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Echoes of Bernanke: Some Investment Managers See Glimmer of Hope

It’s safe to say that yesterday's market surge after Fed Chairman Ben Bernanke's reassuring and uplifting prediction of an end to the recession by year-end and a recovery in 2010 is not the start of a bull market. Hardly, in fact.

It’s safe to say that yesterday's market surge after Fed Chairman Ben Bernanke's reassuring and uplifting prediction of an end to the recession by year-end and a recovery in 2010 is not the start of a bull market. Hardly, in fact. Wednesday morning, the market kicked back, and as this chart points out, 12 years of gains have been ravaged by the current bear market. Still, it may be reason for advisors and clients to crawl out of their hiding places and concede ‘all is not lost.’ Bank of America stock, anyone?

Raymond James chief investment officer, Jeffrey Saut, says that in his talks with advisors he’s found many of them are having trouble seeing through the black clouds that men with nicknames like Dr. Doom and The Black Swan have projected onto the horizon. But not him. “There are some who are convinced the only thing to do is sell everything and short the entire market,” he says. “Well, that's the strategy you should have employed a year ago. The time for that has passed,” says Saut. He isn’t encouraging a mad rush to equities. He isn’t even bullish. But he is somewhere between bullish and bearish, and he’s moved closer to the former in recent days.

Saut, a 38-year investment research veteran, is buying, albeit slowly and selectively. And he has been since October 10, when 93 percent of New York Stock Exchange-listed firms recorded new lows, “a capitulation event we haven’t seen since the 60’s,” he says. “I like distressed debt, there are a lot of opportunities there,” he says. He’s recommending funds like the Lord Abbett Bond Debenture Fund (LBNDX) and the Hartford Floating Rate fund (HFLAX), which, he says, offer the opportunity for equity-like returns, with underlying securities trading at as little as 65 cents on the dollar. As for equities, he says that for five years he’s been telling advisors to stay away from financials, consumer discretionary businesses (other than staples) and technology stocks. And for the most part, his positioned hasn’t changed, except for that last category: Since October, he’s been a buyer of tech giants like Microsoft and Intel, too. He’s also purchased convertible preferred shares in companies like agrobusiness Archer Daniels Midland (ADM) and copper and gold mining company Freeport McMoRan (FCX). Asked if he thinks the market is “cheap,” he calls it “neutral value,” but he likes the implications of technical market indicators like the levels of cash and cash equivalents ($9 trillion) still sitting on the sidelines. “That's more than enough to take the S&P 500 private,” he jokes.

Over at LPL, Jeffery Kleintop, the firm’s chief market strategist, says he’s still defensively-minded. His biggest position is still in investment grade corporate bonds, while 20 percent of his recommended portfolio is invested in covered calls on global macro plays, in a bid to benefit from continued market volatility. But with the S&P trading at the low-end of the 750-1,000 range, he’s starting to dollar-cost-average into other areas. “You’re now being compensated for taking a little more risk,” he says. “That said, we’re still underweight equities, but as of Friday, we tweaked that exposure up a bit,” increasing the allocation to U.S. stocks, in particular small-caps, which are more credit sensitive and more reliant on domestic sales.

His hope, of course, is that credit markets will begin to flow as Bernanke predicts. And while he and Saut may not have the same investment ideas, they agree on one thing: The doomsayers have gone too far. “[NYU economics professor] Nouriel Roubini has been saying we’re headed for collapse for ten years. He's been right for the last ten months,” jokes Saut. Roubini’s call for nationalization whipped the media into a frenzy in the past couple months and gained many prominent supporters, including economists Alan Greenspan, Paul Krugman, Joseph Stiglitz and others. But the list in favor of leaving the banks in private hands (or at least majority ownership) and instead recapitalizing them, has grown too, and besides the current administration, includes: George Soros, Meredith Whitney, PIMCO’s Bill Gross and outspoken bank analyst Dick Bove—now with Rochdale Securities—who put out a position paper on the issue on February 16.

“It's not that it won’t be done. It can’t be done, period,” says Bove of nationalization, even if it only meant taking over a handful of the biggest banks. “The top four banks represent 54 percent of the industry’s deposits and 74 percent of the industry’s debt, or nearly $12 trillion,” says Bove. “The U.S. government has roughly $10.5 trillion in debt outstanding. Nationalizing the banks, even a few of the biggest ones, would double the national debt,” he says.

Besides, Bove doesn’t think the banks need it. Bernanke sure seems to be leaning that way, too, but the government will be making an assessment in the coming weeks with so-called stress tests of the top 20 banks to see if they’re capitalized enough to withstand a severe recession.

“I don’t believe the banks are in nearly as much trouble as we’re being told they are,” says Bove. He points to the fact that cash flow is solid. For one, 96 percent of the loans in this country are paying principle and interest, he says. “The money is flowing in but the accounting system isn’t telling you that,” he says. Bank of America, for one, is hugely misunderstood says Bove.
He issued a screaming buy on the stock on February 21st calling it “the best buy in the history of the New York Stock Exchange.” Is he crazy? BofA, owner of Countrywide and Merrill Lynch? (Note: Thanks to Bernanke’s uplifting speech yesterday, if you’d listened to Bove and bought BAC at the opening on Monday, you’d have turned a tidy 20-25 percent profit.) Sure, Bove has been screaming about “buy” opportunities in the banking sector for a while—and he’s been wrong or early, or both, more than a few times on the way down. But now he says “the mania is driving the market.”

But what Saut, Kleintop and Bove agree on is that only time will tell if Bernanke’s prediction is even close to being right, that it will depend on whether the government’s actions, as Bernanke said, “are successful in restoring some measure of financial stability.” Reducing the Fed Funds rate to near zero in mid-December should encourage people to borrow, writes Saut in his research note on Monday. It also should encourage them to move their money from low yielding money market funds and into superior yielding CDs, thus providing banks the deposits with which to lend. But there’s a time lag for all that, he says. And what about the now $1 trillion (up from an original $200 million) available for the TALF (the Term Asset Backed Loan Facility), which begins providing credit to consumers and small businesses in the coming weeks? “What if, after the aforementioned time lags, these herculean efforts start impacting the economy all at once, dispelling the belief that this is the worst economy since the Great Depression?” Saut asks in the letter. “If so, the much mentioned “L” shaped recession could take the pattern of a “V” with a concurrent economic recovery much stronger than most currently believe.”

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