Financial Stocks Are Ready for Their Pullback

Financial stocks have seen a huge turnaround in the past month and it's as dramatic as a fairy tale can be. It's like suddenly a frog turned into a beautiful princess. Just 60 days ago these banks were bleeding and were in an as ugly shape as an institution can be. But thanks to all the magic potions applied by Congress and the White House, these banks are now in an imaginary healthy shape. Basically what happened was that in a desperate effort to turn around the economy, government threw away all the rational accounting rules and voila, we had a rally. But sooner or later the reality will start showing up again.

Results from Mastercard (MA) and Visa (V) both showed deteriorating consumer quality in the US. While Visa did well in the overseas market, their US revenue was abysmal. Same story goes for Mastercard. Now we take the lessons learned from these two plastic money leaders and apply them to paper money lenders like Bank of America (BAC) and JP Morgan (JPM) and we'll soon reach the conclusion that the US consumer is in as bad a shape as it was 60 days ago.

And worst, consumers will not be able to rebound any time soon, especially in the US. On top of that, government is trying to enact a new law for credit card issuers, which has the potential of significantly reducing the earning power of these banks. And for the first time banks themselves are acknowledging that. But investors seem to have found a new enthusiasm for getting burnt by investing in these financial shares. At these levels, these stocks seem quite scary. Keep in mind that JPM was at around $50 when this crisis started. Now it's back up to $35. So by simple assumption that earning power is not even 1/2 of what it was assumed to be in late 2007. I find this stock very expensive. BAC and C are a different story because, first, these banks have to reach a true solvency level and then talk about earnings. All four major banks C, BAC, WFC and JPM, are overvalued right now in my opinion.

Market is perhaps deriving a lot of optimism from upticks seen in recent housing data and consumer confidence. But numbers can be very deceptive based on how they are presented. Having a 5% gain on a 40 reading is much easier than having the same 5% gain when reading is 80. So while I might agree that the economy has perhaps bottomed, I don't see any reason why it will get back up to the glory days in a one or even two year time period. A "V" shaped recovery is only in the fancy of investors who are willing to buy these financial stocks at current levels.

In my opinion, recovery in the US will be a slow and painful process. Sand castles of fictitious purchasing power created by senseless credit flow have been grounded. While the Federal Reserve is trying to lower the credit costs by continuing its reckless programs, in my opinion they can't continue on that road long enough, simply due to its design. Their actions are inherently opposite of each other. For example, consider their program to buy treasury to reduce borrowing costs. As the costs are reduced and the stock market stabilizes, the treasury, which is already super inflated, will be sold-off heavily. Already treasury yield is at the highest in five months. So will somebody ask how the Federal Reserve's balance sheet looks with the billions of US treasury bonds that they recently bought at their peak? I can guarantee you that it's the stupidest investment any central bank would make.

But given that other central banks are not falling in the trap, the Federal Reserve has to keep providing those dollars in a bid to keep the treasury market from collapsing. The result? Their balance sheet will keep deteriorating if the rest of the market is improving and vice-versa. So given that idiotic policies are the forces behind the current upswing in the financial market, I am doubtful of the length of this euphoria. When I see concrete policies coming out, I'll ask investors to jump in. But right now, it's time to book your profits with the current rally and take a breather. In my opinion, WFC, JPM and BAC are all a sell right now. Their more sustainable level in the near future is $17, $25 and $7, respectively.

Disclosure: currently no position in any stocks mentioned here.

Comments

[Jasper M:]

Good article.
I believe the the Fed is, indeed, headed for either an embarrassing capitulation, or a humiliating public defeat. Either way, it will be the end of Bernanke's career. And hopefully a cautionary tale for those who come after.
Expect Giethner's star to plummet about the same time. Most people probably don't remember, but Cabinet officials are regularly sacrificed in bad times. (In good times, they fail to get in over untaxed nannies, but once in they stay.)

May 05 04:03 AM

[Leo F:]

Geithner's star has a very short distance to plummet. The governor of the Bank of Canada recently took the unprecedented step of publicly catigating the man for his incompetence.

> Expect Giethner's star to plummet about the same time.

May 05 08:46 AM

[normthefedup:]

Interesting concept, author. However, in your perpetual moaning about the dilemma that banks, credit card agencies et al find themselves "trapped" in, you keep harping on the "US consumer." If they are, indeed, making money in other areas of the world, doesn't that profit drop into the same pot as the supposed horrendous losses in the US? Don't ALL companies at one time or another, experience losses at one division while making money at another and, overall, have a good corporate profit performance? You cannot emphasize US losses without looking at the overall picture. US oil consumption is down....OK....but China is picking up. Consequently, the price of oil broke $54 a barrel this morning. According to your philosophy, oil should be about $10 a barrel because the US demand is down. Look at the big picture and wake up.

May 05 09:30 AM

[vodop09798:]

Good show, Norm. My sentiments exactly. Just a potential short grasping at straws.

May 05 12:38 PM

[texasgolfer:]

"sand castles of purchasing power" sounds like a Danielle Steele novel.

May 05 12:56 PM

[horrid:]

Who bought up the banks stocks like that? Why? Does not make any sense.
It is the Fed? Or are the banks themselves repurchasing shares with their TARP money?
Ha Ha

May 05 02:19 PM

[ifuwish2:]

ou are just a stupid guy harping doom since when? way back ,,you keep preaching you think it will happen,,you are so wrong,,im not an expert but not stupid like you...you will see a pullback then right back up..i hope everyone dont listen to you!!you gys been saying this when C went under 1.00 and now look where it is,,dont you really feel STUPID? i do not know how they let you guys write for them,,alpha is a stupid as you for giving you the job ,,dumb,dumb

May 05 11:43 PM