Buoyant stock prices are defying the physics of fundamentals. Equities are also floating on mist despite the gravity of the macroeconomic outlook as we believe the equity market falls prey to over-exuberance and excessive optimism. I query, have we entered into a double-dip recession? I'll answer my own question here, No! The reason is because I do not feel we have organically left the previous recession. The positive GDP prints and "green shoots" were the direct result of government bubble (re)blowing through fiscal and monetary stimulus, culminating in QE v1.5. As the effects wear off, we start to see were the economy really stands. Let's just grab the first four headlines today from CNBC.com a day after a 2%+ rally in the S&P:
- Pending Home Sales Plunge as Housing Market Weakens: Contracts for pending sales of previously owned U.S. homes fell to a record low in June as buyers sat on the sidelines, a survey from the National Association of Realtors showed on Tuesday. Of course, we at the BoomBust made it very clear this was a foregone conclusion, see As I Made Very Clear In March, US Housing Has a Way to Fall.
- US Factory Orders Drop for Second Straight Month: As was expected.
- Consumer Spending, Incomes Flat in June; Saving Up: No surprises here.
- US Unemployment Could Rise Before It Drops: Geithner: Of course, I guess Geither just read my piece from the "Green Shoots" era, “Are the Effects of Unemployment About To Shoot Through the Roof?”
Despite the flurry of the truth finally emerging from among rampant disinformation negative economic news, the markets is only off 2 points today after rallying 24 points for nothing yesterday. Bubble, Bubble, toil and trouble. Needless to say, this happy slappy effervescence cannot (and will not) go on forever. A typical example of said over exuberance is the highly economy and consumer sensitive US hospitality sector where the entire pack of hotel stocks have witnessed a substantial rebound from their lows in March 2009 owing to the recovery seen in the occupancy levels, while the markets ignore the weak prices that are offsetting most of the revenue gains and are undermining a healthy recovery in the sector. The sector is still struggling with the demand–supply gap that developed over the last two years when demand was pummeled by the economic downturn in combination with new supply that continued to add to the vacant rooms. Rooms are being booked at rates below the 2009 levels (post economic bust!) to boost occupancy with group bookings rates showing significant weakness. The subject of the accompanying forensic analysis’s business model is particularly vulnerable as the company derives nearly 78% of the revenues from group bookings and the prices are being slashed at all of its hotels. Price cuts have been more severe at its hotels in Washington and Orlando because of relatively higher supply-demand gap in these areas. Further, price cuts at a time when costs are increasing due to input inflation are likely to hit the margins at the same time that said inflation outstrips wages, income and asset appreciation, creating a profit sapping stagflationary environment. See Continuing the Deflation/Inflation/Stagflation/Depression/Recession Rant… for more on this topic.
The mainstream media has gone Ga Ga over Morgan Stanley's latest results. Just take a look...
The Wall Street Journal Blog: Morgan Stanley Earnings: Sticking It to Goldman Sachs
Morgan Stanley, which beat earnings analyst expectations by posting better trading revenue than its rivals. While Goldman Sachs Group and J.P. Morgan Chase took hits to their trading books, Morgan Stanley’s trading revenue doubled to $3.1 billion from a year ago. What was the secret?
Well, apparently the secret was to get your ass handed to you in the previous comparable period while simultaneously under performing your peers, then turn in a simply below mediocre performance the next reporting period and you will receive accolades from the mainstream media. After all, who cares about those [BoomBust]Blogs who actually bother to read into the results.
The International Business Journal: Morgan Stanley earnings surge, credits trading revenues to DVA ...
On the revenues side, results in its three divisions were much improved from last year but slightly worse than last quarter. Net revenues in Global Wealth Management were impressive, coming in at $3.07 billion, compared to $1.92 billion last year and $3.1 billion last quarter.
Like rival Goldman Sachs (NYSE:GS), Morgan Stanley saw lower underwriting revenues from last quarter and last year, reflecting the difficult environment for investment banking. However, unlike Goldman, Morgan Stanley's trading revenues were strong, coming in at $3.3 billion, up 93 percent from last year and down 11 percent from last quarter.
I don't even think these guys bothered to read the results at all. They are comparing revenues pre-multi billion dollar acquisition with the post acquisition entity. Hey, I can double my revenues if I purchased a company that had 3x my revenues too! This is just sloppy! Yet, these euphoric headlines were all over the place as MS stock climbs nearly 10%. Yes, MS did relatively better than GS, but GS is a federally insured hedge fund (that's right, I said it), and we all know how most hedge funds do in times of volatility and declining prices. Well, I hate to rain on the positive earnings parade, but a couple of my subscribers have requested the truth be told!
