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  • Stick To Solid Research And Valuation Models

    With the bull market showing signs of weakness with increased volatility, the past few weeks has reversed course somewhat with the indexes making up all of their losses for 2015. Now market analysts are beginning to shout that we are going to have a rally through year end and possibly end up 5% for the year.

    Our view is that nothing has really changed. Q3 earning reports are coming in as weak as expected and yet analysts and investors appear to be completely ignoring the picture that many companies are painting. This has us concerned and disturbed. We've been disturbed for the past 6 months as the Fed has continued playing its game of not raising short-term interest rates, and investors ignoring everything other than what the Fed is doing.

    We believe that as time goes on and most companies continue to report extremely weak results (98% are now focusing entirely on non-GAAP numbers) the risk is moving higher.

    Notwithstanding, we are finding that the banking/financial sector continues to be out of favor and that suits us just fine. This is the one sector where everything about the earnings and financial position is perfectly known. We are particularly biased towards smaller community and regional banks as we have been for the past two years. While Corporate America has been turning in extremely weak Q3 earnings, the small community and regional banks are turning in record earnings. People have still not come to the understanding/realization that these tremendously strong results are taking place with interest rates at the lows. On top of that, they are also paying secure dividends, generally in the 1% to 5% range. When interest rates do eventually rise, so too will the earnings at the banks - as interest rate spreads widen.

    We continue applying our model which highlights those banks with excellent earnings growth, asset growth, asset quality, and lower price-to-deposit ratio. Of course, we also give extra points for those with solid insider purchasing trends. We are seeing about 10% per year of the banks we own/follow being bought out, because other larger banks are noticing the same value metrics that we follow and understand that it is more cost effective to buy something cheaply than to take the time and money to organically grow their own enterprise.

    Normally, with an Instablog article we'd point out those banks/companies that we are writing about. However, in this case, because the banks we are talking about and buying are small and thinly traded, we are going to refrain from identifying them, because we are looking to accumulate and build larger positions in them at this time. If we identified them here, it is likely that we'd interest others who would buy and prevent us from being able to purchase the amount of additional shares we want at low prices. So, we'll just say to set your focus on the small community and regional banks which fit the model we've described above.

    The markets will continue to be volatile going forward. We believe that the banking/financial sector can provide some low risk stability and reliable income to every portfolio.

    Nov 03 3:27 PM | Link | 5 Comments
  • End Game For Deutsche Bank

    This morning German banking giant Deutsche Bank made official what they've been hinting at for several weeks:

    • $6.6 billion loss for Q3
    • Elimination of dividend on common stock
    • Cuts of about 35,000 employees
    • Exiting 10 countries

    For the past 10 years, Deutsche Bank has made just about every misstep possible from a business standpoint:

    • Massive losses
    • High risk asset portfolio
    • High leverage ratio
    • Failed acquisitions
    • Fraudulent and illegal activities
    • Failed turnaround attempts

    We believe that DB will ultimately be history. Current actions are simply a walkway along the path to the grave. Unlike most articles posted on this site, where authors will guess at growth numbers, estimate revenues, earnings, concoct pretty cash flow analyses, and focus on things like book value (which they really have no knowledge of whether they are even true), our analysis is going to be at a high level and simply look at the facts of what has transpired, and some logical inferences of how things go forward.


    During the early 2000s, Deutsche Bank had an ambitious plan to become a major force in the investment banking arena. Ambitious plans were put in place for getting the bank to a very high performance level and to show very high rates of return. The primary objective was to enter the bulge bracket and become a top investment house in the United States and worldwide. Under Josef Ackermann, things appeared to be quite successful in the years leading up to the financial crisis. Performance goals were reached, and DB was climbing the ladder of top investment banks.

    In the years following the financial crisis, everything unwound quite rapidly and DB now goes from stepping in one pile of cow dung to the next. Every few months, we learn of another settlement with a regulator to pay for fraudulent or illegal activities which the bank has been a party to, and continues to be embroiled in many legal actions. I suppose much of what has been settled was not technically "illegal" due to standard practice of "no admission of guilt or wrongdoing", which accompanies most settlements. However, DB has admitted to guilt or wrongdoing in a number of these cases - something unheard of in the past. Banks like DB have nothing more important than their reputations, and an admission of guilt or wrongdoing is the ultimate reputation killer. Who wants to do business with an admitted criminal?

    The past 5 years has seen the disaster of co-CEOs Jain and Fitschen and their turnaround plans.


    New CEO John Cryan is now embarking on another 5-year turnaround plan. The initial parts of this plan obviously entail massive cuts in headcount along with the reduction of the business footprint. In the first couple years, this will translate into more massive losses being posted to exit these businesses and severance costs to let employees go.

    As the turnaround slowly moves forward, we see little to no (logical) upside for the shares - because there is no reason for it. Huge losses will continue as Cryan attempts to stabilize the enterprise. We therefore question the valuation currently afforded to the shares. We believe that there are more unknowns and high probability of events on the horizon which can take the shares down swiftly. Some of these possibilities include:

    • additional capital raises
    • asset sales at prices below carrying value
    • write-down of asset/portfolio valuations
    • unanticipated losses on derivative portfolio
    • more unexpected legal issues that have yet to surface
    • inflated book value
    • accounting irregularities
    • other unanticipated revelations

    To summarize the above, there are enormous risks and low probability for a successful turnaround resulting in increased shareholder value.

