Charles Schwab’s Long-Term Outlook Likely Remains Bright Despite Acceleration of Commission Free Trading

Although the equity market had a quick and violent negative reaction to the news that Charles Schwab (SCHW) would be proactive in driving online trading commissions down to zero for the bulk of the industry, I actually think the move was aggressive, made from a point of strength, and does not hinder their ability to grow from here.

Much was made in the press that SCHW had to do this to avoid losing material share to upstarts like Robinhood, but that view ignores the fact that Schwab’s core business is not to provide young people with relatively low account balances a limited set of free services. Simply put, as the world’s largest custodian for RIAs, the Schwab and Robinhood customer bases don’t typically overlap much.

What Schwab was able to do was distance itself further from other traditional online brokerage firms like E*Trade and TD Ameritrade, which get a much larger portion of their revenue (25-35%) from trading commissions than Schwab does (less than 5%). Peers have had to quickly match the zero price point and will now have to reevaluate their business models after losing a huge portion of their revenue. Schwab, meanwhile, can easily withstand a 3-4% hit to revenue and will continue to focus on their core business of asset gathering.

Interestingly, Schwab stock has fallen 15% on the prospect of losing less than 5% of their revenue by moving to free online trading:

The narrative has been that this puts the company now much more in the “bank” category, as it will need to rely even more on net interest income to generate profits. As such, with interest rates falling and the yield curve flattening, the near-term outlook for their business is muted and investors should value the shares accordingly.

While I think that view is likely to be correct near-term, I don’t think it alters the chances that Schwab can continue to be a dominant franchise in their category and grow nicely in the future. If one looks out 3-5 years or longer, there are few peers who can match their service offerings and I doubt they will stop making bold moves when opportunities arise. However, the stock price today is hardly reflective of that after the latest sell-off.

In recent years, SCHW has traded for around 30 times annual earnings, likely due to their standing as one of the most dominating franchises for investing. From 2013 to 2017, the stock ended each calendar year in a relatively narrow valuation band between a 30x to 32x P/E ratio. This also equated to a price-to-book ratio between 3.2x and 3.8x (ROEs of 10-12%).

Given a more interest rate sensitive business model recently and a slowing economy since the one-time jolt we saw from the tax cuts in early 2018, we definitely should expect that valuation to contract. In fact, today SCHW shares fetch just 13.8x 2019 forecasted earnings and 2.3x book value (despite ROEs now around 16% thanks to lower tax rates).

So what is the “right” valuation for Schwab? Should we simply treat it like any other large bank, such as Bank of America and JP Morgan, which both trade for 11x earnings?

Schwab’s profitability ratios suggest to me it should trade at a premium, with returns on equity of 16% in 2018 and earnings set to grow 6% this year. At a 15x P/E ratio, still a discount to the market, we would project a fair value of 2.4x book value. That would put the stock today at an 8% discount to fair value, which is a pretty good price considering that Schwab’s future growth outlook is unlikely to be stunted.

Just how can a business with the size and scope of Schwab grow from here? Well, total company revenue has doubled between 2013 and 2019 despite near-record low interest rates for the bulk of that time period. That kind of growth cannot be matched by large traditional banks. If Schwab continues to maintain its leadership position in the industry, even if it grows at half that rate in the coming six years (or 6% annually), earnings growth could push 10% annually during that span.

Add in a near 2% dividend yield and a stock that appears to be at least 8% undervalued today and one can quickly make an argument that Schwab shares are worthy of no less than a detailed look by contrarian-minded, value-oriented investors focusing on the long term.

Full Disclosure: I have started to nibble at SCHW stock for some clients in recent days and could very well build larger long-term positions over the near to intermediate term

Howard Hughes Corp: A Lesson in Price vs Value

I was planning on writing a bullish piece on real estate developer Howard Hughes Corp (HHC) today, as the stock has been crushed in recent months and closed yesterday at $92.59 per share, 35% below its 52-week high.

