[powayseller]

This is very interesting. So if stock prices are a leading indicator, then all you have to do is look at the stock market valuations to know where the economy is going. GM’s rise from $20 to $30 in the last few months is a leading indicator that GM’s future is brighter than people thought back in April? This assumes the market has all information, and is efficient.

I just wonder how leading of an indicator the stock market was in 1999. The stock market was saying that company profits would grow to the stratosphere. Yet, the market was wrong, and thus, the prices finally crashed. Many mutual fund managers, including top-rated Janus Funds, lost lots of money.

For this reason, I’m not sold on the idea that the market is rational and has perfect information and pricing power. Toll Bros reached a high of $58 in 7/20/05, at the top of the housing bubble. I wasn’t paying attention to the company at that time, but perhaps others were; what made the stock starts its downward slide? Did investors realize the housing market would go down, or was the stock punished as a result of a lowered earnings announcement?

[powayseller]

I think most people believe the market will rebound in the spring. People who don’t need to sell now, may wait to list in the spring. Also, the fall is a seasonal low time for inventory. This year, the inventory could rise if more distressed borrowers decide they need to get rid out from under their loans.

[powayseller]

GAAP rules allow unpaid neg-am income to be reported as income. Fifteen percent of WaMu’s income is neg-am, that is it is earned but not yet received. Probably most of it will never be received.
I knew about the neg-am income reported as profit, and posted about that in the spring, but had no idea how much it was.

Business Week’s Nightmare Mortgages covers this topic quite well.

[powayseller]

How can eps rise when the sales are slowing? Share buybacks?

I see that it can work both ways: companies report lower anticipated earnings, making their share price drop IN ADVANCE. Other times, companies report they HAD lower earnings, and the share price drops AFTER the fact (such as Option One).

[powayseller]

I meant to say “negative amortization income”, which is income booked but not received from option ARM loans. I’m wondering how much of those unpaid interest payments will ever be made; you’ve got option ARM borrowers making the minimum, partial-interest payment. Once the loan resets, not only will they have to pay the higher loan balance (original mortgage + unpaid interest tacked onto the mortgage) over the shorter amortized period, i.e. 27 years if it was a 3/1 ARM, they’ll also face a higher interest rate. I think most of those option ARM borrowers will default. WaMu’s losses will become apparent sometime in 2007 or 2008.

[powayseller]

davelj, It was only AFTER H&R Block announced they lost several million dollars in their Option Arm division, their stock dropped 9%. The profits fell, then the stock dropped. The market is not always so good at being forward looking. Another example is the homebuilders, who only started falling AFTER announcements of slower sales were made.

Perhaps you can give me some examples where the stock price dropped in anticipation of a company’s lower profit. You could use the homebuilders as an example; did they fall BEFORE any downturn in housing was announced, or AFTER?

My source was Joseph Ellis, Goldman Sachs retail analyst, rated #1 for 18 years, whose charts going back to the 1960’s show that earnings are a leading indicator to bear markets. See aheadofthecurve-thebook.com.

[powayseller]

davelj wrote to me “That you “buy stocks only after studying the financial statements and making a list of 3 reasons for buying the stock,” while perhaps more effective than prayer, is not what I personally would consider proper due diligence for an investment. Although I’m sure that Barnes & Noble sells plenty of books that suggest your approach is more than adequate. So, to each his/her own.”

The 3-reasons approach was recommended by Peter Lynch in one of his books.

Another question for davelj: in your post on WaMu you suggest that at least 100 traders would not short WaMu, but then you go on to say that some very smart people have done so. So what is your take on shorting WaMu? Please, instead of writing about me, which is very boring to everyone, could you add something tangible to the discussion?

[powayseller]

qcomer, S&P500 went from 123 in mid-July to 131 today. Did you predict that would happen? If you did, good job.

Stocks prices are lagging indicators. They fall after company profits fall. I expect the slowdown in consumer spending to lead to lower profits and thus lower stock prices.

Short-term trading is for the pros, so that leaves me out… good luck to you though if can be nimble in that game.

[powayseller]

A Chinese friend told me that in China, once you buy a property, you can only own it 70 years, and then the government takes it back; in essence, you are only leasing it. I think the gov’t could pay you when they take it back? This 70-year rule is for the Chinese citizens. A reminder it is still a Communist country.

