Barclays is Cheap

After Wells Fargo and Bank of America raised their dividends in early August by 12% and 14%, respectively, we said it was a clear sign to us that they were not in the eye of the storm of the subprime problems, and their stocks were too cheap.


The chart at the right shows that both stocks have recovered smartly over the last two weeks, as it has become clear that, indeed, neither is likely to take big losses. As we write this, however, we believe both stocks may be still as much as 15% undervalued based on the long-term relationships between their dividend growth, interest rates, and their stock prices.



We want to add another stock to the list of banks that we believe has been unfairly punished by the recent liquidity crisis. Barclays Bank is a London-based bank with offices spanning the globe. They have three world-class divisions: banking, capital markets, and asset management (ishares Exchange Traded Funds).

The stock has fallen by nearly 20% over the last 60 days on fears of Barclay's involvement with sub-prime loans, private equity, and hedge funds. There is no way for us to know their precise exposure to these groups, but the company has repeatedly stated that they are not experiencing any large scale losses.


Barclays recently raised their dividend by nearly 18%. A dividend hike of that magnitude is real money since they now yield over 5%.



The chart at the right is Barclay's Dividend Valuation Model. The blue line is the actual annual price over the last 15 years, and the green bars are the model's predicted values. The chart shows a close association between the model and prices over the last 15 years and a predicted 2008 value of just over $55.

From today's price of approximately $49, including the dividend, our model is suggesting that Barclay's may be even more undervalued than BAC or WFC.

Barclays has been in business since 1736. With that kind of longevity, we believe they might know a thing or two about how to navigate financial storms. Their AA bond ratings ensures access to the capital markets and minimizes liquidity issues.

The bank has been in a pitched battle with the Royal Bank of Scotland to acquire ABN Amro, a Dutch banking giant. We believe that the market is worried that Barclays may be dragged into a bidding war. In our minds, Barclays had done a lot of things right over the past 270 years. We're inclined to follow with their judgment with ABN Amro.

Energy: The New Y2K -- Boeing, Toyota, and United Technologies

While we are grappling to understand the height, width, and breadth of the mortgage crisis, another crisis that we have detailing has fallen off the front pages: the energy crisis. Here's why we have been describing energy as the next Y2K:

1. 9-11 was a harsh lesson in the Islamists' visceral hatred of our Western way of life, and the fiendish extremes to which they would go to harm us.
2. The internecine fighting in Iraq, if anything, should be a constant reminder that the terrorists seek to destroy anyone who stands in their way, even their own people.
3. Katrina showed how fragile our refining and energy distribution systems were.
4. Too much of the American, yes the Western, way of life is held hostage to energy; and too much of the world's energy supply is in countries who hate not just Americans, but any country that follows an open society of free markets and democracy.

The recent sell off has hit almost all stocks and sectors. During this sell off, we have been nibbling on the three stocks that we believe currently possess the best technology and products to dramatically reduce energy consumption, without abandoning out our way of life-- Boeing, Toyota, and United Technologies. These three companies currently have products on the market that can reduce energy consumption by up to 50%(compared to older technologies) in planes, automobiles, and heating and air conditioning systems, respectively.

Here's our bottom line, and we are borrowing from a press release by the World Business Counsel for Sustainable Development (WBCSD): There is a talk about "green" this and "green" that, but, thus far, most individuals, companies, and governments have done very little to diminish energy consumption.

Energy conservation may seem like an oxymoron, but we believe that a true cost-benefit inflection point is near, when people will realize that the technology is available and affordable here and now to dramatically reduce energy consumption.

The reason we call this an Energy Y2k is because when that day comes, there will be a mad rush to get aboard the new technology. We don't know what will cause it, and we have no special skills at seeing the future, but no individual, corporation, or government can live beyond its means indefinitely.

In saying this, we are not talking about doomsday or end-times. We are just saying that there are technologies available that offer people some insurance against rising energy prices, resulting from uncertain energy supplies, and the wisest course of action may be to own both the new technologies and the companies who own them.

