Buffett and the Beautiful Banks

For months now, The Frost Report has been recommending the purchase of US bank stocks. For months now, US bank stocks have been dropping in price.

Earlier this week, Dick Bove of Rochdale Securities received a lot of heat after saying that people were “simply flipping out” about bank stocks, and that valuations were “ridiculous.” He pointed out, wisely, that although bank stock prices were falling, bonds prices were not.

Unlike stockholders, who tend to speculate, bondholders simply want the company to stay in business so they can collect interest and then get their money back. If a company is in danger of going bankrupt, bond prices drop. Yet, financial bond prices are holding steady, some even rising, showing that bondholders are not worried.

On Tuesday, billionaire Warren Buffett was at home taking a bath, thinking about how BofA was suffering confidence-wise and yet was solid financially. He called BofA and made them a win-win offer, and by Thursday morning (24 hours later) he owned 5 billion dollars worth of Bank of America, with warrants to purchase 700 million shares. When the news was released, BofA’s stock price rose 10% in a single day. Fortunately, I had loaded up on BofA stock just three days earlier, when it dropped after a string of rumor emails hit Wall Street claiming that the company was filing for bankruptcy.

US Banks are shouldered with large amounts of potential litigation (ie. they are being sued). They still own thousands of underwater mortgaged properties. Interest rate spreads are affecting bank profitability. Why would an investor with the stature of Warren Buffett be interested in buying bank stocks? Why would Berkshire Hathaway, Buffett’s company, be holding more than 40% of its total investments in the financial sector?

It’s simple. Great investors don’t care about rumors or fear, or whether the stock price is currently falling or rising – they just look at the facts. And, as a sound investment, the facts about banks are compelling. Bank of America is a perfect example:

Bank of America has a Mt. Everest balance sheet, with $140 billion in cash and more than twice that in securities. It actually has $13.86 in cash per share, yet the stock is trading at only $7.76. Put another way, for $7.76 you receive $13.86 in cash, $30 worth of securities, and a business that is gaining market share.

I have to admit, I have found the continuing drop in bank stocks to be both annoying (why are people still afraid?) and exciting (I can buy more!) at the same time.

Perhaps Buffett’s timely investment in Bank of America will finally make people see the light.


Update: On Monday Aug 29th, BofA announced it had successfully sold half of it's 10% stake in China Construction Bank, for a gross profit of 5.3 billion USD. A wise move if ever there was one.

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"A public-opinion poll is no substitute for thought."

Warren Buffett

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For more information, see:

Stock Market Flipping Out on US Banks

Buffett Bolsters Bank of America

BofA Sells Half of China Bank Stake, Raising $8 Billion

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The Fortune Teller

Everyone seems to be wondering what bombshell will hit world markets next. Will the economy continue to recover? Will it slip back into recession? What can we expect and why?

The uncertainty of today's market is perhaps unlike any before it. In response, on this page are The Frost Report's official predictions for the next two years.

Note that as my name is not, nor has ever been “Nostradamus,” so take this for what it is – a murky prediction based on current events and statistics. I encourage the reader to think about the reasoning behind these statements, rather than getting caught up on specifics.

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The world's economies will remain stable - though not rapidly growing - until the cataclysmic event: the collapse of the massive Chinese asset bubble.

Within the next two years, the Chinese bubble in real estate, shell-companies and factories will burst. Faced with huge declines in asset values, China's citizens will go into self-preservation mode and stop buying overpriced real estate and unproven stocks. As corrupt and wealthy Chinese flee with their remaining assets, the poor will be left to wallow. A revolution is a very real possibility.

Due to the collapse of the Chinese bubble, other economies currently dependent upon Chinese overspending will also burst. Canada and Australia will be most affected, as they will be hit with the double-whammy of home price declines of between 20%-40% (depending upon the area), and a fall in commodity prices due to reduced demand. Since both Canada and Australia have commodity-based currencies, these currencies will dive. Large-cap usable commodities producers will also be hard hit.

