ENDGAME - The Final Bubble Survival Blueprint

ENDGAME – The Final Bubble Survival Blueprint

Freedom Financial Archive | Originally posted April 27, 2023

Dear Reader,

Welcome to our publication.

We are happy you have joined us and putting your trust in our service to guide you through this volatile and uncertain period in the markets.

Many sectors within today’s stock market exhibit bubble characteristics.

Higher interest rates from the Federal Reserve and other central banks have made corporations vulnerable to lower earnings and crashes.

Let’s look at the banking sector in particular.

There are two issues making some banks vulnerable and others stronger.

The investing environment for many of today’s most popular bank stocks has created bubble characteristics and has become so treacherous that we’ve highlighted five stocks that you’ll want to be free and clear of.

If you’re a more sophisticated investor, you may consider shorting some of these stocks when the carnage begins. Or, if you are an experienced options trader, you could do even better. By buying put options on some of the stocks listed below, you could make substantial gains.

We also discuss three stocks that have opposite characteristics, and we recommend buying them. These are stocks with solid fundamentals, yet the market has still not priced in their advantages over most in the banking sector.

In any given market environment that contains massive bubbles, there are winners and losers. One of our missions in the NEO Report is to recommend what we expect to be future winners and warn you of potential losers (or stocks that have more risk than reward).

Thank you for subscribing, and we hope you find this report to be a valuable supplement to your subscription.

Before we provide three stocks to own and five to avoid, it’s very valuable to understand a few basic investing terms.

If you’re taking a longer view, you want to think like a long-term owner of a share in a real business. And to do that, it helps to fully understand the two basic investing terms below.

I don’t want to go into detail in this report, but these definitions are important if you’re a new investor who plans to buy and hold a stock, and you plan to treat your stock investments in the classic sense of owning a business.

Otherwise, you might be under the impression, as many new investors are, that stock prices fluctuate on the crowd’s opinion of what companies will dominate the future or that investing is about voting in a popularity contest.

It’s not, really.

Sure, the crowd’s sentiment toward a company matters greatly in the short term. But sentiment doesn’t pay dividends; earnings and cash flow pay dividends.

Ultimately, every investor expects some type of return on their investment. Otherwise, they wouldn’t be involved.

Riding a stock higher based only on a company’s temporary popularity might feel great. But it can feel even worse riding that same stock back down if there was no fundamental support from rising earnings, cash flow or dividends to justify the rise in a stock price.

The best free financial education resource I’ve found online is the Investopedia website. For more detail on each term, I recommend inputting each term into Investopedia’s search box:

Market capitalization, or market cap: The number of shares outstanding of a listed stock, times the stock price. This is the market’s way of assigning value to an entire company by applying the price at which the last, marginal share traded to every share that exists.

There’s nothing really concrete about market cap because an investment bank with a $20 billion market cap in 2023 could have a market cap close to zero by the end of 2024.

But it becomes more concrete when either a corporate buyer or a private equity buyer of a company starts thinking about acquiring it. If a company has a $1 billion market cap, and an acquirer expects its free cash flow to be $100 million this year, and grow free cash flow by 5% per year, then the acquirer would see great value, and perhaps be willing to offer $1.5 billion to acquire it (a 50% “premium” over the market price).

It would be offering 15 times free cash flow (or if you take the reciprocal of a 15 multiple to calculate a yield, you get a 6.7% – and rising – free cash flow yield for the business). If you own the acquired stock at a $1 billion market cap because you recognize the value first, then you stand to make a 50% overnight gain.

Enterprise value (or “EV” in the financial world): Market cap, plus total debt, minus net cash. This is the number the acquirer in the example above would use to calculate the net cost of acquisition.

It takes into account the debt that must be assumed in an acquisition, minus the cash that is already on the acquired company’s balance sheet. If EV is less than market cap, a company has a net cash position.

If, as in most cases, EV is greater than market cap, a company has a net debt position. Unless you’re looking at a financial stock, like a bank or an insurance company, generally EV is not much bigger than market cap.

Here’s a tip to avoid non-financial stocks that are at high risk of going to zero: if EV is five, ten-, or fifteen-times market cap, then the market is anticipating a high probability of bankruptcy.

