Touchdown: When Do Financial Stocks Hit Zero?

Includes: AXP, BAC, C, JPM, XLF
by: Ira Artman

Friday, April 10, 2009. Mark it on your calendar.

What’s that? On or before that date, I ‘predict’ that the US financial sector will either be nationalized or wiped out, IF … the current administration is as successful as the prior administration in curing our economic crisis.

I arrived at this date by a simple linear extrapolation or trend line, which I constructed after I read a 21 Jan 2009 research note from James Bianco of Bianco Research. Mr. Bianco observed:

The financials in the DJIA are

  • Citi (NYSE:C) = $2.80
  • B of A (NYSE:BAC) = $5.10
  • Amex (NYSE:AXP) = 15.60
  • JP Morgan (NYSE:JPM) = $18.09

If every financial stock in the DJIA went to zero on today's [21 Jan 2009] open, it would only lose 331.25 points, less than it lost yesterday [20 Jan 2009] (332.13 points).

Source: James A. Bianco, Bianco Research, LLC The Dow Is Distorted, 21 Jan 2009.

To fix the start of my trend line, recall Professor John Taylor’s “event study,” previously discussed in John Taylor Clears The Way. According to Professor Taylor, his careful examination of credit spreads convinces him that 23 Sep 2008 was an important date. It was important for two reasons.

First, it marked that day the US Treasury and Fed released their 2-½ page TARP plan. The public may have been troubled by its vague generalities, as well as by the arbitrary and unclear rationale provided by the government for its market interventions.

Second, it marks the day that credit spreads began to “blow out” – more than tripling in less than a month. Below is a copy of the chart that Professor Taylor used in his event study:

Source: © 2009 John Taylor, The Financial Crisis And The Policy Responses: An Empirical Analysis of What Went Wrong, Figure 13.

If we can agree with Professor Taylor that 23 Sep WAS important, let’s look at the performance of the Dow Jones Industrial Average (“DJIA”) since that date, along with the contribution to the DJIA of the four financial stocks (“Dow Financials”) identified by James Bianco. See Figure 2 below.

Figure 2: DJIA and ‘Dow Financials’ (4 Stocks)

To construct the ‘Dow Financials’ series for the four stocks in the price-weighted DJIA, I simply added up the prices of the four stocks on every date since Monday, 22 Sep, and then multiplied this sum by the current DJIA divisor. Let’s now look closely at the descent of the Dow Financials, since the end of September, in the figure below.

Figure 3: Contribution of 4 Financial Stocks To DJIA

The blue arrow points to the 20 Jan 2009 value of about 331, mentioned in James Bianco’s research note (see above). Finally, for comparison’s sake, let’s look at BOTH the financials, and the DJIA, rebased so that 22 Sep 2008 = 100 for each.

Figure 4: DJIA and 4 Dow Financials, 22 Sep 2008 = 100

As suggested by the above, while the total DJIA had declined by 25% since 22 Sep 2008, the 4 Dow Financials had declined roughly 60%.

To see how I came up with the 10 Apr 2009 date, look at the following chart. Same DJIA and ‘Dow Financials’ lines, but I’ve added a third line, a trend line.

Figure 5: Trend Line For 4 Dow Financials, Reaching Zero

Just a simple linear trend line. Of course, it’s conceivable – if financials continue their post Sep 2008 descent – that the sector will be nationalized well before April 10th.

Why? As suggested by James Bianco, financial stocks’ contribution to the DJIA certainly underestimates their impact upon the macro economy. But it MIGHT be a good measure of financials’ POLITICAL capital, i.e., their power to prevent their outright nationalization by the newly installed administration.

This exercise suggests things might get a tad busy over at Treasury by mid-April, as the value of financial stocks touches down at zero. If my suggestion is confirmed, those involved would best get an early start on their taxes.

Disclosure: Author holds long position in JPM.