July 30, 2014

Doug Kass on Citigroup

Over a month ago, I sold my Citigroup shares at a slightly lower price than where the shares currently stand. My concerns surrounded the Banamex fraud, the Comprehensive Capital Analysis and Review failure and the uncertainty over the deferred tax asset line and with Citi Holdings' future profits.

Since then, Citigroup has reported its second-quarter results, and I have been going back and forth with Jim Cramer, who is bullish on the stock.

After a lot of thought/input/analysis, I have reversed my previously neutral stance as the facts have changed.

Yesterday, I added Citigroup to my Best Ideas list.

Again, my principal concerns were that a very large percentage of the holding company's book value ($38 billion) was contained in a deferred tax asset, and that Citi Holdings' had a lot of capital tied up (and returns dragged down).

There is obviously a lot of value in not paying taxes. Moreover, if a bank management can consume the deferred tax asset, the bank will, in turn, generate excess capital above Basel 3 requirements (see below). The significance is that as deferred tax asset runs off, the bank's inferior (relative to peers) return on equity will improve, which allows the bank to return excess capital to shareholders and the valuation (P/E ratio) to expand.

Prior to the release of the last quarter, it was unclear that the full benefit of this asset could be utilized, so I had given less value to the deferred tax asset line. Markets generally don't give a lot of value to deferred tax assets (which are not allowed under Basel 3 capital calculations) and typically wait for actual capital to be returned.

With the release of second-quarter results, I have grown more optimistic that both the deferred tax asset and Citi Holdings have greater value than I previously thought.

These are the positive highlights contained in the recent profit report:

  -  Earnings have stabilized after a series of quarterly earnings cuts. Second-quarter 2014 EPS was a strong beat relative to consensus expectations. Loan growth and trading volume were very positive.
 -   An aggressive core expense cut has been obscured by litigation expenses.
 -   Stripping out nonrecurring items, Citi Holdings reported profit in excess of $200 million -- its first profit ever.

Assuming these trends continue, my (and the market's) deferred tax asset and Citi Holdings concerns will abate.

To quantify the importance (and as seen below), the deferred tax asset represents a relatively large percentage of Citigroup's tangible book value of $57 a share:

-   Citigroup's ongoing franchise earns approximately 15.5% on tangible equity of $33.25 a share, representing 58% of the bank's total equity per share.
-    Deferred tax assets represent $17 a share, or about 30% of Citigroup's tangible equity. The deferred tax asset line represents about a 450-basis-point drag to Citgroup's return on tangible equity, which is lowered to about 11% from 15.5%.
-    Citi Holdings ("the bad bank") comprises about $7 a share (or 12%) of the $57 a share total equity base. Before the release of second-quarter 2014 results, Citi Holdings earned about a 5% return on capital, further serving to drag total returns (by about 250 basis points) from 11% to 8.5%.

Assuming that Citigroup's ongoing franchise is valued at 1.25x book value (compared with 1.4x for JPMorgan Chase  (JPM) and worth $41.50 share, deferred tax asset is worth $10 a share and Citi Holdings is valued at $3.50 a share, I value Citigroup today at about $55 a share, over 10% above the current share price.

If, over time, Citigroup can move toward a 12% return on tangible book value (a conservative forecast for now), the shares can move into the mid-$60s over the next two years.

I currently have a quarter position in Citigroup, and I plan to add on any weakness that might occur. 

Article originally published on http://www.thestreet.com/story/12822220/2/rag-doll-taking-another-crack-at-citi-best-of-kass.html

July 29, 2014

Sue Berge issued correction call

We are five years from the Great Recession, and aggressive easing by central bankers around the world is still needed to sustain economic growth. Confidence and faith in the ability of the Fed to exit neatly remains one of the biggest bubbles extant.

Corporations' and individuals' dependency on low interest rates is not likely fully appreciated by market participants. (Just look at the U.S. housing market.) Buying all (even shallow) dips and dismissing short-selling as a mug's game have become entrenched strategies -- signals that, contrarily, risks are rising.

