Recent events from China’s tightening, Euro-zone sovereign risk, to US policy towards banks have illustrated just how important it has become for investors to consider this question: is it wise to invest alongside the governments, or not?
This question is relevant not just for bond investors and credit investors, but also for equity investors.
PIMCO was known to invest alongside the US government when the government was trying to contain the financial crisis, and ripped huge benefits by doing so. However, it is clear from Bill Gross’ Investment Outlooks in recent months that the bond shop has changed its tune:
If 2008 was the year of financial crisis and 2009 the year of healing via monetary and fiscal stimulus packages, then 2010 appears likely to be the year of “exit strategies,” during which investors should consider economic fundamentals and asset markets that will soon be priced in a world less dominated by the government sector. If, in 2009, PIMCO recommended shaking hands with the government, we now ponder “which” government, and caution that the days of carefree check writing leading to debt issuance without limit or interest rate consequences may be numbered for all countries.
PIMCO’s New Normal has an inherent bias against equities. It argues that in this post-crisis world of de-leveraging, re-regulation, and de-globalization, there will be little growth, and hence little upside for equities. This is the year to preserve capital.
Sweeping arguments of this sort appear more self-serving than helpful to individual investors, however. If you’re an equity investor, we think the government factor will continue to play a large role. Investing in equities in 2010, by and large, is investing in economic recovery alongside the government efforts to spur growth and create jobs. No doubt, government actions also represent a great source of risk.
The US will in the foreseeable future have to focus on getting credit to flow, stabilizing the all-too-important housing sector, creating jobs either by directly expanding the public sector or by encouraging private hiring. This focus places a great importance on banking industry, housing industry and the industrial sector.
Banks are healing. Investors who invested alongside the government efforts in 2009 were rewarded. Despite the risk of new regulation and finger-pointing, credit creation remains to be the key for economic recovery. The remaining banks, especially the well-run ones such as Wells Fargo (WFC) and JP Morgan (JPM), continue to represent good opportunities to invest alongside the government.
The battered home building industry enjoys unusual government supports, yet it has caused much less controversy over bailout. The generosity from the government is beyond belief. Take the loss carry-back tax break, for example. Many commentators say it’s a one-time effect. But the fact is home builders are able to collect this benefit over many years. And the government, from the Fed, to the Administration, to the Congress, to agencies like FDIC, all appears determined to put a floor on property prices.
One recent example: The FDIC has chosen Lennar (LEN) as a co-investor in a $3.1 billion portfolio of distressed loans from failed banks seized by the agency. These loans are linked to both commercial and residential properties. The two parties will pay a combined $1.2 billion, or about 40 cents on a dollar. Lennar will contribute $243 million for a 40% equity stake in the venture, while the FDIC will pay $365 million for the rest. The remaining $627 million is seven-year interest-free debt provided by the FDIC. So if these loans, backed by land, developed lots, and other real properties, appreciate in value, Lennar stands to benefit alongside the government and the tax payer. On top of that, Lennar will collect a management fee from FDIC for overseeing the portfolio and loan work-out.
Success is not guaranteed, but with such generous financing terms and a determined government as co-investor, the odd is more than good.
By taking a 60% equity stake, FDIC appears to be sending a strong signal to the real estate market that there will be no fire-sale, and that a bottom has in all likelihood been reached, or supported.
Other builders, if nothing else, should benefit from the price support.
If Uncle Sam is becoming more of a shareholder, shouldn’t individual investors?
Disclosure: Long WFC, JPM, SPF
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