Timothy Geithner, the Law of Supply and Demand, and Better Days on the Horizon

Soon, we will begin to see the outlines of the Obama plan to aid the banks. The administration has said that after Secretary of the Treasury-designate, Timothy Geithner, is approved by the Senate he will describe the administration's programs aimed at unfreezing the banks. In recent weeks, the idea of an "aggregator bank" appears to be gathering steam. The aggregator bank would buy the bad assets, or toxic loans from the banking system at heavily discounted prices, which would then allow the banks, sans the toxic loans, to get back to banking. This may sound much like the original TARP plan, but that plan was scuttled after it became clear that the economy was slowing much more rapidly than anyone had thought. This necessitated that the banks first be provided with more capital to allow them to withstand the increased loan losses that were hitting all their product lines. The aggregator bank would operate along the lines of the Resolution Trust Company (RTC) which was very successful in cleaning up the S&L crisis of the late 1980s and early 1990s. The idea of the government getting more involved in the banking system is a scary thought, especially when congressmen and women all speak in a four-word mantra: loan money or else. Forced lending on housing by the government is one of the reasons we have a credit crisis. There are also fears that some banks will be nationalized, or taken over completely by the government. All of this combined with just awful earnings from the banks to send stock prices scurrying to recent lows. Timothy Geithner is a name we are all going to hear about on a daily basis. Let's hope that he has a better stage presence that Henry Paulson. I'm not as down on Mr. Paulson as many people, but I do agree with his detractors that the TV cameras were not kind to him, making him come off as winging it too often. In fairness to Mr. Paulson, since he was seeing things on a daily basis that he had never seen before, maybe winging it was all he could do. I continue to believe that far too many investors are betting that a depression type decade is ahead of us. I simply cannot get there based on what I see. We have a massive bank bailout plan combined with a massive fiscal stimulus package for the economy. Taken together they could total over 10% of GDP. That magnitude of underpinnings for the economy will have an positive effect. If it does not, then the laws of supply and demand have been rescinded. That cannot be true because the law of supply and demand is what brought us the banking crisis we now face. I continue to be more optimistic than the headlines you are reading on most media. Remember this: no one thought the tech boom would ever stop and therefore investors bid tech stock P/Es up to triple digits. The law of supply and demand has now reduced tech stock PEs to the mid teens, a painful recalibration. No one thought that real estate would ever fall in price, thus no price was too high to pay for a square foot of prime real estate. Today it was announced that the price of of the average house in the US had fallen by nearly 15% from a year ago. There is no shortage of bad news, but the laws of supply and demand have not been rescinded. In today's bad news about housing there was some good news that got very little press:

• Jan. 26 (Bloomberg) -- Sales of previously owned homes in the U.S. unexpectedly rose from a record low, propelled by the biggest slump in prices since the Great Depression as foreclosures surged.

The second part of the news story got lots of ink. The first part, which is just as important, got very little ink. Yes prices are falling, and we are still immersed in a real estate correction, but just as certainly are the bargain hunters now in the game. Last month there were 4.74 million previously-owned homes sold in the US, up 6.5% from the same month a year ago. In addition, the Conference Board's index of leading economic indicators also rose modestly. The first rise in six months.

The real estate market will not turn in a made-for-prime-time, high-definition broadcast captured by old news and new news alike. It will turn in a ragged, ugly, halting manner, but it will ultimately turn. It's good news that more houses are are beginning to sell around the country, even if prices are still falling. There is life in the housing market. The oversupply of housing has driven prices down to meet demand. In a few months, the government will announce that prices have stopped falling. That will be a happy day for all of us. My prayer is that Timothy Geithner plays a big role in causing that good day to come swiftly.

WW Grainger: Another Industrial with Relative Strength

I continue to believe that the bears on the Industrial sector are wrong. The reason is partly based on my belief that the worldwide infrastructure build out, while slowed, is still alive. A couple of weeks ago I showed that Emerson Electric was trying to put in a bottom. I also indicated that our models suggested that EMR was undervalued.

Another stock that is showing remarkable relative strength vs. the S&P 500 is WW Grainger(GWW). GWW, one of the world leading providers of maintenance, repair, and operating supplies has had an impressive string of earnings and dividend hikes over the last few years and has continued to do well in recent quarters.