About three months ago, Boombustblog forewarned that GS will stand out to be the worst hit in the event of trend reversal in the financial markets and the company will have little means to escape the implications of the same on its profitability and solvency. The company generates 60-70% of the revenues from trading activities which is largely dictated by the unpredictable turn of financial events. While the financial markets were celebrating the US officially coming out of recession in the 1Q10, the subsequent Eurozone crisis (see the Pan-European Sovereign Debt Crisis series) and the slowdown of expectations in 2Q10 has beaten down the irrational exuberance and the markets experienced spurt in volatility and drop in prices. The consequent softening of trading revenues in 2Q10 vis-à-vis 1Q10 drove 31% drop in revenues and 82% drop in net income.
The chart below demonstrates how the volatility of the revenues from the trading and principal investments trickles down into volatility of the total revenues and profits of Goldman Sachs. I don't call Goldman the world's most expensive federally insured hedge fund for nothing!
If those that follow me remember, I was bearish on Goldman long before became popular, and profitably too (as the media and analysts fawned all over this company)!
CNBC (the world's biggest Goldman cheerleader) reports "Goldman Sachs' Revenue Falls, but Profit Beats Views" even as Bloomberg reports "Goldman Sachs Profit Falls 82%, Misses Estimates on Trading-Revenue Drop". Whoah... It's hard to get a straight answer out of these news guys, ain't it? Well, one thing they both have in common is that Goldman's trading revenue fell over 40%! Hey, I told you so. Reference my overview of GS's last previous quarterly performance, A Realistic View of Goldman Sachs and Their Latest Quarterly Results
For those who have forgotten the implications of the highly leveraged and opaque financial holdings (the true value of which rests at the mercy of market sentiment) and can turn blind eye to the highly volatile nature of the trading revenues combined with a literal tsunami of regulatory pressure and potential litigious onslaught (all issues which we have repetitively brought up in the past as what appears to be the sole voice of contrarian reason), Goldman Sachs holds a strong investment proposition. However, if fundamental considerations such as the company’s solvency, true economic profit (not the accounting earnings you hear preached from your brokerage’s sell side marketing propaganda research reports) and the sustainability of income are to be considered, GS should NOT appear among the preferred lot.
GS swims and sinks with the financial markets and the performance at the trading desks determines not only the profitability, but the survival of the Company. The market’s unfounded exuberance (largely driven by liquidity rather than fundamentals), combined with the collapse or near collapse of 3 of its 4 largest competitors is enabling GS to generate extraordinarily strong trading results. Trading revenues which account for more than 60% of the revenues not only dictate GS’s profitability but also serves as a cushion to absorb the write-downs on the investments. Thus, Goldman Sachs is amongst the most vulnerable to a major market disruption which can severely dent its earnings stream and expose it substantial equity erosion from investment write-downs. Apart from that, the recent fraud charges filed against GS not only adds to the risk of incurring huge litigation costs but also add to the risk of tighter regulation and oversight of the sector which can hinder the business activity in the coming years.
JPM is leaving no stone unturned to prop up the operational performance and give out green signals, even if it involves the most unsustainable measures. While in 1Q10, trading income came to the rescue of the sagging core operations, in 2Q10, it was management’s over-exuberance (defying logic and rationality, to some extent) resulting in drastic reduction in loan loss provisioning and beefing up the bottom line. Although the credit quality has shown slight improvement (thanks to the enormous fiscal and monetary stimulus), it does not completely warrant for JPM’ unhealthy and hasty decision to substantially pare its loss provisions. I know many financial pundits second guess management as arm chair coaches, but when management error is egregious, well let’s let the numbers speak through graphics….
As Excerpted from As I Made Very Clear In March, US Housing Has a Way to Fall:
Trust me, the collateral behind many more mortgages will continue to depreciate materially as government giveaways and bubble blowing for housing fade!
In a nutshell, a cursory glance of JP Morgan's recent earnings announcement is middling, and that's putting it optimistically. Revenue and profits have fallen nearly across the board, and the earnings beat is a result of moving capital from reserves to the earnings column. Even this may be suspect, for while credit metric trends appear to be improving (largely a result of massive government stimulus), the core, underlying cause of this malaise looks to be on the move downward again. See As I Made Very Clear In March, US Housing Has a Way to Fall.
An Independent Look into JP Morgan (subscription content free preview!)
The JP Morgan Professional Level Forensic Report (subscription only)
The JP Morgan Retail Level Forensic Report (subscription only)
I would like to draw attention to BoomBustBlogger Shaunsnoll and his write up on Envirostar titled, "A dollar for fifty cents: EVI"
EVI is a well run company with 60%+ of shares owned by management that has an absurd amount of cash on the balance sheet, no debt, and trades at a ridiculous valuation with a few likely catalysts.