Well, that idea quickly went out the window when CNBC’s David Faber reported shortly after the opening bell that HHC’s board has hired Centerview Partners to explore strategic alternatives, including a possible sale, joint venture, or spin-off of all or parts of the business. To say that the stock is reacting positively to the news would be an understatement. As I type this HHC shares are up $29, or 31%, to $121 each.

So rather than explain why the stock appeared dramatically undervalued in the low 90’s, which I was apparently one day too late in sharing, I will instead offer up the observation that Warren Buffett’s often-quoted mantra “price is what you pay, value is what you get” is notable in this case.

Some investors give more credence to that concept than others, mainly because while value investors try to find situations where value > price, more short-term and/or technically-inclined investors use the market price as their guide and believe that the daily matching of buyers and sellers across the globe corrects most any material pricing inefficiency. Not surprisingly, I am in the former camp.

HHC is an interesting case because most fundamental analysts believe that the company’s assets are worth between $130 and $170 per share, net of debt, and that those same assets should grow in value nicely over time given their strong locations within the local trade areas they serve. Of course, if this is true, and markets are quite efficient, then the stock should not have closed yesterday at $92 and change.

Typically, bulls and bears are left arguing back and forth about who is right, but sometimes we get a better sense through actual corporate action. We won’t know whether HHC finds a buyer for some or all of its assets for at least several more months (and if so, at what price) but today’s trading action seems quite odd.

I would say that it is rare that a stock surges more than 30% on news that the company has hired bankers to approach possible buyers because we are still very far away from getting any idea as to how many interested parties there are, or what prices they might be willing to pay. Stock moves like this are usually seen late in the process, when a journalist gets word of who is bidding and what the range of bids has (roughly) been. In this case, CNBC’s Faber merely confirmed the hiring of advisors because the process has just begun.

What that tells me is that investors seem to believe a few things. First, that HHC’s net asset value per share is, in fact, materially higher than yesterday’s closing price. Two, that the market believes that there will be ample interest in HHC’s assets such that bids are likely to materialize (though of course no deal can be assured). And three, it probably helps HHC that interest rates have recently come down and lending capacity from financial institutions, hedge funds, and private equity firms appears robust, though obviously that can change quickly in today’s world.

I say all of this because I think it firmly supports the notion that markets in the short term can be quite inefficient. Up until today, HHC stock did not have many fans, but that changed in a matter of minutes as the fundamental story changed (or more precisely, a layer was added; the fact that the board is open to strategic alternatives). Conversely, if it was true that the market was efficient and the consensus view among HHC’s close followers was that the business was worth somewhere close to Wednesday’s closing price, we would not see the stock surging today.

The beauty, of course, is that now we might very well be able to settle the debate about HHC’s net asset value (or at least the opinion of that NAV among folks who want to buy the assets and have the cash to do so). The next few months should be very interesting.

Full Disclosure: Long shares of HHC at the time of writing, though I have been trimming positions into today’s strength, as Wednesday’s announcement confirmed they are open to selling, whereas the stock is acting as if a deal is nearing completion.

*Author Update* 4:30pm ET

HHC stock leveled off for a while and then surged again late in the trading day, closing at $131.25, up nearly 42% for the session. In the spirit of full disclosure, I have continued to sell more at prices as high as $131.50 and have also written some $140 covered calls against shares that remain in client accounts.

Simply put, I understand HHC is a unique company with great properties and I have no doubt that some bidders will emerge to try and pull some of them away from HHC. That said, this one-day move is pretty remarkable and I think it is overdone in the short-term. Accordingly, I think it is silly to not sell any stock at these levels, and would welcome a scenario where it cools down and I can buy back some of the sold shares at lower prices. Tomorrow (the last day of the quarter) should be the second-most intriguing trading day for HHC this year! 🙂

Lastly, some people are speculating that this announcement was all about juicing up Bill Ackman’s portfolio right before the end of the quarter and nothing truly will come of it. While a deal might not happen, I don’t think Bill’s HHC position is big enough (just 2% of disclosed portfolio value as of 3/31/19) for him to have orchestrated this whole thing just to show a better performance figure for Q2. After all, Pershing Square was already having a great year and another 100 basis points is a small prize for such an effort. Just my two cents…

Signs of Topping in the Consumer Credit Cycle

Don’t bother counting me in the camp that thinks they can predict when the next recession will hit. The current consensus from those who try to do such things seems to be sometime in 2020, but I don’t think anybody really knows.