Barron's Drive-By Shooting of Cramer

Maybe the city where you live has enough drive-by shootings that they don't spark much interest anymore. Where I live, Evansville, Indiana, population 150,000, however, drive-by shooting are very rare, and when they happen, everyone knows it wasn't a crime of passion or of larceny, gone wrong, but a professional job. As I was passing through the Atlanta airport today, I noticed that Jim Cramer of CNBC's "Mad Money" and the Thestreet.com was on the cover of Barron's weekly. Barron's cover and lead stories were all about shooting the "jester", or as I call him the "edutainer" of Wall Street. They had gone back to the beginning of the "Mad Money" show and measured how an investor would had of fared had they followed all of Mr. Cramer's touts on the air. The news wasn't good. Barron's crowed that investors would have been better off to have shorted his picks. The charts and graphs were interesting reading and everyone likes to see the sages knocked around every now and then. But as I sat there waiting for my 2 hour-over-due plane, it occured to me that this past week saw billions of dollars evaporate in one of the worst meltdowns of the markets we have seen in a long time. Indeed, the country's largest home mortgage company, Countrywide Finance, may have come within a heartbeat of going bankrupt. And in this time of great volatility and uncertainty, Barron's had chosen not only to do a drive-by shooting on Mr. Cramer, they had put it on the front page. Three things bothered me about Barron's actions:

1. Touch: Good grief what a lousy idea to focus on the Jester when the stock and bond markets of the US and the world were reeling, and people genuinely wanted to know what was going on.
2. Times: It is common knowlege that investors are increasingly getting their investment news from the web and not the traditional financial media. It is also well known that Thestreet.com, Mr. Cramer's online investment site, is very successful and widely respected. Barron's own website seems to be in a constant state of reintroduction.
3. Timing: The thought is almost too delicious to utter. Could it be that the editors of Barrons were trying to show their new boss, Rupert Murdoch, that they can sucker punch the competition with the best of them?

I know Mr. Cramer is an edutainer because Thestreet.com reprints this blog from time to time, and our investment style is as far from his, as Indiana is from New York. We are long-term dividend oriented investors. Our average holding time is 5 years, Cramer's holding time is measured at most in months, if not days, yet Jim Altucher of the Daily Blogwatch often mentions our site to provide a long-term conservative perspective.

I am truly hoping that this is not the first example of the "new" Barron's hard-nosed financial reporting. It is out of touch, it is a cheap shot, and the timing reeks of -- let's show off for the new boss.

I would like to suggest to the folks at Thestreet.com to do an long-term analysis of the track record of Alan Abelson, Barron's long-time feature editor. When he has been bullish, go long the S&P 500, when he has been bearish, short the S&P 500. My guess is that the results will be ugly. In my mind, Mr. Abelson has predicted 7 of the last 2 bear markets.

Booya, Jim, the blue-bloods are attacking the blue collars. This is what you probably always wanted.

Thank You Mr. Bernanke, But We Want More!!

In Thursday evening's blog, we made the case that the Fed needed to cut rates and fast. Friday morning, much to our surprise and delight, they did just that. However, they only cut the discount rate, which applies almost entirely to banks, and not the fed funds rate, which banks use to set rates they charge to their customers. The half percent drop in the discount rate from 6.25% to 5.75% will provide needed liquidity to the banks and has stabilized the markets -- for now. In our judgment, however, unless the Fed cuts the fed funds rate they will continue to be knee deep in "dragons" (see Thursday's blog). Here's the problem as reported by CNNMoney.com A buyer in 2005 with poor credit and limited means might have signed on for a $200,000 2/28 hybrid ARM[adjustable rate mortgage], locking in a fixed rate of 4 percent for two years. After paying $955 a month, the bill would now be set[in October]to spike to $1,331, a 39 percent increase. According to Moodys.com, there are $50 billion of these hybrid mortgages coming due in October alone. Many of these homeowners will not be able to afford the new higher rates and will join the ranks of people trying to sell their properties. With too much real estate already on the market the odds are high that the real estate situation may worsen in the months ahead. If the Fed cuts the fed funds rate, banks will cut their prime rates. Since many adjustable rate mortgage rates are directly or indirectly tied to the fed funds rate, that would mean that the upcoming interest rate reset for the aforementioned mortgage holders will be much more modest than it would be without the rate cut. We believe that the real estate issues in the US are still mostly contained within the subprime arena. The problems, however, threaten to spill over into the prime mortgage market if too much real estate comes on the markets as a result of defaults caused by these adjustable resets. The Fed can say that they are not in the real estate business, but if they do not offer some sort of palliative to the subprime market that will keep people in their homes and paying their mortgages, a broadening real estate slump could derail the economy. In our minds, the time to deal with the problem is now and not when it is a full blown crisis. A cut in the fed funds rate will also assure consumers and, more importantly, employers in the US and the world that a recession is not likely.

