Lewis Threw Shareholders Under The Bus

The news hasn't reported it yet but Ken Lewis, BofA Chairman and CEO, was surely one of the first to contract the Spine Flu. His decision to acquiesce to Paulson and Bernacke, to the detriment of his shareholders, and follow through with the Merrill Lynch acquisition, at the original price, is deplorable. In the military you are not required to obey an unlawful order. Bowing to the pressure from Washington is tantamount to obeying an unlawful order. He should have said no thanks, my obligations are to my shareholders and I need to either walk away from this bad deal or renegotiate the price. He did neither. He caved. He contracted Spine Flu.

Lewis shamefully flushed his shareholders money, under pressure from D.C. He also recently stated that BofA wanted to begin to pay back the TARP money. Now news reports are saying that the stress tests show BofA and Citi are short of capital and will need to dilute shareholders further. Some of that potential dilution may not have been necessary had Merrill not been acquired.  Does Ken Lewis know how to run his bank? 

Why is he still at the head of America's largest bank? It's not because he's taking care of his current shareholders. Could it be because he took care of his soon to be largest shareholder?

THE SPINE FLU PANDEMIC

Our 24 hour, omnipresent news coverage is working overtime on the swine flu outbreak. Before long we will all be paranoid, wearing masks, and hunkering down. This 24 hour news phenomenon has already infected many of our government and business leaders. We are experiencing a pandemic of Spine Flu. The lack of spine and conviction. 

Rather than addressing the economy's problem, too much inappropriate debt, and accepting the penalty, years of pain and unwinding, our governmental leaders are throwing massive amounts of money at the problem with little regard for the consequences. Our corporate leaders have cut people and capex to the detriment of customer service, after years of bloated staffing. 

I prefer investing in companies that are run by management that hasn't been affected by Spine Flu. Companies that haven't felt the need to close lots of facilities and layoff thousands of employees because they didn't hire and expand recklessly. Several such firms are Flowers Foods[FLO], Aaron Rents[AAN], K-12[LRN], and Waste Management[WMI]. All are expanding operations, not contracting, during this downturn. Management showed spine by not over hiring/building during good times which has allowed them to respond to opportunities that have presented themselves during the downturn. While these companies haven't appreciated like the cheap stocks have, they have room to appreciate and they shouldn't crash like many cheap runners are apt to. Growth in safe industries [bread,furniture rental, education, garbage/energy] should be a good place to ride out the Spine Flu. 

Credit Isn't The Only Thing Hurting Banks

I possess 20 years of commercial banking experience, 10 of those as CEO. Even though the industry has changed dramatically in the nearly 20 years I have been out of banking, I feel that I should be able to spot trends, analyze financial statements, and differentiate a good bank from a poor performer. This past year has shown that I can't.

Short positions on numerous financials made me a decent amount of money, but it could have been a fortune had I not always removed my position after a nice gain since they continued to trend downward. All the money I made on shorts, and then some, was lost on a bank turnaround that I was convinced I had figured out, National City. It's a long story, but suffice to say that I had twenty pounds of analysis that turned out to be faulty. 

Being a slow learner, I still follow the banks and look at opportunities. The sharp run up that the banks have experienced isn't sustainable. The yield curve is very lucrative at present and mortgage refinancing fees are plentiful. But in a de-leveraging economy good lending opportunities will be much scarcer than at peak earnings. Lower future earnings leads to lower P/Es and stock prices. Not to be forgotten are the huge loan losses that loom and the eventual dilution that will follow capital raising.

On top of the credit problems that bankers are dealing with, their buddies at the FDIC are adding to the banks misery. Since regulators have done such a poor job of controlling bank lending quality, on and off balance sheet, the FDIC Insurance Fund is in need of replenishment. Besides raising the deposit insurance fee, FDIC has levied a special assessment of 20 basis points. That is huge! At cocktails the other evening the president of a local 200MM bank told me his assessment was going to be $400,000! That is an immediate hit to earnings, or if the bank doesn't have earnings, book value.

Our banks will be earnings constrained for some time.

After all the stress test publicity abates and banks possibly enjoy an upward run, the trend is likely to be down. Since I have proven to myself that i know nothing about the industry anymore, I intend to short selected regional banks and stay with those positions. But for heavens sake, don't follow any of my advise when it comes to banks.

What A Difference A Day Makes

My advice earlier in the morning was not to chase low priced stocks. Since I was being preachy I couldn't violate my own dogma. But others did and boy was it fun. The crappy little company, nameless, that doesn't have a real business shot to the moon. It started the day at .02 and ended at .052!!! The move from .004 several days ago is nothing short of astounding. Logic and analysis cannot be a part of the move because it is illogical. It was all momentum and greed in tiny dollar amounts. But it is symptomatic of the market. Be nimble and lighten up positions.