But that does not mean that keeping an eye out for economic signals is not worth doing. If the consumer credit cycle, for instance, is nearing a top, it very well may impact what multiple of current earnings you are willing to pay for shares of financial services companies. When you see strong return on equity metrics for full year 2018 this earnings reporting season, you might consider the notion that further expansion could be minimal.



In recent months I have come across a couple of interesting press reports that help shed some light on where we are in the current consumer credit cycle, both from the Wall Street Journal.

First, we had a piece in mid December about how credit reporting giant Experian was going to start including cell phone bills in credit reports. The goal is to boost credit scores so that lenders can widen their pool of eligible borrowers:

“Most lenders tightened standards dramatically after the 2008 financial crisis, and have been in intense competition for the most creditworthy borrowers ever since. And while most large banks have limited appetite for the subprime borrowers they lent to in the runup to the financial crisis, some have been eyeing customers with thin borrowing histories as a new revenue stream, a sign the lenders believe the good economy still has room to run.”

So rather than scare their investors and regulators by accepting lower credit scores when considering new borrowers, why don’t we ask the credit scoring bureaus to find ways to raise credit scores so that more people qualify. Yikes.

And cell phone bills are not the full extent of the changes. The article goes on:

“Fair Isaac Corp. , creator of the widely used FICO credit score, is close to launching a new credit score in partnership with Experian that will factor in consumers’ history managing their checking and savings accounts, which will give a boost to most consumers who keep at least several hundred dollars in their accounts and don’t overdraw.”

Given that the credit reporting companies get paid by the lenders, not consumers, it stands to reason that when approached by their customers to refine their scoring methodologies, they were amenable to the idea. Kind of reminds me of the scene in the movie The Big Short when the Standard and Poor’s employee explains why they rated all of those sub-prime mortgage bonds triple A; “because if we didn’t give them the ratings they wanted, they would go down the street to our competitor.”

The signs of a topping credit cycle don’t end there, unfortunately. It appears unconventional mortgage underwriting is making a comeback as well:

“Aryanna Hering didn’t have pay stubs or tax forms to document her income when she shopped around for a mortgage last year—a problem that made it tough for her to get a loan. But the nursing student who works part time providing home care for children and the elderly eventually hit pay dirt: For a roughly $610,000 home loan, a mortgage company let her verify her earnings with 12 months of bank statements and letters from clients. Ms. Hering said money she collects from roommates and from renting to Airbnb guests covers more than two-thirds of her roughly $4,300 in monthly payments, and her earnings cover the rest.”

While not a large proportion of the overall home lending pool, these types of loans are growing quickly:

“Lenders issued $34 billion of these unconventional mortgages in the first three quarters of 2018, a 24% increase from the same period a year earlier, according to Inside Mortgage Finance, an industry research group. While that makes up less than 3% of the $1.3 trillion of mortgage originations over that period, the growth is notable because it came as traditional home loans declined. Those originations fell 1.2% over the same period and were on track for a second down year in 2018.”

So what exactly were the terms of the loan Ms. Hering received? Tell me if this sounds familiar:

“Ms. Hering, who is 30 years old, received a loan at a rate of just over 6% for the first five years; it adjusts after that.”

Do these stories mean that the economy is about to collapse a la 2008? Of course not. All it means is that the business cycle is alive and well and that consumer lending has reached the point where prime borrowers have reached a level of debt they are happy with and lenders are now stretching a bit to grow. This happens every cycle, frankly. What it tells me is that delinquency rates are probably troughing out and overall credit quality and lender returns are probably peaking.