I wanted to clarify these points upfront before you read this report.

From these two numbers, you get an idea of what you’re paying for stock, relative to the value you’ll get in the future. Value can come in the form of a small cash dividend today, or a much larger dividend in ten years (as a “growth investor” tries to anticipate).

Again, if you’re just starting out, or even if you’re an experienced trader, and have not invested at least a few hours or days to familiarize yourself with the basic investing jargon, I highly recommend investing some time. It can pay dividends over your investing career.

Also, education will broaden your interest in the fascinating stock market, which is always loaded with great opportunities and hard-to-see pitfalls. More education and experience will help you recognize opportunities and avoid pitfalls.

I’ve been researching stocks professionally for decades and still approach it as I did at the beginning of my career. When you’re always learning, and the environment is constantly adapting around certain core principles, this venture doesn’t get boring.

If you approach stock investing as though you’re owning a share of real business, and not trading flickering tickers on a screen, you’ll stick with it when times are tough. And in tough bear markets, it feels best to quit and sell, usually at the worst possible time.

Today, investors look in the rearview mirror and see nothing but years of rising prices for the major indices. But as any driver knows, you don’t want to drive looking through the rearview mirror.

The path forward in stocks is unknowable with any certainty. But experience and valuation tell me that the three stocks below offer much more reward than risk. And the five stocks below that offer, in my view, more risk than reward.

First of all, the market is still trying to digest the problems circling around the financial industry, which is very fluid at the moment.

In March 2023, UBS “officially” purchased Credit Suisse (CS) following additional support from the Swiss Central Bank. CS has struggled with multiple restructuring and bailouts/ lines of credit since the 2008 financial crisis. It isn’t surprising to see UBS absorb CS. But, the question becomes can UBS handle the unwind of Credit Suisse exposure?

UBS has seen its Credit Default Spreads (CDS) blow out as investors are concerned CS could weaken UBS to a large degree. CDSs are essentially insurance packages in case of default by a company, country, or bond.

Pressure Is On Small Banks

There is hope that the latest bank contagion will be contained, but there is renewed pressure on the small banks in the U.S.

We believe that the pain is far from over given the pressure at the regional bank level. Small banks are some of the largest underwriters of commercial and industrial loans (C&I loans) as well as commercial and residential real estate. (More on this later in this report)

The consumer piece is also coming under pressure since those loans are usually by way of credit cards or lines of credit against homes or other hard assets. I think that asset prices have a long way to fall, which will put more pressure on the loan books at these banks.

It will be very difficult for the Federal Reserve or the U.S. government to backstop all the unsecured deposits. There is about $18 trillion in deposits with only $125 billion in the FDIC (Federal Deposit Insurance Fund). The Fed has assembled the potential to backstop about $2 trillion, but that would just be another massive QE injection that would send inflation surging again.

Bond volatility has surged to new heights as it approaches levels not seen since 2008. As global volatility increases, there will be bigger reductions in risk assets as companies and consumers pull back more aggressively.

The additional stress across the market is going to put more downside pressure on earnings, and we expect to see another shift lower in the stock market. This will set up more “fear” and reduce economic activity further.

In the U.S., we have final sales of private domestic purchases falling rapidly, which will weigh on earnings and margin. The next down wave will be rapid and result in more fear permeating the system as many investors (especially retail) remain long equities.

A Credit Crunch Is Coming


As the bad debt expense rises, the banks have less money to lend as they need to keep more cash on the balance sheet to account for the write-downs. This has created a broad freeze in new loans and underwriting, which will take the credit impulse down significantly in the near term.

Here’s the problem.

The willingness to lend was already in recession territory the past couple of weeks BEFORE the regional bank chaos began. The shifts in liquidity, concern around deposit bases, illiquidity of hedges, and weakening loan portfolio is going to shrink that even faster.

Just like everything else in today’s financially manipulated world, loans and leases in bank credit are at record levels. So, any shift in asset valuation can have huge ramifications. Leverage is great when it’s all sending us higher. But the moment it turns lower, the losses add up rapidly.

