JPMorgan: Buying the Stock, Not the Sector

Over the last couple of days, the market’s reaction to the bad news surrounding the housing and financial sector is, I believe, quite insightful about the psychology of the market and the reason for the substantial daily swings. The main concern seems to be the fear of another mortgage underwriter or investment bank going under. I can’t help but realize how the market psychology about this so-called “bad news” is extremely similar to late 2006/early 2007, at the height of the M&A boom; only this time, market dynamics are reversed.

You might be surprised how one can say that a market which refused go down despite the burst of the housing bubble, and a market which refuses to pick itself up despite a host of economic incentives, might be similar. Well, the similarity lies in the fact that traders seem to trade sectors, not individual stocks.

Do you remember how, back in early 2007, each Monday there would be a host of multi-billion private equity buy-out deals announced, and how the target of that deal's whole sector would be buoyed exuberantly as a result of that buy-out. Well, the situation in the financial and housing sector recently seems to be similar in that traders again are playing the sectors rather than individual stocks.

For example, over the past couple of days news about another major investment bank going under surfaced, and rather than the most likely candidates being beaten down, the whole financial sector got slaughtered. Among the names being irrationally sold-out were names like JPMorgan (JPM), which in my opinion carries almost a zero possibility of going under.

I have stated JPMorgan especially because I’d like to comment on that specific company’s situation. If there’s a fear of a major financial going under, I’d think that JPMorgan would be the envy of investors, especially those who don’t want to abandon the financials altogether.

One should ask what, given the government-backing the institution received in rescuing Bear Stearns, are the chances that the same government would allow it to collapse? There are also a host of other reasons, like its size and its relatively better performance, why JPMorgan is a safe haven. If all this is not enough, JPMorgan would probably be the sole benefiter of a major financial investment bank going under, since it would give the firm the opportunity to acquire one of its major competitors at a rock bottom price.

I usually don’t recommend going against the trend (and although I believe the financials are due for another jump, I won’t recommend going long housing or financials, either). However, given the scenario I have explained above, I think JPMorgan as an individual stock is a safe and promising bet to get long. I think the stock is poised to go above 40 in a very short time, and if it doesn’t get stopped by technical traders at 40, it might even see the 44-45 range in a month.

Disclosure: Author holds a long position in JPM

Comments

[Jimmy Lathrop:]

I can't make an intelligent investment decision on your hunch.

2008 Aug 21 07:36 AM

[Brahm:]

I fear the unknown, It is clear that the markets (and the best and the brightest) did not figure out everything with regard to what could happen to the financials and other mortgage related securities during the past five years. It is true that JPM has the $29 billion commitment from the Treasury. But the disaster may surpass that level. .After all everything is related to other matters in the finacial markets.

2008 Aug 21 08:21 AM

[Smalltownba...:]

Some comments on JP Morgan in the mortgage industry.

First: One of the highest risk areas of mortgage lending right now is Home Equity Lending. JP Morgan Chase has more exposure in this area than any other lender as the leader in this product for many years, especially after the Bank One merger.

Secondly: Chase has always purchased a much higher percentage of their loans through the broker/wholesale/corre... channel than through direct origination and the deterioration of quality in this part of their business has led them to 1. eliminate wholesale sub-prime 2. eliminate wholesale Home Equity Lending 3. eliminate non-conforming Jumbo lending These were defensive measures taken after the damage was done. These actions have dramatically reduced their ability to generate new revenues from mortgages while increasing runoff from their existing portfolio. At the same time they have significantly reduced their sales and support force on the direct lending side because of an ongoing refusal to fix a broken technical origination platform.

JP Morgan Chase has been a major player in US mortgage lending for a long, long time and they are moving away now because even their tight controls were not able to protect them from the virus which started this problem which was "stated income and No Doc" mortgages, not sub-prime. The problem just manifested when the virus was spread to the sub-prime channel as common sense would dictate to anyone with a brain.

While retail mortgage is not a huge factor for JPM, the mortgage servicing and wholesale operations have always been integral and will have a significant impact that has not yet shown up in their public numbers.

I spent over 5 years on the inside of this operration and very little has changed.

2008 Aug 21 08:47 AM

[jjason:]

John, I went through your article three times and no fundamental data was given about this company. For example...What is the debt to equity ratio and the total debt to equity ratio???

What is the book value and the tangible book value??? and other important FACTS.

And, as Brahm said " I fear the unknown ".

Too many, well paid, people and executives have really screwed up their businesses and the US economy. The shareholders and the public are now suffering. And many or these people went to the best business schools in the nation.

2008 Aug 22 02:47 PM