Sally Forth Mr. Bernanke, Sally Forth

By Greg Donaldson and Mike Hull Terra incognita is a beautiful Latin word that means: "the unknown lands". As Wikipedia says, however, its simple meaning over the years has taken on a sinister quality, because of the word's use in map making. Wikipedia explains that cartographers labelled "unexplored or unknown regions"(terra incognita) with "Here be dragons". Unknown lands, then, are not lands of potential milk and honey or amber waves of grain, they are places where dragons roam. In the recent market selloff, all financial companies have become terra incognita, and thus, knee deep in dragons, whether or not they have subprime loan problems. When Merrill Lynch goes from reiterating a buy on Countrywide Credit on last week, to issuing a sell on Wednesday and using the words liquidity crunch and bankruptcy as the reasons, we realize we are not in a charted territory. There is no way to see a daily map of Countrywide's financial position. We suspect not even the Countrywide people actually know what is going on, particularly after Merrill's call. And we strongly suspect that the list of banks willing to loan Countrywide money is now a lot shorter than is was last Friday. The dragons are on the loose and they will continue to devour company after company until the full extent of the less-than-prime mortgage market is known, and that could be awhile. For this reason, it is time for the Federal Reserve to get into the dragon slaying business. They need to cut rates and cut them now. Don't wait for the next meeting, don't wait for the economic data to show weakness, don't wait for inflation to go to zero. Cut rates now and be prepared to cut them again if the overall stock markets do not calm down. Unless the Fed does this, investors will continue to be left guessing where the dragons will strike next, and the banks will tighten credit farther and farther, which will practically assure more dragons will be loosed. The reason the cartographers put dragons in the unexplored lands was because no explorer had had the courage or resources to go into that unknown land and say that there were no dragons to be found. That is what the world needs Ben Bernanke to do. He needs to stick out his neck and show the world where the dragons are and are not, and he does that best by cutting rates to assure investors that a recession is not on the horizon. In our judgment, this crisis will end when the Fed begins to cut rates. It's just a question of how long before they have the courage to act.

