Jordan: The Trade in Banks Is Now Over

Ryan Leggio: You've really remade the portfolio over the last few months, and I wanted to talk about two aspects of that which are quite interesting. The first was earlier in the year with financials. Can you talk a little about what got you in to some of the financial names and what you got out maybe a little prematurely?

Jerry Jordan: Sure. I'm going to pat myself on the back to start off with before I tell you how much of an idiot I was, which was a year ago, March of '09, right at the bottom, we were very bullish. We had owned almost no financials whatsoever for the prior 16 to 18 months, had avoided that entire debacle, and we thought the market was bottoming, we thought that people had thrown the baby out with the bathwater on the financials. You know, it's hard to remember, but stocks like GE went from $10 to $3 in six weeks. Citicorp went from $5 to $1 in four weeks. That's the sort of stuff that generally smacks of absolute desperation and exhaustion selling.

So we, actually, in our opportunistic style, we went in, and we went from a 0% weighting in financials to a 20% weighting in financials into the end of March '09. But we were out of all the stocks by August. We can get into it, but we're not believers that there's a new secular bull market in financials.

And we decided we were not going to buy them back until they did their next round of financings, which they ended up doing in November-December. And we bought the stocks, and we probably took the position back up to a 12% or 15% weighting in the fund.

And then when the Greece/Portugal decline occurred in January-February of 2010, this year, we got a little bit shaken and the stock market sold off. We'd raised some cash in our fund, but we actually put it all to work. We were 100% invested right at the bottom of February, because we figured the market had sort of done enough on the down side and was due for a rally, but we really didn't think the banks were going to be the way to play it, with what was going on in Europe, the risks that reminded everybody.

And then the fact that they'd done all of these refinancings. It seemed to us that people had to have been satiated in their demand for shares of banks. And then technically, as the last little bit amongst the bank stocks all broke down in February, and we said, "Alright, you know what? The market's going to rally, but these aren't the horses to be on. These aren't the horses to be riding in this race." And so we sold our banks.

You know, off the top of my head, I forget what we bought, but whatever we bought didn't do as well as the banks did and the banks too off from there. It's one of the worst trades I've had in 10 years.

Leggio: Is there a lesson there, though, because it really looks like from a fundamental, bottom-up valuation perspective, and even a top-down perspective, you got it right and you had little downside? And yet you and shareholders didn't really benefit. Is there a lesson there either for you or for other shareholders?

Jordan: Well, I don't know, because there are obviously plenty of times in the last 10 years where a group that had led the way in the downside, then had a huge rally back up, then rolls over and breaks down, you should have been out of them. You should have sold them and not come back to them. This was one that that didn't happen. So it's hard to say.

It's easy, like a lot of these things, it's easy to look at it now and say, "Boy, you should have known," but it's very hard sometimes to say, "OK, this is the breakdown you shouldn't sell. No, no, this is the breakdown you should sell." I like to believe that I'm not going to make that mistake again, but I'm also human enough to know that I probably will.

Leggio: Sure, and maybe we can talk about banks a little bit because some noted value managers have been buying some of the big banks, which look cheap on a tangible book value basis, like a Citigroup. What's your thoughts there on why they may not be as attractive as some may think?

Jordan: Yes, I have been a believer from the beginning that the banks were, at best, a trade. I think that trade is now over. I think that trade is over for a number of reasons. Number one, many of them are back to book value. I still am very suspect of book value, that they need to mark down a lot more of their portfolio. There is still the specter of too much housing out there. I don't think it's going to be bone crushing to the economy, but it's still out there as a weight.

And just history. History says when you have a group like the banks were, where the financials get to be a huge percentage of the economy, a huge percentage of the S&P 500, when they finally pull the rug out and that group crashes, it's usually over for the group. That doesn't mean you can't find a name here or a name there that's a winner, but that generally that's it for the sector for a long time. And yes, the group went down a lot but it's now rallied a lot and it's our belief that you've got history working against you.

And then you've got the fact that Congress is now, it seems to me, after the testimony and the grilling of Goldman Sachs employees yesterday, they're now lined up against the banks. We're going to see financial reform, and that reform's going to take a number of steps. I would expect to see increased regulation, absolutely. A reduction in leverage allowed, absolutely. And then very possibly they're going to force them to start splitting off their businesses.

Much more of a Chinese wall between the broker or dealer and the M&A side. Not exactly all the way back to Glass Steagall, but maybe something like it. And I think all the proprietary trading, which has driven 80% of the profits in the last five or 10 years, I think that's going to be forced out of the business. And once you take that out of the business, I think that materially changes the profitability of these entities.

I also think it changes of the profitability of the proprietary trading, because now they'll no longer have all of that customer flow to lead them in the right direction.