While these are important tidbits to consider when valuing financial services companies on multiples of book value or normalized return on equity, it is probably not going to help pinpoint the next recession. Leave that job to the economist community that has correctly called ten of the last five recessions, or the Federal Reserve, which has never (and will never) predicted one at all.

After Post-Election Euphoria, Big Banks Start To Look More Attractive After Sideways Action

I was underweighted bank stocks heading into the 2016 presidential election and proceeded to watch as they soared immediately following. I didn’t jump on the bandwagon because although the reasoning was solid (less regulation, higher interest rates) the stocks seemed to get way ahead of the actual fundamentals (in terms of timing). Below is a chart of the KBW bank index during that time:

 

 

 

 

 

 

As is often the case when upward moves appear a bit too steep, the stock have since leveled off and moved sideways for the last year or so. I have gotten more interested lately, not only because valuations are more attractive, but because the regulation relief is indeed occurring now and more normal levels of financial market volatility bode well for banks with exposure to the investment side of the business.

To figure out the best companies to focus on, I decided to see what the valuations today we saying about the profitability of the large banks, relative to the return on equity metrics posted for the first quarter, which is the first period where tax rates have come down to the new, lower level.

Oftentimes investors simply look at price-to-book ratios (the most common valuation metric for banks) and assume that the highest ones are fully valued and the lowest are most attractive. While this may be true sometimes, I am more interested in how the market is valuing these banks relative to their profitability outlook. To judge on that level, I prefer to see where price-to-book ratios are, versus where I think they should be based on each bank’s fundamentals. To do so, I look at return on equity and look for relative mismatches in the data.

Below are current metrics for six of the largest U.S. banks:

 

 

 

 

If we only look at price-to-book, we would want to buy Citigroup and short JP Morgan. But since JPM is a best better managed bank, and earns 50% more on its equity (15% vs 10%), those two banks should not trade at similar P/B ratios.

To balance out the data, I calculate what I call “Implied P/E” which tells us what valuation the market is pricing in, assuming current ROE’s remain constant. On this metric, we see that JPM is trading at 10.9x earnings (if they earn 15 cents for every $1 of equity, a P/E of 10 would equate to a price-to-book ratio of 1.50x). Similarly, Citi trades at 9.8x implied earnings.

All of the sudden, JPM doesn’t look as expensive relative to Citi. The price-to-book premium is 67%, but since their returns are different, the premium us really more like 11%. Framed that way, investors who might have balked before could very well decide they prefer JPM at ~11x earnings, to Citi at ~10x.

The chart above resulted in me being less interested in WFC, even though their recent troubles on the surface appeared to provide long-term investors a good entry point for the stock. Of the entire list, I would say GS and JPM are the best-run companies. To see GS at the top of the list on my preferred “implied P/E” metric really got my attention. Their long-term track record as a public company (since 1999) is quite impressive and as a result, I am quite intrigued by the stock at current prices.

Full Disclosure: Long shares of Goldman Sachs at the time of writing, but positions may change at any time without further notice.

Even After 30% Decline, Equifax Shares Not Cheap

It seems that data breaches are going to become the norm globally, if they have not already, so whenever a company is hit by hackers and the stock price declines as a result, I try to take a look and see if there are investment opportunities. The best example was Target several years ago, when hackers pierced the retailer’s in-store credit card scanners and stole customer payment data. While the media would have had you believe people were going to abandon the chain for life, after 6-12 months (and many more hacks of other companies), it was business as usual.

Equifax (EFX) might be a different animal given that they are in the business of collecting credit data, but most corporations do not seem to be much of a match for professional hackers. So while it is easy to argue that their security should have been stronger than Target’s, I am not so sure that a year from now Equifax’s business will be materially harmed. It is worth watching, however, since there are other data providers corporate clients can use.

What is interesting to me is that even after large drop (in recent weeks EFX shares have fallen from the low 140’s to today’s $103 level), the stock is not cheap. In fact, it appears it was quite overvalued leading up to the hack disclosure, making a 30% decline less enticing for value investors.