Mike Hull Responds to a Client's Concerns

Mike – My thoughts regarding the financial stocks are as volatile as the market lately. One day everything looks great -- the next day it's a disaster. Is there a calmer and more reasoned perspective? Thanks, Bill Bill, You must be setting me up for something. That's ok. I always love your questions. "Is there a calmer and more reasoned perspective?" (than one day everything looks great -- the next day it's a disaster, especially for the financial stocks) I think so. No, of course there is. Absolutely. That perspective lies in what we know, what's inevitable, and what we own. What We Know We could load up both sides of the bear & bull aisle with what we know and probably make a pretty good case that the economy and the market will find their way to healthy paths. The economic data already collected doesn't show much weakness, outside of housing: While growth in most areas of the economy has slowed, consumer spending continues to grow, as does business investment and industrial production. With a very low unemployment rate and loads of demand from a strong global economy, it would take a housing crash or a run-away credit crunch to throw the U.S. into a recession. Our view from the beginning cast doubts that the housing troubles would be wide-spread. Yes, it's a problem, but the bulk of the problem is falling upon a few large states where sub-prime lending was prevalent and where speculation needed to stop. And, yes, some of the more greedy finance firms fueling this will see their capital evaporate. Has this led to a credit-crunch. Absolutely. Banks are built to protect themselves from risk. Credit will get tight. This won't be fun. Yet, credit-worthy borrowers will still find cash available to them. And that leads us to "What's Inevitable ..." What's Inevitable First, both U.S. corporations[banks included] and emerging economies have built up significant reserves over the last five years. Both have accumulated immense and unprecedented profits since 2003. If they need it, capital will be available. Second, at the beginning of last week, Dick Green of Briefing.com said it so well: "The Federal Reserve's first priority is to act as the nation's central bank, and to ensure liquidity in the banking system. If the Fed feels that there is an unwarranted restriction of credit, they will act." In other words -- It's Inevitable. The Fed will not let these credit fears run our economy aground. They just demonstrated that in a big way: 1) On Friday, they announced that they stand ready to provide liquidity to banks with unusual or extraordinary credit needs who cannot find funding through normal channels. 2) And, they began walking the talk by infusing $38 billion into the U.S. banking system on Friday. The European, Japanese, Canadian, Australian and other central banks injected nearly another $100 billion to their banking systems. As Greg said in Friday's blog, the Fed has not stepped in to bail out bad loans; it has stepped in to ensure that the gyrating markets don't cause the banking system to freeze up. Will they do more of the same if they see the need? Absolutely. It's inevitable. It's their job. What We Own But, while I've danced around it, your question was really expressing concern for the financial stocks. Calling the total return for financial stocks this year (dividends +/- price changes) dismal would be an understatement. The five banks we hold in your portfolio have dropped 9.2% in price. With the dividends received so far, that return has been pared to - 6.8%. And, therein lies the key. The U.S. banking system will survive. It's inevitable. And, I'm betting, as you would, that the five banks you own will still be thriving well after you are comfortably into retirement. The "key" I mean to emphasize here is that whether you are living off this fund or not, we will own these banks (at least four of them) because we want them producing (dividend) income for you. Regardless of where the market takes their prices in the short-term, we believe, as they do, that they will continue to deliver good dividend growth. Over the last five years, those five banks have increased their dividends on a compounded annual basis by an average of 16.8%. They currently have dividend yields between 3.3% and 6.0%, average 4.8%. That alone makes them look like great bargains to the long-term investor. I don't see the risk as whether these banks could see their stock prices drop further this year or not. The biggest risk by far is that you or I would decide we didn't have the patience to watch these volatile stock prices and cash out at these prices. The last thing I want to take a Pollyannic approach to this. The reading I've done this weekend shows me that more than a few reputable people watching this truly fear the subprime-loan-housing-bubble-burst-credit-crunch will spread far enough to cause a recession. The Fed's Friday actions should help calm the markets, but it may not be enough to calm all the fear that is moving the market. The ride could get even bumpier from here. Yet, that same reading tells me the Fed has enough tools at their disposal to stem the tide and keep the economy on course. This isn't the bursting of the tech bubble in 2000. It is not the Asian Contagion of 1998. It is not 9/11. In each of these instances the Fed stepped in and kept the banking system lubricated. Ben Bernanke has gone so far in his writings to advise that the 1929 stock market collapse and following depression could have been avoided if the Fed had provided enough liquidity. I have to believe he'll be there for us now, but I believe it will take some patience. This won't end Monday. Mike

Fannie Mae -- A Pictures Tells . . .

Why would the price of the company loaded with more home mortgages than any institution in the world be moving higher over the last month when it seems the US real estate market is in the process of vaporizing?

The chart at the right is of Fannie Mae, the quasi-government home mortgage company and largest holder of US home mortgages in the world. For you technicians, you see a classic divergence over the last month with Fannie Mae - FNM, moving higher and the SP 500 moving lower.

Surely the chart must be wrong. Why would FNM be moving higher at a time when many stocks with no connection to real estate at all are falling?

The answer is that there is not a problem with the "prime" mortgage business in the US, so FNM's loan portfolio, which averages about 80% of the value of the underlying houses, is very secure. FNM is moving higher because the problems in the subprime market have tainted the available supply of credit for all housing. This has prompted FNM's CEO and many congressmen to ask that FNM's statutory lending limit be raised, both in the amount they can loan in an single transaction, as well as, the size of their total loan portfolio. In essence FNM is moving higher because the odds are good that they are going to be able to --yes--make more mortgage loans.

In my judgment traders are jumping to huge conclusions that US housing is collapsing; it is not. High risk mortgages are in big trouble, but Fannie Mae and other prime mortgages lenders, such as the banks, are well protected by the equity in their outstanding mortgages. Furthermore, the overall US housing market is protected by the solid US economy and the low unemployment rates.

The traders are panicked and stocks are flying all over the place. Do not confuse that with the strength of the underlying economy, or the value of the average stock. Cooler heads, however, are starting to step forth to diminish the confusion. The Federal Reserve just announced that they stand ready to provide liquidity to banks with unusual or extraordinary credit needs who cannot find funding through normal channels. They also bought $19 billion in mortgage backed securities from banks. The Fed is now firmly in the game, and I believe the markets will begin to calm down. The Fed has not stepped in to bail out bad loans; it has stepped in to be sure that the gyrating markets don't cause the banking system to freeze up. That's their job. I'm glad to see that they are finally doing it.

I own FNM, but this is not a recommendation. I am just using it to make the above points.