The Tasgall Group

This is a little old (June 2, 2008), but worth sharing…  John Hussman reviewed the FDIC Quarterly Banking profile…  here’s what he found.

“Industry earnings for the fourth quarter of 2007 were previously reported as $5.8 billion, but sizable restatements by a few institutions caused fourth quarter net income to decline to $646 million.”

Note what the FDIC is saying here. The banking industry reported $5.8 billion in earnings to its investors, but restatements took that total down by 89%. Stop and think about that - only 11% of the earnings that were reported to investors survived after the restatements. And yet, investors seem naively willing to take recent earnings reports, guidance and charge-off levels at face value, as if these reports can be trusted. Unfortunately, all that seems to matter to investors over the short-run is whether earnings-per-share can beat estimates by a penny, regardless of whether they are massively restated later.

Quite an indictment…  and the whole article is worth reading if you want to understand the state of banks today, and why they’re still not as cheap as one might think.

Marketwatch is leading with a headline this eveing saying “WaMu bucks bank trend“.  And indeed, the stock is up over 8% in after-hours trading…  but that’s hardly the whole story, despite a sensational headline…  Which one of the following details do you think is the most important for WaMu today?  The one where it “leaped” by 9% after hours, or the one where it went down over 34% earlier in the day?

From John Hussman, when talking about recent prices in the Crude Oil market:

Geek’s Rule o’ Thumb: When you have to fit a sixth-order polynomial to capture price history because exponential growth is too conservative, you’re probably close to a peak.

You’re usually in unusual territory when exponential growth is too conservative.

If you’re wondering where the next rally will begin (whether you beleive it will be a bear market rally or the next bull market), it is a good idea to watch the VIX index.  As you can see from the chart below, medium-term lows for the SPX (S&P 500 Index) coincide with upward spikes in the VIX.  At current levels, we don’t have a spike, though this isn’t a precise indicator of timing.

You can track the VIX at the usual places.

With oil on everyone’s mind these days (and since Jason breached the topic), I’ve had one question nagging at me. Everyone seems to think that oil and gas have nowhere to go but up. If that assumption holds, then why wouldn’t everyone just buy all the oil futures they can, hold them and become rich? Or to put it another way, why doesn’t the supposedly efficient market just spike price all the way to $200-300/barrel if that is really where we are all but destined to go. Why the steady daily grind up? It’s the basic contrarian question: if everybody thinks it’s going up, doesn’t that put it into question that it’s going to happen?

Like all speculative bulls, they have to go through the motions. Rarely does a market have an instantaneous bubble rise. It takes time. But I can’t help but wonder if the minute everyone thinks it can’t ever come down that it will. If oil were destined to go up until it is replaced, then there really isn’t any point in even wasting one second investing anywhere else, is there?

Here’s an interesting excerpt that I saw over at the blog Infectious Greed…

The remedy to high food prices is to increase food supply, something that is entirely feasible. The most realistic way to raise global supply is to replicate the Brazilian model of large, technologically sophisticated agro-companies supplying for the world market. To give one remarkable example, the time between harvesting one crop and planting the next, in effect the downtime for land, has been reduced an astounding thirty minutes. There are still many areas of the world that have good land which could be used far more productively if it was properly managed by large companies. For example, almost 90% of Mozambique’s land, an enormous area, is idle.

Unfortunately, large-scale commercial agriculture is unromantic. We laud the production style of the peasant: environmentally sustainable and human in scale. In respect of manufacturing and services we grew out of this fantasy years ago, but in agriculture it continues to contaminate our policies. In Europe and Japan huge public resources have been devoted to propping up small farms. The best that can be said for these policies is that we can afford them. In Africa, which cannot afford them, development agencies have oriented their entire efforts on agricultural development to peasant style production. As a result, Africa has less large-scale commercial agriculture than it had fifty years ago. Unfortunately, peasant farming is generally not well-suited to innovation and investment: the result has been that African agriculture has fallen further and further behind the advancing productivity frontier of the globalized commercial model.

As I read about this and annecdotes about ranchers reducing their cattle herds and chicken producers cutting back (due to the high cost of feed), I believe we’re going to have a food crisis sooner or later.

Here in the US, we will probably still be fed (if not over-fed), but it will cost more as a percentage of our total spending…  if some Americans are having trouble paying for gas to get back and forth to work (see Mish’s Pawnshow Society for more shocking annecdotes), what happens if your food costs shoot up alongside?  Maybe people will shift to simpler (vegetarian) diets, or be forced to cook at home more.

Regardless, with every danger is opportunity.  If beef becomes scarce, we can consider investing in Cattle Futures, or the relatively new ETN COW that tracks cattle futures (oh the ticker symbols!).  Likewise, DBA (agriculture ETF) has been good for trades in the past (DBA is only corn, wheat, sugar, and soybean, so it did not participate in the recent price run-up in rice).  General commodities funds/ETFs are normally overweight oil and energy, so it’s nice to have these focused funds/notes available if you’re interested in trading these trends.

