Tonight the WSJ had a wonderful explanation of how the problems in Europe unfolded. I’ve been very disappointed in the response of regulators and politicians both in the EU and the United States, and I see a lot more in common with Hoover’s economics during the Great Depression, as opposed to what solutions actually got us out of it. Right now you have the Federal Reserve doing everything they possibly can to stimulate the economy, yet from a fiscal and political point of view, there is very little sense of urgency or direction at fixing the core problem, which is the economy and specifically the jobs market. Instead of allowing the gears of capitalism to run, we are in an environment where the rules are constantly changing as far as capital ratios, ratings requirements, regulations, etc. These uncertainties dampen confidence and cut access to capital which is a fundamental ingredient to grow the economy, and to create jobs.
It is important to note that these problems are very much priced into the market at least as far as equities go. It is only in this type of dysfunctional environment that banks trade at 50% of tangible book value, and around 5 times trough earnings. They have never been this cheap for this prolonged period of a time, particularly not when they are profitable with the strongest balance sheets in their history. Companies like Microsoft and Cisco that generate amazing returns on invested capital are trading at less than 10 times earnings when you back out the cash. Oil stocks such as BP and Transocean Rig are trading at 5 times forward earnings, even with oil hovering around $100. Assured Guaranty, Met Life, and Berkshire Hathaway, are generating solid profits and are buying back their own stock to take advantage of the discount prices. We expect our other financials to do so as well after they pass the newest version of the stress tests which is due out in a few months. In the words of Horace from 20 BC, which were also echoed by Benjamin Graham “Many that are fallen shall be redeemed, and many shall fall that are now in honor.”
I truly believe that once both regulators and politicians decide that the time for associating blame for the ills of the past that caused the Great Recession, and provide a solid framework to move forward that businesses can trust we will see one of the truly great bull markets of our lifetime. This year has been extremely challenging because the US economy has been stronger like we suspected, commodities are up, and corporate profits and balance sheets have been exceptional. While these attributes were appreciated in the beginning of the year as the market rallied, an obsession with Europe, and some of the highest global correlations I have ever seen have negatively impacted many companies that shouldn’t have been effected nearly as much. The strategy moving into 2012 will be to own more stock at these amazing levels. We will focus as always on the strongest financially that offer the highest reward to risk ratios. Fixed income is not attractive whatsoever, so the best thing that can happen is to get exercised on some of the puts we have sold that will get us in at cheaper prices, and then to ride the rally up. We’ll also want to supplement that with covered calls going further out in time, and far away from the current prices which should result in increased cash flows, while allowing the maximum amount of capital appreciation potential. Value stocks rarely stay this cheap for long and the markets are forward looking, so the key is to be patient and stay the course. Most stocks that we are in have upside potential between 50-150% over the next 3-5 years, and you only get that type of return potential when there is an ENORMOUS amount of fear similar to what we are seeing in Europe. Below is the article for you to enjoy and if you have any questions or thoughts please don’t hesitate to let us know!
INVESTING IN THE FINANCIAL MARKETS INVOLVES RISKS. OPTIONS ARE NOT SUITABLE FOR ALL INVESTORS.