On Picking the Right Pundits

Includes: BAC, RF
by: Jeff Miller

High on the list of investor mistakes is chasing performance. Even though the top market pundits are aware of this fact, they make the same mistake -- time after time.

Buying what worked last year is the easiest way to pick stocks, sectors, or managers. It is also the worst. Despite this, it is the key question that every new investor asks. It is natural. It seems relevant. For most investors it is the most obvious part of "due diligence."

When we are having a good year in stock picking, as we are now, it is easy to go with the flow. But it is not really what we recommend. Our long-term record -- and that of others -- should be the real question.

The False Litmus Test

We are in an era where CNBC introduces every bearish pundit with "He was one of the first to see the problems in the [housing, credit, CDS, derivative] market." There are no track records on those who missed some big gains by making very bearish predictions many years before the collapse. Taking the other side, people like Warren Buffett were well aware of the risks, maintained cash, but bought back into the market "too early."

We now have a bunch of rookies who think that Warren Buffett has "lost it." They also think that some perma-bear is a genius.

One of the big news stories yesterday was the SEC filing from hedge fund manager John Paulson, noted for making big money by shorting financial stocks last year. When a major bear on a sector switches positions, that is news.

Yesterday on RealMoney Jim Cramer observed "Buffett got this period wrong and we bid up anything he buys. Paulson got it right and we are supposed to ignore him."

Cramer repeatedly highlighted Regions Financial (NYSE:RF) and also mentioned it in his regular "Stop Trading" spot on CNBC. The stock rallied after his early comments and popped eight cents again on high volume during the CNBC appearance.

Everyone noted that Paulson had a large position in Bank of America (NYSE:BAC). Cramer felt that RF was the stronger play.

Our feeling is that both Paulson and Buffett deserve respect. There are many different methods that generate above market returns in different time frames. The facile emphasis on last year's pundits has already been a losing move for many investors. And please note that Cramer was not disparaging Buffett, but emphasizing Paulson.

Meanwhile, Felix Salmon (one of our featured sources) was highlighting a bearish Bloomberg article by Jonathan Weil, suggesting that the footnotes showed that Regions Financial was insolvent!

We can imagine investors selling the stock based upon Weil or Salmon, buying it based on Cramer, or being very confused after reading both.

Another Example

Tonight's Kudlow program had a segment with Elaine Garzarelli. The assembled punditry scoffs whenever she appears. Her great call on the '87 crash is an ancient memory, and most now dismiss her bottoms up method of evaluating stocks and sectors. We disagree.

Most pundits do not really consider her methods, which are actually quite good. She has a viewpoint that may well prove to be correct, flying in the face of the conventional wisdom of traders. Here were a few key points:

  • Her 2010 S&P earnings estimates are $73 and she is looking for a multiple of 17.5. That corresponds to the pre-Lehman market of 1250 in the S&P 500.
  • She sees the biggest threat to this valuation as an increase in risk spreads. Corporate bonds are an alternative to stocks.
  • She also replied to Kudlow that more FASB efforts to impose unrealistic marks on existing holdings would be a big negative.
  • She sees the downside for stocks as 4 to 7 percent, mostly based on normal fluctuations.

Our Take

The Garzarelli earnings estimates and multiple are actually quite reasonable given current interest rates and growth projections. The S&P at 1250 gets back to pre-Lehman levels. It is not "bubble land." That was at a time when the market expected a recession, but not a depression. It represents a good initial target for stocks. It is not an extreme target.

The declining risk spreads have increased the valuation for stocks. She is correct in noting that any increase in bond yields is the biggest risk for stock valuation.

Making a major investment in equities implies a significant reward/risk picture. This ratio of 5 or 6 to 1 is pretty attractive. The exact timing (September selling?) is a bit of a guess.

Full disclosure: We have a small position in BAC, a larger position in regional banks, and we are taking a serious look at RF.