Blog Posts by Jeff Macke

As Cyprus reminds the world that the European banking crisis is by no means fixed, investors in the big bank stocks that have been leading this rally are getting taken to the woodshed. For those looking to protect gains but who want some exposure to the improving U.S. economy, KBW's director of research and chief equity strategist, Fred Cannon, suggests taking a look at the smaller U.S. regional banks (KRE).

Cannon's logic is as follows:

• Banks under $50 billion in assets are, as he puts it, out of the sights of the Federal Reserve. They don't have to worry about the Volcker rule and their executives aren't likely to be grilled in Senate testimony anytime soon.
• With strong balance sheets and little place to go with the cash, there's potential for deals that add to earnings immediately. As Cannon puts it, acquisitions are "heating up in the smaller banks," which creates a natural bid for the stocks.
• Exposure to strong regional economies. Moving around the country on the hunt for small banks allows investors to pick and choose their exposure to local economies. Shale oil, Texas drilling and institutions with exposure to America's drive for energy independence are booming even as the rest of the nation waits for the recovery to kick in.

Prosperity Bancshares (PB) in Texas is right in Cannon's wheelhouse.

The sequestration deadline has come and gone, yet nothing much seems to have changed. There are extended lines at airport security — but that's been the case since 9/11. The White House tour guides were laid off — but that was an obviously political gesture.

From the looks of it Sequestration was only the latest item on a growing list of DC failures that ended up being wildly over-hyped. The debt ceiling debate, and the resulting debt downgrade amounted to nothing. The fiscal cliff was settled largely by shuffling around some deadlines and making one slap-dash agreement. The only thing that really seems to have happened as a result of policy changes is job growth moving from the public to private sector (which is a good thing anyway). The ability of policy makers to convince Americans the sky is falling has all but disappeared.

Ben Stein, former Nixon speechwriter, economist and FTC lawyer, warns against complacency. Stein notes that government spending amounts to around 25% of GDP. "If it changes a lot, it matters a lot. A lot of people will be unemployed, there will be a lot less or more demand, it matters a lot if something that size is affected," Stein says. "Government is such a large factor that any kind of movement in government spending is of some significance."

While every nip here or cut there may not mean much in and of itself, but collectively these policy tweaks change the bedrock of American life. The consequences of of the forced cuts from Sequestration and other failures from both sides of the political aisle may not be felt for quite some time but will eventually result in potentially chilling places.

One of the most surprising things about the latest leg of the stock market rally is that bank stocks have been leading the charge. Normally a group at the core of any financial catastrophe is left for dead years after the crisis. In this case, the financial sector that created the trash funding that fueled the housing bubble, has been outperforming the broader market year-to-date, over the last 12 months, and since the start of 2012.

Fred Cannon, chief equity strategist at KBW, says one of the best things the sector has going for it is just how far the stocks had been beaten down in the first place. "While the market is making new highs, banks and financials are not," he notes. Measured by the Financial Sector SPDR ETF (XLF) or the KBW Bank Index (^BKX), financials are still almost 50% below their high water marks despite more than doubling from March 2009 lows.

Coming off what Cannon describes as a low base can only take a stock sector so far. Every tick higher moves the big bank

According to a blistering 300 page Senate report released yesterday, JPMorgan (JPM) executives misled regulators and were less than forthcoming about key information regarding the bank's financial exposure related to the "London Whale" trading losses.

The findings were released on the eve of a Senate hearing underway today in which several past and present JPMorgan officials will testify regarding the trading losses. CEO Jamie Dimon will not be testifying today, but Senate reserves the right to hold more hearings on the matter.

Nothing happens in Washington or finance without some sort of underlying agenda. The length and depth of the Whale investigation has the Wall Street gossip mill in overdrive. The most popular theory is that the report is both a slap at Mr. Dimon -a staunch critic of government involvement in banking regulations- and the first salvo in the ongoing fight over the Volcker rule.

Fred Cannon, chief equity strategist at KBW agrees. He says there are two underlying but related issues in play during today's testimony: "Are these institutions really able to be examined?" and "are the trade books even manageable to anyone?"

JPM has two choices in terms of how to respond to the report. One is to claim the delays in disclosure were a function of news making its way gradually through a massive organization. The other option is to humbly confess to intentional obfuscation and throw itself a the mercy of the Senate.

The producer price index rose 0.7% for February but only 0.2% ex food and energy. Meanwhile weekly jobless claims dropped 10,000 to 332,000, continuing a slow improvement and moving the four-week moving average to the lowest level since 2008. Of course all this could be trumped by the hotly anticipated consumer price index report tomorrow morning.

But the point of investing is to make money. In the attached video Jonathan Hoenig of CapitalistPig.com offers a piece of advice for folks searching for a single data point to use when judging the health of the market.

