To OTC Journal Members: 

Today's new small stock idea was temporarily derailed while I await a major corporate development from this particular company. With this development, I will be able to suggest it is absolutely time to buy this stock. Without it, we'd be too early and it would be too risky. Stand by for more information and a possible restart next week.
 

Financials On Fire: Time To Revisit?

In between stories about Bernie Madoff being carted off to jail, today's financial media news was repleat with stories of the rebound in the banking sector. 

Here's a chart of the XLF- the ETF that trades up and down with the financial sector. I recommended a buy at $9 with a short term price target of $11 back in January. After two surges over $10, XLF came back down to my $8.50 stop loss and was closed out.

It's time to revisit this idea along with the news flow coming from both Wall Street and Washington. On the Wall Street side- Tuesday's 6% rally in the markets was fueled by newly anointed penny stock CitiGroup (NYSE: C). Citi announced it turned an operational profit in January and February, which took the market completely by surprise and started the rally.

As Warren Buffett pointed out in an interview earlier this week, spreads have never been better for banks, and the current cost of funds is about 1.5%. The little bit of loaning they are doing is very profitable business.

It's the past transgression that cause all the concerns, and there's no doubt there is certainly a lot of trash on their balance sheets. Perhaps bank balance sheets do have more challenges ahead. If the real estate market continues to weaken, mortgages will as well, and there there's the giant specter of credit card defaults looming.

You can't help but wonder if all these problems are already baked into the prices of these stocks. There is some interesting news on the balance sheet front, and this time it's coming out of Washington.

Today, there were hearings held on Capital Hill concerning modifying the "Mark To the Market" rules, an issue I have already written about enough times to put you in a coma.

However, it's worth looking at again, because I believe it's potentially huge for this sector, and its worth understanding. Mark to the Market is the practice of valuing the assets on a balance sheet based on a market bid price without allowing for the calculation of any intrinsic value. 

When markets become highly inefficient, mark to the market simply doesn't work very well. This doesn't mean it has to be changed. However, identifying the disconnect can put money in your pocket if you're willing to act when others don't understand what's going on.

I don't know how many AAA mortgages originated post 2006 Citigroup is carrying on its balance sheet. I do know Citigroup has to carry those mortgages at $.28 on the dollar- a massive discount. I also know this is an artificially depressed price. Take a common sense approach. If you have a default on a house with a $300,000 mortgage, you are going to repo the home and auction it. If the original sale price was $300,000, the house is no doubt worth at least $200,000 now. Let's say it gets auctioned at $150,000- that's still nearly three times the value Citigroup has to carry it on its balance sheet, which wreaks havoc on their ability to conduct normal business.

Much like the delusional psychological perception investors have when it feels like stocks can never go down, short sellers are emboldened in the same way, and now believe it's possible the financials could be driven to zero across the board. In the last three days, a little fear was re injected into their thinking.

Today Congress was discussing the possibility of modifying "Mark to the Market" accounting regs, and I for one applaud the exercise. I'm glad they are bringing attention to the issue, and their actions might help bridge the disconnect chasm that exists in this sector.

Auditors used to have the ability to assign some intrinsic value to assets based on their judgment. Abuses of that system in the late 90's by the likes of Enron and WorldComm changed that methodology, but perhaps the regulators over reacted a bit, as they are wont to do.

I'm not an analyst, so I can't rip apart the Citigroup or Wells Fargo balance sheets. However, I do have common sense. I can sense the shorts starting to realize the financials probably aren't all going to zero no matter how much money they have or how much they want them to. 

If Congress decides to modify Mark to the Market, the shorts will scream the rules are being changed in the middle of the game, and they will get their brains beat out. The Uptick rule won't make them feel any better.

Their could be a huge move looming in the financials, and it's worth watching. I'm not brave enough to chase the XLF after the last few days, but I would not hesitate to pounce on it at a 38.2% retracement of the last 3 days move- $7.34 would float my boat, with a $6.35 stop loss and a $10 price target.

This weekend- a sneak preview of a new idea for next week that is massively oversold, and a look at the Semi Conductor index, which do not make a new low last week.

Home Page : www.otcjournal.com
Email Questions or Comments To: editor@otcjournal.com