The Cascading Fortunes of Bank of the Cascades

It’s been a while since I’ve discussed Cascade Bancorp in these pages. I guess I had pretty much written it off a while back when the stock went under $2 and the FDIC presented the bank with a cease-and-desist order requiring it to raise capital.

However, I still believe it is a good barometer of the local real estate debacle as well as the regional economy and the company announced a few interesting developments today.

First, the company’s earnings, or lack thereof, continue to be plagued by the difficulties in the real estate market. Here are a few highlights of the report:

-Remarkably, the bank has now lost over two-thirds of its book value over the past twelve months alone as loan charge-offs grew nearly 250% over the past year.

-A bit of good news: non-performing assets generally appear to be leveling out at the bank.

-Bad news under the good news surface: Commercial real estate delinquencies (now the single largest segment of the bank’s loan portfolio) rose roughly 75% over the past three months.

This sudden and disturbing rise in commercial delinquencies may be signaling the “next shoe to drop” for the bank and the Central Oregon economy.

Commercial real estate here in Bend followed residential into bubble mode and may now be following it into the painful flip-side of bubble economics: the mean-reverting bust. If this is, indeed, the case we should not expect the local economy to meaningfully recover any time soon.

The company also announced today its first step in meeting the demands of the FDIC cease-and-desist order. An investor group has pledged to purchase $65 million in CACB stock at no more than 87 cents-per-share. To put this in perspective, the company’s total market capitalization is currently about $25 million. If this deal were to close today this means these new investors would immediately take ownership of over 70% of the bank.

However, the FDIC has required the bank to raise at least $150 million leading to even more dramatic dilution for existing shareholders. This commitment then is merely a baby step along the seemingly steep path of solvency and independence for Bank of the Cascades. Its survival in its current form is still very much in question.

Are Stocks Still Cheap?: A Long-Term Look at Bear Market Valuation

Back in March I wrote a piece called “The Cheapest Stock Market in Decades” demonstrating what a rare buying opportunity stocks presented at the time. Since then the stock market hast soared an amazing sixty percent. Obviously, then, stocks aren’t as cheap as they were only six months ago.

So let’s take a look at the current value of the S&P 500 in relation to its earnings. The first chart plots the the value of the index in relation to its peak earnings (June, 2007 is the latest high water mark):

The chart above shows that stocks briefly dipped below their average valuation over the past century but the recent rally has resulted in stocks, yet again, becoming overvalued. It also demonstrates that stocks never saw the degree of undervalution that they witnessed in the previous, major bear markets (i.e. 1973-74 and 1930-31).

This next chart plots the price of the S&P 500 to its 5-year average trailing earnings:

It shows a very similar picture to the prior chart. Stocks never reached a standard deviation below average valuation during the last bear market.

And finally, the S&P price relative to its actual, trailing twelve months’ earnings:

The current reading is literally off-the-charts. This is due to the fact that the recent earnings collapse is the most dramatic on record (current earnings of roughly $7.5 for the index result in a current price to earnings ratio of 140: 1050/7.51 = 140). Earnings for the S&P 500 over the past couple of years have dropped over ninety percent. This is significantly worse than the seventy-five percent decline in earnings experienced during the great depression.

The earnings crash of the great depression caused a bear market in stocks which saw valuation remain below average for roughly twenty years. In contrast, despite an even more dramatic decline in earnings stocks have recently spent a mere eleven months below fair value and are now back above this level.

Put another way, after spending over twenty years trading above fair value encompassing the largest bubble in stock market history during which stocks traded over three standard deviations above their long-term average valuation, the recent reversion has only resulted in a brief dip into the realm of undervaluation in which stocks never even saw a full standard deviation below average.

One would reasonably expect that the biggest bubble in history should be followed by a similarly significant decline or reversion. Even if it only rhymes rather than repeats, history demonstrates this to be true. The 1930-31 and 1973-74 bear markets saw stock market undervaluation persist for at least a decade or two and, on more than one occasion during each bear market, saw valuations at least one standard deviation below average.

Hence, from a fundamental perspective, I believe it is reasonable to expect stocks to return to an undervalued condition that persists much longer than the eleven months we recently witnessed. In addition, it is not unreasonable to expect stocks to reach a valuation at least one standard deviation below average just as they have in prior, major bear markets.