As credit growth dries up, we are going to see a sizeable drop in real credit growth, which will take GDP down with it as well. In the chart below, essentially what matters for growth (black line) is the credit impulse (blue) with the second derivative being credit. If we assume stabilizing credit and avoid an outright credit crunch, the second derivative turns very negative regardless and still risks a broad U.S. recession.

We have pointed out in the past that a recession was unavoidable, and we believed it would be a shallow and prolonged drawdown. We are still keeping that as our base case, but the stress is growing which can send us lower much faster.

The Fed is launching initiatives that will “slow” the drop, but it won’t by any means reverse the problem. The bank failures are the SYMPTOM and not the CAUSE!

We have highlighted from day one that banks/investors were failing to do the necessary due diligence in evaluating risk and hedging appropriately. This is all because of their access to ZIRP and endless QE.

The moment many of these zombie companies could no longer roll their debt, it would all come crashing down. As we have said, rising rates fix a lot of problems, and we need to purge the system.

The U.S. is now a classic credit impulse story. Usually, it’s hard to disentangle demand vs supply in the credit impulse – the change in the flow of credit – but SVB and ensuing pressure on U.S. regional banks is a true exogenous shock that will drive the impulse sharply negative.

The Fed has dumped a ton of liquidity into the market and added about $297 billion in assets to its balance sheet. This essentially erased half of the QT that has taken place since April’22 and all of it was done in a single week.

We also saw a surge of U.S. banks borrowing from the Fed’s discount window to a level that dwarfs the GFC and COVID shocks. It totaled about $152 billion with the recent record being in 2008 at $112 billion.

Financial Conditions Are Worsening

This tightening scenario is a key reason why the Financial Conditions index took a HARD turn lower and is the tightest since March 2020.

The yield curve inversion reached its steepest levels going back to the early 1980s and has now started to snap back higher as the market starts to price in underlying rate cuts being pulled forward.

During the last six U.S. recessions, we saw the yield curve (10 years minus 2 years) steepen aggressively as the Fed entered a rate-cutting cycle. The market is pricing in the same today, pointing to a Fed Funds rate of 3% by the end of 2024.

The uncertainty surrounding the world is also playing out in U.S. CDS’s as the value of them surged.

We have done nothing but increase the money supply for the last 60+ years, expanding the amount of liquidity in the market steadily. We need to pull some of this froth from the market, but as you can see from the insanity, many banks, investors, and corporations aren’t prepared for the party to end just yet.

“Just one more hit” seems to be the view from around the world. But at some point, we need to end this monetary experiment as the law of diminishing returns catches up to us rapidly.

The below chart puts into context just how “small” that money supply shrinking was and yet people have now lost their minds.

Indicators Point To Recession

Even before all of this unfolded, the leading economic index has been dropping with its eleventh straight month of declines. The streak has never been seen without an economy already being in or heading into a recession.

The shift in the banking world and underlying economic headwinds are sending CAPEX expectations through a floor after already assumed to be lower.

Three Stocks To Buy

But there is a way to try to capitalize on the current banking crisis.

There is some opportunity for the best banks that have managed their portfolios to come out on top. The best place companies remain MTB (M&T Bank), PNC and FITB.

They have the least exposure to deposits over $250k and don’t have unrealized losses like the rest of the group. These three banks will be able to balance the next few months and pick up valuable assets. Weaker banks will be selling more assets to raise capital to secure deposits. We expect to see more portfolios come to market, and it will only strengthen the banks that have managed their risk and loan books like these three banks.

Our recommendations are three of the most well-managed banks in the country.

M&T Bank Corp. (NYSE: MTB) is an American bank holding company headquartered in Buffalo, New York. It has 1,000+ branches in 12 states in the Eastern United States.

M&T Bank has been profitable in every quarter since 1976 and also has the distinction of being only one of two banks in the S&P 500 that did not lower its dividend during the 2008 financial crisis.

In 2022, MTB acquired People’s United Bank in an all-stock transaction valued at approximately $8.3 billion. MTB’s market cap is $19.83 billion.

MTB trades above the median implied cost of equity so it’s an attractive entry point from a risk/reward standpoint.

M&T Bank is well positioned in the current environment with approximately 50% of deposits FDIC insured.