I went back and looked at Equifax’s historical valuations and found that the stock has ended the calendar year trading between 14x and 23x trailing free cash flow since 2010. I would say that 20x is a fair price for the company.  But pre-hack the shares had surged more than 20% year-to-date and fetched roughly 27x projected 2017 free cash flow. So at today’s prices they still are trading at the high end of recent historical trends at ~20x.

For investors who think this hack will come and go without permanently damaging the Equifax brand, the current price is a discount from recent levels but hardly a bargain. If you are like me and would want to see how financial results come in over the next 6-12 months (to see if customers are bailing), you would want a far better price if you were going to start building a long position now. And even when you felt comfortable with the long-term prospects of the business, the current price would hardly scream “buy” at you.

The stock seems to be acting well in recent days, which suggests many are taking the bullish view. While I don’t necessarily think that is the wrong move, recent history suggests the stock isn’t worth the $140+ it was trading at prior to the hack.

Full Disclosure: No position in EFX at the time of writing, but positions may change at any time

Even Great Investors Like Bruce Berkowitz Make Mistakes

I know, I know, the headline above is not earth-shattering news. Every quarter dozens of the world’s best investors disclose their holdings to the world via SEC filings (granted, the data is about 45 days outdated, but it still gets lots of attention). It’s easy for individual investors to follow well-known money managers into certain stocks, figuring that they can piggyback on their best ideas. I can certainly find far worse investment strategies for people to implement, but it is still important to understand that even the best investors make mistakes. And there is nothing stopping the stocks you follow certain people into from being one of the mistakes rather than one of the home runs.

I think this topic fits right in with my previous post on Sears. Not only is Eddie Lampert the company’s CEO and largest shareholder, but he is one of the best hedge fund managers of the last 25 years. It is perfectly reasonable to assume that a billionaire in his position would be primed to create tons of value for investors. And yet, since Lampert orchestrated the merger of Kmart and Sears, which formed Sears Holdings in 2005, the stock price has dropped from $101 the day the deal was announced to $40 a decade later. Adjusted for dividends and spin-offs received over that time, Sears stock has fallen by about 40%, while the S&P 500 index has risen by about 80% during the same period. Eddie Lampert’s ownership and involvement alone has meant little for investors’ portfolios. Simply put, Sears Holdings has been one of his mistakes.

Interestingly, many of the company’s steadfast bulls point to the fact that another very smart and successful investor, Bruce Berkowitz of Fairholme Capital Management, owns 23% of Sears Holdings. That’s right, Lampert and Berkowitz own or control 70% of the company. Berkowitz isn’t new to the Sears investor pool either; he started buying the stock in 2005 just months after Sears Holdings was created. How can both of these guys have been so wrong about Sears for so long? It’s not a tricky question. Neither of them is perfect and they have made (and will continue to make) mistakes. It really is that simple. Since I have written about Eddie Lampert many times since this blog was launched ten years ago, I think it would be interesting to try and figure out why Bruce Berkowitz has been on the losing end of Sears.

Berkowitz’s background is in analyzing financial services companies, which is why you will often find most of his capital allocated to banks and insurance companies. Those industries are his bread and butter. In fact, Berkowitz’s flagship Fairholme Fund had more than 80% of its assets invested in just four companies as of February 28, 2014: AIG, Bank of America, Fannie Mae, and Freddie Mac. If that doesn’t signal his preponderance for financial services companies, I don’t know what would.

Now, Berkowitz has not been shy about why he invested in Sears Holdings; he thinks there is a ton of hidden value in its vast real estate portfolio. Unfortunately, his trading record in Sears (he first bought the stock during the third quarter of 2005 at prices well over $100 per share) shows that real estate might not be one of his areas of expertise. Warren Buffett has popularized the term “circle of competence” and tries very much to only invest in companies he understands very well. That’s why up until recently (his 2011-2013 purchases of IBM shares bucked the trend) Buffett has avoided technology stocks.

I would postulate that real estate investments do not fit squarely into Bruce Berkowitz’s circle of competence. As you will see below, his trading record in Sears underscores this, but we have also seen it with his massive and long-standing investment in St Joe (JOE), a Florida real estate developer.

