Monday, May 16, 2011


Tough, tough market.

Unpredictable and increasingly volatile, without any leadership except the global consumer non-durables.

Not a good sign.

Bill Gross recently discussed the bond market, the U.S. deficit and Greece.

His key points include:

* Treasury Secretary Tim Geithner gave the U.S. debt limit "wiggle room."
* QE3 will take the form of language instead of buying.
* The IMF can do its job without Dominque Strauss-Kahn.


* A low in bond yields: The continued drop in the yield on the 10-year U.S. note to 3.15%. Last week, despite a large supply overhang, there was no change in the 10-year U.S. note yield. Several Treasury auctions were easily absorbed.

* A double dip in housing: A still-large shadow inventory of badly delinquent and foreclosed homes continue to weigh on home prices, which resumed their fall in first quarter 2011. There was little in the way of new or meaningful housing statistics last week. That said, mortgage rates did hit a five-month low and both refinancings and purchase applications improved.

* Worrisome group rotation: The continued improvement (absolutely and relatively) of the consumer nondurable sector. Last week consumer nondurables continued their leadership role.

* Weakening commodities: We have witnessed a decline in the price of copper (to below its 200-day moving average), oil and other major industrial commodities. The downward trend in commodity prices (and industrial and materials share prices) continued with a vengeance last week.

* Economic indicators flash caution: A multiyear low in the Baltic Dry Index, a weak household jobs survey, the ISM nonmanufacturing Index falls to the lowest level in nine months and, for the fourth straight week, we get an initial jobless claim print above 400,000. The University of Michigan survey improved. On the other hand, the Small Business Optimism Index dropped to an eight-month low. Meanwhile the initial jobless claims stayed higher than 400,000 for the fifth straight week.

* Emerging weakness in non-U.S. markets: A break is developing in the natural-resource-based regional markets of Australia, Mexico, Canada and Brazil. Emerging markets continued to break down in response to the descent in commodity prices.

I don't necessarily admire GS as a company; or a number of decisions its leaders have made over the last 5 years or so. That said, let's take a look at the bullish case for Goldman.

To me, buying Goldman Sachs is analogous to when Whitney Tilson and Glenn Tongue were deftly buying BP after it had experienced the threatening oil spill and its shares plummeted.

The issues Goldman has with the government are its oil spill.

Based on my analysis and for the first time in quite a while, Goldman represents a potentially interesting value investment.

Its shares have gone done in a straight line from over $170 a share in January to its current level of about $141 a share during a potent bull market run for the indices.

Frankly much of Goldman's government "problems" (brought up in Dick Bove's research) are not new -- they have been known for several years.

And I have read Mike Taibbi's Rolling Stone article. It was an entertaining read, but much of it was hyperbolic. Taibbi's articles always are.

I understand that today's Goldman Sachs is not John Whitehead's Goldman Sachs. I don't intend to be an apologist for the brokerage -- as with numerous other financial institutions, mistakes were made in a relatively freewheeling, overly leveraged and under-regulated period. And, as a consequence, Goldman Sachs has become the whipping boy, with all the attendant valuation vulnerability and uncertainty.

But I am also mindful of what both former Gov. Jon Corzine and Omega's Lee Cooperman said about Goldman on CNBC last week:

1. The best and brightest still reside there;
2. Goldman generally conducts itself in an ethical manner (it is part of the company's heritage); and
3. The company will rebound from the errors made in the last cycle.

With the shares trading at around $141 a share, there appears to be good value relative to the company's current stated book of $130 a share (which should rise to $140 a share by year-end 2011.

So, I now have the opportunity of partnering with Goldman's partners (the smartest guys in the room) without paying a premium to book value.

This is a bet I am willing to make given its leadership in trading (agency and proprietary), mergers and acquisitions and general investment banking strengths. Moreover, as measured against its peers, Goldman Sachs has the strongest capital position and is the brokerage closest to meaningful capital return (through buybacks). And, even with the institution of Dodd-Frank legislation, Goldman's earnings appear to be capable of growing at 10%-15% a year, and the company has more than $40 billion in revenues (annualized) and "earnings power" in excess of $20 a share.

The risk, as I (and others) see it, is that Goldman is seen as a continued "target" of legislators and politicians -- contributing, potentially, to a secular contraction in its P/E multiple.

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