“Price!” Hoenig offers. “In my world the three rules for investment speculation are price, price and price.”

Note that he didn’t use words like “nominal” or “quantitative easing.” He didn’t even bother to name check Bernanke. The point at which the rubber hits the road is the value of your portfolio. Everything else is just an input in a giant mental spreadsheet designed to help predict price.

That doesn’t mean to lunge in and out of stocks based on a day worth of action. “Stocks move like the seasons,” Hoenig says. A bad day for stocks (ask your dad about when those used to happen) doesn’t mean the trend has reversed any more than a cold day in March means there will be no spring.

One week ago the nation's largest bank holding companies all managed to get a passing grade on the first round of a two part stress test conducted by the Federal Reserve. The tests were designed to assess "their ability to withstand an extremely adverse hypothetical economic scenario." Later today the Fed will pass judgement on each bank's capital distribution plans, including buybacks and dividends; a decision which will be much more meaningful to banks like Citigroup (C) presumably champing at the bit to increase its dividend yield above 0.1%.

Dan Alpert the founder and managing partner of Westwood Capital suggests the tests are as much about perception as financial reality. "The stress tests overall is really an example of the Fed, particularly Dan Tarullo, keeping his feet on the neck of the banking institution." Suffice it to say the banks themselves object to both the testing and the notion of having Mr. Tarullo's foot on their collective necks.

That antipathy and the limitations of the testing process were on full display last year when banking representatives led by JP Morgan's (JPM) Jamie Dimon met with Tarullo in a closed door session. According to reports at the time, the meetings were centered around the banking execs' frustrations with examinations as well a preemptive strike against still pending rule limitations regarding banking activities. Less than a week later Dimon and JP Morgan announced a surprise trading loss on massive bets placed by a division ostensibly charged with minimizing risk in the banks holdings.

Alpert says the stress tests still mean very little as a practical matter. The exam assumes conditions including a 50% drop in equities, a rise in unemployment to 12.1%, and a 20% decline in housing prices lasting for 2 years. "The conditions and assumptions that are in the test are horrible," he says in the attached clip. "If you had that kind of nuclear melt down what you'd have after 24 months would be carcasses of banks."

The Commerce Department released retail sales for February this morning that were much stronger than anticipated. At least on the headlines. Total sales were up 1.1% overall and .4% ex-good and autos, well ahead of estimates of .5% and and .2% respectively. The strong numbers came despite a more than 10% rise in the average price for a gallon of gas during the same period.

So we're in the clear, right? Not so fast says Dan Alpert the founder and Managing Partner of Westwood Capital. "The things you'd expect the well-to-do to spend on which is housing and automobiles have all gone up dramatically" says Westwood.

Strip away those gains and look at areas where the less affluent would be expected to purchase at a disproportionate rate and the picture gets gloomier. As Westwood reads the data, anything that economists would have expected to be hit by the payroll tax cut declined.

Food services and bars dropped .7% compared to January. Home furnishing dropped 1.6% and electronics appliances were off .2%. Not catastrophic drops but nothing to sneeze at coming as they did during the first month the payroll tax cut really hit consumers hard.

At the current $191 price, shares of Netflix (NFLX) are up 106% for 2013. At that pace the stock will end the year at $125,088 for a tasty 13,503% gain. Spoiler Alert!: it's not going to happen. To try to figure out alternative scenarios Breakout welcomed the Don of the Optionmonster.com family, Jon Najarian to explore the possibilities.

"I think this one is extended but it has managed a combination of squeezing shorts and a decent business model," Najarian says in the attached video. By business model Najarian isn't referring to the streaming business, where barriers to entry are stunningly low on the technology side. Netflix's real edge is in content and the price proposition for customers. For roughly the cost of an HBO or Showtime subscription consumers can get all of Netflix on-demand at all times.

The battle over content is where the real fight is. It's not clear if Netflix has deep enough pockets to bid against conglomerates for early rights to movies and TV shows. Instead the company is moving in another direction by branching into the production of original content.

So far the results have been mixed. "Lilyhammer," a fish-out-of-water tale staring Steven Van Zandt as a mobster exiled to Norway, was a flop. In contrast the recently aired series "House of Cards" staring Kevin Spacey was a huge critical success.

Creative success is difficult enough. Netflix also has to deal with economic realities associated with producing shows. "House of Cards" reportedly cost the company $100 million dollars just to secure the talent. Industry experts say cheapest shows run about $3.8 million per episode. In contrast "House of Cards" started with a $4.5 million budget and high profile director David Fincher "took it way above that."

Streaming and making movies and television shows are two cut throat businesses. The streets of Hollywood are littered with the discarded dreams of people who thought they could make a great television show. If Netflix misses a step Wall Street could be cruel.