What is Different?

When the market suffers a fit of selling, I always re-examine my outlook and ask myself, "What is Different?" This has to be done with an open mind and after looking for new facts.

Reading the news articles on CFC I see their earnings miss is blamed on unexpected losses in "prime home equity loans". Hmmm. Reading further in the WSJ: "Many of the home equity loans that are going bad are 'piggyback' loans to borrowers who took out a second mortgage because they couldn't afford a large down payment and didn't want to pay for mortgage insurance." Naturally these people bought homes at the peak and now the home prices are below the combined 1st and 2nd mortgage balances.

What is "prime" about a second lien loan to a borrower without a standard down payment? How can this ever be considered "prime"? These loans were miss-classified by CFC. CFC wanted to put paper on its sheets with disregard of reality. This says nothing about the economy or the huge standard mortgage markets.

AMZN beats earnings bigtime. It's stock ripped up afterhours. Who are Amazon's customers? The consumer.

This is the third major selling fit that the "subprime" screech has generated [late Feb, early June, and yesterday]. I think "subprime" mortgages are the housing loan analogue to "high yield" bonds [ aka "junk bonds" ] in the corporate markets. In the 1989-90 period, there was a seize up in the junk bonds market that caused lots of problems. This was legislatively created as Congress banned junk bonds from S&L balance sheets and the insurance industry created new capital requirements that greatly cut insurance company holdings. So the junk bond market had much forced selling and few buyers. Simultaneously, there was a commercial real estate debacle as that market was overbuilt and the S&L and insurance company loans had reached idiotic levels. A major investment bank went bankrupt [Drexel Burnham Lambert]. Combined with the surprise first Gulf War and its oil price shock, we had a short recession.

Some LBOs are actually having to pay spreads and terms that are reasonable - how shocking! And the bridge loans firms are re-learning the lessons of the past. High yield spreads are actually getting reasonable - they were insanely thin in the Spring. By the way, the historical cumulative default rate on Ba/BB corporate bonds is about 20%. For B/B corporates it's about 40%. Recent corporate default rates are far, far lower. So junk spreads under 250 for Ba/BB and 400 bps for B/B are stupid. Some of those spreads were at the "stupid" levels recently. Have any major LBOs defaulted? No. Have we seen any major defaults? No. This is a move back to reasonable pricing - aka a correction.

You can see how different the 1989-1990 period was: massive dislocation in multiple problem sectors and legally forced selling plus a surprise war. And now instead of predicting a housing recover soon we hear it's a "Depression" and no recovery until 2009. No one seems to want to buy the homies now or is predicting a bottom. Last summer and fall everyone was buying homies, thinking it was the bottom. Bill Gross says a big drop in equities coming. Hmmm. Wasn't he saying that last year? Isn't he a bond guy? Hmmmm.

So without a recession and since bottom fishing seems dead, is the "bad" news all in? Is it really that "bad"? Or is this just beefer panic and profit protection selling and more shorting by the bears? And even the Fed does expressly say they are watching the housing markets closely. Uh, that means that they will consider a rate cut if it gets as "bad" as the bears say it will. I think they will cut this fall, for several reasons including the downtrend in core inflation rates.

So running threw my mind as I sat watching the birds and squirrels while listening to Tommy Dorsey with Frank Sinatra singing was how "stupid" this selling in the major financials seems. And in the past at those times I've bought stocks. So yesterday in the comments I posted that I put some fins on the sheets - just to remind me to look.

I'm going to build a big position in the major financials - only the big ones like BAC, C, JPM - maybe more as I look around. Their PE multiples are really low and I think way undervalued. My Alpha Fund target return is 30% per year and I think this sector will give me that leg next year. I'll average in over six months or so - you have to use time diversification on these type of moves to avoid overtrading.

PS: No surprise, the bears are hitting the early bounce. Be patient. Buy dips of good stocks if you have cash.

PPS: Interestingly, I heard that some beefers are stopping redemptions. Hmmm. Beefer liquidations would be a plus long term, imho.