The Iconoclast Investor

You can say all you want that we’ve been in a secular bear market since 2000 … and you may be right.  But secular bear or not, that didn’t stop many big winners from lifting off from 2003-2007, including Apple, Google, First Solar, Crocs, Research in Motion, Coach, XM Satellite Radio, Intuitive Surgical, Potash, Mosaic, Intercontinental Exchange, Nasdaq Stock Market, Southwestern Energy, Ultra Petroleum … need I go on?

The reverse is also true.  We might have been in a secular bull market during the 1980s and 1990s, but many investors lost most of their capital during the ‘87 crash, the 1990 bear move or the ‘97 and ‘98 emerging market debacles.

Listen, I’m a long-term investor, and I plan on being involved in the stock market for decades to come.  But allowing the secular-cyclical, bull-bear debate to affect your investments can be a mistake.  It’s better to just go with the evidence the market has presented.  Right now, the market timing indicators I follow are still bullish, although the recent correction brought a couple of them close to the brink.

In the longer term, I’ve written before in a few different spaces that I do believe the bear market is over and we’re in a new bull market.  The main reasons I believe this are (a) the huge decline that has already taken place since 2007, which brought about 50-year lows in consumer and investor sentiment, (b) the bottoming process from October through March of this year, which repaired the damage from the crash (c) the minuscule number of stocks hitting new 52-week lows even during the market’s latest pullback (still in the single digits!), and (d) a couple of the “blast-off” signals the market flashed in March and April (such as 90% of all NYSE stocks getting above their respective 10-week moving averages).

Maybe a better way to say it is that, given the above, I think the odds are heavily in favor of this being a new bull market, not just a brief rally.  However, there are no 100% bets in the stock market–as we’ve seen during the past year, anything is possible in the stock market.  If my indicators turn decisively negative, am I going to say, “Well, this is just a pause before a renewed upmove.  Buy with both hands!”?  Of course not.  I’m going to go with the evidence, i.e., raise some cash, try to hold on to my strongest performers, and then re-evaluate the situation every day.  Let someone else make the bold call–remember the saying that “there are old traders, and there are bold traders, but there are no old, bold traders.”

So far, the indicators are positive, and while the past couple of weeks have been damaging to a wide array of stocks–from leaders to off-the-bottom stocks like financials and commodities–I’m still betting that this is a bull market.  Cyclical or secular?  I’ll let you debate that one.

While every investor knows the terms bull market and bear market, every investor seems to have a different definition of each.  Some people consider any period of rising prices a bull market.  Others require that prices generally rise for a certain time–maybe six months–to be called a bull market.  And of course there’s the popular (though highly flawed) view that any 20% move up in an index represents a new bull market, while a 20% decline constitutes a bear market.

Adding complexity to these simple phrases is the cyclical versus secular debate.  Simply put, a secular bull market is one that supposedly lasts many years or even decades.  The years 1982-2000 are often called a secular bull market–on a very long-term chart, prices headed higher during that time.  But you also had individual bear markets within that time, lasting maybe six to 12 months each, before the bulls retook control.

On the flip side, the 1966-1982 period is often referred to as a secular bear market; the Dow didn’t make any progress during that time!  But within that period you had numerous cyclical bull markets, again, each one lasting six to 12 months, before the bears retook control.

That brings me to today, as some people are referring to the current three-month upmove as just a bear market rally.  Some are referring to it as a cyclical bull market within a secular bear market that began back in 2007.  Still others think we’ve been in a secular bear market since 2000, while others believe we’re in a new bull market.

Confused yet?  You should be!  I like a good debate as much as the other guy, but in this case, I find the whole secular-cyclical-bull-bear debate to be a waste of energy.  I specifically remember when I was at Prudential Securities back in the late 1990s, and the market was beginning to fall apart thanks to the Russian ruble and Long Term Capital Management implosion.  At the time, Ralph Acampora, who was head of Prudential’s technical analysis team, was on the squawk box, telling all the brokers and money managers he was turning bearish for such-and-such reasons; the specifics aren’t important.  (For the record, turning negative was a good call.)

What I do remember is that one of the brokers asked a question:  “Ralph, do you think this is a correction?  Is it a cyclical bear market within a secular bull market?  Or is it the start of a secular bear market?”  I will never forget Acampora’s answer:  “Call it a banana for all I care.  Prices are heading down.”

At the time I liked to debate and was a bit disappointed in his answer.  But as the years have passed, I have learned the value of what he said.  Really, the whole debate is just semantics and takes away from the major goal–making money.

Have all banks run amok? Not quite. I’ve gone out on a limb lately and recommended a couple of banks in the advisory I edit, Cabot Benjamin Graham Value Letter.

Hudson City Bancorp (HCBK) owns and operates 127 savings bank branches in northern New Jersey and New York City. The bank specializes in writing jumbo mortgages in the more affluent counties of New York and New Jersey. High loan standards and the avoidance of the sub-prime market have led to Hudson City’s strong balance sheet and low mortgage defaults.

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Hudson City is taking advantage of the current favorable interest rate environment and the lack of competition in writing jumbo mortgages. However, the company’s banking area includes residents who work in NYC’s hard-hit financial district. We expect earnings per share growth of 13.3% during the next 12-month period, which we believe will be sustained in future years. The dividend has been increased every quarter for the past six quarters and now provides an attractive 4.6% yield.

HCBK are undervalued at 11.6 times forward EPS. The bank’s unique niche in the banking sector and conservative lending practices make HCBK an attractive long-term holding. We expect HCBK shares to advance to our Minimum Sell Price within two to three years.

And …

Wells Fargo (WFC) provides banking, insurance, investment, mortgage, and consumer finance services throughout North America. Wells Fargo, founded in 1929, has been conservatively operated and therefore has experienced lower loan losses than most major banks.

