Stock Gurus: Meredith Whitney

Meredith Whitney appeared on CNBC on Monday, 11/16, on CNBC's Closing Bell after Bernanke’s speech. I don’t always agree with Meredith, but she’s always insightful and her opinions are backed up by solid analysis. The only caveat is that timing may be an issue for her. For me, her comments make sense, question of when things will happen, and perhaps if they will be as severe (which is related to timing. Timing more spread out, less severe). Here’s the highlights of her comments:

- Mortgage Backed Securities. Bernanke didn’t say much. She wanted him to talk about the agency mortgage-backed purchase program, and he didn’t. The Fed has been buying Fannie, Freddie agency mortgage paper, and it’s 1/3 of their balance sheet, was zero at the beginning of the year. Fed is probably buying more than 100% of what’s available. Through these programs, rates are low, 20% of the banks’ capital has been created (estimated), allowed bank asset values to rise. Program almost done. When Fed exit, interest rates go up dramatically (probably more than 10%), affordability goes down, credit losses spike again, another leg down in the housing market. “I haven’t been this bearish in a year.”

Other programs have wound down, except for agency MBS. Extend program, Fed becomes one of the largest buyers of junky debt. Deed for lease program. If you can’t afford modification, then gov will rent house. So does gov become direct owner of US real estate?

- Consumer. Doesn’t Understand Why Stocks Are Up. Particularly in the consumer space. No fundamental reason. Plus contraction in consumer credit. Never been so much consumer credit contraction, even in Great Depression. In 1990-91, contraction, but securitization provided liquidity to consumers, consumer actually had more liquidity during that time. $1.5 trillion of credit lines pulled from the system. Is now re-accelerating. Not a good Christmas coming. “There’s nowhere to hide at this point”.

Retailers have reduced inventories, so that may be better. But so many credit lines cut, the middle class is getting squeezed the hardest. Worry about that most. Also getting kicked out of banks.

- Banks. To pay back TARP, banks will have to raise capital again. Adequate capitalized today? No way. Trade has been short regionals, long capital markets banks. Works because government behind capital markets. “If the lifeguard is on duty, people will jump into the pool”. Lifeguard will go off duty, just don’t know when. Capital markets volumes will be down. Equity volumes down, fixed income volumes are down, so big banks are converging closer to the regional banks. Reducing weightings on big banks.

But still, their stocks are rallying, doesn’t make sense. No root in fundamentals. Money on sidelines – never underestimate, usually goes to smarkt places. But now money not going to agency MBS. No substitute buyer. Money going to hard assets, businesses, gold. No one is buying mortgage backs.

Dip like last year? Don’t think so because before had mark-to-market accounting, makes big difference. Don’t think BAC will go back to $3. But thinks banks will go back to tangible book value. Have said this for 2.5 years now. Only trade above when there are core earnings. But increasingly clear, core earnings will not be what they claim. Likely will be ½ to ¾ of that, some fraction. Implying estimates will go down. Therefore, sell the banks.

- States. States need money. 44-48 states underfunded, and will be progressively more underfunded.

- Real Estate. Surprised Bernanke talked about real estate. Still residential real estate, many people have glossed over the fact that there will be another leg down in commercial real estate. Home ownership stands at 67.8%, will normalize at 65%. “Still the great sucking sound of liquidity coming out from the market.” Mortgage modifications – only 1% of trial modifications have gone to permanent modification status. Just waiting, 1^st quarter, when numbers show up, mortgage rates spike and fewer people qualify for mortgages, another leg down. Residential still much bigger threat than commercial. Banks assume real estate doesn’t go down further, 10% unemployment – already there. And states are still firing people.

- Where Put Money? Sit on cash for a little bit because you have to wait for leg down, S&P expensive across the board. Estimates have to come down, look opportunistically. Banks that are asset-sensitive to consumer credits are not where you want to be. Some core business that benefit from transaction services will benefit. Everything’s expensive now.

- Double Dip? Not as severe on second part of dip.

- What does it take to become more positive? Valuation, all about price.