Banks Are Yet Again Under Pressure

Wow.

Just when you thought that Team 850 had managed to contain equity weakness, they pull their bid and stocks go down like a lead balloon. Yesterday's price action was frankly farcical, as Spoos caught a bid on news of a bilateral deal for the automakers....only to get cratered when news subsequently emerged that no deal will be passed any time in the foreseeable future.

CORRECTION: Yesterday in this space, Macro Man made some non-negative comments about the US Congress. This should have read "They're all a bunch of muppets." He regrets the error.

In any event, this was a particularly painful sell-off. While Macro Man was/is a strategic equity bear, he had expected to see a rally to sell into. As such, he has watched his view pan out without having a position (and therefore, a profit.) Very frustrating indeed.

The ruptures in fixed income markets alluded to yesterday picked up a significant head of steam, as the back end of the US curve engaged in what can only be called an uber-rally. 30 year Treasury yields fell by more than 40 bps....and they lagged 30 year swap yields by more than 25 bps! We have seen this movie before in Europe, with exotic interest rate structures blowing up and causing unprecedented volatility (and inversion) in swap curves. Needless to say, the movie doesn't end happily....though at least the US version won't be punctuated by a rate hike next month.

We are now at the point where the pricing of certain fixed-income markets appears to defy all rationality, and indeed belief. The chart below shows the US 2-30 swap spread curve, which compares 2 year swap spreads to 30 year swap spreads. An inversion shows that the environment is distressed- i.e., that bank credit is less desirable in the near term (2 years) than the longer term (30 years.) As you can see, despite 2 year swap spreads coming back in, the 2-30 swap curve has inverted massively. That's not good news.

One theme that's starting to get quite a bit of airtime to justify a bullish stance on equities is attraction of the dividend cover in the US. Incredibly (to anyone under the age of about 70), the current dividend yield of the S&P 500 is now higher than that of the 10 year Treasury bond. This is supportive of stocks, the thinking goes, because you get paid to hold them relative to bonds!

Perhaps, but there are two pretty good reasons why it would be very dangerous indeed to use this as a market-timing tool...or even a valuation device. The first, of course, is that a dividend paid last quarter will not necessarily be paid next quarter. Particularly in this uncertain environment, one in which earnings expectations remain too high, Macro Man would expect the realized dividend stream over the next twelve months to be less than the trailing divvy yield indicated on your Bloomberg screen.

More interestingly, those dividend yields need to be volatility adjusted. In case you hadn't noticed, equity volatility has gone up a bit recently. A 4% dividend yield on a 12% vol index isn't quite the same as a 4% yield on a 80% vol index. Hell, just ask the holders of structured credit turds how attractive their yields are!

In seriousness, this issue of volatility and risk premia has historically been an important one. From the beginning of the 20th century until the late 1950's, the SPX dividend yield stayed well above bond yields. It was only in 1959 (according to data from Robert Shiller at Yale) that the two yields crossed over, a relationship that they have held for the ensuing 49 years. But if we are talking about Depression-style economic and market conditions...doesn't it make sense that the dividend yield/bond yield relationship reverts to type as well? Are equities not something of a damaged asset, as the business model of earnings growth funded by leverage is discredited?

Would it be that bad, or even surprising, if we reverted to a world where dividends explain a greater proportion of equity returns, and price appreciation less? It's certainly food for thought.

In any event, US banks are once again coming under pressure, with the once-mighty Citi (C) looking like it's in trouble. Rumours of a merger (more on this below) are circulating throughout the market today, which have given futures a bit of a bounce. A number of punters that Macro Man speaks to are suggesting that banks now look cheap and worth a flutter from the long side.

In response, Macro Man asks them to have a look at the chart below. It is lagging, coming as it does from the Fed's flow of funds data - the last update was for Q2. And it is macro data - circumstances may be different for individual institutions. But insofar as the theme of 2008 has been "the great de-leveraging", it must be something of a concern that as of Q2, commercial banks' asset growth was a) still double digits, y/y, and b) still near the highs. Worrisome stuff, as it suggests still more pain in the pipeline.

