Replies to post #262825 on $Stock*Shop*Charts*News*Option$

[Kujo]

Nice reads SL

[Stock Lobster]

Denniger Dismantles Bove and other market bottom callers:

Friday, March 21, 2008

Why Dick Bove (And Market Callers Like Him) Are Wrong

Ok, having spent a good part of the day (and all of the afternoon) in an hour-and-a-half phone call with Mr. Bove, and then following up with a bunch of emails, I think I understand the premise of his "buy bank stocks now" call.

I also understand where I believe his fatal errors of analysis lay, and why this will be borne out in the fullness of time.

Let's start with the premise:

"This is a generational opportunity to buy (bank stocks) on the cheap."

Ok, that's pretty clear on its face.

But what did he really say?

He also did say that the economic turmoil is not over.

In fact, on the phone with me, he admitted that he expects a "mild to moderate" recession - remember that while I (and many others) believe we are in one right now, you can't call a recession until you are deep into the middle of it, and often they are not officially called until they are over!

But what underlies this bullish call on bank equities?

Simple - the ability to earn cash as a consequence of "positive carry" due to the upsloping yield curve.

Now let's examine the underpinnings of the argument, and see how many trucks I can drive through it. (By the way, I'm emailing Mr. Bove a link to this; if he's interested in rebutting any of the arguments or I have misunderstood his position, I will be happy to append to this entry.)

Mr. Bove's assumptions are bold, italicized, and underlined. The rest is mine.

The yield curve is positive sloping and this will drive positive earnings reinforcement. True. Point to Mr. Bove.

Housing will bottom this summer and begin to recover in the fall. Oh boy. I'll take the other side of that bet. The argument is that in "previous housing recessions" this has worked out because housing tends to collapse fast, then plateau and eventually recover slowly. However, there is a problem this time, and its best represented here:



Now let's define the other housing tops. Specifically, according to Mr. Bove (who has done his homework in this regard) they are generally agreed to be 1904, 1926, 1950, 1972 and 2006, roughly. (He apparently doesn't count the mess in the late 80s out in California; I suppose there's an argument that this was regional and therefore shouldn't count, but you can clearly see it in Mr. Schiller's chart above)

Notice anything? All of those tops were in fact peaks (except for 1972), but they were very small peaks in terms of adjusted home prices.

But incomes will (do) make up for it. No they won't. In fact, since 2001 if you exclude the top 5% of income earners average household income has actually declined slightly on an inflation-adjusted basis.

We went from an indexed 125 (the maximum peak of previous housing bubbles) to 200 this time, and are just starting to roll over. The trough is in the 100-110 area on a historical basis; to assume that we will have a year of decline followed by stabilization when only 20-25% of the corrective move necessary has taken place thus far is hopelessly wrong. This is the largest housing bubble in the history of the nation and simply on that basis to assume that it will unwind in 2 years is pure folly.

Also note that we STILL haven't gotten entirely back to sound lending principles, which are 20% down payments, 36% DTI and a 30 year fixed mortgage. Until we do and prices adjust at that level we are not at a housing bottom.

The Fed has our back, basically. Really? The Fed has consumed about half of its balance sheet with the TAF, TLSF, PDCF and whatever other alphabet soup they have dreamed up thus far, oh, and about $100 billion in direct slosh (at present, less the TAF.) They do not have an infinite balance sheet with which to play. I'll deal with the "they'll print" argument below.

Bear Stearns was a sea change. Actually, no. I argue that Bear Stearns was both a raw violation of The Federal Reserve Act (for which The Fed may find itself in a bit of trouble when Congress gets done) and an indication of pure desperation. It may also have some element of a Jamie Dimon "jam job" in it but that's speculation on my part. Sea change? Only if you consider the tide going out before a tsunami strikes as a "sea change." Intelligent people run when that happens, not stop to pick up the seashells and fish!

Corporate balance sheets are strong. Point granted. Do you think perhaps CFOs and CEOs have some sort of idea of what is coming and as a consequence they have been raising cash?

Household balance sheets are strong. The hell they are. They are no more accurate than are the phantom "marks" on subprime CDOs that are allegedly "wrapped" by the monolines. Take out the phantom home price appreciation and suddenly household balance sheets don't look so good. Now subtract out of the stock market losses of the last three months. Guess what? The debt is still there, but the assets have shrunk. For most people their largest asset is their house, and it has "doubled" in value in the last five years. Fair and well, but if that "doubling" is in fact all phantom appreciation, what happens to the balance sheet when it comes back off? Remember, a house bought with 20% down is "geared" at 5:1 and one bought with 5% down is geared at 20:1. Hmmmmm.....

