January 9, 2008    Notes from Conference given by Michael Metz.  He is chief investment strategist for Oppenheimer.  This was an AAII NYC presentation.  Please understand that notes below are not my views.  This was generated from notes I took during his discussion from what I heard Michael Metz discuss.  

I previously attended Mr. Metz speak at this  event a year ago.  Here is a link to last years notes  http://rbcpa.com/2007_01_11_Metz_AAII.htm 

 

Investment Preferences in an Era of Deleveraging:

( Notes in black font, my comments italicized below: )

 

1.    During the excellent introduction, Mr. Metz was introduced as "being well known for realism in market trends." 

2.    "Most news tonight is not new news, and not good news."  (I reflected on the meeting, and realized that this years discussion was similar to last years.  I mention that with fascination, as I found the similarity  very interesting.  Over the last year we have witnessed what might merely be the start of a banking crisis and the potential of massive changes in world liquidity.)

3.    "We face very serious economic problems when asset classes are over-priced."  Metz feels that residential and commercial real estate and bonds are all expensive.

4.    Stocks are not cheap, but not as expensive as other asset classes.

5.    There was an "orgy of leveraging set up by Federal Reserve in 2002 - 2003."

6.    Home price inflation has been world wide.  There were excess valuations and the bubble is now being popped.  He feels this will last through 2009.

7.    "I see a significant decline in commercial real estate prices."  He cites an erosion of collateral values and increased expenses of maintenance.

8.    Predicts increasing impairments of capital at Banks.  The banks are becoming less willing and not willing to lend.  Reserves were also low.  (This has been discussed at this site for years.  We mentioned this in many Countrywide discussions, as well in our notes on Seth Klarman's book titled, "Margin of Safety." http://rbcpa.com/Notes%20To%20Margin%20of%20Safety.pdf   "As I read this, I was wondering if the “pay option mortgages,” which are being offered by many lenders, are one of these products. These negative amortization and adjustable mortgages have been around for 25 years. Yet, they have not proliferated the marketplace in the past as much as they have the last several years. Lenders such as Countrywide, GoldenWest Financial and First Federal Financial have been using these riskier mortgages as a typical type of loan in 2005 and 2006. “Investors must recognize that the early success of an innovation is not a reliable indicator of its ultimate merit.” “Although the benefits are apparent
from the start, it takes longer for the problems to surface.”
)

9.    There was a great wave of home equity withdrawn in the past years.  This added to great increases in consumption.  He thinks consumption will naturally decrease because of this.  "Great problems for economy based on consumption growth."

10.    Because real estate prices are falling, he predicts that revenues from Municipalities and States will be contracting.

11.    Does not think capital expenditures will rise.  He thinks the major users of technology will have decreased capex needs.  He includes financials and retail in this community of users.

12.    Interest rate outlooks not promising.  Feels inflation is "seeping through the system." Because of this, he expects long-term rates to rise.  Willingness of China buying cheap treasuries are over.  Hence, long rates will rise.

13.     A positive element is he claims Corporations are not highly leveraged.  Predicts a dramatic economic slowdown.

14.    Institutions have risk aversion, whereas 4 months ago they had a desire for risk.

 

What do you do?

 

1.    Retail and Financial services are not attractive.  Avoid financials as there is no visibility and capital positions are weak.  Retail is way over capacity.  Upscale consumers are starting to get hurt.  "Lots of problems in Malls and offices."

2.     To buy bonds are 4% is the height of folly.  If you need income buy 2 year treasuries or 5 year munis.  Likes BlackRock Muni Fund (MHD).  Claims they have limited leveraging and 9% discount.  "Makes sense."  ETY 13% discount.  Not highly leveraged and they write put options on their portfolios.  ETW , lower risk for current income.  Feels that long term "bonds are the most over-priced asset class in the world."

3.    Always opportunities in Stocks.  Valuations are not high, nor are they low.  Balance Sheets seem ok.  Best area is North American Exploration and Development.  Most of world output is controlled by a few corporations.  He sees consolidation in every sector.  Claims that Russian and Saudi Arabia  control world oil and they will not let the price drop.  Claims that any rational person should be terrified of Middle East.  Hence, investing in this sector provides insurance.  He mentioned Anadarko (APC), Chesapeake Energy (CHK), Devon (DVN) and XTO.