GWW's Dividend Valuation Chart above currently shows the price line (red line) buried deep into the value bar (blue bar). To us this means the stock is currently significantly undervalued. Projecting in next year's dividend growth and change in interest rates, we see an even higher value bar as show by the striped bar to the far right. With the stock trading near 76, our model is making the case that GWW may be as much as 25%-30% undervalued.

The chart shows that this is as deeply undervalued as GWW has been in 20 years. If the world economy is turning to dust, GWW will not be immune. However, if the collective efforts of governments worldwide to stimulate growth through increased emphasis on infrastructure is successful, the company is likely to continue its good trends of earnings and dividends growth.

The authors, DCM staff, and our clients own this stock. Do not make investment decisions based on this blog. It is for information purposes only.

Home Sales May Be Nearing a Bottom, Banks to Follow?

I remain optimistic that housing is nearing a bottom. Collapsing prices have created very good buying opportunities and a pick up in home shopper traffic. Add to the fall in prices, the recent sharp reduction in 15 and 30 year mortgage interest rates (now under 5%) and housing is becoming very, very cheap by any standard, including replacement cost. My optimism on housing encourages me to be optimistic on banks, even in the face of all of the bad news about loan losses. In my judgement, most banks in the US have been trying to get out ahead of their actual losses by setting aside reserves greater than they believe will be necessary to cover their losses. They have been doing this, not to deceive investors, but to take the loan loss reserve issue off the table. If they can do this, then bank stock prices will turn higher for good because it will be clear that the worst of the housing debacle is behind us. It is with this in mind that the upcoming earnings reports from the banks are of keen interest to me. There will be gains and losses on a reporting basis, but my eye will be zeroed in on what the banks do with the loan loss reserves. If they increase them appreciably, the turn in the banks is months away. If reserves stay near their current levels or rise only modestly, the turn in bank stocks may be near. Tomorrow JP Morgan reports. They are as important a bank as there is in this country. They will set the tone for those that are to come. Over the next two weeks the following banks will report earnings. Marshall and Isley, First Horizon, Bank of America, Northern Trust, US Bancorp, Bank of New York, BBT, Fifth Third, Key Banks, and Sun Trust Banks. My guess is that there will be a mix of adjustments to reserves among these banks, but the stocks will all be treated alike. If JP Morgan and Bank of American report tame loan loss reserves, all the banks will rally. If the big banks have worse than expected numbers, all the banks will get hit. Having said this, even if the loan loss reserves numbers are not good, I still believe the high quality banks are near a bottom. I believe this because I believe that real estate has gotten cheap enough that drive-by shoppers will increasingly stop in for a look, and when they do, the combination of price and mortgage cost will turn shoppers into buyers.

Emerson Electric: Heating Up?

Investors decided in September and October that the global economy was not decoupled from the US economy and slammed both international and domestic stocks. If the US was catching a cold, then the rest of the world would soon be sniffling. Indeed, world economic data fell off the table almost as swiftly and as deeply as it did here in the US. The string of very weak economic releases both in the US and around the world makes the chart above of Emerson Electric (EMR) very curious. The chart is of EMR's price movements over the last 12 months. Emerson's large book of international business explains its September-October collapse, but the rolling bottom from November through today is hard to explain from at least three levels:

1. Why should an cyclical industrial stock that sells big ticket automation equipment be bottoming and turning higher without any signs of improvements in the US or world economies?
2. Why should a stock with big export business be turning up when the higher dollar would seem to have diminished the company's competitive advantage?
3. With all the bad news out there, why would any stock be trying to lay in a bottom, as EMR's chart appears to be.

I think the answer to all three of these questions -- and all the others that may come to mind -- is simple: investors are beginning to get a better feel of how long and deep the recession may go on, and who the ultimate winners will be.

If the Federal Reserve and the US Treasury are going to prop up the banks and other key industries, and the new Administration is gearing up to stimulate the US economy by as much as $1 trillion, the economy may show positive results faster than many people thought possible just a few weeks ago.

Emerson bills itself as "a diversified global manufacturing company that brings technology and engineering together to provide innovative solutions. . . ." If the stock is turning, investors must be concluding that the global economy is not on its death bed and that the combination of the undergirding of the banks and the speedy initiation of government stimulus packages around the world will show results over the next 12 months.

Our models indicate that EMR is undervalued. The recent attempt at a bottom is a good sign that this undervaluation is being recognized by more and more investors.

The author does not own the stock, but is intrigued by its recent action.