EVI primarily distributes commercial and industrial laundry and dry cleaning equipment including a proprietary line of dry cleaning machines (98% of revenue) with a focus on environmentally friendly dry cleaning methods and equipment. There is even a “green” angle here for you environmentalists! Overall prospects for this business are not great but not terrible. Much of their dry cleaning products sales goes into hotels, hospitals etc, which is obviously very weak. They do have some good growth into international and latin America though, which is ~20% of their sales and growing. Not exactly the most “sexy” industry but keep reading!
Valuation for this company is ridiculous given ROE, ROIC, cash flow and balance sheet and there are some clear catalysts that could unlock value in the next year. Company has ~80% of market cap in cash, no debt, is fcf positive, insiders own >60% of shares, and company has respectable ROE, ROIC and EPS growth over last few years.
Summary: So you essentially have 25% downside and 70%+ upside using relatively conservative estimates, for a 2.5x return/risk ratio with very little risk of permanent loss of capital. Impossible to know exactly what could happen but it seems under almost any scenario the company is under valued. Stock could do anything in the short term but over the next year or two I have a hard time coming up with any scenario that has less than a 40% return. Given market environment and limited downside this looks pretty compelling to me. I am a buyer at anything <$1.20. If the company starts having multiple quarters of negative net income indicating likely extended cash burn or if management shows me reason not to trust them, then I will likely exit the investment.
To read the full write-up as well as ability to download an accompanying word.doc, visit Shaunsnoll's microblog on the BoomBust by clicking here. Neither I, nor BoomBustBlog necessarily endorse this work, nor have we verified the contents, for it is independent and research and opinion posted by Shaunsnoll but I do encourage all readers to investigate, comment and share.
Any registered member may post their ideas to their own microblog, and if the content is deemed compelling I will announce it to the general population for review. You may also install the Google Ads application from within your profile and generate some ad revenue from our site's traffic.
Relevant commentary from BoomBustBlog and sources throughout the Web on the accounting change that added 80% to the S&P since March 2009!!!
Warning Shots from the IASB: FT
- The IASB came under fire in the fall/winter of 2009 in regards to mark to market rules
- Banks wanted continued relaxation of valuing models in order to “smooth out volatility swings in asset prices”
- IASB and FASB plan to converge on mark to market ruling by 2011, both have stated a desire for more transparent financial statements, but have been politically compromised by bankers and commercial lenders
FASB Plan Would Force Banks to Report Loan Fair Value: BusinessWeek
- FASB is seeking to approve a proposal that would force banks to mark loans at market value by 2013, potentially having billions of dollars at risk for writedowns
- In April 2009, FASB gave significant leeway to banks in regards to pricing and modeling loan values, banking consultants are very opposed to a reversal of the measures
- Pension obligations and leases will be exempt from new measures
It has taken a while to get this out, but the core message hasn't changed...
1Q10 Results review
For 1Q10, MS reported significant increase in its net revenues to $9.1 billion from $6.3 billion in 4Q09 and $2.9 billion in 1Q09, primarily driven by trading and principal investments revenues which increased to $4.1 billion versus $1.3 billion and $205 million in 4Q09 and 1Q09, respectively. Trading and principal investment revenues in 1Q10 increased off improvement in debt-related credit spreads and better results in Fixed Income. Revenues from Investment banking and Asset management, distribution and admin fees increased 21.4% and 126.7% (y-on-y) to 1060 million and $1,963 million, respectively. However, both the categories reported a quarter-on-quarter decline in revenues of 36.6% and 0.6%, respectively. Commissions earned for the year increased 63.8% (y-o-y) and 1.1% (q-o-q) to $1.3 billion. Compensation expenses increased to $4.4 billion from $2.0 billion in1Q09 and $3.8 billion in 4Q09, while non-compensation expenses were up 38.4% (y-o-y) mainly off MSSB inclusion and higher business activity. Consequently, net income from continuing operations increased to $2.1 billion, which was further supported by a $382 million tax benefit associated with prior year’s undistributed earnings of certain non-U.S. subsidiaries.
Below, please find our recent review of Wells Fargo's latest quarter. At the end of the review are pertinent links for both subscribers and non-subscribers to peruse.
Results Review – 1Q10
In 1Q10, WFC slashed the provisions for loan losses, without any significant improvement on the loan losses and NPAs side, to offset the decline in revenues and preventing it to trickle down to the bottom line. The annualized provisioning rate came down to 2.91% in 1Q10 against 3.2% in 4Q09. If WFC maintained the same provisioning rate as 4Q09 in 1Q10, the pre-tax earnings would have been 13.2% lower than the reported pre-tax earnings. WFC would have recorded a q-o-q decline of 12.3% in earnings against the reported q-o-q increase of 1.0%.