Years or Longer? It's Far More Likely Than You Think
- March 15, 2011: Anatomy of Bubbles; Negative Returns for a Decade Revisited; Is Gold in a Bubble?
- August 23, 2011: Another "Lost Decade" Coming Up; Boomer Retirement Headwinds; P/E Expansion and Contraction Demographic Model; Negative Returns for a Decade Revisited
- August 29, 2011: Value Restoration Project: Stock Market Valuations and Trends Over Time
- January 23, 2012: Debt and Deleveraging: Did the U.S. Overcome the Debt Crisis? Light at the End of the Tunnel Anywhere? Five-Pronged Solution
Clearly I have been preaching a consistent message, and equally clearly the market has other ideas. I was in a similar situation in 2006, calling for a recession when the yield curve inverted, waiting an agonizingly long time for it to arrive.
This is yet another agonizingly long time for me as it has been for Hussman who writes ...
My greatest concern as an investment manager is the possibility that some number of our shareholders will grow so exasperated with remaining defensive during these periods that they capitulate and take a significant position in the market at the worst possible point.
In a market that has now underperformed Treasury bills for more than 13 years, with two plunges of more than 50% in the interim (all of which we anticipated), my hope is that shareholders recognize our record in identifying major downside risks, and understand - if not fully agree with - my insistence on stress-testing our methods against Depression-era data in 2009 in response to the credit crisis.
The completion of the present bull-bear market cycle (and it will be completed) will undoubtedly present strong opportunities to play offense, but today stands among a Who's Who of the worst historical times to do so. Particularly for investors who do not have a large number of future cycles between now and the point they will need to draw significantly on their assets, a defensive stance is crucial here.
Red highlighting is mine.
Here is a quote from Howard Marks at Oaktree Capital as referenced by Hussman.
Howard Marks, Oaktree Capital, The Most Important Thing (2011)
"You simply cannot create investment opportunities when they're not there. When prices are high, it's inescapable that prospective returns are low. That single sentence provides a great deal of guidance as to appropriate portfolio actions. Patient opportunism - waiting for bargains - is often your best strategy."
I tracked that message down to chapter 13 of Marks' Google Book The Most Important Thing: "The Most Important Thing Is .... Patient Opportunism"
The wait may be agonizing, but it beats the consequences of plunging in at exactly the wrong time as happened in the Nasdaq in 2000, in housing in 2005 (on arguments "get in now before it's too late), and in the stock market in 2007.
History suggests there will be better opportunities around the corner for those who have the patience to wait for them. How long that wait might be is still anyone's guess.