Commentary by John Dorfman
March 23 (Bloomberg) -- After falling 25 percent this year through March 9, the Standard & Poor’s 500 Index has bounced 14 percent, rising in six of the past nine trading sessions.
Is the grinding bear market of the past two years over? I suspect so and believe this is the rally I predicted on Feb. 23.
Even if this respite proves short-lived, though, it is worth looking at this surge for hints of where the stock market’s future leadership will come from.
So far, financial stocks, the very group at the heart of the long decline, have led the rebound. Since the March 9 bottom, five of the 10 best performers in the Standard & Poor’s 500 Index are financial-services companies.
Citigroup Inc. has rebounded 150 percent since March 9. Bank of America Corp. has bounced 70 percent. American International Group Inc., now majority-owned by the government, jumped 260 percent even as it was vilified for paying rich bonuses while accepting aid from U.S. taxpayers.
Of course, these stocks are still shadows of their former selves. Citigroup shares were above $55 at the end of 2006; today they trade at $2.62. Bank of America stock was near $54 in October 2006; today its price is $6.19. As for AIG, it exceeded $98 a share in 2000, and today languishes at $1.26.
Critics scoff that even a dead cat will bounce if thrown from the roof of a skyscraper. Personally, I am not tempted to buy AIG or Citigroup because they may need to send most of their profits (if any) over the next few years to Washington, as pay- back for the federal bailout.
Bank of America may seem tempting at 0.2 times book value (corporate net worth), but I’m resistant. The loss of $1.79 billion in the fourth quarter is probably not the end of the red ink for the Charlotte, North Carolina-based bank.
There are genuine values to be found in the financial sector, though. I think investors will see some dramatic recoveries by banks, brokerage houses and insurance companies over the next two to three years.
Berkshire, run by the redoubtable Warren Buffett from headquarters in Omaha, Nebraska, is active in insurance and reinsurance through subsidiaries General Re, National Indemnity, and Geico Corp. But it’s far from a pure play in finance.
The company owns in their entirety more than 70 companies such as Benjamin Moore, Clayton Homes, Dairy Queen, Fruit of the Loom, Nebraska Furniture Mart, NetJets and See’s Candy. It also owns stakes in about a dozen public companies, including American Express Co. (13 percent), Burlington Northern Santa Fe Corp. (23 percent), Coca-Cola Co. (8.6 percent), ConocoPhillips (5.4 percent), Kraft Foods Inc. (9.4 percent) and Washington Post Co. (21 percent).
Because these are minority stakes, Berkshire doesn’t directly get credit for their earnings. Accordingly, I believe that the price-earnings ratio of 14 for Berkshire stock is overstated. The true ratio is lower because the true earnings are higher.
Berkshire’s Class A shares dropped five months in a row, to $78,600 at the end of February from $136,600 at the end of September. Today they trade at $84,574, or 1.2 times book value and 1.2 times revenue. I think the shares are a bargain, and I feel happy that the ship is steered by Buffett, widely regarded as the best investor in the U.S.
Avoiding ‘Stupid Lending’
San Antonio-based Cullen/Frost has avoided subprime mortgages, no-documentation mortgages, interest-only mortgages, and other stupid lending practices. As of December, its non- performing loans were only 0.65 percent of total assets.
So far, the bank’s earnings are holding up well in the recession. In the fourth quarter it earned 89 cents a share, down from 93 cents the same quarter a year ago.
I’m drawn to Goldman Sachs because of its record of financial innovation, it’s skill in managing risk and a history of having its executives tapped for high positions in government. The big worry with Goldman is debt.
As I remarked in last week’s column, I underestimated the perils of debt when I invested in Bear Stearns Cos. early last year. With Goldman, I take some comfort from the fact that the firm had $15.7 billion in cash as of Nov. 30, up about $5 billion from a year earlier.
Over the same period, Goldman whittled its total debt down to $524 billion from $713 billion.
Investors’ perspective on financial stocks is bound to be tied into their view of Barack Obama’s administration and its ability to deal with the nation’s financial crisis. Critics see President Obama as a reckless, ambitious leftist. My judgment is that he’s an intelligent centrist, proposing bold remedies only because of the sweep and severity of our economic problems.
Disclosure note: I own Berkshire Hathaway, Cullen/Frost and Goldman Sachs personally and for clients. I do not currently have long or short positions in the other stocks discussed in this column.
(John Dorfman, chairman of Thunderstorm Capital in Boston, is a columnist for Bloomberg News. The opinions expressed are his own. His firm or clients may own or trade securities discussed in this column.)
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