Below is a quarterly summary of Fairholme Capital Management’s historical trading in Sears stock (I compiled the data via SEC filings). Of the 24.5 million shares Fairholme currently owns, more than 55% (13.6 million) were purchased over a 15-month period between July 2007 and September 2008, at prices averaging about $110 per share. More troubling is that this was when real estate prices in the U.S. were quite bubbly, coming off a string of record increases (most local markets peaked in 2006 and 2007) and Berkowitz was largely investing in the company for the real estate. The timing was quite poor. All in all, if we assume that Fairholme paid the average price each quarter for Sears, the firm’s cost basis is about $85 per share (before accounting for spin-offs).

FAIR-SHLD

St Joe (JOE) has also turned out to be one of his relatively few mistakes. It could certainly be merely coincidence that both the Sears and St Joe investments were made based on perceived (but yet-to-be-realized) real estate value, but I’m not so sure. Like with Sears, Fairholme Capital Management has a very large stake in St Joe. In fact, Fairholme is the largest shareholder (owning about 27% of the company) and Bruce Berkowitz is Chairman of the Board (sound familiar?). Berkowitz started buying St Joe during the fourth quarter of 2007, around the same time he was massively increasing his investment in Sears. His largest quarterly purchase was during the first quarter of 2008 (talk about bad timing), when he purchased more than 9.2 million shares (37% of his current investment).

St Joe’s average trading price during that quarter was about $38 per share, but subsequent purchases have been at lower prices, so the losses here are not as severe as with Sears. By my calculations (see chart below), Fairholme’s average cost is around $28 per share, versus the current price of about $20 each. But again, not only has the investment lost about 30% of its value, but the S&P 500 has soared during that time, so the gap in performance is so wide that it would take a small miracle for either of these investments to outpace the S&P 500 index over the entire holding period, as the returns needed to make up for 7-10 years of severe losses during a rising stock market are significant.

FAIR-JOE

Now, the purpose of these posts is not to point out the few big mistakes two very smart investors have made over the last decade, while failing to mention their big winners. Any of my readers can look at the history of the Fairholme Fund or ESL Partners (Eddie Lampert’s hedge fund) and see that they both have posted fabulous returns over many years. The point is simply to show that sometimes these investors make mistakes, even with companies where they own and/or control a huge amount of the stock. Just because Eddie Lampert and Bruce Berkowitz are involved in a major way (either in ownership, operationally, or both), it does not ensure that the investment will work out great for those who eagerly follow them. Just because they are smart investors does not mean these are “can’t miss” situations. There are plenty of people who are sticking with Sears because of Eddie, or sticking with St Joe because of Bruce. That alone, however, is not necessarily a good reason to invest in something.

I will leave you with one more example of Bruce Berkowitz making a large bet on a stock outside of his core financial services wheelhouse. At the end of the third quarter of 2008 Fairholme Capital Management owned a stunning 93 million shares of pharmaceutical giant Pfizer (PFE). It was an enormous position for him and was featured in many investment magazines. This single $1.73 billion investment represented as much as 24% of end-of-quarter total assets under management for Fairholme, and all of those shares were purchased over a 26-week period in 2008 (more than 3.5 million shares purchased, on average, every week for six months).

FAIR-PFE

Now, given how large of a bet this was, even by Bruce Berkowitz standards, it would have been easy to assume that this investment would be a home run. But as you can see from the trading data above, Fairholme lost money on Pfizer after holding the stock for only about 18 months. During the fourth quarter of 2009 alone, the firm sold more than 73.4 million shares of Pfizer (after having purchased 73.7 million shares during the second quarter of 2008). Perhaps pharmaceuticals aren’t Bruce Berkowitz’s bread and butter either. Fortunately for him and his investors, however, his prowess picking banks and insurance companies has helped him compile an excellent track record since he founded his firm in 1997.

Full Disclosure: No position in St Joe or Pfizer at the time of writing, but positions may change at any time.