Source:
Online Data Robert Shiller
http://www.econ.yale.edu/~shiller/data.htm

The Danger of Being a "Naive Contrarian"

Back in early March, I wrote a piece for the local newspaper called, “Fortitude in the Face of Crisis” (renamed, “There’s money to be made during even the worst of times”, by The Bulletin). The article described why I had become so bullish on the stock market at the time. Needless to say, I was harshly criticized by the bear crowd for “abandoning the dark side.”

Those who agreed with my bearishness at the height of the real estate bubble and during the early stages of the financial crisis obviously found it difficult to change their perspectives along with the changing valuations. Inertia is a powerful force even outside of the world of physics.

What was the cost of their persistent bearishness? Missing the biggest rally in 70 years.

Barry Ritholtz wrote an interesting piece today, titled “Beware of Naive Contrarianism”, that goes a long way towards explaining the inertia that entrapped the bears last Spring. It brings to mind all the kids that think they’re being rebellious by dressing like punks. The trend becomes so popular (witness the success of Hot Topic, a nearly billion-dollar retailer focused on the market) that the true rebel becomes the kid who shuns it altogether.

I’ve been that kid my whole life.

"In Praise of Cash" or "Putting My Money Where My Mouth Is"

Roughly three months ago, I wrote a piece in which I explained that the great number of stock market skeptics at the time meant that the market would probably continue to rally – standard contrarian fare, really.

Stocks have, indeed, continued to rally these three months weeding out a good number of skeptics. In other words, a good deal of the fuel propelling the current rally has already been spent.

More recently, I wrote that, contrary to financial industry gospel, you don’t always have to be committed to the stock market in some capacity; holding cash until you find a compelling investment opportunity is a fine idea and, in fact, the selfsame approach I use professionally in managing investments for my clients.

The 45% gain in stocks over the past few months has necessarily led to a reduction in attractive investment opportunities. Needless to say, that and the changed sentiment picture has me holding a bit more cash these days.

Calling Out Your Broker

“Trim your exposure to stocks when you feel the need but never get out of the market completely. You must have some exposure to the stock market at all times. The risk of being out of the market completely is just too great.”

This is the gospel of the investment industry. This is what sells mutual funds. This is also how people lose money (sometimes lots and lots of money).

I call bullshit.

In fact, I believe the true investor starts with the opposite approach. The true investor begins by putting her hard-earned capital into risk-free t-bills or FDIC-insured CD’s, etc. She looks for compelling investment opportunities. When she finds something that she understands to be a very attractive opportunity then, and only then, she commits capital.

It’s not rocket science; it’s just common sense.

The bottom line is this: if you don’t have a very good reason for owning a particular investment you shouldn’t own it. It’s as simple as that.

The investment industry, however, wants people to believe it’s much more complicated than that. The industry wants you to think you’re not smart enough to decide what’s worthy of your hard-earned capital. The industry wants you to pay commissions 24/7, 365 days a year in a zillion different markets around the world. The sales pitch (scare tactic): “you might miss out on a HUGE upside move if you don’t own at least a piece of everything and stay invested at all times.”

My counter-argument: you might also lose a boatload in the process (i.e. the stock market over the past decade). Plenty of people have made a fortune simply putting their money to work in t-bills and CD’s, saving as much as possible and letting the compounding do the work. You don’t need to do any more than this.

You can certainly do better if you can find a few great opportunities over the course of your investing career. But there certainly is no compelling reason to be invested in everything at all times.

Dont Believe The Hype – Public Enemy

SkyGrid: A News Junkie’s Dream Fix

I’ve been playing with a new news service called SkyGrid for the past few weeks. For news junkies like me SkyGrid is one of those apps that comes along and soon becomes an integral part of our daily routine. I put it up there with my Google Reader feeds and My.Alltop in terms of the benefit I get from it.

SkyGrid is currently in private beta right now so it’s not easy to get access to it. However, the company has offered me the opportunity to invite a few readers to test it out. If news is as important to your business as it is to mine I highly recommend you check it out. Click here to sign up.

Revisionist History and the Rarefied Air of Bend

“It used to be that when the state caught a cold, Bend caught pneumonia. I think because of our construction and our boom and our growth, we’re a bit insulated from the rest of the state.” -Oran Teater, June 2005

“It was a frenzy for quite a while. We knew it wasn’t going to sustain.” -Oran Teater, May 2009

What a difference four years make. In the former mayor and current city councilor’s first quote, given to the Bulletin during the height of the real estate bubble, it certainly doesn’t sound like he’s saying, ‘of course, it won’t last’ or ‘the current frenzy is unsustainable’ or, better yet, ‘beware! Financial Armageddon is coming!’

