* Evening Whiskey
December 4th, 2007Sentiment in worldwide equity markets continues to be pretty pessimistic and not many other asset classes seem to be able to offer relief. Except for government bonds ofcourse, which continue to be well bid in these circumstances.
On the subject of govvies, we think that you are absolutely out of your mind if you are buying them at these levels (European ten year government paper is yielding 4% and U.S. treasuries are 3.86%). If you subtract headline inflation from these yields you are basically left with nothing and that’s not even taking taxes into account. No thank you. We’d prefer to put our money elsewhere.
So where is elsewhere then? Short-term deposits don’t look like too bad a bet if you’re as uncertain about what the future will bring as the media are right now. We are a bit more adventurous though and don’t mind some volatility. Therefore we’re looking at the stuff most people aren’t considering right now: the financial sector.
Sure, banks are in trouble and the reasons for those troubles are front-page news every day. But boy, look at those yields. Pull up the Belgian/Dutch bank Fortis for example. Based on Bloomberg data on the consensus view amongst the 23 analyst that are following the company, Fortis is currently trading at 6.7x 2008 earnings (dividend yield 7.5%) and 5.9x 2009 earnings (dividend yield 8%). Now consider this. What if we buy some shares @ 17.75 (today’s close) and at the same time buy some puts December 2008 strike 18 below this position for which we pay approximately 2 euro. Next year we’ll receive about 1.30 dividend which pays for most of this put protection, leaving us with a net investment of 18.45 per share. Since we’re owning the puts, we’re effectively hedged at 18 and downwards till the end of December 2008, our downside risk is effectively 0.45 per share, about 3% from our entry level. In return we’ll get full exposure to the upside in Fortis, should -after the fact- the current financial crisis turn out to be yet another great buying opportunity. In the mean time of course we could write some shorter dated calls to improve our averages. Not too bad a bet we’d say and one that can be copied in a lot of financial companies out there.
Even disaster creates opportunity.
—— Evening Whiskey is a an irregular update on the state of financial markets and the opportunities it provides by dealingfloor.com. It is not investment advice and not a substitute for your own judgment. When taking on any investment, make sure to have a first aid kit at your disposal that is jammed with tranquilizers and sleeping pills, you’ll need it. History is not a guide to the future, nor is anything else. Any sane person knows that there’s no sure thing except death and taxes. Fortunes are made and lost each day in this arena. If you can’t stand that heat, please stay out of the kitchen.