Bank balance sheets are strong and so will be earnings. Really? Prove it. Give me a value on all the Level 3 assets. And let's talk about accounting games; Lehman essentially took down liabilities and due to how accounting works that inures to "earnings", but in fact its a problem because it shrinks the balance sheet and further is unlikely to be repeated. Without that little accounting gimmick they would have reported a loss last quarter. While we're at it, shall we discuss the off-balance sheet liabilities? Didn't Bear Stearns come out three days before they blew up and tell us all they had a tangible book value of $80/share? Where did it all go in three days? Finally, if balance sheets are so strong then please explain to me why S&P just cut the ratings outlook on that very same Lehman (and Goldman!) to negative, citing a belief that profits may fall as much as 30%? (Psst - what if Lehman can't find another $600 million to play with next quarter in accounting moves? Hmmm... do they lose $400 million? I think S&P is overly optimistic.)

So long as bank cash flows are sufficient to cover expenses, all is ok. Really? How'd that work for Bear Stearns? Or Northern Rock, if you want to put not-to-fine a point on it? In reality all banks exist only because of confidence in their operations; this is a reality in a system where banks are allowed to fractionally reserve. If confidence fails then so does the bank, as Bear Stearns so vividly demonstrated, and that failure can come within hours. In today's world of ACH and wire transfers you can literally have your funds out of a bank in 15 minutes.

Commercial credit demand is growing and is generally very strong. Granted, although the rate of increase has slowed significantly in recent weeks. Now answer this - how much of that borrowing is FORCED as other means of raising money have slammed shut in borrower's faces? CIT drew down $7 billion Thursday; that shows up in C&I loans made but it was hardly a "voluntary" borrowing! This is going on everywhere as asset-backed commercial paper, auction-rate markets and others have seized tight. Forced borrowing being used as an indication of "strong" credit demand is similar to the mistake people made in counting "M3" growth in the last year or so - that too is forcible as "shadow banking system" money is forced out of that conduit and into the regulated system where it can be counted. This isn't an indication of "robust" demand, it is an indication of panic!

Foreign money is coming into the market (at least in Florida) and this is helping. Yeah, like it helped the fine folks from the land of sand who bought into Citibank eh? History is replete with people throwing their money down the toilet trying to call bottoms, and just because someone has a lot of money doesn't make him or her right in their call (Joe Lewis anyone?) Florida, south Florida in particular, is still outrageously overbuilt. The state bird down there is still the construction crane - I was on a cruise out of Miami this winter and was astonished to see empty condo buildings - literally empty, but complete. How do you know? All the units are dark at night!

That's the gist of the argument as it was presented to me. Now let me add a few more implicit assumptions which Dick may not have made, but I suspect he did, because you pretty much have to in order to arrive at where he landed. Again, these are MY assumptions, so I will un-italicize them to differentiate them from what he actually said in one form or another.

The economic impact of the housing adjustment will be reasonable. No it won't. Assuming Fannie and Freddie's estimates for home price declines plus Case-Schiller's existing index, we've seen 7% declines in home prices in the last year and Freddie/Fannie are assuming another 5-7% to the "bottom" (which they also claim they think will happen this year.) Assuming this figure is correct, it will wipe out 10-15% of the $36 trillion (roughly) value in our housing stock, for an economic impact of $3-5.4 trillion dollars. That wealth is permanently gone, never to return. If you use my "base case" figures of double that (30% peak-to-trough declines on average) then the economic impact is somewhat north of $10 trillion. The US GDP is $14 trillion annually, more or less. This WILL produce a permanent change in the standard of living in over 100 million US households, and our economy is 70% consumer spending. Now obviously, all this adjustment will not be taken to spending at once, but to think that it will not cause decided negative prints in the US GDP for some time is difficult to stomach. This contraction in household wealth, as it flows through to spending, then leads to decreases in economic activity (e.g. you don't buy as much stuff) which in turn leads to decreases in C&I loans - lending activity dries up from the demand end as well. We haven't even begun to see the impact of that on the banks.