Thirty-five months without a meaningful correction is an excess itself.

It has become downright embarrassing for the cautious among us. Toward that end, a longtime and well-respected bear, technical analyst Sue Berge, gave up the 10% correction call this week.

Seasonality might also be a concern, as historically, markets often run into trouble in the July-to-October period. July and/or August highs are commonplace in the modern investment period. Some of the more serious examples developed in overbought markets in periods such as 1929, 1937, 1946, 1957, 1987, 1990 and 2007. Between now and November, investors and traders face atypically large uncertainties, including:

    -again, rising geopolitical issues
    -a Fed that is ending its bond purchases and is considering an interest rate rise
    -a potentially divisive midterm election that will set the stage for legislation in the years ahead.

To summarize, segments of the market are beginning to wear out, and certain conditions that have led to low volatility and an unrelenting bull market are looking like a rag doll.

July 28, 2014

Doug Kass: 7 concerns of the market

Despite headline records, market conditions (subsurface and not-so-subsurface) could be turning, and my net short exposure reflects my concerns.

1. We have a bull market in stocks but also in complacency (a self-satisfied view that fails to take into account adverse outcomes).

2. There are technical divergences aplenty (the beneficiaries of the market melt-up are narrowing).

3. Bears have become an endangered species, and some measures of investor sentiment are at a bullish extreme.

4. The fuel of corporate buybacks (junk bonds) is starting to retreat from bubble-like conditions.

5. Geopolitical risks are multiplying geometrically.

6.The domestic economic recovery has been an exclusive one.

7. Stock valuations (adjusted for normalized profit margins) are well above the historic averages, and financial engineering may not steer us to higher P/E multiples forever.

Originally published http://www.thestreet.com/story/12822220/1/rag-doll-taking-another-crack-at-citi-best-of-kass.html

July 22, 2014

Doug Kass advice for market moves right now

Unlike others, I am not recommending stocks.

That is your job, and it's your homework every day to distill all of the input (perhaps including mine and certainly some of the goodies on this site from people such as Jim "El Capitan" Cramer, Helene "The Divine Ms. M." Meisler, Rev Shark, Tim Collins, Paul "The" Price "Is Right" and others) so that you can to make sensible investment decisions relative to your risk profile and time frame. 

I will, however, suggest one investment this morning that I encourage you to consider.

As I warned multiple warning signs portend that the U.S. stock market possesses an unattractive reward vs. risk -- importantly, this includes the notion that geopolitical risks all around the world are rising geometrically -- and those signs are being ignored.

Again, some of these caution flags include rising valuations (adjusted for a normalization in corporate profit margins), climbing geopolitical risks, technical breakdowns (including but not isolated to a lagging Russell 2000), an imbalanced and exclusive domestic economic recovery and subpar U.S. and global economic recoveries.

These conditions provide a cocktail of market uncertainty that is likely to provide a market hangover. This is particularly true after a near-trebling in the S&P 500 since the generational bottom of 2009.

My investment suggestions this morning are simple and direct.

   - Step back and err on the side of conservatism now.
   - Maintain larger-than-normal cash positions.
   - Be more diversified across company/sector lines than is typical for you.
   - Trade opportunistically (with less frequency), and unless your time frame is measured in years, avoid investing for now.

Mr. Market will always be there for us, and when you feel it is a bit safer to return, do so.

Moving to a more specific strategy, recent events underscore a favorable reward vs. risk in closed-end municipal bond funds. The performance of the group this year is up by better than 10%, proving again that the tortoise can outrun the hare.

I own 14 closed-end municipal bond funds, and I have six of these names on my Best Ideas list. These funds are still at a larger-than-historic discount to net asset value and generate excellent (pre-tax equivalent) yields. As I have noted (and in support of the evident value), Nuveen recently announced a partial tender (10%) at 98% of net asset value for four of its funds. This asset class, highlighted in January in my "15 Surprises for 2014," could provide investors with not only a great risk-adjusted return but also a potentially large absolute return. 

