Financials Future Still Uncertain

By Marc Lichtenfeld

Sounds Nice…

As I was running to catch my early morning flight on Saturday, I grabbed a copy of the New York Times and Barron’s. I looked at the Barron’s cover and figured that I must not have gotten enough sleep and was still in dreamland.

Right there in big capital letters was the advice to buy banks, with the caveat that you should do it selectively.

And no, as it turns out, I wasn’t dreaming.

The article argues that valuations are low and the companies still have significant earnings power.

Last week’s sharp rally in the financials gave investors some hope that the banks were done cratering. And many took Wells Fargo’s (NYSE: WFC) strong earnings report as a sign that we’ve seen the worst in the sector.

…But The Worst Isn’t Over Within Financial Investments

The way I see it, this magazine cover reinforces the idea that the bottom is nowhere in sight.

Now I’m not a conspiracy theorist, despite my belief that the 1985 NBA draft was rigged so that the Knicks would—thankfully—get Patrick Ewing. Nor am I a Chicken Little, as I believe any of my regular readers can attest to.

But while I’m not about to say the sky is falling, I do believe bank stocks will for a while.

This is not a stance I take lightly, especially considering that Mt. Vernon Research Investment Director Karim Rahemtulla, is well-schooled in picking and choosing from the financial sector. In fact, using his deep in the money covered call strategy, he has actually racked up gains on companies like JP Morgan, Wells Fargo, and US Bancorp.

(If you are going to get involved in financial investments, you really should only pick the stocks and strategies that Karim recommends in Xcelerated Profits Report.)

If anyone can pick winning stocks in a losing sector, it’s Karim.

But you have to look at it this way: if some of these banks needed to raise money and were offering bonds at a competitive rate, would you help finance them?

Would you buy a Lehman Brothers (LEH) bond maturing in 2017 with a yield of 6.3%? I sure wouldn’t.

How about a Fifth Third Bancorp (FITB) 4.9% yield maturing in 2018? Thanks but no thanks.

A Key Corp. (KEY) bond maturing in 2014 paying 5.6%? Ummm…No, I think I’ll pass.

If I’m not certain that a bond will be paid back, why would I want to own the stock? After all, the bond owners get paid before the stock owners.

It’s my contention some of the banks and brokers don’t even know what they own on their balance sheets. The mortgage products and derivatives were so complex that the average CEO can’t explain them.

And these guys aren’t dumb. They may have made some poor decisions, but stupid they ain’t.

We may get a lift for a while, but there’s going to be a lot more pain in the sector as companies are forced to continue write downs when they realize the value (or lack thereof) of the garbage on their balance sheets.

Zig When They Say Zag

Furthermore, the magazine cover indicator has been a fairly reliable predictor of stock movements. It was even proven by academics at the University of Richmond.

The professors examined headlines from three major business publications over twenty years and compared the stock performance to the bias in the headline.

The study concluded that positive stories were typically published after periods of strong out-performance and negative stories after underperformance. In other words, these stocks had already made their strong moves.

Stocks with negative stories outperformed the overall market by nearly 13%, while positive story stocks outperformed by 4%.

The most famous example of a magazine cover as a contrary indicator is the August 13^th, 1979 cover of BusinessWeek magazine which proclaimed, “The Death of Equities”. Of course, we know that the market is up well over 1000% since then.

Magazines tend to be late to the party for several reasons. Their job is to sell magazines. So they will often only publish a story—and especially a cover—when they know that the topic is already well into the public consciousness and is being talked about.

When was the last time you received a good investment idea, that everyone was already talking about?

Similarly, a stock often only catches the attention of a journalist or editor after it’s made a big move. Many of them are writers first and stock market mavens second, which means they’re going to put emphasis on the writing instead of analysis.

Where was the financial media calling for a bottom earlier last week when shares of Washington Mutual (WM) plunged 35%, Wells Fargo dropped 11% or Bank of America (BAC) slid 15%?

