Uncle John's Cabin

QOTW - Dancing on the Edge of a Knife with (GS)

Rating: 2.67 not yet rated(3 votes)    Vote:

You are logged in as | Logout

In response to the question of the week about Goldman Sachs:

I will agree (GS) looks to be the best of breed in the financial sector, certainly at least in the investment banking side. It was genius to short the sub-prime mess while selling the same product to others or is that called sleazy? Either way though, it didn't seem to be illegal. Their numbers were better than expected but hardly good. The bar had been lowered so much by reducing expectations, that it would really have been a disaster to have missed earnings. So far, their name has been untarnished, their trading desk seems to be doing well in this market and they have held their price better than most of their competitors. These all seem like good signs to me. But I don't think it is that simple.

Usually when one or more companies get dragged down, their entire sector goes down and trying to fight that trend is futile. This has been the case for GS to date. There are other good names here too like JPMorgan that just got a steal that could pay off in spades for year to come with the purchase of Bear Stearns (assuming there are no more legal complications from Bear Stearns shareholders that seemed determined not to take the offer.) GS should also pick up some business with the imminent closing of (BSC).

In a time when a rumor can cause a run on a bank or take them out, anyone invested in these companies are playing with fire. But, risk is where the profits are and if you can stomach it, these financials have been beaten down so badly that when the worm turns, they are due for a big run. To me, the questions are who and when? Who do we pick to invest in and when do we choose to do so?

There is an interesting fact to mention here. The investment banks and the commercial banks use two different accounting methods. The investment banks use a "market to market" approach that means they have to markdown (or up) their assets when similar assets are traded. This means the investment banks have to take the big write-downs faster than the commercial banks which use an accrual accounting method. The hidden writing on the wall here is that the commercial banks may not have shown the public how bad it is yet as their losses may still be hidden in accruals. The flip side of this argument is that the markdowns are too extreme and when the liquidity comes back and these assets can be priced better, there should be significant write ups. This would also mean the commercial banks accruals get reversed and the paper losses that he investment banks suffered may never happen to the same degree at all for them.

We are dancing on the edge of a knife here. If the commercial banks take a big hit as the accruals pile up, the investment banks like GS can still take a big hit as the entire sector goes down. It also seems that no bank is truly safe at this point in time. As Bugs Bunny used to say "Hare today, goon tomorrow." The Fed has proven it's willingness to preserve the banking system at virtually all costs (as I believe it is mandated to do) but that does not mean it will take pity on any bank that stands in the way of stability. Witness Bear Stearns and the Fed's participation to virtually take the bank down to prop up the system as a whole. Was BSC really only worth $2? I think most people know the answer is no. They were obviously worth more than that. (A moment of silence please to morn the non-executive employees of BSC and their retirement portfolios and careers.) But that was the number that was needed to make things happen so it became the target number. Technically, its not a $2 per share offer, it is a stock swap for JPMorgan shares and as JPMorgan goes up in value so does the offer but not by much considering it's low starting point. I also have to love the observation that Dylan Rattigan made that JPMorgan paid less for Bear Stearns then the Yankees paid for A-Rod! /grin

To wait until this clears up may mean missing a huge part of the recovery and run up. To jump in now may mean taking a big bundle of risk with a possible hefty return or loss. The general consensus on the street seems to be that it will take the financials to lead the way to a market recovery. Without them, the market will clearly either stagnate or continue it downward trends.

My personal risk tolerance does not lean me towards buying GS as these prices or at this point in time. Once the commercial banks report in the next few weeks and the rate cuts and Fed actions have been digested by the market, we could very well see a quick leg down for the financials again, especially if someone else gets into trouble. (Lehman Brothers?) Both Lehman and GS got a negative outlook and possible downgrade from S&P today. GS has also jumped almost 40 points in the last week and that probably was an over shoot.

If I were to buy into GS, it would be at a lower price point as it could very easily retest its 52 week low of $140. A price point of closer to $150-$155 and a few weeks of more earnings, especially the commercial banks with no more bad news (failures, runs, huge unexpected write downs etc...) would make it interesting but still, very risky with only the possibility of a high reward. My prediction is we will see Goldman Sachs back at the $150 range and some point next month and only then, based on the news could it be worth dipping a small toe into the water with maybe a quarter position and look for opportunities to buy dips over the next 3-6 months. Until then, the knife is way to sharp for me.

OK, time to get back to basketball and a weekend of beer, pizza and poker. (Hmmm, maybe I should by BUD instead.)

Good luck to all,
Uncle John

Disclaimer: I just bought a large short position with SKF at this time in the game. This is a big risk and I could get hammered on it. I bought in recently after the financial run up due to earnings from GS and others this week as well as the Fed and GSE actions and the short squeeze due to the options and futures expirations. The reason I believe the downside risk is still there is the very quick run up of the US banks, as well as the European bank situation. While I do not believe they are represented in the SKF, I do believe bad news from Europe will take the sector lower and I don't believe the European banks have been as aggressive taking write-downs and we will likely see some bad news from them within the next month.