Push comes to shove, The Fed can print. Sure, they can try. What happens if they do? Well, first, Treasury would have to print up some bonds to do that, which means Congress would have to raise the debt ceiling. By how much? Well, let's see, to absorb the entirety of the above, $4-5 trillion worth. The total public debt outstanding, by the way, is nine trillion. Anyone care to believe that The Fed (and Treasury) would get away with this without having real interest rates (set in the bond market) shooting up to 20%? Me neither. What happens if real interest rates go that high? Well, with the blended government borrowing costs running about 1/4 of that, interest rate expense for the Federal Government would quadruple, from $400 billion to $1.6 trillion a year, or more than half the Federal Budget. As the total budget is approximately $3 trillion dollars, its obvious that this would instantaneously destroy Medicare, Social Security, or some combination of the two. In short, entitlement spending would be severely impacted. Pitchforks and Torches would shortly appear from Granny's garage and descend on Washington DC. At the same time corporate borrowing costs would triple too, which would basically destroy those "nice and strong" corporate balance sheets. We get a depression this way via the wholesale destruction of The Federal Budget and private enterprise all at once. Congratulations.

Long-term interest rates can be held down around 4%, fixing the affordability problem. Nice try. Notice that that didn't happen even during the 2001-03 slowdown with a 1% FFT. We got close though - 5%ish. Unfortunately this time around we won't be so lucky. The last time we had a confluence of virtuous factors in play, including foreign governments needing to "sterilize" our trade imbalance; as a consequence they were heavy buyers of Treasury debt, holding down yields. Sadly this cycle has finished; the concept of "burying" our price inflation into emerging markets has come to an end. China is now faced with a horrifying inflation problem and a bunch of bad debt and is both raising interest rates and reserve requirements to try to deal with it. Currency pegs are being stretched all over, with Hong Kong being the latest to threaten an implicit breach (they refused to follow our latest Fed action.) That cycle is likely over for good, which means that the abnormally low interest rates of the last five years are over too. Historical average 30 year mortgage rates are near 8%, and should we return there that whacks another 25% or so off what is an "affordable" house price.

The only way we see long-term (30 year) money at 4% is with the 30 year Treasury Bond near 3% yield on a sustained (year+) basis. And the only way that happens is if we get an economic depression, thus crushing demand and inflation expectations (e.g. expectations are for deflation, not inflation.) Should that happen then yes, house prices under today's incomes are affordable, but the unfortunate reality is that in a depression 20% unemployment becomes a reasonable expectation too and so do huge haircuts to incomes for those who keep their jobs. 30 year money at 4% on a sustained basis is simply unrealistic under any other scenario, ergo, the call for this outcome is idiotic.

Timing wise, its a good time to buy because the bear market is (nearly) over. Like hell. Show me a bear market in the past 100 years that has lasted only four months and a recessionary market (with a REAL recession) that has fallen only 15% peak-to-trough. You can't, because on average bear markets last nine months and peak-to-trough valuations suffer a haircut of 30%. The last Bear Market was in 2001-2003, lasted about two years and resulted in a loss of fifty percent in the S&P 500 yet the economic conditions barely met the classical definition of a recession! That all happened without a credit and derivative bubble to do systemic damage! The only "short and fast" market drops like that were not associated with recessions - 1987 and the summer of 2006 being the poster children of examples, with the latter being a circumstance that I made an insane amount of money from buying hammered stocks very cheaply only to dump 'em in the early part of '07 when the overextension of this Bull became apparent.

Bottoms are accurately called by many market participants. Historically, it doesn't work like that. Bottoms happen when nobody wants to own stocks. In the 2000-2003 bear market CNBC called bottoms all the way down until the summer of 2003 - when they basically gave up. That was the bottom! At present we have Dick Bove calling a bottom, half the people on the floor of the NYSE and CBOT interviewed on CNBC daily calling a bottom, and Cramer alternating between calling a bottom and looking like he is about to blow his brains out on national television. In addition as I have shown a true bottom happens on a cross of the 20 Week over the 50 Week moving average by more than 1% - this is a timing signal that has worked since the 1930s. As of last week the gap between the 20 and 50 week moving averages continues to WIDEN, not narrow. This same signal on the XLF shows an unmitigated disaster. By the way, on the XLF that indicator went positive on the week of 6/9/2003, which was damn close to the actual bottom, no? It also called the top on the XLF around the week of 9/17/07. Not bad, not bad. Oh, the gap, as of Thursday, was 14%, which increased from the week prior.

The market is cheap. The hell it is. On a current market basis the S&P and Russell P/E have actually increased in the last year. The Russell is currently trading at a P/E of FORTY! That's ridiculous. While small-cap stocks frequently trade at a premium in terms of P/E, "premium" means somewhere around 20ish. That puts the Russell around 350 and currently it is right near 675! In addition current S&P earnings estimates are actually above last year's actual earnings. There is not a snowball's chance in hell that those earnings numbers will be met on a full year basis; analysts are always late to this party and as estimates come down P/Es rise which puts more pressure on equity prices. Reality should start to intrude on earnings in the first quarter, and really get some legs into the second and third.