Only after everyone was already talking about the remarkable comeback of the sector at the end of the week, did the writers at Dow Jones declare the bottom in bank stocks.

Why?

It’s what everyone wanted to read after the crazy events of the past five days. I guarantee that a cover that stated bank stocks are headed lower wouldn’t have sold as many copies.

In fact, I’m certain that a cover like I just described would not have made me pause long enough to pick up a copy, in my dash to the plane.

The bottom line is this: Covers that everyone wants to read sell magazines. They don’t accurately predict the stock market.

Hoping your longs go up and your shorts go down.

Today’s Smart Profits Notes:

• And speaking of banks, Fannie Mae (FNM) and Freddie Mac (FRE) are still capturing the unwanted spotlight. With the government likely to back them up with much needed funding, they might be able to pull through with this crisis with their businesses at least intact, though their reputation might not be able to claim the same. Together, they own or guarantee over $5 trillion in home loans.
• Wachovia (WB) felt the pressure this past quarter, with a just-reported loss of $8.86 billion. All told in the April-June period, it lost approximately $4.20 per share. But they seem to be taking responsibility for the poor numbers, if Chairman Lanty Smith’s comments are any indication. In an effort to build themselves back up, they’re taking action, including leaving the wholesale mortgage lending business altogether.

Related Articles:

Immersion Is “Force Feeding” Its Way Towards Solid Growth

The Best Stocks To Invest In During a Bear Market

Two Good Stocks To Invest In

Comments

[texalope:]

Fannie and Freddie are really troubling. As part of their mandate the government requires them to take on some mortgages that are riskier to fulfill their social responsibility. The market kills the stock making a capital raise all but impossible due to shareholder dilution. Paulson then comes up with the" bazooka in his pocket plan" promising taxpayers that if he has to use it the shareholders will be wiped out. He contends that he favors private shareholders investing in the GSE's. Yet, what shareholder in his right mind would invest in these businesses under the threat of being wiped out by the secretary of treasury under the guise of protecting the taxpayers. As a shareholder who lost a tremendous amount of money, it's frustrating to see 200 government auditors from OFHeo swarming over the GSE's books and saying their capital exceeds regulatory requirements by 20%,. Then the Treasury secretary says he;s sent in auditors to reexamine these same books- It's pathetic. Where were these regulators and the treasury secretary last year when the share price was still 70. All the issues were known then and discussed. Our entire government is in reactive mode. THey don't get in front of any issue. This is pathetic. Are these really the best leaders we can find?
The same can be said for the late to the party SEC. All of a sudden after massive destruction of value they decide to enforce short sale rules- and they only apply it to 19 companies. What about eliminating shorting on the uptick rule. I'm not saying that shorts are wrong. I'm only saying that the same way I'm required to buy stock that really exists, a short should be required to sell stock that really exists. What is wrong with that?

2008 Jul 22 06:12 PM

[pachanguero:]

nice stuff, banks are rotten holes of stinking flesh. run like hell.

2008 Jul 22 06:23 PM

[bigtime99:]

Not going to make a significant run up anytime soon, because the fundamentals of a garbage economy aren't going to reverse anytime soon...

2008 Jul 22 10:12 PM

[Timmothy Posey:]

Come on guys, you are all starting to sound like the Chicken Littles from MarketWatch

2008 Jul 22 11:05 PM

[***ize***:]

I like your comments texalope... "late to the party" is right.

2008 Jul 22 11:05 PM

[buyitcheap:]

top may be in today on the IYF and IYF (and UYG at $24.76). Looks like the financials may be turning since their up move seems a bit exhausted...

2008 Jul 23 12:57 PM

[flashrob:]

some backup on this from Congress...

www.infowars.net/artic...

flashrob

2008 Jul 23 01:23 PM

[bill d:]

texalope is right on.
Banks et al are just as dirty as the people who are supposed to be watching over them. But then is that really news ?

Short term holding BAC stock & LEH calls

2008 Jul 23 06:52 PM