The Guest Blog

Helmers: Predictions 2012


Why financials are on the cusp of a big 2012:

Financials are outrageously cheap on an historical basis. Capital levels broadly are higher than at any other time in the last 50 years. An investor can currently buy money center banks in several cases at a discount to liquidation value (tangible book value) and get the ongoing franchises for free. No matter how in?flux their franchises might be, the only way these stock prices can be rationally justified is if assets are fraudulently priced on the banks’ books (highly unlikely after four years of regulatory and auditor scrutiny) or the US economy is about to collapse (also highly unlikely given the aggressive Fed stance and lack of cyclical excesses in the economy).

Europe is not going to blow up. While problems certainly exist, there is no smoldering “Lehman Moment” coming. Authorities are galvanized on both sides of the pond to meet any potential crisis. The recent ECB funding is a lifeline to weaker institutions and allows those banks the time to sell assets and recapitalize in an orderly fashion. Further, even if Europe were to fall into a significant recession, this has never “pushed” the US into recession historically. Only 10% of US GDP is tied directly to Europe; if Europe suffers a 2% contraction, the impact on US GDP should be de minimis.

The US economy is getting better. Recent data have consistently exceeded expectations(employment, retail sales, etc.) despite the best efforts of the markets and the media to scare the pants off of the average American consumer. Are “Joe Six?Pack” and his girl really going to alter their spending patterns because the Italian 10 year yield is breaking over 7%? All Americans really care about is whether they have a job, and well over 2 million new jobs have been created this year. Strangely enough, the only Americans who appear to have had their behavior impacted by the news from Europe are corporate CEOs. This is clear in the Q3 GDP data. Corporations ran down inventories in preparation for a material consumer slowdown that never came. Corporate America has had to play catch up in the 4th quarter to meet normalized consumer demand.

US real estate isclose to a turn , not a collapse. Affordability is as high as we have seen it in over 30 years. Recent data suggest it is 18% cheaper today to buy than to rent an equivalent home. Historically, new homes have traded at roughly a 14% premium to existing homes??today that premium is closer to 30%. This discrepancy highlights the fact that foreclosed homes gradually being pushed through the legal python are distorting price data to the downside. Current homebuilding rates barely replace annual housing obsolescence. Meanwhile, households continue to form and grow, creating pent?up demand. The fear of shadow inventory is overdone as every “shadow seller” must live somewhere once his or her house is sold.

US (and global) financials are WAAAYY under owned. People are underinvested in stocks generally (not unexpected towards the end of an 11?year bear market). Even accounting for that, the true market pariah continues to be financials. Everyone is underweight, from the individual to the investment manager. The few exceptions (think Bruce Berkowitz and John Paulson) are suffering massive redemptions. The 2008 trauma scarred investors in ways that only the Great Depression can trump. Our trust in the foundation of the financial system was shaken. Iconic names went bust (Lehman, Bear Stearns) and investors in other names were virtually wiped out (AIG , Citi , Wachovia , Countrywide, WAMU ).

Occasionally great investors like Berkowitz and Paulson are made to look foolish by Mr. Market. Those moments, however, rarely last long and often mark an inflection point. Think back to 2000 when no less than Warren Buffet was made to look temporarily foolish as the tech bubble hit its zenith.

Financials and the stock market as a whole were a good buy six months ago from a valuation standpoint. Now may well be the last chance for a prudent investor to buy into a critical part of our economy at less than liquidation value. They say that no one rings a bell at the bottom telling you to buy. I’d say it’s time to listen real hard.

John B. Helmers is currently principal and chief investment officer of Swiftwater Capital Management, an asset management firm he founded in 2004 in Greenville, SC. The firm implements a disciplined, value-based investment strategy in its active management of equity-based, macro, and commodity investment portfolios and a portfolio of real estate assets.