The Case for 300%: Why Wall Street Stocks Lead Out of Recessions
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Why is it that Wall Street always seems to lead the markets south when times get hard – only to pull the markets right back up when the economy begins to rev up again?
It has to do with sharing information. Lots of it.
For an example, let’s consider The Blackstone Group (NYSE: BX), the private equity firm started by ultrazillionaire Steve Schwarzmam. Here’s what happened.
Blackstone had a huge advantage in 2006 over other private equity firms. And real estate groups. And credit groups. And hedge funds. And M&A advisories. Why? While many firms specialize in just one of those areas, Blackstone is much more like JPMorgan (NYSE: JPM) or Goldman Sachs (NYSE: GS) in that it has expertise across a broad spectrum of businesses.
So when Blackstone’s real estate fund managers noticed in 2006 that residential real estate prices were falling in the US, Spain, and India, they knew that something was wrong. So the group’s executives talked it over with Blackstone’s 16-member executive team, comprising members from all of the five business areas listed above.
It turns out that Blackstone was getting priced out of deals, and that residential real estate prices were growing faster than personal incomes – a danger zone for investors. After sharing this information with the other executives, Blackstone realized that the credit markets were beginning to tighten and that deals were being priced at outrageous levels. So the group capitalized on their special knowledge.
The private equity group began selling many of its holdings and simultaneously lining up credit. The real estate group began dumping its investments, and the other groups joined in – hoarding up on cash.
The payoff was not a long ways off.
After the markets had crashed and companies like Citigroup (NYSE: C) and Bank of America (NYSE: BAC) were left gasping for air, Blackstone went on a buying spree. Its private equity group began buying up companies on its wish list - investing in assets that greatly appreciate during boom times. And its credit group, GSO Capital Partners, which Blackstone bought in 2008 to double the size of its credit division, began snapping up the distressed debt of Blackstone’s own private equity holdings for rock-bottom prices. Blackstone knew the companies well and understood that it could service their debt.
Overall, Blackstone benefited because it was superior at sharing information. When one group sniffed trouble, it shared its findings with the rest of the firm. And all groups worked together to profit out of the correction. The evidence is in Blackstone’s share price, which broke below $4 in early 2009, but now trades just under $14, representing an approximate 250% gain in three years.
The stories are similar at other Wall Street firms, such as the companies I mentioned above.
Another key example is Apollo Investment Corporation, a mezzanine investment fund that invests between $20 million and $250 million in deals. The stock sits near $8 right now, but traded as low as $2 during the peak of the financial crisis, a gain of 300%.
To conclude, financial firms often lead rebounds for two reasons. First, they own assets that lose value in recessions and gain value in the boom times. Second, the best firms are superior at sharing information between business units, leading to foresights within the market.
Why am I writing about this now? Because the S&P 500 sits near 1,400. If the market gains just 10%, it will be near its all-time high around the 1,550 area. The sustained bullish market flies in the face of a high unemployment rate and other negative economic indicators. I believe that the market is due for a short-term pullback (unless Mr. Bernanke unleashes another bout of quantitative easing soon), giving investors an opportunity to scoop up shares.
And finance firms tend to do well after they have been beat up.
ChrisMarasco is long JPM, GS, and BAC. The Motley Fool owns shares of Bank of America, Citigroup Inc , and JPMorgan Chase & Co. Motley Fool newsletter services recommend Goldman Sachs Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.