Sunday, August 3, 2008

Home Sweet Home and Richard Pzena

I am finally back. Had an awesome vacation though honestly a little long. I will probably post more on the vacation later but I will be desperately trying to get caught up and posting things I find interesting. First is a commentary by Richard Pzena. Thanks goes to Pete for bringing this to attention.

I have large amount ofrespect for Richard Pzena. Not sure why but he has always been one of my favorite value investors to listen to because he is a contrarian even for many value investors. Not surprisingly he has been very bullish on financials and has gotten slaughtered. Here is his latest letter.

He talks about the usual stuff, mark to mark accounting, sell off being overdone etc. The problem I really have is once again he (like many others) is comparing this to 1990 and 1991. He talks about defaults rates since 1989. This is not 1990 all over again. The housing downturn is and will continue to be much bigger than 1990. At best it may be 1981 all over again and it is probably worse than that.
Here are two graphs from his commentary. Click on the graphs to look at the them The first graph shows declines from peek to trough from 1989 through 1990 for banks being 45.8% while 2007 to 2008 peak to trough for banks has been 46.6% somehow showing that banks have bottomed. Once again this is worse than 1990 and if I am right than stocks need to go down more!!! The second graph shows default rates from 1970 to 2008. Banks are low in defaulting at 2.4%. First how does he define default? Second, most banks never default but are taken under (I don't think Bear Stearns would qualify as a default). That does not mean banks don't disappear and much more shareholder value than is shown is wiped out.

I agree with his overall conclusion
The market’s panic over the impact of mark-to-market accounting on financial companies’ earnings has created an extreme valuation opportunity. Further, this obsession with current news has caused most investors to disregard the data that actually drive these companies’ long-term earnings prospects. Of course, not every financial company is going to come through this period intact. Some of the losers have already fallen and others are likely to follow. However, these are exactly the times when serious research and valuation discipline can add significant value. We believe that world-class franchises like Citigroup, Royal Bank of Scotland, HSBC, and others are being offered at fire-sale prices relative to their long-term normal earnings power. The timing of the turn, as always, is uncertain. But the opportunity is greatest when unquantified fear is at its peak.
Whether he has picked the winners I have no idea. I unashamedly will say I am not smart enough to figure it out. There are great opportunities in banks right now if you can stomach more downside and you smarter than I. Most of the easy money on the short side is gone but I will argue there is still much easier money on the short side in banks currently than on the long side. He is still early.

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