Touchdown: When Do Financial Stocks Hit Zero?

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 (C) = $2.80
• B of A (BAC) = $5.10
• Amex (AXP) = 15.60
• JP Morgan (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.

Comments

[ironpants:]

Truly hope you are wrong.
However, suspension of mark-to-market, or creation of a super bad-bank could immediately upend your thesis.
Let's see.

Jan 27 09:14 AM

[helplessobs...:]

Ira,
If the DJIA banks get nationalized along with other biggies, what happens to the solvent large regional banks like BBT, PNC and Comerica?

thanks,
helpless

Jan 27 09:48 AM

[Ira Artman:]

FYI - Here is an interesting article from the Institutional Risk Analyst, discussing the differing treatment (and risk positions) of large and small banks:

The Big Banks vs. America:
A Roundtable with David Kotok & Josh Rosner
Institutional Risk Analyst: January 26, 2009


us1.institutionalriska...

Jan 27 11:26 AM

[DVW:]

That's silly. So you're taking lines on a chart and extrapolating them to zero. I've seen some crazy analysis on this site, and this is right up there with it.

Jan 27 04:07 PM

[kozanack:]

I don't think it's silly that the DJIA financials could all go to zero. But, yes, I doubt that it occurs in linear fashion. Probably more likely that they are taken over in ones or twos during the next few months


On Jan 27 04:07 PM DVW wrote:

> That's silly. So you're taking lines on a chart and extrapolating
> them to zero. I've seen some crazy analysis on this site, and this
> is right up there with it.

Jan 27 10:46 PM

[Ira Artman:]

The 'concept' as noted is a simple extrapolation, and of course says more about where we've been than where we're going. That's the point.

What is astounding is that for all intents and purposes, there's really not much difference between a $2 or $3 stock and a penny stock. What is truly astounding is that some of these $2 or $3 stocks sold for $30 1 year ago, and $60 two years ago.

Jan 27 11:27 PM

[nyorker:]

Thinking that If every financial stock in the DJIA went to zero and the dow would "only" lose 331.25 points is pretty disingenious, in my opinion.

Seeing as a large part of the problem with the market and financials is based on peoples "perception" and "sentiment" of what is and is "going" to happen is responsible for much of our problems right now.

If the financials went to zero, you would probably be looking at Dow 4000.

Unfortuantely, hysteria rules the day more than charts do.

Jan 28 07:05 AM

[Ira Artman:]

Nyorker, kozanack and DVW:

Thanks for comments. James Bianco was talking about the fact that price weighting of DJIA can, when component prices are low (and below their own guidelines) lead to results that underestimate the 'footprint' that the companies represented by the stocks have on the real economy.

Don't disagree - of course he's right.

There is another issue too, which is more of a *political* issue than an economic or financial issue.

Specifically, at what point do firms with low stock prices and capitalizations (relative to their recent past) lose their standing as political players or as voices that are given consideration when political decisions are made with respect to their fate?

That's what I (at least) am wondering about. Extrapolation and line are simply devices to focus the discussion and make an impact.

Thanks again, for reading and comments. - Ira

Jan 28 11:22 AM

[nyka:]

Another alleged "expert" mouthing off, strictly to get much-needed attention. Following this guy's prediction, I would have lost out on today's impressive rally...specifically in bank stocks. Ira, time for you to return to your full-time job as a used car salesman.

Jan 28 04:46 PM

[User 290784:]

This is one of the most stupid analysis I have ever read. If you apply the same reasoning to the technology stocks based on the price increases between 1998-2000, NASDAQ should be 30,000 point by now. And, based on the price trend between 2000-2001, NASDAQ index should be only 100 in 2002!

Jan 29 10:51 PM

[Ira Artman:]

Thank you for comments. If you were dissatisfied with the above, then you probably won't appreciate the following, "Now & Then", either:

mortgagenewsclips.com/.../

Again, both the link above and the original article are about politics, rather than finance. Finance has nothing to do with the current state of banks.

Jan 30 09:23 AM