VIA - http://www.thestreet.com/story/12779256/1/yellens-testimony-tanks-trade-dont-invest-best-of-kass.html

July 21, 2014

Janet Yellen and Fed policies creating more problems

To some degree, Yellen's statements are laughable.

    "Inflation sub-target" -- I thought the target was 2%?
    "Slack in the labor market" -- aren't we right near the 6% target?

The Fed isn't raising rates. It believes it can opine and twist and tweak words to manage the world economy. They are geniuses in booms and saviors in busts, but in reality, they are just dangerous interventionists whose policies are widening the wealth gap and creating immense capital misallocation.

If I were a senator, I would be throwing tomatoes on Capitol Hill today. 

July 15, 2014

Can job hiring lead to more output ?

Originally published on Thursday, July 10, at 8:47 a.m. EDT

Initial jobless claims came in at 304,000, down a bit from the prior week and better than consensus.

The four-week average is now 312,000, slightly above the low point in May.

Continuing claims rose for a third straight week, but only modestly.

The labor market is recovering with gains of over 220,000 on average per month for five consecutive months.

The key question remains for economic growth and corporate profit margins is whether the climb in hiring's and average hours worked can be matched by an increase in output and expanding productivity.

via http://www.thestreet.com/story/12772177/1/skeleton-in-the-eu-banking-closet-parsing-jobless-claims-data-best-of-kass.html

July 14, 2014

Doug Kass shares his worry on EU Banks effects on European economy

I spent the better part of my early Wall Street career following the banks. I have some Street cred.

It all began when I was a Nader Raider, and I wrote three chapters in Ralph Nader's book Citibank while an MBA student at Wharton. (It began my master's thesis, and I got an A+!) I then went on to the research department at Putnam Management, where I covered the banks, government-sponsored agencies, savings and loans and selected financial companies. (Institutional Investor Magazine voted me the No. 1 buy-side banking analyst in the 1970s.)

Leading up to the Great Recession, I accurately forecast that the deepening problems in the U.S. financial sector would lead to a massive global credit crisis and economic contraction. I made a lot of money being short Countrywide Financial, Citigroup  (C), Bank of America  (BAC), AIG  (AIG), MGIC Investment  (MTG), PMI Group, Radian (RDN), Ambac  (AMBC), MBIA  (MBI), Fannie Mae, Freddie Mac and others. Most of these stocks declined by over 90% when I was short them. At one point, several dropped by 99%!

Which brings me to the current situation in Europe's financial community.

Banco Espirito Santo has been viewed as a primary source of concern in the global markets this week. In reality, the Portuguese lender's credit problems and accounting irregularities are a one-off and don't represent a systemic problem.

There are more significant skeletons in the European banking closet, however, and Banco Espirito Santo doesn't reside in it.

Over the past two years, verbal jawboning by European Central Bank President Mario Draghi has artificially buoyed sovereign debt prices/values and depressed sovereign debt yields -- the banks in Europe are loaded up with this paper.

If the ECB experiment fails, the entire EU banking industry is in jeopardy, and a systemic failure will follow.

It is important to note that the European banking system is much more leveraged than that of the U.S. -- oversight and regulation is weaker, and EU banks play a greater role in their economies, as they are far larger relative to European GDP than in the U.S.

Thus far, the markets are not disconcerted and have accepted ECB policy/influence (artificial as it is).

But if, as it appears, the European recovery might be weakening (see below), therein lies the skeleton in the European banking closet. EU banks' balance sheets are filled with artificially priced and inflated notes and bonds.

via thestreet.com

July 7, 2014

If everyone is bullish should you be buy ?

