05/06/09 A Gift for the Banks
A Gift for the Banks
The fundamental backdrop is increasingly subject to interpretation. First quarter corporate earnings were not as bad as expected – but how much was a result of cost-cutting that cannot be repeated? Home prices are stabilizing – but more homeowners are underwater. Banks are beginning to lend again – but no one wants to borrow. Sincere people can spin the data into a plausible story that confirms whatever they already think. We continue to focus on unemployment because it is the root of so many other questions. Today’s ADP report suggested that Friday’s non-farm payrolls will not be as bad as expected. Economists are now talking about a sluggish, prolonged “jobless recovery.” Why this would be bullish for stocks is unclear to us, but we won’t fight the tape.
Results of the bank “stress tests” are leaking out, and it appears most institutions will be deemed undercapitalized. Of course everyone knew this months ago, but it is nice to see that the regulators are at least making a modest attempt to reveal the facts. As we noted last week, the solution for most banks will be to convert the preferred stock they issued under the TARP program into common stock. Remember last fall when we were told that TARP would turn a profit for the taxpayers? That lie is now exposed. The current maneuver is nothing more than a cash gift from taxpayers to bankers. It is a great deal for the banks – which is why financial stocks are flying higher this week. The worst of the bunch, Bank of America (BAC), has seen its common stock jump more than 45% in the last five days despite the massive dilution that is now all but certain. Sadder still, even this generosity will probably not be enough. Look for the banks to be back at the trough in a few months.
The Treasury, for its part, will probably end up as majority owner of some banks. President Obama has said he does not wish to be in this position for very long. Even if we grant his sincerity, we don’t see how he can avoid it. What does he intend to do with the bank shares he now owns on our behalf? Private buyers are not exactly coming out of the woodwork. Moreover, the political pressure on the administration to force economically irrational decisions on the banks it owns will be intense. We do not foresee a good outcome for this.
The 10-year Treasury yield broke above 3% last week and is still at 3.152% today. The 3% level now looks more like a floor than a ceiling. As we noted last week, this looks like a significant shift in Federal Reserve policy. Bernanke did not defend the 3% level for months for no reason, and we find it hard to think he surrendered without good reason. The most plausible theory is that selling so much new debt was proving too difficult at lower rates. If so, rates will likely climb even higher in the coming months. Long-term Treasury securities do not look nearly as attractive as they did in December.
The Materials sector jumped into first place, and all sectors showed dramatically higher momentum. Consumer Discretionary and Technology round out the top three. Health Care, Utilities and Consumer Staples are still on the bottom, indicating investors are growing more aggressive. Every sector except Health Care is now in an intermediate-term uptrend, and Health Care is neutral with an RSM of zero.
As with sectors, all the Style categories have picked up momentum over the last week. The top three and bottom three categories stayed the same, however. The theoretically-safer Large Cap and Mega Cap categories are at the bottom, again suggesting that the caution which prevailed for several months is giving way to widespread bullishness. While this seems to conflict with reports of negative sentiment, the numbers are what they are. Every corner of the Style box is trending up; the differences are only in degree.
Emerging Markets made a huge jump this week, with Latin America jumping from an RSM of 38 last week to 97 today. In part this is a reaction to the swine flu scare which pushed some Latin American markets down last week, but the gains are still impressive. Japan picked up momentum in absolute terms but fell to the bottom of the list after being overtaken by UK and World Equity benchmarks. Canada made a big gain as well, helped by rising commodity prices.
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.
“Imagination is more important than knowledge.”
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