When and Why We Bought the Financial Sector

Henry wrote:

Is it true you guys bought financial stocks at the very bottom of the drop after Bear Stearns (BSC)? A friend of mine is a member there and claimed that, but you know how claims can be.

Indeed I do, which is why we maintain a complete archive of every note sent to subscribers. Any member can browse through past issues chronologically or read content grouped by label on the subscriber site.

As for our buying of financial stocks at the "very bottom," it's somewhat true. We researched exhaustively to find what we thought was the best one of the big banks and brokerages, but couldn't find anything really compelling to differentiate one from the other. Unlike Jim Cramer, we did not find Bear Stearns to be attractive.

Ultimately, we decided that buying the whole sector with leverage to get twice the bang out of a recovery was the way to go. We never believed the crap about subprime and credit concerns spelling the end of the financial system as we know it. (Surely you didn't fall for that!) Anybody who's studied the market for a while knows that financial stocks get a washout about once a decade, it's always called the end but it never is, and those who buy at the point of maximum pessimism do very well in the recovery.

Think back to the S&L Crisis of 1990, the Asian contagion of 1997, and the collapse of Long-Term Capital Management in 1998. They were all supposed to be the end, none were, and we knew without a doubt that this time wasn't the end, either.

We chose ProShares Ultra Financials (UYG) as a simple way to leverage the Dow Jones Financial Sector index. We bought shares at $24.20 on Monday, March 17, which was a magnificent entry price due partly to luck, to be honest.

The ETF closed the previous Friday at $27.42. In that weekend's note to subscribers, I wrote about the bottom of the financial crisis being close, and we placed a good-till-canceled limit order to buy at $27.

All hell broke loose in Asia on Monday, and after the storm hit New York, the ETF opened at $24.04, we bought at $24.20, and it ended the day at $26.44. The 52-week low of $24.01 was set that very morning, so we're very pleased with our entry price. See the chart.

So far, we're up 48%. That's the story.

Comments

[grs44]

I agree wholeheartedly with the buy on financials, though my logic might vary. I believe the whole sector has written off a lot more than it should have, and there will soon be write ups. Why? CEO's are not risk takers, and they prefer the herd mentality which can hide their deficiencies. So while everyone was emptying out the dirty closets, they all jumped in.

Now I believe they have cleaned out the closets, and some good stuff will be found in there. That and I am not seeing the vacant foreclosed homes like I used to, so I am guessing that the people with bad loans have acted by now. There are still problems in CA, FL and NV, but otherwise we are in OK shape.

Talk to bankers today and they all seem to have found religion again, and the underwriters are not nearly as deaf, dumb and blind as they once were, and few banks are buying bad mortgages any longer. We might go horizontal for a while, but will go up and to the right in the near future.

UYG seems to be the way to play this if you believe like I do that financials are on the way back. Good luck!

[Whisper OnThe Wind]

The foreclosed homes are in Michigan. Still, I'm with you on the financials, and will continue to pick up a little more here and there.

[netscorer]

to grs44: you assume a lot when you say that CEOs already cleaned their closets with current write downs. Yes, most of them are not risk takers, but try to find a more lying and manipulating group of people - you'd have a hard task. Banking sector got itself in huge trouble with boom of Derivatives Market without proper tools of evaluation and current mortgage meltdown is just a beginning of revalue of the underlying assets that drive that market. I agree with Jason that long-term financials are looking very attractive (and congrats on timing the market) but the next couple of years may be very ugly and The Bear Stearns disaster was not the last run on the bank we will see.