1. Rationale for the Regional Bank Strategy: There are several ways for the Regional Bank Stocks basket strategy to work over the next ten years. And the past few months have provided examples. The recent drop in stock prices and fears of an upcoming double dip illustrate how it may fail. Then, they may be individual stock successes and failures among the banks in the basket irrespective of what is happening to regional banks as an asset category.
First, I would expect a number of the regional banks in the basket, currently at 38 names, to be acquired in an on-going banking consolidation. Last week, I received a 100% pop in the shares of Wainwright (WAIN) after it agreed to be acquired for $19 in cash. Sold 50 Wain at $18.7-Being Acquired Bought 50 WAIN at 8.72
None of the purchases have been made based on such possibilities, nor would I buy a bank stock based on such a speculative strategy revolving around potential buy-outs. Still, I expect this consolidation to continue and to benefit from it in the coming years. A Keefe, Bruyette and Woods report released last week identified several possible sellers including a few that I am monitoring but do not currently own. MarketWatch NYT I have no interest in Western Alliance Bancorp, one of the banks mentioned in this report as a potential seller. Another one, Susquehanna (SUSQ), is already owned and I have been considering whether or not to increase my stake. Since I initially put SUSQ in category 1 which limits my investment to $300, I would need to elevate its status to category 2, with its $2000 limit, before adding shares to my existing position. I sold my shares in Wilmington (WL), another potential acquisition candidate identified in the KBW report. Sold 100 Wilmington Trust (WL) at $14.13 The shares are now trading just above $11. I have been considering buying those shares back but I want to see a decent earnings report before doing so.
Although the regional bank strategy is long term, I will sell a bank in the basket for one of several reasons. WL was sold due to my negative reaction to the earnings report released before that sell (Q/E 12/2009), and that opinion was subsequently reinforced by the report for the Q/E 3/2010. So, I am trying to be disciplined about implementing and managing this strategy.
Second, for the Old Geezers out there, it only seems like yesterday when the banks managed to blow themselves up with bad real estate loans in the late 1980s and the early 1990s, commonly known as the S & L crisis even though the problem extended to commercial banks as well.
There are a couple of lessons to be learned from that historical event. First, bankers are not that smart. Eventually, given enough time and a little rope, many of them will find a way to destroy or severely damage their bank. In my lifetime, nearing the start of its 6th decade, these blow-ups have happened repeatedly, over and over again, and it would be foolish to predict that the bankers will learn anything to avoid such mishaps in the future (a few exceptions to any rule of course). But, after the blow-ups occur, the share prices swoon to single digits, and the FDIC and the American taxpayer clean the mess up. The stocks of the surviving banks are then in a position to begin a long term bull move, assuming the recession does not turn into another Great Depression. The American economy has proven resilient to the tireless efforts of a few overpaid Masters of Disasters to undermine its vitality. So, when the economy finds its sea legs again, even the most poorly run financial institution can prosper.
If you want to buy a bank stock, it is best to just wait for the bankers to blow their institutions up. Then try and figure out which ones may survive and at least have some turnaround potential. It helps to buy some at the period of maximum pessimism. An example of that approach was my 50 share buy of Webster Financial (WBS) at $4.58 in March 2009. Generally you do not have to wait very long for this potential buying opportunity to occur. The current fiasco, however, started to germinate about 15 years after the last one, which is a long time historically for the bankers to go without blowing their banks up. Five to ten years seems to be an appropriate time frame to mark the exit from the regional bank stock strategy, rather than hoping for another 15 year run.
Third, many of the banks will grow during the Fiasco Cleanup period as a result of FDIC assisted acquisitions of failed institutions. I received a good pop on the shares of East West Bank (EWBC) after it acquired a failed bank with FDIC assistance. East West Bank/ I went ahead and sold my shares for the reasons explained in this post: SOLD 50 EWBC at $19.04 Buy of 50 EWBC at $5.7 Some of the smaller banks will become large regional banks before the current crisis is over.
Fourth, many of the banks will cut or even eliminate their dividends during the Fiasco Period. This makes them unsuitable for buy and hold investors and retirees interested in a reliable stream of income. But, if you buy one that has been smashed to say $5, and then survives, there is the possibility that the bank will start to increase the dividend again.
Since my cost is constant, each increase in the dividend increases my yield. It would not be uncommon at the end of a long bull market in bank stocks to see a dividend yield of greater than 20% based on the constant cost purchase at extremely depressed levels during the Fiasco Period. To illustrate this point, I used Webster Financial as an example, assuming the bank eventually restored its dividend to 2007 levels while my cost remained constant. Item # 1 More on Regional Bank Strategy In that hypothetical, the yield would be over 25%.
Anyone can go back and time to test this hypothesis. You would simply take a bank stock price in 1990 or 1991, and assume a purchase at a price prevalent at that time. Then, go forward to say 2005, and find the annual dividend rate for that year. How much is the yield then based on your constant cost?
