How to Trade This 'Bear' Market - Barron's

Barron's says current financial sector turmoil is the worst since the Long Term Capital Management Crisis of 1998. Bear Stearns (BSC), Goldman Sachs (GS), Lehman Brothers (LEH) and Morgan Stanley (MS) are slated to report Q1 earnings this week, and the results aren't going to be pretty.

Bear Stearns rescuer J.P. Morgan (JPM) may be the troubled firm's only potential suitor; HSBC (HBC) has also been mentioned. While brokerage firms usually command at least their book value, reported last November at $84/share, Bear's loss of investor confidence means it will lose prime-brokerage clients by the day if it delays a sale. Seabreeze Partner's Douglas Kass thinks Bear will be bought before Monday's open, at a price something close to its current $30/share.

Kass says he has covered short positions in Merrill Lynch (MER), Lehman, and Morgan Stanley, noting the Street has already more-than priced recessionary and book-value fears into share prices. He remains short large money-center banks including JPM, Bank of America (BAC) and Citigroup (C), citing potential concerns over their consumer loan portfolios. Peer John Linehan of T. Rowe Price says dollar-cost averaging down makes sense amid the panic that dominates current trading. He likes MER, MS, and AIG.

Among I-Banks, MER is the most leveraged, with $1.02T of assets supported by $27.6B of equity; next comes GS with $1.1T of assets supported by $39.7B. A 1% loss could wipe out almost 1/3 of GS's equity, and more than 1/3 of MER's. Portales Partners' Charles Peabody estimates GS will write down $500M on commercial mortgage-backed-securities and another $2B on leveraged loans; for MS, he sees $500M and $1B; and for LEH $700M and $1B. Losses may be mitigated by hedging, but it's hard to know if and how much the firms hedged their positions. At current prices, BSC trades for about 1/3 book value, C for 0.87x, and LEH and JPM trade at book.

Yet, despite the doom and gloom, Barron's says that, "With Bear in crisis, the Fed in Superman's cape and the stocks in purgatory, it's much too late to sell." Ok.

Comments

[David Fischer:]

Sorry, but never to late to sell. So far we have only seen the unwinding of some of the massive derrivative bubble, the most obvious subprime mortgage and some prime. The bottom won't come until your neighbor hands back the keys to the Mercedes, gets his diners club card cut at that customery friday night fine dining establishment, and the wife is selling Gucci hand bags at garage sales to raise money to pay the mortgage.
We are not even close. The game is only in the 3 rd inning. Too much trust was put in the current system, that the old sayings of paying cash, etc, are coming back to haunt those who trusted Wall street and the fed in this creative pyrmid scheme. This debt bubble won't be solved with more debt unfortunately. So unlike 2000, this one will have to be slow and painful. No superman cape will help the damage done here.

2008 Mar 16 11:14 AM

[NARSpin:]

This is once again one of Douggie Kass's classic "too early" moments. If he covered MER,MS,LEH before Friday - he missed a ton of easy money. Expect Monday to be no different.

2008 Mar 16 11:18 AM

[GKM:]

So Kass covered in some of his shorts - and left on his shorts for the key institutions that make up America's financing empire. A ringing endorsement for the soundness of the American banking system that is not.

2008 Mar 16 01:02 PM

[Sedan:]

Too late to sell..........never. Questions really is where do you put the proceeds that will provide a better risk adjusted return.

2008 Mar 16 03:25 PM

[R. Richard ...:]

Note the following quoted from the above:

"Losses may be mitigated by hedging, but it's hard to know if and how much the firms hedged their positions."

How about with whom? Who, and importantly WHAT, are the counterparties?

2008 Mar 16 03:37 PM

[Mong:]

There's a very strange bias going on with these financial news articles blogs etc. Namely, these often say (i) "hold on, its a blip downwards, nothing to worry about" (ii) "its fallen a bit, so its good value" (iii) " buy because its fallen and hence is good value or a bargain " (iv) "its fallen too far and you can't sell". This is being, I think, more than a bit sneaky to readers. More than a bit sneaky, I stress.

2008 Mar 16 08:37 PM

[cluless:]

I am stunned that Bear only fetched $2 per share. Recent book value was reported at about $80 per share for Bear Stearns. At $2, this valuation is almost a 98% discount to book value. I thought book value was the breakup value of a business and when the business goes bankrupt, then the shareholders get some reasonable percentage of book value. This deal may be good for Bear's counterparties, clients, and the financial system, but it is incredibly bad news for amateur investors like me. We all depend on accurate and honest information to make informed investment choices, but clearly "book value" in the case of Bear, and presumably all financial corporations, if not all stocks, is pure fiction or fantasy.

2008 Mar 16 11:07 PM

[NoFate:]

$2 a share ...we finally got MARK TO MARKET!!!

Now the rest of the investment banks have to drop to $2 and we might be at a bottom.

Disagree? Great ...SOLD TO YOU!

2008 Mar 17 02:21 AM

[zankaon:]

The Fed has no authorization under law to open a window (line of credit) to any brokerage firm i.e. investment house. JP Morgan is a true bank of course. But not the brokerage firms. The Fed is providing a floor on downside risk for such extremely highly leveraged illiquid assets; then a victim of domino theory anxiety (remember Viet Nam and also the North Slope?).

2008 Mar 18 02:31 AM

[nofactor:]

¿Can heavily short selling a stock be a way to ouster its management team or annihilate a competing company on basis of a rumour?
So if the stock market is a place for company's to get public financing, it's clear that this all comes at a price.

2008 Apr 01 07:43 PM