The bank’s capital position is also strong given prudent balance sheet management resulting in lower unrealized losses relative to peers with the optionality to extend duration at higher rates. We recommend buying.

PNC Financial Services Group Inc. (NYSE: PNC) is an American bank holding company and financial services corporation based in Pittsburgh, Pennsylvania. Its banking subsidiary is PNC Bank, and it operates in 27 states and the District of Columbia, with 2,629 branches and 9,523 ATMs.

The bank is ranked ninth on the list of the largest banks in the U.S. by assets and its market cap is $50.04 billion.

PNC Financial outperformed its peers in the iShares Regional Banks ETF, demonstrating the market’s confidence in its leadership prowess. We believe PNC can outshine its competitors during this banking crisis and emerge stronger than ever, which will cement its market leadership. We recommend a buy.

Fifth Third Bancorp (NASDAQ: FITB) is an American bank holding company headquartered in Cincinnati, Ohio. It’s one of the largest consumer banks in the Midwest and South, operating in 11 states. Fifth Third operates 1,100 branches and 50,000 ATMs.

The Bancorp operates through three segments:

Commercial Banking, which offers credit intermediation, cash management and financial services to large and middle-market businesses and government and professional customers.

Consumer and Small Business Banking provide a full range of deposit and loan products to individuals and small businesses through a network of full-service banking centers and relationships with indirect and correspondent loan originators.

Finally, Wealth and Asset Management provides a range of wealth management services for individuals, companies and nonprofit organizations.

This diversification will help FITB thrive as this banking crisis unfolds and weaker banks are vulnerable to takeovers from banks with stronger fundamentals like Fifth Third Bancorp. We recommend a buy on this bank as well.

Five Banks To Avoid

Here are five bank stocks to avoid and sell if you own them.


These banks are heavily exposed to the commercial real estate sector. That’s bad news for investors.

After decades of thriving growth bolstered by low-interest rates and easy credit, the $20 trillion commercial real estate industry has seemingly hit a wall.

Office and retail property valuations have been falling since the pandemic brought about lower occupancy rates and changes in where people work and how they shop.

Also, Fed action to fight inflation by raising interest rates has also been a headwind for credit-dependent companies that large banks serve.

Recently, short sellers have stepped up their bets against commercial landlords, indicating that they think the market will continue to fall as regional banks limit access to credit. Real estate is the most shorted industry globally and the third most in the United States.

Take a look at this chart:

Fund managers see commercial real estate as the most likely source for a systemic credit event.

This is not good news for most of the major players in the sector. Now private lending to the industry is starting to slow — which was happening even before the Silicon Valley Bank failure even happened. Credit was getting scarce for all commercial real estate and this bank failure on top of that only exacerbates that trend.

Also, there’s been a fundamental shift in how we use office space and that has changed demand. That’s something you should have your eye on, especially as low-interest office loans come due. We’re running into a situation where office owners have to refinance at a higher rate and only 50% of the building is being used. That doesn’t translate to good cash flow metrics for the lender.

Higher rates and in turn recessions are notorious for quickly identifying risk. Unfortunately, real estate will not be immune. Commercial is already starting to swoon and start the party off with the office sector.

As rates continue rising and remain higher for longer, look for this trend to accelerate and ultimately spill into the residential sector. Look for considerably more spectacular failures in the near term, the only questions are how many and who.

Here is the list of banks to avoid:

BlackRock Inc. (NYSE: BLK)

Blackstone Inc. (NYSE: BX)

Wells Fargo & Co. (NYSE: WFC)

JPMorgan Chase & Co. (NYSE: JPM)

Goldman Sachs Group Inc. (NYSE: GS)

The primary way real estate could cause problems for the economy is if an extended decline in the value of commercial mortgages made deposits flow out of banks, forcing them to crimp lending not just to developers but to all customers.

In extreme cases, that could threaten the banks themselves. Stay away from the major players exposed to the commercial sector listed above for now.

That concludes our Final Bubble Survival Blueprint report on three bank stocks to buy and five to avoid. Thank you for reading and for your investment in our research service.

Good Hunting,

Freedom Financial News