Friday, September 9, 2022

Look for inflection points; Doug Kass shares my bullishness on bank stocks; My tennis tournament this weekend

By Whitney Tilson

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The ONLY way to play markets like these

Warren Buffett once said, "Price is what you pay... value is what you get." The best investor in the world knows the only way to prosper (especially in markets like these)... is to invest in VALUE. But this $2 stock could be the last value play in the market today. See why this $2 stock go up 25x and still be a bargain here.

1) Picking up on where I left off in Friday's, Wednesday's, and yesterday's e-mails about my recent presentation to two groups of high-net-worth investors... After outlining my investment philosophy, I shared five big lessons. Here's the next one:

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Billions Pouring into the Next Big Industry

Major investors are taking note - and the legend who bought Amazon at $48 and Apple at $0.35 is pounding the table on one $4 stock.

2) A good example of a variant perception I have today is that the stocks of big banks are attractive. We have two open recommendations in this sector in our flagship Empire Stock Investor newsletter, Goldman Sachs (GS) and Wells Fargo (WFC) – subscribers can read the full writeups here and here, respectively.

(If you aren't a subscriber, you can become one and access all past issues – including the brand-new September issue, which just came out on Wednesday with our latest recommendation – for only $49 for the first year by clicking here.)

For more on why bank stocks are attractive today, below is a missive by my friend Doug Kass of Seabreeze Partners...

With Growing Macro Clarity, Banks May Emerge as a (the) Leading Market Sector in 2022-2023

  • There is a growing probability that the banking industry may face an almost picture-perfect economic and interest rate backdrop
  • I am no Pangloss, but the outlook for traditional banking remains quite strong
  • At the core of my optimism regarding financial stocks are my expectation for a mild and brief recession, contained credit issues, a solid labor market, a relatively healthy consumer – armed with large unrealized gains in equities and in the housing stock – a still healthy housing market, a view towards higher interest rates (for longer), a strong and under-levered U.S. banking industry/system with healthy structural economic underpinnings and, as a starting point, low relative (0.5-0.6x) and absolute valuations (8-9x) 
  • For me, it's the time to be an opportunistic buyer during the potential bottoming in the nontraditional – capital markets, trading, investment banking – financial industry fundamentals that I expect
  • Remember, in banking, the value is the customer base – the industry's deposit/asset bases are "sticky" and higher rates for longer means the value of those deposits are appreciating

I have been following financial stocks since I was a "yute."

  1. While earning my MBA at Wharton I was a "Nader Raider." In that capacity I co-wrote (three chapters) of the book Citibank with Ralph Nader.
  2. My investment career started as a housing analyst at Kidder Peabody, where I produced research on mortgage-related equities.
  3. At Putnam Management in Boston, I was voted by a leading investment magazine as the top ranked buy-side analyst of banks and thrifts. 
  4. I am currently a Special Advisor to the Board of Directors of Ocwen Financial (OCN), a leading mortgage originator and servicer.

      So, while at times my head spins regarding cloud, artificial intelligence, and other specialized/niche technology stocks, I have a reasonably strong knowledge of many facets of the financial industry.

      Turning Much More Optimistic

      A month ago I turned more cautious on the market and on bank stocks. Since then, most large money center banks have declined by about 10% as fears of a deeper recession have returned:

      Aug 11, 2022 ' 02:05 PM EDT DOUG KASS

      Backing and Filling?

      • Banks have been the world's fair
      • But in keeping with my more cautious market view, I have been selling calls against my positions in WFC, BAC, and C
      • May be time for the group to rest
      • I still see a strong upside for those with [a] 1–3-year horizon

      Given the following set of circumstances, it is time to become much [more] optimistic on bank equities, particularly when viewed in an intermediate or longer timeframe:

      1. Of note, comments by Federal Reserve Chairman Powell and other Fed members suggest that they have finally come to the realization that inflation will be slow to moderate and that, resultingly, interest rates will likely remain higher for a longer period of time. As the banking industry is asset/rate sensitive, monetary policy will be an ally to bank profitability, valuations, and stock prices.

      2. Not reflected in the historically low valuations, the large money center banks have high and improving quality, predictable and more sustainable profit streams, which are now benefiting from a rising trend in net interest income and an elevated and relatively sticky retail deposit base. When rates are climbing and will remain relatively high, as I expect over the next few years, I view the explosion in those "sticky" deposits as a strengthening asset, similar to a rising deferred revenue line, setting the stage for more predictable and higher profits in the years ahead.