A word on risk — the ETNs (exchange traded notes) have counter-party risk, which is something that doesn’t apply to ETFs or stocks…  if a major brokerage house or hedge fund is on the other end of those notes when it blows up, your holdings of an ETN like COW might be adversely affected.  It’s low probability, but a real one that you should be aware of.

Very impressive info nugget at the NY Times (via The Big Picture) on how much fertilizer is being used around the world…  (or more specifically, the growth of said fertilizer use…)

The amount of fertilizer is amazing, especially considering the recent run-ups in supply/demand issues with various foods.  The dead zones are also something to consider in long-term thinking…

As mentioned, Mosaic (MOS) and Potash (POT) would be big beneficiaries of the fertilizer growth, as would companies like Agrium (AGU) and the like.

From Bloomberg:

On a conference call today, analysts demanded that Immelt explain why he told retail investors on a March 13 Webcast that Fairfield, Connecticut-based GE would likely meet its annual forecast of at least $2.42 a share.

“Two days after the Webcast, the Bear Stearns situation took place,” Immelt said. “The last two weeks in March were a different world in financial services.”

There is plenty of criticism going around, and rightfully so.  But unless GE was directly invested in Bear Stearns shares, this shouldn’t have had such a big impact on it’s quarterly earnings.  But if we look past the headlines, we might be able to see why this really happened.

For several years now, GE has always met or beat earnings estimates by a penny every quarter.  This is basically impossible to do for a company that size without doing some fancy footwork.  That footwork usually involved GE Financial, and specifically buying or selling large assets in order to smooth their earnings in any given quarter.

From the article, “GE put its U.S. credit card business and Japanese consumer finance units up for sale last year.”  These are two of the assets that they were planning on selling to help them smooth out this quarter’s earnings and meet the earnings that they had originally stated.

So, while many people are pointing to GE and saying they’re a financial company disguised as a manufacturing company.  While that is partially true, it is not surprising to me that when the Bear Stearns collapse rattled wall street, no one wanted to buy GE’s assets to help them out — everyone who was able to buy assets of this size was busy covering their own balance sheets…

So, did GE deserve the brutal reaction on Friday?  (The stock closed down 12% for the day.)  Yes, but I think it also opened up an opportunity.

I don’t know whether GE will fall out of good graces with institutional investors because of this, but I believe their business is strong and their strategy (outside of the financial footwork) will be successful in the long run.  This might be a good opportunity to buy shares of GE at the bottom of a 3 year long price channel.

A quote I came across today…

 ”As of the end of the fourth quarter of 2007, 5.82% of all mortgages were delinquent, with fixed and adjustable subprime mortgages running at a 14% and 20% delinquency rate, respectively.”

On an unrelated topic, my previous question of whether or not you should consider credit a form of emergency savings…  you shouldn’t.  From Mish:

Nina writes…  “I’ve always believed that keeping a HELOC readily available is the best insurance policy and the back-up plan for if / when the emergency fund runs empty…”  and then “..we got the letter from Citibank about our $168,000 line of credit: “We have determined that home values in your area, including your home value, have significantly declined. As a result of this decline, your home’s value no longer supports the current credit limit for your home equity line of credit. Therefore, we are reducing the credit limit for your home equity line of credit, effective March 18, 2008, to $10,000.”

Credit can, and in extreme circumstances will be withdrawn.  There is no substitute for cash, and credit is not an emergency fund.

On another topic, BSC (as per the rumors in my last post) is bankrupt.  It has managed to be sold for $1 billion thanks to a NY Fed bailout and the desire to keep the counterparty system from collapsing on itself.

My perspective on the bailout is this…  if you see your neighbor playing with firecrackers in their living room, and you warn them of the dangers…  you feel like you’ve (maybe) done your ethical duty.  But when their house catches on fire, you can’t stand there saying “I told you so…”, you have to grab your garden hose and try to help put out the fire.

The Fed’s parade of obtuse acronyms and abbreviations is their own modern day version of the garden hose.  Will it work?  Time will tell…  but they have to at least try to put out the fire before the whole neighborhood goes up in flames.

Does Bear Stearns (and the rest of Wall Street) deserve to be bailed out?  No, absolutely not.  But their house is on fire, and it blatantly threatens our own houses (society at large), so emergency measures are required.  The time to avoid moral hazard was two or three years ago.

Now I’m pretty much as “free market” as they come…  but I have to say either we don’t have government bailouts, or we regulate those who would receive said bailouts.  If the Fed is going to back-stop Wall Street (which, for all intents and purposes, it has to), regulation is required.  You can’t have your cake and eat it too — or rather, you shouldn’t have your cake and eat it too.

No, not da bear market… da Bear Stearns (BSC). Yesterday was one heckuva swing in the mid-tier broker. With a daily low of $55.42, and a daily high of $68.24, that is a whopping 23% move from peak to trough (and back, mostly) in one day. Here is a 1-day chart:

Even more amazing, rumors abound regarding the broker. Today there is a rumor going around that the Fed acted to keep Bear Stearns (BSC) from going under. Yesterday it was that Bear was at risk of bankruptcy, accompanied with a high volume of put action.

If the Fed did consider Bear’s position with yesterday’s TSLC announcement, I only have one thing to say… Counterparty risk is a bitch during a deleveraging cycle.