Finally, Macro Man has a few quick-hit observations/tidbits about banks and the market in general:

• Apparently, nearly 40% of the companies in the SPX no longer qualify for inclusion in the index. The S&P 314 doesn't quite have the same ring, does it?
• There are only 9 stocks in the S&P 500 that are positive y-t-d.
• Goldman Sachs (GS) is now below its IPO price in 1999 (and waaaayyyyyyy below its capital raise offering price in September). Hank Paulson hasn't done much right, but getting out of GS stock at ~$200 tax free was a sensational trade.
• Citigroup's market cap as of yesterday's close was $26 billion. Assuming headcount were reduced to 300,000 today.....that would still value each employee at only $86,666. Still, it could be worse...GM's market cap only values its workers at $6,578 a head...which is close to their hourly wage.
• Although Macro Man cannot verify this, apparently UBS stock is now trading at a lower price than a Big Mac in Zurich. Attention UBS employees: if your boss tells you that this year's bonus will be a "whopper", that's not necessarily good news.
• Finally, in case you haven't heard it, the hot rumour has Citigroup merging with Goldman imminently. Apparently the new firm will be called "Sachs and the Citi".

Comments

[David White:]

The fact that the Congress did not just dole out funds to the automakers was a good thing. It showed some sanity. It showed they are not too scared. They demanded a plan from the automakers. They should. It appeared the automakers were just going to beg that they be bailed out without any long term plan other than further bailouts. The Congress actually gave the automakers a negotiating tool. The UAW will likely have to agree to pay cuts in much the same way that the airline industry has done. Otherwise it is unlikely there is a possibly viable plan for the automakers.

Those guys seemed to have no clue, excpet that they knew they were in trouble. For highly paid executives, they looked extremely foolish.

2008 Nov 21 09:49 AM

[John Pseudonym:]

The CEO of Ford made (or showed what) a fool of himself whining about not getting any money.

First he's says it's not his fault the economy tanked. That's true, but it's his job to at least have a plan for/if/when the economy tanks. What the heck are you being paid for? To stand their in good times and collect big checks and then whine when times turn bad and your company is instantly bankrupt?

Then he whines about people not getting loans (that they can't pay back) to go out and buy those $50,000 SUV's. Apparently he thinks the good old days of loaning money to people that can't pay it back are just a few months away and with this government bridge loan he can survive until the banks start giving away money again.

Not only did these fools not see it coming, they don't even understand what it is that has bankrupted them!

It's over GM, FORD and Dodge. The credit bubble has burst and it will be a long time (after you're gone) before we start loaning trillions to people that will never pay it back.

Here's how to save your company.

1. Go into CH11

2. Dump all of those ridiculous union contracts.

3. Fire 50% of your employees.

4. Hire a new design/engineering staff.

5. Build good cars people want to buy.

2008 Nov 21 10:05 AM

[Lex Luz:]

Seems to me that before we direct more blame and ire at the UAW, their contracts, and the workers they represent, we ought to consider the possibility that the executives and managers across these failed instituions MAY have had slightly more influence in setting "strategy" (in quotes for a reason) than did the swing shift frame assembly team at plant 413 or whatever.

The fact is that all three of these companies have been failing for 35 years; their failure to anticipate and understand the first Honda Civic put the big three out of business as surely as did last year's gas-price bubble and the ongoing credit unwind.

Of course the union contracts are a burden that can no longer be borne. No question that the UAW and its leadership have had a hand in driving this industry into the turf. The final responsibility, though, belongs with executives and management whose hubris through four decades of mind-bending decline now extends to going begging to Congress for a massive handout. The fact that they can't even be bothered to figure out how they would use that money realistically to transform their businesses is a clear indication of their incompetence first, and their arrogance more importantly.

The unions are nothing more than a rat feasting on the hindquarters of this dead, rotting elephant.

2008 Nov 21 10:26 AM

[Smarty_Pants:]

"Apparently, nearly 40% of the companies in the SPX no longer qualify for inclusion in the index. The S&P 314 doesn't quite have the same ring, does it?"