The Average Investor Can (And Should) Ignore the 60 Minutes Story About “Rigged” Markets

The piece on 60 Minutes this past Sunday has ignited a discussion about high-frequency electronic trading systems and undoubtedly has spiked sales of the new Michael Lewis book entitled “Flash Boys: A Wall Street Revolt” which digs deep into the topic. Since I have yet to read the book, I am not going to get into many details here, but the big issue is that technology has become so advanced these days that certain people are now able to get insights into what orders are coming in for a particular security, and jump in front of those orders to make a few pennies per share on the backs of smaller investors. It’s gotten so bad (read: unfair) that a company called Virtu Financial Inc, which recently filed documents to go public, disclosed that it has only lost money on one day out of the first 1,238 trading days it has been operating.

Since I work with regular retail investors, the most salient question my readers might want to ask is “Does this affect me?” I would say “No, it doesn’t.” There are definitely counter-arguments to be made, but for the typical investor (who is investing in the stock market and planning on holding a stock for months or years) the existence of high-frequency trading firms should not even be a blip on their radar. The market is not “rigged” against the types of investments they are making. If you want to invest in Company A, you have done your research, and you feel as though paying $20 per share for that stock is an attractive price, then all you have to do is enter a limit order to buy Company A at $20 per share. In that scenario, you know what you are getting, you know what price you are paying, and you feel good about your odds of success. Over time if your investment thesis proves accurate then you will make money, and vice versa. Nothing else really should matter to you.

Now, it is hard to argue that we should embrace or even accept a system where certain groups of people with more money and better technology should be in a position to game the system and earn a profit 1,237 out of every 1,238 days the market is open. Hopefully regulators will do everything they can to close these loopholes in the system. That said, the discussion around whether regular investors should change how they save and invest based on this new book or the 60 Minutes segment are focusing their coverage and attention on the wrong headlines, in my view. Carry on.

Consumer Debt Paydown Crimps GDP Growth

It’s election season so both candidates would love for you to think that the POTUS has a lot of control over economic growth, but this week we got a report that sheds light on one of the major reasons the U. S. economy is growing at around 2%, down from its long-term average of around 3% per year. The New York Federal Reserve reported that credit card debt balances last quarter dropped a $672 billion, a level not seen since 2002. It also marks a 22.4% decline from the peak we saw in the fourth quarter of 2008.

So how exactly has this de-leveraging trend negatively impacted GDP growth? Well, consumer spending represents about 70% of GDP, so a drop in credit card balances of $200 billion over the last few years represents a lot of money that was sent off to pay bills, not spent on goods and services. Toss in another $100 billion of spending that would normally be incremental over that time period due to overall growth in the underlying economy, and you can see that about $300 billion of consumer spending has been absent from the system, compared to what would have been normal.

With annual U.S. GDP at around $15 trillion, this consumer credit card de-leveraging represents about 2% of GDP growth lost. Over 3-4 years, that comes out to about 0.5% GDP impact per year. In a world where GDP growth has dropped a full percentage point from its long-term normalized level, consumer debt repayments account for a major portion of that slowdown. You aren’t likely to hear much about that on the campaign trail, but politicians rarely deal with facts and truths when it comes to hot-button issues like the economy.

JPMorgan Sell-Off Excellent Example of Contrarian Opportunity

News of a $2 billion trading loss at JPMorgan Chase (JPM) last week prompted a 15% sell-off in the stock, which now sits more than 20% below its 52-week high, at a trailing P/E ratio of 8, at only a slight premium to tangible book value, and with a dividend yield above 3%. One of the best ways to be a successful investor is to buy quality companies at times when their share prices are temporarily depressed due to short term news headlines that likely will not impact the long term profit generation of the company. Warren Buffett has perfected this investment strategy over many decades. While JPM was not really on my radar before last week, the recent events at the company have changed that. At around $36 per share I think JPM makes for a very attractive long term investment. As a result, I have initiated a position in the company.

Full Disclosure: Long shares of JPM at the time of writing, but positions may change at any time