4.    Metals and Commodities - thinks valuations will rise.  "Reminds me of early 20th century."  Likes ABX.

5.    Middle stages of great boom in Agriculture prices.  Mentioned meats and erratic weather.  Mentioned ETF "    POWERSHARES DB AGRIC (AMEX:DBA)."  Talked about wheat, corn, soy and sugar, being the cause of "enormous social problems."

6.    Look at China and Taiwan as companies.  Look at their financials.  Claims they are better than USA financials.  He likes the ETF's there as well.

7.    Likes GE and JNJ.  Claims they are examples of companies that have foreign market exposure, and are cheap.  Stocks still asset of choice, but could be uncomfortable for 12 months or so.

8.    Idiosyncratic stock risk because of unpredictable economy, hence earnings disappointments.  Use ETF's versus Traditional Homes.  Used home builders as an example, feels several might go under, so use the ETF instead.  Same with the media group.  Although claimed NYT was "fascinating at $15."

More miscellaneous discussion

1.    Oil Service still attractive.

2.    Still likes CNE ( $13.50) .  Last year he said he " loves Canetic Resources Trust (CNE - 12.77))

3.    Believes we are in a recession.

4.    Believes US Dollar is hitting bottom versus Euro, whereas Asia bonds should rise.  Says US strong dollar policy is "crap, don't believe it, every sovereign nation wants cheap currency."  US currency is cheap, but over-owned.  Claims there should be an "ETF out there for Asia Bonds."

5.    Health care companies very attractive.  Was asked by a colleague of mine what he thought of Pfizer.  Metz said, "Balance Sheet is impressive, could restructure and see some attractive returns.  Not sure if returns would be as good as JNJ, but would still buy it. "Frankly I am bottom fishing in Pfizer."  Claimed Merck is best of big Pharma, but rich in price, might be overvalued.

6.    Multinationals are attractive because of world wide currency concerns.

7.    Comfortable with Auction Market Preferreds and all that "Vanguard does."  He mentioned Vanguard in relation to attendee being concerned with Money Markets piercing $1.

8.    "I think we are in a bear market.  It might get rough and unnerving before it is over.  Kind of classic.  Certain areas might escape bear market."

9.    "Greatest event of the century will be the West getting poorer and the East getting richer.  China will go higher and their exports will become more technical and higher end.

10.    Does not like TIPS because yields are too low.

11.    Utilities - Valuations high, yields low, price earnings high, yet might be reasonably attractive.  Not cheap, but better than bonds.

12.    Does not like indexes at the moment.  Feels stocks are expensive and with exceptions environment is bad for stocks.  Hence more of a stock pickers market.  Feels small and mid cap will be hurt the most.

13.    I questioned him on Brookfield Asset Management (BAM).  He said he heard of it, but knows little about them.  (The reason I asked is because they are leveraged which he does not like and they have a lot of real estate, yet he enjoys infrastructure companies, Some North American power and Timber situations, and also likes Brazil.  Anyway, it was fun to ask him.)

14.    Berkshire Hathaway - "I am a great admirer of Warren Buffett."  He thinks he is stretching on things to buy.  Does not consider Berkshire a safe-harbor and thinks it will sell at a discount to NAV.

15.    Predicts that credit cards will be the next problem, with higher defaults, then autos, then commercial real estate will feel pain, then private equity.  Thinks we have just touched the surface.

16.    IT - "unattractive"

17.    "Goldman Sachs always does the right thing."

18.    Claimed timber is great investment over 50 years.

19.    International Real Estate - thinks USA problems will be exceeded by UK, Spain, Ireland and Europe.

20.    "Defense sector is unfortunately attractive."  Wasn't sure of any specific investments, "but should be an ETF out there.  (That answer made me think perhaps he is not so knowledgeable in this area.)

21.     Doesn't like GM or Ford.

22.    GE being tarred with financial brush.  ( I reminded myself to look at the bonds.  What is the bond market saying?)

23.    Still likes EWJ - "haven't been right yet."

24.    Next great boom in USA will be infrastructure.  Claims Democrats with Democrats than Republicans with infrastructure boom.  Claims won't see this till 2009.  (This might tie into GE with infrastructure element).

25.    Brazil is attractive, well balanced and not expensive, whereas other South American countries have political issues.  Hence Metz does not have the appetite for risk in South America.

26.    Altria (MO) - "good company, but such a personal antagonism to cigarettes, I wouldn't buy the stock."