Similar asset-plunging disruptions will be felt throughout the world, from Israel to Lebanon to South Africa. The list of countries experiencing low-interest rate asset bubbles is long. As citizens around the world shut their wallets in response to their shrinking net worth, world markets will decline.

During this entire period, gold and silver prices will roller-coaster from one extreme to another, from both high demand and the actual need to cash in gold and silver for money. Due to fear in the stock market, gold and silver producers will be in the strange position of having record profits and marginal stock prices at the same time. It will be possible to buy these stocks and receive excellent dividends.

The big winners of all this strife will be the US and Japan. US markets will drop when China’s drops; but, because US markets are already valued so minimally, the US market will rebound quickly. US housing, already fairly priced in some regions and underpriced in others, will remain a coiled spring, waiting to jump.

Any substantial drop in values in US markets will be a long-term buying opportunity. If one is smart and buys actual stock (not options), and uses no margin (borrowed money), this period will be extremely lucrative, though time and patience will be required to reap the rewards. In fact, buyers of US stock and real estate who have the conviction to buy as prices drop - and hold without selling - will be the big winners of this century.

Japanese manufacturing will have a tough time at first, since Chinese companies fighting for business will go cutthroat with regard to pricing. As more and more Chinese companies fail, however, Japanese businesses will pick up the pieces. Both Japan and the US will benefit from the low cost of Chinese goods and materials available for purchase. Due to the influx of low-priced Chinese goods, inflation will be kept in check.

Canada, Australia, New Zealand, Germany, Norway, England and other Germanic-speaking countries (excluding the US) will recover but remain sickly for years to come, since a quarter of their populations will be bound by high levels of personal debt. All talk of China becoming the “next superpower” will disappear.

The events of the past three years have resulted in the strange worldwide coexistence of vastly overpriced assets (ex. Chinese real estate and BRIC stocks) and vastly under priced assets (ex. US regional financial stocks and real estate). "Regression to the mean" will haunt unwary investors.

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Time will tell if these predictions prove correct, or not. But, for great investors it really doesn't matter.

I have been buying undervalued stocks of great companies, and will continue to do so regardless of whether or not the world's economies are rocked; and that, my friends, is perhaps the greatest lesson of all.

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"Nearly everyone interested in common stocks wants to be told by someone else what he thinks the market is going to do. The demand being there, it must be supplied."

Benjamin Graham

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For the Love of Money

Every time I think that the bloated Chinese real estate market must surely be “done” and that a crash is imminent, new societal changes or schemes arise that keep it going a little longer. This month is no exception.

The first new catalyst is a controversial change to Chinese marriage laws, which will indirectly affect real estate.

Under the new marriage laws, the original registered owner of a property will get all the value and appreciation in that property, no matter what. This law was likely enacted to protect men from increasingly greedy Chinese women (known as shèngnǚ) who refuse to date any man who does not provide her with - at a minimum - a luxury car and a condo. However, the result is that if a man with a home marries a faithful woman, and his wife pays half the mortgage and maintains the home for the next 30 years, upon divorce she will get nothing. Needless to say, women in China are not pleased with the new law. In retaliation, it is expected that women will work longer and purchase their own property, or demand that their husband purchase one in their name.

The second catalyst is a scheme related to the Chinese government’s attempts to curb speculation.

In major Chinese cities such as Shanghai and Beijing, a “family unit” is restricted to owning only two properties: one as a residence and another for investment. Banks cannot give loans for properties beyond the allotted two per family unit. To skirt this new rule, happy couples are faking divorce. According to Bloomberg, fake divorce certificates go for about $45 US. After receiving the fake divorce papers, each person is then able to buy two properties.

In an effort to get rich quick - unrestricted by moral boundaries - the citizens of China continue to gorge themselves on real estate candy and other money-making treats, oblivious to the monumental sickness that will surely follow.

