Traderbill's Financial Markets Weblog

…that is the question that is…or should be…running around every investors mind. After all, if the selloff that began in the US Friday and was augmented in the global markets on Monday while the US played, and then continued and worsened by Tuesday was caused by a mere credit downgrade of AMBAC, a monoline (municipal and derivative insurer along with MBIA, FGIC and several smaller players), couldn’t the 360 point drop in the Dow yesterday before rallying back to a 302 point gain and closing just 3 points below it (Tuesday it fell 565 but still closed -124) have been some sort of a capitulation trade?…especially since financial stocks rallied so much (see summary below?) and the apparent catalyst was some form of rescue package for the…monoline insurers? Well, yes…but no.

First, one has to consider the structure of a monoline insurer. There are two components: the good, municipal bond insurance with huge reserves since they have had few if any claims…and only have to make the debt service payments until the issuer is back on its feet in a default (bankruptcy  …remember Orange County…or NYC? both came back from the dead), so there is little risk there, just an annuity of revenues from qualified issuers seeking to broaden the number of buyers…in an era of loose credit furthermore, most buyers of muni’s do not research them so it provides comfort  …for 0.25% per annum of the outstanding bonds…a license to steal; second is insurance of derivatives…you know, the ones we created on Wall Street and exported to the rest of the world creating this mess…these were used to “insure” the contracts so highly leveraged investors (read hedge funds) could be accepted as a counter-party. All well and good (?) until the credit crisis reached this stage after it was found that our revered rating agencies failed in their mission…with the help of the originators of course. Then as was pointed out to TB these insured contracts had clauses such as the right of rescission if one of the counterparties lost 50% of their net asset value (perhaps this is the source of Jim Cramer’s ’plan’ that the government should create a pool and a floor of 50% of the value of each and every CDO contract…please, Jimbo!). Importantly, it is the right, not the obligation to rescind the contracts so much as a bankruptcy judge would lift the profitable leg and make the losing one a general creditor, so it is with these contracts. Why would you rescind a winning contract (except to force payment) while the losing one is a no-brainer, and poof!…there goes that ‘perfect’ hedge.

So perhaps now you see why some sort of rescue plan was welcomed with open arms by the market. More correctly, short covering of financial stocks occurred while the winners of yesteryear, Amazon, Apple, Google, and RIMM took big hits along with other lesser winners while also continued to slide. Past performance is no guarantee of future performance  …especially if you kind of cooked the books at the end to keep the game going by shipping out product that wasn’t ‘quite’ needed (AAPL, RIMM), or provided costly free shipping past the cutoff for land delivery just to boost sales (AMZN)…amazing?

It is this dichotomy that concerns TB that the rally was not Memorex. That said, it might be a good time to rethink the financial sector (although TB has no inclination to buy brokers  …the only one he likes, Schwab, is too pricey), and look at the companies that are good but guilty by omission such as US Bancorp, or Provident Bankshares (which KBW discussed very positively yesterday), and TB actually succumbed to buying both (that’s simply disclosure not a recommendation), minutes before the close sadly well above the intraday spike down to new lows! He also bought AT&T which is trading way below the levels it was at when the iPhone deal was announced. What do all of these have in common (and they are just representative not the only ones out there)? DIVIDENDS and Solid Dividend Yields! To TB’s way of thinking that will get you thru…so long as the stocks have been pummeled and the p/e ratios and PEG are in line and the dividend has been increased, not merely maintained. AT&T (T) fell short of TB’s goal of a minimum 5% (4.68%) but historically reinvesting that dividend has been a highly profitable trade…due to the 15% dividend tax the best bet is to buy them in taxable accounts so that the whole thing isn’t taxed as ordinary income when you withdraw from your IRA/401(k), but it still works. 

TB still likes bonds and was tempted to add to his long zero coupon treasury positions (only in tax deferred accounts!) as the compounding at the yield at time of purchase does wonders in a period of declining yields. But what goes up, must come down if rates rise but that could be years away, no?  

   

So the quandary is…do you buy now and hope the worst is over…or do you wait? The one thing you cannot do at this point is sell…it is far too late for that…unless you want to lock in some gains to offset losses (i.e. Google, RIMM and Apple)  …and that appears to be just what the smart money is doing. It is very rare for a leader one year to be a leader the next and at the prices and multiples these stocks trade at even after giving back more than a quarter of their entire rally gains, it is even more difficult. Ask Bill Miller, the Legg Mason fund manager that set a record for beating the S&P 500 consistently…but in 2006 he held on to his big winners mainly Amazon which destroyed his winning streak…only to come back last year. Of course that brings up another caveat: invest for the long run…but if you are a baby boomer keep in mind that could be another 10 years…already we are in trouble over the last 7…8?

TB felt it was important to comment on this after being bearish for so long…to avoid the label “even a broken clock is right twice a day.” But that does not mean he is a raging bull…or even cautiously optimistic…but he does feel that for a ’select’ group of stocks it could be a good time to buy  …especially with so many stocks down 20% or more from their highs (of the ones TB purchased: T -13%; USB -14%; Provident-PBKS -44% and 48% for 12 months…again these are NOT recommendations!).

The areas where TB disagrees strongly with the pro’s are retail (consumer discretionary, technology, and most financials – those that have been beaten up and deservedly so…money center banks, brokers, housing). This commentary was not designed to convince you of anything…merely think for yourself.