The credit markets are "unsticking". Like hell. An IRX print of 3.0 (0.3% annual yield) is "unstuck"? More like absolute panic buying of treasuries. Now why would someone do that? They'd only do that if they were looking for somewhere that they were absolutely certain they'd get their money back! Realize that with an 0.3 or 0.5% yield annually investors who are parking their money there are willing to take a roughly 3.5% annual LOSS just to insure they get their money. If you have someone intentionally taking a loss they are either insane or well-aware of what is coming and this is the best of the choices available - which is a pretty clear statement that all the other choices are, in their opinion, WORSE!

There won't be a "mark" explosion. A bet I wouldn't take. MBIA/Ambac were important to the municipal market but far more important is the wrap they provide on a number of other institutions' holdings. The key item here is that bank reserve requirements against those holdings are based on their credit - an implosion by any of these firms could triple the reserve requirements against wrapped-and-held CDOs, CMOs and similar overnight. The result of such an event is likely to be extremely severe. There is no way these firms can possibly pay any but a minuscule amount in claims .vs. their book and there are rumors all over the street that defaults are being hidden by banks here and now rather than calling them out on it because doing so could precipitate a cross-default firestorm. Unfortunately, Merrill may have lit the fuse on this last week when they went after a division of XL Capital alleging exactly that - they owe 'em on a swap they wrote and are refusing to pay. XL's latest quarterly has an ominous statement in it related to capital adequacy should they be forced to pay off on too may of their obligations. Hmmmm....

We will get through this without forcing all the balance sheet games to stop, all marks to be taken, and all off-balance-sheet nonsense brought back into the open. If you say so. I don't believe it, because, as I've repeatedly noted, confidence is all that a financial institution has to sell when you get to the end of the day. Confidence is, at this point, basically gone.

That's it, in a nutshell.

We'll see who's right in a year or so.

Here's one other thing to consider - nearly all of these "market callers" have none of their own skin in the game. One of Bove's points to me is that he "pays" if he's wrong (because he might lose his job.) Well that's nice. Guess what? My money is where my mouth is, and if I'm wrong, I get to hand out shopping carts at WalMart since I live off my portfolio income.

And for the record, here's some real ink on the .COM blowup (heh they published late, but not never); I went to 100% tax-free Munis in late '99 and missed it all. Awwwww. My "buy point" for the broad indices was hit in 2003, at which point I purchased big positions in both SPY and the Qs (both of which were sold in 2007, natch.)

There is a big difference between someone who claims to call markets as an "analyst" and someone who makes his calls with his wallet.

The former risks his job but can always get another one among the Pigmen (and before you dispute this, tell me how Abby Cohen is still employed after her disastrous calls in the Tech Wreck?) The latter risks his house, his car, his boat and his retirement.

Who has a greater incentive to actually analyze and tell you what they really think.

Yes, I talk my book. Would you expect anything else?

Heh, if I'm wrong, I'm wrong. Toss the slings and arrows my direction; the real pain will come in my brokerage statements. But if I'm wrong then the entirety of history in the US Stock Market is also wrong, and just once, "this time its different" will prove out.

I don't like those odds.

posted by Genesis | 8:34 PM

http://market-ticker.denninger.net/2008/03/why-dick-bove-and-market-callers-like.html

[le2]

det sjove er, at man slet ikke forstår at sundheden eller usundheden i den financielle verden slet ingen betydning har for konjunkturudviklingen

og at aktierne uden for finanssektoren vil stige ligeså hurtigt igen som da de falt

uanset hvordan det går i finanssektoren

finanssektoren har slet ikke den betydning man tror den har

den burde faktisk afskaffes

det der har en betydning vedrørende finanssektoren, er de formuer andre sektorer og privatpersoner har

og de behøver jo ike at klokke i det fordi et par dusin eller mere i finanssektoren har gearet deres investeringer nogle flere gang 10%

det er der ikke mange andre selskaber og privatpersoner uden for finanssektoren, der har, så de lever stadig i bedste velgående

men desværre har finanssektoren monopol på at vurdere hvordan det går alle steder

så når de selv mærker en krise i deres egne sektorer tror de straks at det også vil gælde for alle andre

men det gør det slet ikke

så derfor får vi snart en opgang i aktierne, der allerede er begyndt siden bunden i midten af januar