04/08/09   Bank Stress Tests: Abort, Retry, Fail?

Editor’s Corner

Bank Stress Tests: Abort, Retry, Fail?

Ron Rowland

Earnings season is upon us once again.  It is unclear whether corporate profits (or lack thereof) will be higher or lower than they were in the panic-stricken 4Q 2008, but they are expected to be 37% down from a year ago.  We claim no forecasting expertise in that area, and there may be significant variation between companies and sectors.  In any case, we would pay more attention to the year-over-year results, which will be more indicative of the long-term change in consumer confidence and spending power.  Also look inside the reports to see how much cost-cutting (mainly layoffs and inventory reduction) added to the bottom line.  Having cut overhead to the bone, companies must now increase sales in order to generate profits.  Many will find it very difficult to do so.  However, the market tends to react to whether or not earnings “expectations” were met as opposed to the “actual” earnings results.  The “outlook for the remainder of the year” portion of the reports will also be closely watched. 
Remember the bank “stress tests” that the Treasury announced with great fanfare a few weeks ago?  The results are starting to come in, revealing…we don’t know yet.  The reason we don’t know is that Treasury has apparently decided to delay any public announcements so as not to “interfere” with impending quarterly reports by those same banks.  This suggests that the findings of the stress tests are probably less than reassuring – even with the bar set laughably low.  If the news were good, there would be no reason to delay its release.  The financial sector is still a long way from recovering its lost glory.  
Equity benchmarks are showing mild intermediate-term momentum, but the long-term trends are still very bearish.  The S&P 500 is at the high end of a downward-sloping channel defined by the highs of early November, early January, and now early April along with the November and March lows.  The range of this channel is huge, nearly 30% from bottom to top, starkly illustrating the tremendous volatility seen in recent months. 
Treasury yields have been slowly climbing back from the sharp drop following the March 18 FOMC meeting.  The minutes of that meeting, released today, reveal that the Fed officials feared the U.S. was falling into a self-reinforcing cycle of rising unemployment, falling business activity, and tighter credit.  Their solution to this challenge: print more money.  The 10-Year Treasury yield is once again approaching the 3% level that the Fed seems determined to defend, so we will not be surprised to see new and even more imaginative monetary interventions in the near future.  For now, Treasury bonds look like a relatively safe parking place.  We are not sure they will remain so much longer.
Almost every sector was up strongly over the last week, the primary exceptions being Health Care and Utilities.  Not surprisingly, those two sectors are now at the bottom of our relative strength charts.  Growing strength in Technology, Telecom, Consumer Discretionary and Materials indicates we are seeing a rotation out of defensive sectors into more cyclical and aggressive niches.  We continue to urge caution, as the enormous volatility means both absolute and relative strength trends can shift very quickly.
Most of the style categories have now slipped from negative to positive momentum, with the Growth categories still leading the way.  Mid-Cap Growth successfully tested its November low, but its recent rally ran out of steam before the January highs could be challenged.  None of the Style categories have broken above their January peaks, and all are still within very wide trading ranges.
As with the style rankings, breakouts above the January highs are non-existent in our International categories.  Exceptions can be found in a few narrow local markets, such as Taiwan.  Japan has slipped back down the rankings and is now tied with the U.K. for last place.  Canada is still in fifth place but made gains in absolute terms. 


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

“Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risk.”

Nassim Taleb


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