Bank Stocks Rally: Sustainable or Bear Market Blip?

The reason why so many investors have been skeptical about the recent rally in stocks has to do with the role of bank stocks, which have been at the heart of both the drop as well as subsequent 20% rebound. The question is whether this recent dramatic move up in financials is sustainable or is merely a temporary blip, as the market reevaluates the inherent risks. I present a good summary by Goldman, arguing that all signs point to the latter. I particularly draw your attention to exhibit 9 showing the number and magnitude of some bear market rallies in the context of an overall declining market.

Rally in context

Bank stocks have staged a big rally and investors are now asking is this a bear market bounce or have we seen the bottom. In our view, this is a bear market bounce as:

(1) Non-performing assets are still accelerating: The fundamental data is not getting any better on consumer credit. Master trust data on credit cards points to a significant deterioration in consumer credit quality – losses increased 90 bps month on month which is the highest increase since the cycle started. Moreover, we are likely to see a resumption of writedowns in March given the “X” indices have fallen by 8% so far this month (click on charts to enlarge).





(2) Reason for rally: Part of the rally has been driven by comments from several banks that they have been profitable in the first 2 months of the year. However, we expect that some of this performance is driven by one-off factors such as write up on debt, mortgage origination fees, strong capital markets activity in Jan and Feb, which may fade in coming months and limited reserve builds despite our expectation that NPAs will continue to grow (click on charts to enlarge).



(3) Next catalyst: The next major catalyst in the banks sector will be stress test results, which will most probably come out in the middle of April. We cannot rule out banks unexpectedly failing this test and being forced to either raise capital from investors or take government capital. We expect that some banks that pass the test will look to issue equity to pay back government TARP. Either way, we expect significant equity issuance.

(4) Valuation may not provide a floor. We are now back to 0.8X tangible book, up from 0.5X two weeks ago. Both are low relative to long term averages. That said, when we look at prior severe regional home price depressions both in the US and globally, we find "trough" valuations within the range of 0.2X - 0.7X tangible book (click on charts to enlarge).

Comments

[Mbuna:]

Allow me to pour some gasoline on your fire here. Hat tip to Naked Capitalism and courtesy of the Financial Times:

A “black hole” in the US commercial property market is set to put further pressure on troubled banks, the head of leading private equity firm Apollo Management has warned.
Leon Black, founder of the firm, said the extra costs of cleaning up the US banking industry could total as much as $2,000bn, putting further strain on the economy. He said the woes of the commercial property had not yet been reflected fully on bank balance sheets.

“You have the black hole of commercial real estate and that hasn’t happened yet,” said Mr Black in a wide-ranging interview on FT.com.

“There you are sitting with $4 trillion of debt and you know not all of it’s bad but a lot of it is diminished and that really hasn’t yet been addressed.”

He warned it would be 12 to 18 months before there are lasting signs of US economic recovery.

Mar 20 04:35 AM

[Kevin Walmsley:]

Absolutely not sustainable. Sell. And tell everyone you care about.

Mar 20 05:38 AM

[J. D. Swampfox:]

If You Can

If you can keep your head when all about you suckers are buying bank stocks based on smoke the Dimon's and Pandit's blow...

If you can watch Tangible Common Equity when all about you suckers accept the Tier 1 Capital fantasy that FASB wants to allow...

If you can focus on Comprehensive Income when all about you suckers fall for whatever the bank wants to report for Net Income...

Then, while all about you suckers are asking for bailouts from FED, Treasury or SIPC, you'll be rich, my son, and then some.

copyright J.D. Swampfox, March 20, 2009

Mar 20 08:13 AM

[robert99:]

More gasoline: the mortgage resets, which tipped the balance and began this meltdown, are not over. Wave two begins... uh... now, and doesn't end until 2011. Everyone knows about CMBS (which is a higher proportion of banks' balance sheets than RMBS), so no need to trumpet that one. I'm 70% long, with quite a few stocks up 40% or more since the bottom. I think it may be time to take profits.

Mar 20 09:03 AM

[William Cowie:]

This may simply be the shorts getting out. Those with access to the most current short interest numbers can confirm or deny this.

Mar 20 09:19 AM

[Thadeus Tho...:]

All I can say abut this is that anyone who has kept track of the commercial real estate property market much realize it is at as inflated or more inflated than the residential market. I know of two individuals who got out of the stock brokerage business in around 1999 when the market tanked, and promptly started dealing in commercial real estate property. The commissions there were obscene. Business rental property got bought and oversold so many times that owners kept raising rents to the point that some business owners moved out of buildings. It's nuts when a small hair salon owner like my wife goes to has to pay 50 - 55% of her monthly income as rent. So here's an example of the real estate business profiting with no thought or concern of how the big ticket sale of a building will affect another business owner. I'm not saying all real estate people are heartless and self centered. They just fell into the same path that the mortgage lenders did. Sell a lending product, sell a property, damn the torpedoes! More greed, more lack of ethics, all for one and all for me attitudes got us here.

Mar 20 09:50 AM

[logicalman:]

SHORTS HAVE NOT BEEN SQUEEZED ENOUGH YET!!!

Mar 20 12:44 PM