Don't worry. Those which don't qualify for that probably DO qualify to be in the S&P Banking Index now, or as it will soon be known, the S&P Turd-Backed index.

2008 Nov 21 11:50 AM

[gabe borens...:]

This is not the time to argue about the merits and faults of the requests for financial aid by the auto industry.
Lend them the money with some compensation /wage restrictions.
This is not the time to philosophise as the markets are unstable.
Continue with injecting liquidity(TARP) ,lower the FF to zero and impose six months moratorium on shorts .
This will allow the implemented measures to work without the speculative distractions.
On June 3,2005 I have said the following in an interview with Mark Gilbert(Bloomberg -London)."All of the economic forces point to a dramatic slowdown ahead which will turn into a serious recession,with almost no tools left to abort that possibility".
Now I have to listen to "experts" that this economic upheaval was unpredictable.
The implemented measures will contribute to the economic rebound but speculators must be stopped from udermining unprecedented effort at rejuvenating the eeconomy.
The SEC should impose moratorium on "shorts" immiediately.

2008 Nov 21 12:05 PM

[John Pseudonym:]

"The SEC should impose moratorium on "shorts" immediately."

That's ridiculous. If a company is healthy and "shorts" go after them, the shorts are going to get their heads handed to them.

Shorting is only successful when you short bad companies and bad companies are doomed to fail no matter if their stock is being shorted or not.

2008 Nov 21 01:56 PM

[mykie:]

I would expand that blame list a bit further. I was in the auto business as the son of a Dodge Dealer back in the early sixties. I still have a photo of my father, the Chrysler representative and myself, posing around an alternative fueled car. We drove around in it. In other words, the technology to build and sell that car has been around over 40 years and yet, that car never made it to market. Why?

On a macro level, it has been waiting for leadership and vision. And if that leadership and vision doesn't come from the car makers then it must come from the government. It didn't. Not only didn't it come from the government but later, I think in the eighties, the CAFE laws were either abolished or lowered and the result was more gas guzzlers.

By now and from when gasoline hit $2.00 per gallon many years ago, shouldn't the post office, fire department, police departments, etc, be driving alternative fueled vehicles? Couldn't the cost of a recent pre-emptive and discretionary war with something to do with securing oil for future use been spent instead subsidizing these public fleets?

Finally we have a President with vision who will give us some leadership by aiming us towards alternative fuels and away from our oil addiction. So blame the car makers, our government and us, the ones that voted in an oil man for President.

On Nov 21 10:26 AM Lex Luz wrote:

> Seems to me that before we direct more blame and ire at the UAW,
> their contracts, and the workers they represent, we ought to consider
> the possibility that the executives and managers across these failed
> instituions MAY have had slightly more influence in setting "strategy"
> (in quotes for a reason) than did the swing shift frame assembly
> team at plant 413 or whatever.
>
> The fact is that all three of these companies have been failing for
> 35 years; their failure to anticipate and understand the first Honda
> Civic put the big three out of business as surely as did last year's
> gas-price bubble and the ongoing credit unwind.
>
> Of course the union contracts are a burden that can no longer be
> borne. No question that the UAW and its leadership have had a hand
> in driving this industry into the turf. The final responsibility,
> though, belongs with executives and management whose hubris through
> four decades of mind-bending decline now extends to going begging
> to Congress for a massive handout. The fact that they can't even
> be bothered to figure out how they would use that money realistically
> to transform their businesses is a clear indication of their incompetence
> first, and their arrogance more importantly.
>
> The unions are nothing more than a rat feasting on the hindquarters
> of this dead, rotting elephant.

2008 Nov 22 10:07 AM

[jepittman:]

There are obviously no standards whatsoever required to write on this site.

2008 Nov 22 05:01 PM

[happysoul77777:]

The trading desks (market makers) of these big brokerage firms, big banks asked for the repeal of the uptick rule in 2004 and they got in July 2007. They had thought that would give them an advantage over other investors. Well, they deserve every bit of their own medicine. Their banks are going to be sold into zero by other hedge funds and their competitors.

2008 Nov 22 05:53 PM