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Related Video: "No House No Car"



Lyrics:

Warm sunshine, shining on your face
Looking at the young guys all around, every one of them looks girly
Having a house and a car is what women long for
Marrying the right person is our biggest wish

I'll ask if you have a car, I'll ask if you have a house
My mother will also ask you how much savings you have
If you have no car, if you have no house
Move aside and don’t block my way

I also have a car, I also have a house
As well as money in the bank
If you guys aren’t even as capable as me
Don’t depend on me, I’m not your mother

You don’t have a car, you don’t have a house
Don’t expect to get a beauty into bed

You are actually poor, you only drive a lousy BMW
Don’t pretend you’re a rich guy who can keep me as his mistress

You don’t have a car, you don’t have a house
Yet you still want to get married and be a groom
If your life isn’t well off
Why should I stand by your side?

You say I am too cold, but I may as well admit
You can call me a gold-digger and I won’t feel hurt
A man after all should be like a man
Without a car, without a house, forget about finding a bride

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China's High Speed Railway

And the economic war with Japan



China’s high-speed railway serves as a reminder that China is still a single-party (communist) country, where central planning and pride can result in disaster.

A few weeks ago, one of China’s shiny new bullet trains crashed into another, killing 40 people. The story hardly made the news in North America, but for Chinese and Japanese the story was huge.

Immediately after the crash, the Chinese government took the lead rail car and literally buried it. Outraged citizens demanded that the car be exhumed and an investigation launched, though few expect that this investigation will be thorough. Later, it was found that rail employees had been warning their relatives not to use the trains, since their operators had insufficient training and the trains were being run too fast.

The question is, why did China not give their operators sufficient time to train? And, why did they run the trains so fast? The answer: Japan.

Due to an ongoing rivalry with their historical archenemy, China’s rail lines had to be opened on time and had to run faster than Japan’s - no matter what. Running the trains at higher speeds than their Japanese counterparts was seen as integral to defeating Japan’s copyright infringement claims, since China claims to have improved upon Japanese technology.

Just weeks before the crash, the Chinese government released Japan-bashing reports about how their train technology was superior to Japan’s, and how Japanese patent infringement claims were groundless. China’s ministry of railways was quoted as saying that “The Beijing-Shanghai high-speed railway and Japan's Shinkansen line cannot be mentioned in the same breath, as many of the technological indicators used by China's high-speed railways are far better than those used in Japan's Shinkansen.”

Despite being furious, the Japanese transport minister responded calmly, saying merely that “a heated verbal battle” was not advisable.

To the gross embarrassment of the Chinese government, the Beijing-Shanghai rail line has now been recalled for safety reasons.

At present, China has 13 high-speed railways in operation. At present, few people trust them enough to travel on them.

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"While responding to media questions concerning the safety of traveling on the high-speed line, he (chief engineer of the Ministry of Railways) said that he is fully confident in the safety of the travel link and that the passengers' safety is guaranteed."

Xinhua news, June 27, 2011

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For more information, see:

China's high-speed rail technologies better than Japanese Shinkansen

China denies Japanese rail patent infringement claims

Trains fly on Beijing-Shanghai high-speed railway

China recalls bullet trains in new blow to technology
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Culling the Sheep - again

This week marked the single biggest wave of selling by retail investors ever recorded.

On Monday Aug 8th 2011 alone, Swiss bank UBS recorded retail outflows of 1.3 billion dollars! No wonder the markets crashed.

In The Intelligent Investor’s Mind, I speak about "myopic loss aversion" – the tendency for people with long-term goals (such as retirement) to focus on short-term events, especially the gyrations of the stock market. Myopia literally means “shortsightedness.” Such shortsightedness typically beds with "recency bias" – the tendency to think that the current situation (good or bad) will last forever. This week’s market activity shows just how strongly these cognitive errors can destroy people’s financial well-being: usually their own.

If you doubt the intensity of this week’s retail investor freakout, check out these choice quotes:

"Investing in U.S. Markets is DEAD....DEAD… and it is NOT COMING BACK!!"