No. It sounds just a bit more optimistic than that. It sounds as if he’s telling Bendites there is really nothing to worry about. Bend is an economic island unto itself, an economic utopia.

Four years and the worst recession in decades later, however, and it seems he was much more prescient about the current “economic Pearl Harbor,” as Warren Buffett has dubbed it. Mr. Teater is clearly taking a page out of Sir Alan Greenspan’s revisionist playbook.

There were a few of us who actually did know that the real estate bubble and concomitant economic boom were unsustainable. There were even fewer of us who warned of the inevitable consequences. Mr. Teater was not one of us, though he now claims to have been. Politicians will be politicians.

This time Oregon hasn’t just caught a cold. It’s Oregon that has caught pneumonia and Bend has tuberculosis (or swine flu – take your pick). If the country has, indeed, witnessed “economic Pearl Harbor” then, in comparison, Bend has seen “economic Hiroshima.”

Bend currently sports the 8th highest unemployement rate in the country out of 372 metropolitan areas surveyed by the Bureau of Labor Statistics. That’s the top 2% in the country, putting us in a very rarefied air (obviously not the kind that the City Council and the Chamber like to brag about, however.)

It doesn’t help that the politicians and other organizations that not only witnessed the bubble but encouraged it and actually helped inflate it are now focused on covering their behinds. If we are going to rescue the patient and turn Bend’s economy around, it’s going to take sober analysis and strong medicine. And I, for one, don’t think this is too much to ask of our public servants.

So Many Rush Limbaughs

A few months ago radio megastar (and megalomaniac?) Rush Limbaugh famously said he hoped to see Obama fail in his role as president. He was widely chastised for it and rightly so. The dictates of honor and class don’t allow for such vitriol.

I recognize that the stock market is not the same as the office of the President but there is a very loud chorus of market watchers out there right now expressing a very similar discouragement of the current rally in stocks to that Limbaugh expressed towards Obama. “I hope the stock market fails,” is now the unspoken mantra of many market pundits and amateur traders alike.

There are many different reasons, obviously, for the continued pessimism. Bears want to see their ultra-dire fantasies become reality so they can say, “i told you so.” Bulls want a pullback to give them the opportunity to make purchases they were too scared to make a few months ago.

Politically, there are the Limbaughs of the world that would like to see the stock market validate their negative assessment of the administration. There are others who would like to see a bit more economic weakness to spur another round of stimulus spending.

These various justifications, however, are beside the point. The majority is still widely negative and that continues to give me hope. As I’ve said before, quoting Bob Dylan quoting Abe Lincoln, “all the people can’t be all right all of the time.”

In the spring of 2003, the beginnings of the last bull market in stocks, it seemed the market was fueled by skepticism as it rallied nearly 40% from its lows without a single, significant pullback.

This rally has the same feel to it: fueled by skepticism. The crowd may, indeed, get the selloff it’s looking for but I wouldn’t count on it.

Getting Extrinsic in 2009

Early in January I wrote that “My Back Pages” was “Going Radical in 2009″. The blog had become too disjointed with link dumps, charts and tangents that I wanted to refocus it on bigger ideas.

I haven’t been totally successful putting this intention into practice so far but I think I’ve found some help. I’ve been using a few other services lately that are perfect for link dumps, chart and tangents.

First on the list is Twitter. I’ve been using it for a while now and I’ve written about it before. It’s also getting a boatload of press lately. Twitter is a very good outlet, in fact the best I’ve found, for posting links to spark discussions on various topics I’m not eager to write a full blog post about. Join the discussion on Twitter @jessefelder

The second service I’ve found useful recently is Posterous. I’ve only been using it for a couple of weeks now but it’s ideal for posting charts, photos and the editorial cartoons I love so much. My Posterous Blog can be found here: jessefelder’s posterous

Finally, Chi.mp could be the next big thing in the world of social media. It basically works as an aggregator of social media services to create what I call the “poor man’s home page.” Check out http://jessefelder.mp to see my Chi.mp profile.

Banks Breakout With 70% Rally in 8 Trading Days

The chart above is an updated version of the one I posted a couple of months ago under the title, “Fat Bottom Banks?” The banks rallied after that earlier post but not to the degree I anticipated they might.

Over the past week or so, however, the banks have rallied roughly 70% off their lows and have now clearly broken the downward channel on the chart. Amazingly enough, they are still 40% below the 200-day moving average.

The easy trade, the reversion trade, is now pretty much over, however (as we got the 50% move and then some). Still, the path they take from here will tell us much about the strength of the stock market’s current rally.