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The Credit Crunch is Far From Over

Written By Brian Hicks

Posted April 28, 2008


Bill Miller has seen better days. Unfortunately, so have the shareholders of his renowned fund, the Legg Mason Value Trust.

Miller’s famous fund fell on hard times in 2006 due a series of bad bets on stocks decimated by the housing bubble. Since then it has only gotten worse.

Those ill-timed investments broke his famous streak of beating the S&P 500 for 15 straight years.

But if anything, Miller is an eternal optimist. Even today, he’s still bullish on the same stocks that have only punished him.

In fact, in a letter to his shareholders last week, Miller said he was still sticking to his guns.

“Most housing stocks are up double digits this year despite dismal headlines, a sign the market had already priced in the current malaise. I think likewise we have seen the bottom in financials and consumer stocks, but not necessarily the bottom in headlines about the woes in those sectors,” Miller wrote.

Moreover, Miller told his clients, “I think we will do better from here on, and that by far the worst is behind us. I think the credit panic ended with the collapse of Bear Stearns, and credit spreads are already much improved.”

Of course, there are only two things wrong with all of that rosy analysis.

The first is that the bottom in housing is nowhere in sight.

And the second is that the credit crunch—that Miller insists is behind us—is far from over.

Here’s why. It’s simple arithmetic.

The latest estimates peg the banking losses now at a monumental $1 trillion. That’s not a typo.

It’s trillion with a “T”. That is four times the inflation adjusted amount of damage from the S&L crisis.

And considering the fact that we have only written down about $250 billion of those losses, it kind of makes you wonder where the other $750 billion is hiding.

Add in the fact we are already in a recession, and it makes you wonder also about the wisdom of Miller’s latest call.

So are we half way home as Miller and some other analysts suggested last week or much farther out?

Well here’s what the analysts at Morgan Stanley think: They say we’re only in the third inning.

That sounds about right to me.

From Reuters by Joesph A. Giannone entitled: Morgan Stanley see big bank woes just beginning

“Morgan Stanley analysts on Monday told clients to “sell the rally” in financial stocks, slashing forecasts for big bank earnings and warning that the current credit crunch is only just beginning.

In aggregate, Morgan Stanley reduced its estimates for 2008 large bank earnings by $17 billion, or 26 percent, and reduced 2009 forecasts by $13 billion, or 15 percent. The analysts expect higher loan losses and expenses, offset by higher net interest income, though profits could fall further still if the Federal Reserve stops lowering interest rates.

“More capital hikes and dividend cuts (are) coming as our credit deteriorates and forward earnings decline,” analysts led by Betsy Graseck wrote in a report. “We think we are only in the third inning of the credit cycle and expect this credit cycle will be worse than (the slump in) 1990-91.”

Morgan Stanley’s top “long” picks have less credit sensitivity or better capital structures: Bank of New York Co, JPMorgan Chase & Co and PNC Financial Group.

By contrast, investors should “underweight” banks with greater exposure to mortgages — Wells Fargo & Co and Wachovia — and those that operate in harder hit sections of the United States — Fifth Third Bancorp and KeyCorp

Morgan Stanley also called for underweighting Citigroup, citing its exposure to risky assets relative to common equity.”

By the Way, it was Miller who also said this: “How do I know when I’m wrong? When I can no longer get a quote.”

Of course, it may just come to that for some of those stocks he is still so bullish on.