    On top of all the internal issues at DB, we believe that the global economy is knocking on the door of the next recessionary period. This will be very negative for DB, as it will make it difficult to even maintain the current level of business activity and attempts to sell assets will not attract favorable prices.

    Our Conclusions:

    1. We believe that 5 years from now, Deutsche Bank will not exist
    2. Near-term, during the coming 12 to 24 months, the shares will go lower...on a path to the low $20s and quite likely to the mid/upper-teens
    3. As the current turnaround efforts turn out to be yet another failure, we believe a German competitor will step up and acquire the bank.
    4. After DB is acquired, it will be disassembled...some pieces will be assimilated with the acquirer, the remainder will be sold at fire sale prices or thrown in the trash.
    5. Acquirer will be the new banking leader in Germany and likely EU
    Oct 29 9:28 AM | Link | 3 Comments
  • It's The Top Of The Ninth Inning

    With the DJIA posting another 100 point loss yesterday, the index is once again down for the year, by 0.5%.

    When we began the year, market analysts were predicting gains of 5% to 10% for the year. At this time, it's all going to need to come in the five months remaining. We are questioning the probability that will happen, having serious doubts.

    There has been a fair number of doom and gloom articles over the past couple years, and most have been written off with the authors being labeled perma-bears. It's now time to revisit these articles and look at them in the context of what is currently taking place in the US and the rest of the world.

    Some of the issues we've been concerned about over the past few months have been escalating (e.g. weak earnings and non-GAAP reporting of earnings). However, we are additionally beginning to have external shocks thrown into the situation...Russia, China's inflated/manipulated stock market, Greece, oil, commodities rout, among others.

    At this time last year, the markets were jittery as the Fed was preparing for QE tapering. Many feared that with the elimination of QE, the markets would have to go lower and that the $85 billion per month infusion was unduly supporting the market. After a mild "shock", markets recovered and moved higher. Today, the Fed is signaling it will raise interest rates in September. What we see is an overwhelming number of articles indicating the Fed will not raise interest rates, that it cannot - they will delay, or possibly never increase rates. We also have the IMF, which has now made two requests to the US Fed not to raise interest rates, because the rest of the world is not prepared for the ripple effects. The last IMF request a couple weeks ago suggested waiting until at least sometime in 2016 for the first rate increase.

    We believe the Fed will move forward and raise interest rates by 1/4% in September because the data which the Fed has been telling us it has been watching is indicating the US economy can handle it. We don't believe it's prudent to be playing a game of poker, with the Fed sitting on the other side of the table, as an investor being the one to call a bluff. We very much believe that corporations can handle a rate increase from an economic perspective. However, the psychology of market participants will drive the indexes lower. Part of this will happen because at this time, valuations are out of line with reality. Part of this comes back to our prior thoughts regarding non-GAAP reporting.

    Some will say this is simply a short-term QE taper tantrum all over, but we'd disagree. For the most part, corporate earnings are weakening and have deteriorated over the past few quarters. Low interest rates are no longer providing sufficient stimulus for business investment to drive increased profitability. Stock buybacks, mergers and acquisitions, and other mechanisms of financial engineering are driving the latest round of corporate earnings.

    Now, the thing is that most folks are basically looking at the September interest rate hike as a binary event, but that is foolish. Interest rates will be going higher, and that is all that matters. Whether it's September, December, or early 2016, it is coming.

    It's a crap shoot how the market will react to the Fed's decision come September - regardless of whether interest rates are increased or not, the story can be twisted to be positive or negative. Our belief is that the headlines will be negative no matter how the Fed acts...valuations are simply too high at this time - pushed to current levels by investors looking for yield however they can get it. Throwing money at high-flying share prices hoping for any type of earnings beat has been a favorite these past two weeks. This is yet another red flag for us that the end is near. We see volatility continuing through August with ever increasing turbulence in the indexes, and then we have the Fed decision in September.

    At this time, we have essentially moved to the sidelines, going to 90% cash. Over the past 8 weeks, we've even been purchasing CDs laddering 50% of our portfolio in 3 month to 4 year maturities. Our belief is that there is a much higher probability of a major market correction during the coming months, than for the beginning of the markets next move higher. At best, the markets will stagnate, merely staying within a "narrow" range with DJIA between 17,000 and 18,500. We don't see DJIA moving to levels such as 19,000 or 20,000 - we believe something in the 16,000s is much more likely.

    We've already begun taking some ridicule for our beliefs and portfolio positioning. However, our view is that it is silly to fight for the last 10% profit while risking over 5 years of tremendous gains. The probability is that the market will make a significant move lower, before a significant one higher. Current fundamentals and valuations simply do not support the argument for moving significantly higher - regardless of the interest rate situation.

    Jul 24 7:51 AM | Link | 7 Comments
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