Fifth, I thought that it was nonsensical for the market to trash well capitalized banks, who continued to earn money during the Near Depression, and who maintained their dividends and even increased them in some cases.. Many of them refused to participate in TARP. There are several banks in the regional bank basket that fit these criteria. The NYB purchases, for example, were made at price to yield around 9%. Added 50 NYB at $10.57 50 NYB at 10.9 50 NYB at $11 Bought 50 NYB at $11.3 (NYB subsequently benefited by FDIC acquisitions).
A smaller bank, UBSI, was increasing its dividend and was bought at a price to yield of 7%. In other words, banks who did not drink the kool-aid will go down too during the Fiasco Period. A number of these smaller banks, which at least appear to be much better run than their larger brethren, have dividend yields in the 4% to 6% range, refused TARP money, and continue to generate earnings even during the worse period of the Near Depression.
In conclusion, I ultimately do not know the names of the banks that will fulfill the principal goals of the regional bank strategy. That is why I have a basket of them, and limit my financial exposure to each name, based in part on how badly the institution fared during the Near Depression. I have very negative opinions on some of the institutions placed in category 1 but some of my largest percentage gains have come from those names, which justifies in retrospect including them with the $300 maximum limit. If the economy enters another recession between now and the expiration time frame for this strategy (2014-2019), then the stocks in the basket will lose value. I have already had about 5 grand in unrealized gains go up in smoke just on the fear of a double dip. So there are risks to any long term strategy such as this one.
2. The Age of Leverage and Its Aftermath: Once the Age of Leverage came to an ignoble end in the summer of 2008, bringing the world's financial system to the edge of the abyss, the most pressing problem was to prevent the onset of another Great Depression. This was accomplished in the U.S. by both the TARP program, widely derided by the tea party crowd and most members of a certain political tribe, and the Federal Reserve's monetary stimulus. By 2007 there was no way to avoid the train wreck that was about to occur, and there will be no quick way out of the mess.
The chart in this NYT article shows graphically the impact of the recession on the unemployment rate compared to past recessions. There is no panacea to this kind of debacle once it happens.
3. Historical Time Periods for Unstable and Stable Vix Patterns and S & P Movement Within Each Pattern:
In numerous posts I have discussed the importance of identifying whether the U.S. stock market is in an Unstable or Stable Vix Pattern for purposes of providing some guidance about asset allocation and trading strategy decisions.{ See, e.g. More on Failures of Standard Asset Allocation Models and Target Funds/Use of Volatility in an Asset Class to Make Adjustments to an Asset Allocation Trading and Asset Allocation in Stable and Unstable VIX Pattern The Roller Coaster Ride of the Long Term Secular Bear Market }
The following synopsis assumes familiarity with the broad contours of the VIX Asset Allocation Model as outlined in Vix Asset Allocation Model Explained Simply With as Few Words as Possible. The application of the model to an asset allocation decision in 2007, which mandated a reduction of stock exposure in August 2007 after a Trigger Event, a major disruption in a Stable Vix Pattern, is outlined in VIX Chart from 2007: Alerts and Triggers Major Disruption of Cyclical Stable Bull VIX Pattern.
Some other important posts that discuss the importance of these events in asset allocation and trading strategies include the following:
In the following Table, I am defining the periods of the Unstable and Stable Vix Patterns since the onset of the VIX data in 1990. At the start of the Vix data series in 1990, the stock market is in a cyclical bear market within a long term secular bull market starting in August 1982. I am marking the end of an Unstable Vix Pattern by continuous movement below 20 in the VIX for 3 months, allowing for some minor and short term movement above 20. Before making an asset allocation change after the start of the Unstable Vix Pattern, I wait for the return of the VIX to below 20 after the Trigger Event. This has worked since 1990 but may not in the future. It permits the investor to sell at a better price after the Trigger Event, which is invariably associated with a decline in stock prices.
Stable VIX Pattern: March 1991 to October 1997
Unstable VIX Pattern October 1997 to October 2003
Start of Unstable Pattern: S & P 500 at 1012 (Measured not from Trigger but return of Vix to less than 20)
Stable VIX Pattern October 2003 to August 2007
Start of Stable Vix Pattern: S& P 500 at 1050
Return of VIX below 20 After END of Stable Vix Pattern in 8/2007: S & P 500 at 1525 (9/17/2007) ^VIX: ^GSPC
Unstable Vix Pattern August 2007 to Present
Return of Vix to Below 20 after Start of Unstable Vix Pattern: S & P 500 at 1525
Currently: S & P 500 Closed Friday 7/2/2010 at 1022.58.
I date the start of the long term secular bear market in October 1997 and one reason is shown in the foregoing. The start of an Unstable Vix Pattern in October 1997 is coupled with a return in the S & P 500 back to the level that the model said to sell in February 1998. Even during an Unstable VIX Pattern, there can be profound up cycles which could be profitable for those who are lucky enough to play the move. However, the lesson from the Vix's history is that the market will end an Unstable Vix Pattern period at or below the starting point, usually after a number of years. Before the onset of the current Unstable VIX Pattern, the prior one lasted SIX YEARS. I suspect, more of a guess, that the start of the next Stable VIX Pattern will start below S & P 1525, possibly around S & P 1250, possibly in 2 or 3 years, near the mid-point of the last Stable VIX Pattern move.
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