Now if there was ever a position that should be lightened up on, it is the speculation I just wrote about. However, significant selling is apt to bring the price crashing down. I'll dribble my shares out over the next couple of days.

Tomorrow is the last day of trading on April options so I'll get ready to write covered calls again on Monday on my remaining portfolio.

My Speculation Says It All

Faithful readers of Crusty's blog know that I remain very cautious and expect stocks to revisit previous lows during our protracted recession. When the market finally goes up and stays up it will require years of ownership to regain prior peak pricing since the leverage that fueled those prior earnings will not be present. We're probably starring at a decade of negative-to-slow growth. Lower profits will not justify high multiple so stock prices will not be returning to old levels for years.

That's the main reason I haven't been writing about any new long ideas. Patience will let me buy at lower prices later. Since the market's present bias is upward, I haven't written about any short ideas because you can go broke shorting stocks when the market wants to go up. So, I've shifted into neutral for the most part.

The present run up is speculation driven and that can be seen in the performance of all the $1ish  type stocks. The Citis, AIGs,GMs, etc have all have spectacular runs. Crummy stocks have done wonderful. Here's an example of Crusty's premise that speculators are swinging for the home run. As a public service I am not going to name the company in my example, it is beyond risky. Not more than 3 weeks ago it sold for .004. That's right, less than one half of one cent. Today it is .02! A 5X move. This company makes C look good. People are betting wildly and this rally will finish off a lot of investors. We will finally get capitulation. Wait for it.

Stay defensive, be patient, and let speculators party for awhile. There will come a time when negative bets make sense, then, following capitulation, a time to buy. Unless you know a company that is going to be purchased, bide your time. If you don't agree, for heavens sake, don't chase the lower priced speculations.

DON'T DRINK THE KOOL-AID

After 18 months of misery the concoction put before us tastes pretty good. Just one sip and you're ready to believe that all is well and good times are here again. But they aren't. Don't drink the CNBC kool-aid. Even a packet of Fed largesse and Government stimulus isn't sweet enough to drown our past sins quickly. All segments of consumer, business, and government drank a debt version of kool-aid and look where it has taken us. Our society is going to de-leverage and it is going to have a bitter taste, not a sweet one like the first 6 1/2 years of the century. 

Conserving capital is more important than missing a rally. Unless what I think is kool-aid is really a magic potion, we have more bad time ahead in both the economy and stock market. Any market recovery will not be across the board so index funds will not be attractive. Debt laden companies will be especially vulnerable as banks turn conservative and credit markets stay with a new found respect for caution. Restructurings will become commonplace. Earnings growth will be anemic and it will take years to return to the peak profit years.

If tempted to drink, take only a small sip and be ready to spit it out.

HOCUS POCUS PROFITS

Anyone else tired of company executives and their hired accountants using "non-recurring expense" and "one time charge" to make the income statement look prettier? Earnings are earnings and that is what we should look at. The income tax statement would be even better if we had it available. Any other metric is noise and should be a red flag to investors.

The biggest red flag being raised at the moment is by the banking industry and its use of "operating income". Tell me the value of earnings pre provision for loan losses and asset impairment. They could be wonderful and the bank could still lose a huge amount. Unfortunately the market has seized upon statements of positive operating earnings at BofA, J.P. Morgan, and Wells Fargo and driven those stocks upward and took along the remainder of the financial industry.

There is no doubt that the Fed has engineered an environment, the upward sloping yield curve, where banks will be able to generate significant amounts to fund loan charge-offs. But those amounts may not be sufficient in face of deteriorating home equity and credit card loans plus the soon to be problem areas of commercial real estate and commercial lending. I can't think of a time when lenders had all portfolios struggling at the same time. Financial stock prices may have gotten ahead of where they should be. Accounting alchemy should not be the basis for investor enthusiasm.

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THE JINGA MARKET

Recently I've been ruminating on the "old days" of investing, the days of fractions, not decimals. On good days stocks went up 1/32, 1/8, or, maybe, 1/4. A good market day and you got a 25 cent upside! If a stock went up over 1% it meant it was being acquired. The advent of decimals signaled smaller moves per the experts. Stocks would be priced in pennies and market makers would no longer skim the difference between fractions. The change was intended to benefit small investors. God, I long for a return of those peaceful, fractional, days.

A market that routinely moves 2-3% upward or downward is now commonplace. What fundamental change could possibly validate those swings? I'm afraid it isn't fundamental investment analysis. We are in an era of trading on steroids. A super charged Jinga game that could fall at any time. The scary part is that we won't be able to forecast the crash since the market isn't functioning rationally. Investing morphed into trading and trading morphed into speculating. Trying to stay with an investor mentality takes huge testicles and a very long timeline.

The huge swings we experience daily are cause for continued concern. I fear that we will return to a lower level of valuation before any serious correction upward. We still haven't seen that investor capitulation that can signal a market bottom and a renewed interest in equities. Be careful as the Jinga blocks are still being removed from the stack.