      3. As to the current yield curve inversion being considered an industry negative, I don't see it that way as long-duration mortgages are no longer as dominant on bank books. Rather, shorter-term loans and investments have become more conspicuous on bank balance sheets. Therefore, asset durations have been shortened, lessening the impact of an inverted curve.

      4. Banking industry asset tests are unrealistic and too restrictive/stringent. In reality, industry capital is in excess and company repurchases are very accretive to EPS. As the economy recovers in 2024 and forward, it is likely that asset tests will result in regulators allowing more aggressive capital asset strategies.

      5. With solid balance sheets and large technology expenditures materially behind them, large U.S. banks have deepened their moats by expanding their franchises and market shares at the expense of non-U.S. financial institutions and emerging fin-tech players that have materially disappointed their stakeholders.

      6. Remember, some inflation is good for banks because nominal growth, which boosts loan, asset, and deposit levels, is more important than real inflation adjusted growth!

      7. Second quarter results showed the benefit of the recent climb in interest rates. Strong growth in net interest income will be a feature of 3Q2022 and second half results.

      8. While credit costs will be rising somewhat, quarter over quarter, loss rates and reserve builds will likely still be very low as debt excesses are contained and consumers have large embedded and unrealized gains in their homes and in stocks. Our financial system is strong when compared to other economic downcycles.

      9. Capital market and mortgage related revenues/profits are already known to be weak, for obvious reasons: market price declines, slowdown in home turnover, and weak investment banking. Nevertheless I vastly prefer banks to brokerages because they are less asset sensitive than the latter, which do not benefit from the marked accumulation of industry savings accounts and the inevitable advance in net interest income.

      10. Finally, most large money center banks have an important presence in the consumer banking and mortgage markets. I do not share the dire expectations for the consumer in light of the still healthy housing market, the large unrealized cushion of gains in both equities and in the housing stock, coupled with very low "locked in" mortgage rates of about 3%, and a strong jobs market.

      Bottom Line

      At the core of my optimism regarding financial stocks are my expectation for greater macro clarity of a mild and brief recession, contained credit issues, a solid labor market, a relatively healthy consumer armed with large unrealized gains in equities and in housing stock, a still healthy housing market, a view towards higher interest rates (for longer), a strong and under levered U.S. banking industry/system with healthy structural economic underpinnings and, as a starting point, low relative (0.5-0.6x) and absolute valuations (8-9x).

      My advice is to be opportunistic and to avoid the rear view mirror, the consensus and the downbeat emotions that are the natural byproduct of lower bank stock prices over the last month.

      I am now aggressively embracing the weakness in financial stocks, with an eye on a multi-year investment that could take the group much higher when fears of a deep recession recede.

      Positions: Long BAC, C, WFC, JPM, and PNC. Short BAC and WFC calls.

      Thank you, Doug!

      3) Last month, one of my tennis teams (age 40-plus) drove three hours to Schenectady, New York to compete in sectionals against five other teams, with the winner advancing to nationals.

      As I wrote in my August 22 e-mail, we got smoked, losing all five matches.

      But hope springs eternal! The other tennis team I'm on, age 55-plus, also made sectionals... so we're driving back to Schenectady today to play two matches tomorrow and two on Sunday (each match consists of three doubles matches, two sets each, with a 10-point tiebreaker to determine the winner if the first two sets are split).

      Given that I just turned 55 last November, I'm one of the youngest competitors, which gives me a big advantage. I'm playing No. 1 doubles with a strong partner, so hopefully we'll lead our team to victory. It would be fun to go to nationals, which are in Florida in January.

      Wish us luck!

      Best regards,


      P.S. I welcome your feedback at [email protected].

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      Empire Financial Research

      Whitney Tilson

      Empire Financial Research founder and CEO Whitney Tilson is the editor of the Empire Investment Report, a monthly investment advisory that focuses on cheap, high-quality stock ideas.

      Whitney graduated with honors from Harvard University and Harvard Business School, where he earned an MBA and was named a Baker Scholar. Whitney spent nearly 20 years on Wall Street, during which time he founded and ran Kase Capital Management, growing assets under management from $1 million at inception to a peak of $200 million.

      Once dubbed "The Prophet" by CNBC, Whitney predicted the dot-com crash, the housing bust, the 2009 stock bottom, and more. Now, he's sharing his secrets and strategies with followers of his latest endeavor, Empire Financial Research.

      Read more