"Yeah, it's different all right, as in it is ALL coming down."

"Their plan is to get rid of paper currency and go to digital currency so they can make you a slave."

"666, whatever you'd like to call it is coming."

Yet the market rollercoastered, showing that as much as retail investors were frantically selling, professionals and value investors were swooping in to pick up the spoils. Bloomberg reported that insider buying by S&P 500 company executives reached levels not seen since March 2009.

This week also revealed some great moments in calm and cool leadership. First was Barack Obama’s matter-of-fact speech regarding the S&P debt downgrade, where he basically said (I’m paraphrasing), “I didn’t need a downgrade by S&P to tell me that our government had a dysfunctional moment. We need to fix the way our government works.” The second was from Federal Reserve chairman Ben Bernanke, who said that he would keep interest rates low (which makes it easy for businesses to expand & develop), but other than that, the markets just need to grow up and get on with it. The final moment was an interview with Bank of America’s Jamie Dimon, who demonstrated the sensibility of long-term thinking (see video below). Interestingly, all of these great moments were regarded negatively by the public, who just wanted their leaders to DO SOMETHING!

As usual, the counterintuitive nature of the stock market is at work: those who are fearful of losing their money are losing their money; those who are unafraid of losing their money are making more.

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"There is no comparison between fear and greed. Fear is instant, pervasive and intense. Greed is slower. Fear hits."

Warren Buffett, Aug. 11, 2011

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Musings about the Debt Crisis

The market activity of the last week has been nothing short of amazing. It wil, no doubt, provide fuel for several year's worth of analysis by investment psychologists. Consider these amazing facts...

1) The Debt Debate. For almost two weeks, the U.S. government debated spending measures to reduce the deficit. After they had reached an agreement, the markets crashed (see my earlier post, "The Market Gets Ugly," for a full explanation).

2) The Downgrade. Standard & Poors downgraded U.S. debt, meaning that S&P feels the probability of the government defaulting on its loan obligations is now higher. As a result of this downgrade and the subsequent market crash, investors... (wait for it, this is really good) bought hordes of U.S. treasuries! That is, they escaped the crisis of a U.S. debt downgrade by buying into the safety of U.S. debt.

3) Scapegoating and Fundamental Attribution Errors (forms of logical fallacy) in the media. Pundits are taking to the airwaves to say that the crash would never have happened, if only they been in power. This includes Sarah Palin and Donald Trump, whose opinions almost symbolize rhetoric over logic. Investors, demanding an explanation for what they cannot understand, are listening to anyone who seems to have one.

4) Ignoring Statistics. Just as they do on the upside, emotional investors are now completely ignoring fundamentals. There are many profitable companies in the U.S. that are once again trading at low single-digit P/E ratios! The average investor is looking at the equivalent of a $.10 slice of homemade apple pie and saying, "I'm sure not eating that s**t!"


I have to admit, I'm finding this all terribly fascinating. And I love buying stocks that others are throwing away.

Fear is here.

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"If stupidity got us into this mess, then why can't it get us out?"

Will Rogers

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United States Loses AAA Credit Rating

Standard and Poors, a once-excellent bond rating agency that now largely ignores economics and instead reflects market sentiment, downgraded the US to a AA+ rating this week. After holding back a big yawn, I took another sip of coffee and went to get a danish.

The Economist magazine said it best (with complete lack of emotion) a few weeks ago: "America's net indebtedness is a perfectly affordable 65% of GDP...the current problems, rather, are political." Yet, this reality has not stopped pundits and game-playing politicians from making it seem like America will go bankrupt tomorrow.

After the US Treasury pointed out that S&P had miscalculated by a couple of trillion dollars while making its decision, S&P responded that they have decided to maintain the downgrade anyway.

Ratings changes are great for business. S&P’s well-timed downgrade will give stockbrokers around the world a fantastic excuse to call their already-flustered clients on Monday to solicit new trades.

Panic and churn!