[powayseller]

I read Hamilton’s article, and noted in his chart, that M3 rose much faster than M2 in the last few years, for the first time ever in his charts. Thus he concludes with:

“Of course, the intriguing thing is that big surge in M3 growth relative to M2 of the last few years, which raises the possibility in some people’s minds that U.S. inflation will suddenly start being fueled by eurodollars and large time deposits.

But if that happens, it will be something new.” – Hamilton

[powayseller]

If WaMu keeps recording $200 mil/quarter of unearned option ARM income, by the end of 2006 they would have close to $1 bil of neg-am income, and I wonder if that entire amount has a chance to disappear. Just think how likely it is that an optionARM borrower will make the payment on the unpaid interest after their loan resets to a higher rate. If the ARM resets go as we think, many of those borrowers will give their keys back to the bank, and then there goes a big chunk of WaMu’s past recorded income, and future income stream, plus the bad loans they have to record on top of it. One thing’s for sure, WaMu’s share price has stayed steady for 2 years, so the risk of losses is not yet priced into the stock.

Bugs and SDAppraiser, when you see NODs, which lenders are the main ones? The article listed the top 10 subprime lenders in the US, with Wells Fargo at the top and WaMu last.

[powayseller]

davelj, has your approach been promising? What is the rate of return you have earned over the last decade?

By the way, I would love access to companies to ascertain more than they are required to publish in their SEC reports. So many times I have wished I could call the CEOs with a list of further questions. Have you access to that kind of info?

Can you get WaMu info for us? What do you think of shorting WaMu? You’ve criticized my approach, but didn’t answer the purpose of this thread, which is shorting WaMu. Would you do it, and why or why not?

[powayseller]

davelj, I don’t know at whom you’re directing your comments, and for what purpose. I don’t recall anyone on this thread saying they would buy or short stocks off a Yahoo message board recommendation. I buy stocks only after studying the financial statements and making a list of 3 reasons for buying the stock, and I’ve posted about this before. You can e-mail me at [email protected], or post your name and e-mail address so I can contact you, and we can further discuss what your problems are with me, off this forum. I request that you stay on topic, which in this case, is shorting WaMu.

Bugs, with loan purchases decreasing, it seems WaMu won’t get stuck with too many new loans-gone bad. I would think that the bulk of their problems, if any, were created in 2005 – 2006, when their neg-am income went up five-fold. Do you think that this appraisal change would increase their neg-am income even further, from the current $203 mil/quarter?

[powayseller]

Hey Rightside, before I even read your post, I had decided to congratulate you on your LEND decision. You definitely turned out to be right. So this congratulation has nothing to do with your agreement with me on WM. Eric Janszen from iTulip told me he’s torn between shorting WaMu and Wells Fargo, but hadn’t studied the financial statements yet for a final decision.

[powayseller]

Definitely, the market is often clueless, therefore I don’t believe in efficient markets theory. For a recent example, just look at H&R Block; the day the Option One news came out, the stock dropped 9%. The market was clueless about the risk that Option One was taking on. If the market was smart, then H&R Block would have been discounted long before the news came out. The same thing happened with Toll Bros; it only started falling at the same time the RE market fell, not before.

I can understand a stock falling on unexpected news, i.e. a new lawsuit, a drug with bad test results. But when a stock falls because of an EXPECTED earnings shortfall, what else can one assume other than the market is clueless? We on piggington certainly expected this type of loss, even if we didn’t put money on it. Certainly none of us are buying bank or lender stocks now.

One thing I do agree on with both of you: I have no chance going against the insiders or the big traders. I’m no trader, and only a half-ass investor, better at knowing when to get out of the way, than figuring out where to jump in.

I appreciate the input on WaMu, but I wonder if they can maintain their income, when 20% of it is unpaid interest. In the mortgage industry, that is considered a sign of a stretched borrower. Since 20% of their net income is unpaid but earned neg-am income, so if even half of that has to be written off, WaMu will certainly take a fall in its stock. Another weakness for WaMu is its credit card acquisition (Providian). I expect to see a lot more credit card defaults in 07 and 08, as consumers file for bankruptcy.

Thanks for your comments, everyone.

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