The acquisition of Wachovia at the end of 2008 will more than double Wells Fargo’s loan portfolio to $850 billion. The purchase, however, added a greater percentage of delinquent loans and mortgages than the company’s recent experience. Wells Fargo has raised additional capital to meet new Federal requirements, but will need to raise additional capital soon.

We expect loan losses to diminish substantially before the end of 2009. We believe the banking industry faces challenges that will linger for several more years. Wells Fargo, though, is in good position to take market share from other banks, because Wells Fargo is generating strong cash flow and is improving its balance sheet. In addition, the acquisition of Wachovia at a fire-sale price presents a huge opportunity for the company to cut costs and streamline operations during the integration process.

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WFC’s EPS were only $0.83 in 2008 but will increase to about $2.00 in 2009. At 11.5 times our $2.00 estimate, WFC shares are a bargain. The dividend, which was reduced recently, now yields 0.9%, but dividend payments could be increased as early as 2010. Warren Buffett is a major investor and Whitney Tilson, co-founder of the Value Investing Congress, recommends purchase.

I bank at one of the larger banking institutions in this country and have kept my account there for a number of years. My loyalty has been tested lately, though, on more than one occasion. I won’t go into all the details, except to say that my latest encounter was the doubling of the interest rate on my credit card for no apparent reason.

My problems, though, are minor compared to bank customers who have over-borrowed and cannot keep up with the required payments on their credit cards, loans, or mortgages. And therein lies the crux of the entire problem. For the past 25 years, consumers have been borrowing too much so they can enjoy the good life. State and local governments have been borrowing too much so they can provide more and more services. And now the U.S. Government is running huge deficits to help prop up a troubled banking system and a sinking economy.

Banks have received rather large sums of money to help them through their financial crisis. We all have been reading for the last several months about bank executives receiving large salaries and bonuses partially funded by the bailout money from you and me. It seems to me that bailout money ought to be restricted to help banks stay solvent and to provide much needed capital to make loans to you, me and businesses of all sizes.

I concluded long ago that banks loan out tons of money when the economy is robust, but then become fearful and make loans hard to get when the economy is tanking. It seems to me that this phenomenon exacerbates the economic cycle. Loaning more money when we really, really need it during economic downturns would make more sense and help the U.S. economy avoid the up and down cycles that are harmful to so many. What’s the solution? When times are good, banks and the rest of us should save for a rainy day.

While I’m on a roll … “Too big to fail” scares me. What is too big, and how is too big going to be determined? Will there be two banks that are too big, or will there be 100 banks that are too big? And what is going to be done about these banks besides pumping trillions of our tax dollars into “big” banks when they run into a problem or two. My solution? Go back to the good old days when banks did banking, brokerage firms offered brokerage services, mutual fund companies ran mutual funds, and insurance companies offered insurance.

Now we have financial institutions, like my bank, that offer all of the above and more. “Jack of all trades and master of none” comes to mind. Maybe we should break up our so-called financial institutions by restricting the services that they can offer. Oh no, did I say break up banks? My dad would roll over in his grave if he heard me offer that suggestion. But, as a customer, I would like to be dealing with an expert rather than a jack-of-all-trades. As an investor, I would prefer investing in a few stodgy old banks that pay hefty dividends on a regular basis, rather than financial institutions with questionable investments.

One final thought on how banks and financial institutions should be regulated in the future to prevent another financial crippling financial crisis. We have a lot of regulations already in place that would have helped keep us from getting into this current mess. If the Securities and Exchange Commission (SEC) had diligently done its job, Bernie Madoff would not have gotten away with bilking hundreds of investors out of billions of dollars.

We even have banking guidelines that suggest that banks avoid investing in risky investments. Evidently, regulators found that the word “risky” is vague and didn’t know how to apply such a rule. OK, let’s add an amendment or two to prohibit banks from specifically investing in derivatives, credit default swaps and all similar gambling strategies that might be created in the future. And it goes without saying that all regulatory authorities should be well staffed and well funded to ensure that all regulations are fully enforced. Enough said!

With most stocks getting hit in the past week, it’s hard to find a stock that’s at a pristine buy point.  And, frankly, even if I saw one, I’m not sure it would work out–when the market is under pressure, good stocks can go bad in a hurry.  So I want to highlight a company with a new product, with outstanding sales and earnings growth, and whose stock is probably the strongest in the entire market–in other words, it’s a potential winner once the bulls re-take control.

The company is STEC Inc. (STEC), which I’ve written about a few times in both Cabot Market Letter and Cabot Top Ten Report.  On the surface, the firm appears to be just another semiconductor firm, producing solid-state (read: flash) drives.  And there’s nothing special about that; SanDisk and others produce flash memory for many consumer devices, and at this point, flash is just a commodity product.

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However, STEC Inc. does not produce flash memory for consumer products–it’s targeting large-scale commercial uses like servers and huge storage devices.  And it turns out these drives are NOT run-of-the-mill; STEC Inc. has basically no competition, and that’s a big deal because the drives save tons of component and power costs (up to 50%!) and boost performance markedly when compared to hard disk drives.

IBM is using STEC’s drives in two of its most popular storage and server systems, Fujitsu is using STEC’s drives in one of its storage systems, and Hewlett-Packard is also a big-time customer.  Right now, demand is so strong that STEC just upped its second quarter earnings guidance … causing a massive 30% jump in the shares.

Honestly, I do think you could nibble here, maybe buying a token position … but I’m content to simply watch it closely and wait for a better-looking entry point.  If the market has indeed shrugged off its case of the jitters, I expect STEC to enjoy further upside.  Keep it high on your own Watch List.