Over the weekend the Bank for International Settlements warned that global stock markets and financial conditions might be irrationally detached from underlying economic conditions and called on central banks to abandon policies that have stoked asset price excesses. The BIS argued that markets might be unprepared for a rate rise and implied that investors might be too optimistic in their faith in global central bank policy.

I didn't need the BIS's two bits, as I have argued, and will continue to argue, that this is one of the most forgiving stock markets in history, as equity prices have arguably disconnected from the real economies.

The bullish meme has now morphed from the notion that the domestic economy will reach escape velocity and re-accelerate dramatically into the quarters ahead to the idea that the prospects for the expansion's length has improved.

No worries, argue the bulls, because the expansion cycle, though sub-par and substantially less robust than previous forecasts and cycles, will make up for a lack of strength with the prospects for durability and sustainability. And not only does the Fed have your back but so do corporations (in the form of aggressive share buybacks and heightened M&A activity).

It is this thesis of modest growth, reasonable dividends, continued share buybacks and eventually productivity enhancing capital expenditures that has been embraced by market participants. So, according to the bullish cabal, barring a black swan or adverse geopolitical event, a recession or any meaningful swoon in stock prices are years away.

The miserable economic and stock market experiences of 2007-2009 are distant and nearly indistinguishable shapes in the rearview mirror today.

As evidence of this, many money managers (e.g., Legg Mason's Bill Miller) who had fallen (badly) have now risen like a phoenix from the ashes and have regained their reputations.

In other words, fear has been driven from Wall Street.

Nevertheless, in its extreme, today's markets, according to the naysayers (who see subpar and unsteady global growth, vulnerable profit margins, disappointing profits ahead and a general detachment of markets from the real economy), are a fairy tale and are more representative of Hans Christian Andersen's, "The Emperor's New Clothes."

Originally published on http://www.thestreet.com/story/12760683/1/kass-the-emperors-new-clothes.html

July 2, 2014

Doug Kass 10 observations last week

-The Dow Jones Industrial Average has risen six consecutive days for the first time since late December 2013 and closed at another all-time high.

-The DJIA and the S&P 500 both are starting the summer very close to headline-grabbing, round-number benchmark levels (i.e. 17,000 and 2000, respectively).

-The 10-day NYSE put/call ratio has dropped steadily to the lowest level (fewest puts) since late December 2013.

-The VIX fell to another seven-year low last week below 11.

-Merrill Lynch reported a large $13 billion inflow into equity funds last week.

-The Official Monetary and Financial Institutions Forum survey of public sector institutions in 162 countries, which included 157 central banks, 156 public pension funds and 87 sovereign funds, showed tjat as they have seen income decline an estimated $200 billion-$250 billion, they have built public equity holdings of at least $1 trillion in recent years. Ergo, even the central banks are being forced into equities.

-Gold had a sharp rally through 1,280 to 1,300 an ounce resistance last week, completing what at least may be an intermediate bottom. The next more important resistance barrier is 1,400 to 1,420 an ounce.

-Oil rallied through resistance at 105 a barrel last week, as Iraq worries increased. According to technicians, the major breakout or resistance point for WTI crude is 110 to 111 a barrel. A move through that level would imply much higher objectives. Energy stocks continue to be current market leaders.

-The 10-year Treasury yield rose back to recent highs around 2.65% last week but failed to follow through -after the FRB policy announcements. As of yet, there has been no decisive change toward higher rates, but the 10-year yield chart is at a critical juncture.

-The search for yield and stability in equities continues and resulted in new highs in utilities, REITs, MLPs and consumer staples again last week. The Dow Jones Utility Average is the largest major sector index gainer this year, up 15.47%. Other large-caps with higher-than-average dividend yields or dividend growth are also in demand. Until bond yields turn up significantly, this emphasis on dividend income from stocks forced by the FRB zero interest rate policy may become the next big speculative excess.

Article originally published on http://www.thestreet.com/story/12754960/1/kass-10-observations.html