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Top Contrarian Investor’s Big Bet for 2010

Stock-Markets / Financial Markets 2010 Dec 29, 2009 - 04:57 PM GMT

By: Q1_Publishing


Best Financial Markets Analysis ArticleIf you don’t believe crisis creates opportunity, just ask David Tepper.

In a recent Wall Street Journal feature - Fund Boss Made $7 Billion in the Panic - all of Tepper’s “secret” strategies were revealed for all to see.

Tepper’s strategies were so simple and lucrative, you’d expect everyone to be taking notes, right?

Well, the thing is most investors will never follow them.

In fact, some are already writing off his next idea as ludicrous. Yet, as you’ll see in a moment, it’s just “crazy” enough to pay off big in a few months.

It’s Good to be Alone

You see, Tepper is a true contrarian. Not long ago he was completely alone in the financial world. Last February, when the markets were sliding, he was buying the worst of the worst - bank stocks.

He saw something very few others did. And was well rewarded - to the tune of about $2.5 billion personally – for it.

Now, he’s set make another contrarian bet that could net him an even bigger fortune. But any profits made on this “crazy” idea will come to those investors with a truly open mind and those who, as President’s List readers know to watch out for, look for “unexpected” catalysts.

For Contrarian Investors Only

According to Tepper, he’s now moving into another highly troubled sector, commercial real estate.

The Wall Street Journal states:

Mr. Tepper remains upbeat. He says he expects interest rates to stay low, and argues that stocks and bonds are reasonably priced.

This belief is driving another risky bet. At the end of each quarter this year, Mr. Tepper noticed that investors were dumping holdings of troubled bonds backed by commercial properties. He had never dabbled in these investments, but he and his 10-person team did some research and judged them attractive, with some seemingly safe debt trading at yields above 15%.

Mr. Tepper slowly spent more than $1 billion to gain ownership of between 10% and 20% of highly rated slices of commercial mortgage-backed securities, or CMBS.

I know what you’re thinking…commercial real estate debt is a disaster waiting to happen.

Bloomberg recently reported, “[Commercial mortgage-backed securities] loan defaults rose to record in third quarter…The loan delinquency rate for bank-issued commercial loans is the highest since the second quarter of 1994.”

Worst shape in 15 years? Sure.

Disaster waiting to happen? Definitely.

But with the Fed’s printing press running on high, the government pressuring banks to make loans and refinance mortgages (both residential and commercial mortgages), the commercial real estate can has been kicked pretty far down the road.
In the meantime, the window of opportunity is wide open. Here’s why.

Connecting the Dots

On the surface, commercial real estate and the debt tied to it are bad shape.

It’s no secret. Everyone knows it. But commercial real estate is so out of favor, priced for the worst, and at a point where the market would react positively to any good news. And it looks like there is some good news just around the corner.

You see, commercial real estate values are closely tied to lease rates. They’re determined by the cash they generate from leases. That’s why Manhattan office buildings, which charge very high rates to financial firms, are worth a lot more than Detroit offices.

Lease rates, in turn, are determined by supply and demand. For example, as the banking and financial service sector ratchets employment levels down the demand for prime Manhattan offices decline too. Meanwhile, supply of available office was on the rise. As a result, the cost of leasing a square foot of office space in Midtown Manhattan fell 24.3% in the first half of 2009 and is down another 17.2% in the last six months.

Demand for commercial real estate, in turn, is driven by employment. More employees mean more demand for desks and office space.

Therefore, commercial real estate values are determined ultimately by employment rates. Or as U.S. News & World Report puts it, “As unemployment goes, so goes commercial real estate.”

And that’s the real wild card for commercial real estate right now.

Just Crazy Enough to Work

While most everyone is expecting unemployment to continue to rise, a few folks are looking ahead to the three catalysts for a rebound in employment.

First, there’s the 2010 Census. The U.S. Census Bureau still needs to hire hundreds of thousands of temporary workers to complete the countries decennial headcount. In all, it’s going to take between 1.2 million and 1.4 million workers to get the job done.

Second, there is the impact of the recently enacted extension of emergency unemployment benefits. The benefits were extended through the end of February.

At last report there were more than 4.2 million people who already exhausted their regular unemployment benefits (normally six months) and move to extended unemployment benefits. If and when these benefits are exhausted, the folks who have been holding out for a job at their old salary or in their same field where jobs may not be anymore, will do take what they can to get in the job market.

Basically, extending unemployment benefits keeps more people on the unemployment rolls (they actually delay a genuine recovery as well, but that’s a topic for another day). So once they expire and checks stop coming in, unemployment will decline.

Third, the end of healthcare reform is nearing. Despite how many unintended consequences will come from it and the increased costs of employment it will create, it will be a known factor. The uncertainty surrounding it will have fallen sharply. Also, the political capital exhausted to ram it through, will (hopefully!) prevent a cap-and-trade scheme from being seriously considered.

Since commercial real estate values, lease rates, and the ability to make good on interest payments on debt is de facto driven by employment rates, the catalysts are in place for a rebound in commercial real estate.

So looking ahead a bit, Tepper’s bet is just crazy enough to work.

The Truth about Contrarian Investing

In the end though, only time will tell if Tepper’s commercial real estate bet will pay off.
Most investors, however, would refuse to even consider it. But with the level of bearishness in commercial real estate debt, the rock-bottom valuations, and the “unexpected” uptick in employment coming, the idea could work out exceptionally well.

More importantly, Tepper’s current success (and his past wins and losses) shows one of the most important principles of contrarian investing successfully.

That is knowing that all investments will not necessarily work out.

Consider Tepper’s track record. It’s something only a contrarian could understand. He bought big into Korea in 1997 after the Asian

Currency Crisis and then again on banks stocks earlier this year. Those turned out spectacularly well.

He also has some that didn’t work out nearly as well. For instance, he bought into auto parts maker Delphi in 2006 not long before it went bankrupt and dove into large-cap stocks in early 2008.

But that comes down to what successful investing is all about. A topic discussed regularly here at the Prosperity Dispatch.  

As contrarians we have already learned that not all rock-bottom buys will work out. However, when you invest consistently into opportunities where the potential reward is far greater than the risk, they all don’t need to work out to make an absolute fortune.

That’s why, despite all the problems with commercial real estate debt, it’s an idea worth looking into a bit further. More to come.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

Disclosure: Author currently holds a long position in Silvercorp Metals (SVM), physical silver, and no position in any of the other companies mentioned.

Q1 Publishing is committed to providing investors with well-researched, level-headed, no-nonsense, analysis and investment advice that will allow you to secure enduring wealth and independence.

© 2009 Copyright Q1 Publishing - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believe

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