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Churn (verb):

1) Agitate milk or cream in order to produce butter.
2) Excess trading of a client’s account in order to increase broker’s commissions.

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"If anything, it may change my opinion on S&P."

Warren Buffett, when asked if S&P's debt downgrade will change his opinion about U.S. treasuries.

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The Market Gets Ugly

Today’s market drop of almost 5% will make front-page headlines tomorrow, and retail investors (who seldom read business news) will not take it well.

It’s not that people are panicking (yet) so much as giving up. Faced with debt ceiling debate stress, the prospect of defaults in Europe and slowdowns in China, they are simply packing it in. They are saying, “enough of this,” and selling.

It all started last Thursday, when investors began moving out of US stocks (or US anything) due to the uncertainty of the debt ceiling. For almost a week, news viewers were inundated with stories about "unpayable debt" and "market uncertainty." And, once uncertainty takes hold, it is ravenous.

For the unexceptional investor, not knowing whether or not something terrible will happen is even worse than knowing that something terrible will happen.

Just a few days ago I viewed the market drop as an unnecessary annoyance, caused by a few idiots in Congress. Now that the drop is significant, however, this is looking more and more like an opportunity (or a rout, depending upon your financial preparedness).

I plan to mix myself a rum and Coke, and have fun watching the lemmings sell their stocks for less then they are worth, out of fear. There is now enough negativity in the market to assure at least several days of rollercoaster rallies and dives.

In the following months, junior precious metal miners like Nevsun Resources (NSU) and Great Western Minerals Group (GWG) should profit well from the uncertainty. Leper stocks, such as Bank of America (BAC) and Barclays (BCS) are already great bargains, and may get even cheaper.

Stay away from the overbought stocks that retail brokers have been recommending for weeks: precious metal ETFs, tech stocks, emerging markets (ex. China and India), and Canadian banks.

Be aware that this could get ugly before it gets better. Keep your head.

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"I see no reason why 1931 should not be an extremely good year."

Alfred P. Sloan Jr. of General Motors, 1930

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Disclosure

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.
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The Debt Ceiling Hurt Locker

and the triumph of founding fatherism




The debt ceiling was raised, the crisis averted.

So why did the stock market go down again? Wasn’t there supposed to be a rally?

You may recall the award-winning movie from 2008, The Hurt Locker, in which a US soldier disarms bombs in Iraq. For the enemy combatants, blowing up innocent civilians was acceptable so long as it furthered their goals. I mention all this because it seems eerily similar to what we all witnessed in Congress last week.

Tea party members actually said – publicly - that they were willing to let the US default on its debt if it led to reforms later. That is, they were perfectly willing to detonate an economic bomb in order to reach their long-term objective (which, ironically, was to save the economy). Sane members of congress, despite universally despising the bill, passed it only because self-destruction was worse.

Both Republicans and Democrats swallowed bitter amounts of compromise to get the job done over the weekend, which was admirable. Despite this, rightist media is still calling the President a “Marxist thug” and “Nation Destroyer,” along with the usual racial slurs (ex. “leader with swollen lips.”)

Some of the tea party's ideas are actually good, though most members probably don't realize why. For example, Keynesian spending (to improve the economy) doesn’t work if everyone is worried about the country spending too much and defaulting on its debt; in this case, fiscal conservatism is better. It’s not the tea party’s economic ideas as much as their methods which are concerning.

The stock market continues to drop because people around the world increasingly regard the US as fanatical. The nation’s cult religion, “founding fatherism,” is growing faster than Falun Gong.

Many believe that because of fringe groups, the United States simply can’t be trusted.

Can it?

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(about the civil war in Cuba)

Michael Corleone: "I saw a strange thing today. Some rebels were being arrested. One of them pulled the pin on a grenade. He took himself and the captain of the command with him. Now, soldiers are paid to fight; the rebels aren't."
Hyman Roth: "What does that tell you?"
Michael Corleone: "It means they could win."

From the movie, The Godfather, Part II

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