Why Stocks Scare Me Now

On August 27th, I wrote that the Fed may be buying stocks to reflate the banks. I can't wait to see, after being audited, what they actualy own. Today, it seems like my hunch may be starting to get some wonderment from others. If this is the case, make sure you do not own stocks. In fact, as I blogged Wednesday before the FOMC statement, it's time to get short. With the Fed now slowing their rate of securities purchased, they and the banks will have less fiat to buy and support this market. Judging by mutual fund inflows of late, they may be the only bid in the market. Look what others are starting to say.

With higher stock prices, banks can issue secondaries, thus flooding the market with shares and giving themselves cash to offset their balance sheet from bad loans. Also, since banks can't earn their way out of this mess via lending, the idea was tossed around that they are buying stocks for a massive profit. Stocks that they will sell and leave to the public, thus transferring the cost of the bailout to the public via the stock market. Take a look at the graph below from ZeroHedge.com, and then read the original article I wrote a number of weeks before:



I realize this may sound like a nut job conspiracy theory, but I am just thinking out loud and wanting to document when this was thought of.

Maybe, just maybe, the Fed is inflating the banks through stock market gains. Stay with me before writing me off as a quack.

On August 26th, Kate Berry from American Banker wrote an article titled "Postponing the Day of Reckoning" In it she stated:

[Banks also] are allowing borrowers to be delinquent for longer and longer periods of time before initiating foreclosures.

This absolutely jives with what I see on the street. I have two close friends who haven't paid their mortgage in 10 and 13 months. Yet, they don't hear anything from their lenders.

Is this because the banks don't want to book these non-paying loans as losses? The article continues:

Tom Booker, a senior vice president in the default information unit at First American Corp. in Santa Ana, Calif., concurred. "There are borrowers who are six or eight months in default; they may have exhausted their workout options; but they're put on a forbearance plan because it's an interim to a final resolution, which is foreclosure," he said. "Banks don't want to take the losses now."

Darrell Duffie, a finance professor at Stanford University's Graduate School of Business, said accounting rules give banks plenty of leeway to determine when to take losses.

"Banks are believed to be carrying a lot of loans at accounting levels well above their true market value," he said. "But once a property goes into foreclosure, their options have disappeared."

So the banks aren't realizing the losses, and they're doing nothing about it. People live in their homes for free, the bank loses thousands of dollars per client in interest income, but they are saved because they don't have to write off hundreds of thousands per non-payer in losses. Thus they preserve their capital ratios and allow them to live another day. Brilliant (tongue in cheek). And scary.

So here is a conspiracy scenario:

1. Banks make bad loans and are crushed when the market tanks.

2. Fed Prints money and gives to banks to keep them afloat.

3. Banks don't write down loan losses, so their capital is not hurt, but lose interest income from borrowers not paying their mortgage.

4. Banks need to earn an income to stay in business and "earn" their way out of these massive loan losses.

5. Banks trading units "invest" in securities and the market and the market ramps non stop, thus offsetting lost revenue from loans with trading revenue.

6. Banks eventually sell and leave investors holding the bag, thus getting their money anyway from the masses whom they lent money.

I know - sounds crazy. But Thursday I just read this from the UK Telegraph:

Mr. Steinbruck said the markets are awash with liquidity again, but little is going into the real economy. "The banks evidently prefer to put their money into securities rather then granting new loans because they can get a higher return. After two years of financial crises the gambler mentality is gaining the upper hand again."

The German authorities are deeply frustrated that so few banks have resorted to the rescue scheme to rebuild their capital base. Critics say the Bundestag imposed such stringent conditions that the lenders have opted instead to rein in lending.

Does this not sound similar to what could be happening here? I know it's a black helicopter/conspiracy theory, but it seems the Feds and US are desperate to do something to change the reality they currently face. What better way to save the financial system than by bailing out the banks and not forcing them to write off bad loans after 180 days like GAAP requires. Instead, let them gamble in securities, and maybe even stocks? It will be interesting to see how well the trading units of the big banks do in the next few quarters.

If this "highly unlikely" scenario is true, the banks will sell, have the cash they need to write off the massive loans, but will have sucked the money out of unsuspecting investors pockets. In the end - they will have won. They will have gotten the US investor, pensions, and retirement accounts to bailout their bad loans, and we can't get mad at the government because it didn't commit more taxpayer money to bailout more losses. Instead, asset price increases, and then selling those assets to investors, bailed them out. Or better put - investors "bailed" them out.

Unlikely... but interesting to ponder, no?

I have wondered how my friends can live payment free for over a year. This theory could be a reason, even though it seems unlikely.

In either event - remain cautious, and keep an eye on those bank trading profits.

Disclosure: Long SH, PSQ, UUP, DOG in client accounts

Comments

[Roger Knights:]

"On August 27th, I wrote that the Fed may be buying stocks to reflate the banks."

To spare other readers the tedium of trying to track that article down, it was posted here on Seeking Alpha on his Instablog, which can be found by clicking on his Profile link. It is substantially the same as the article above, which is excellent. (I think Tyler Durden has also suggested this possibility. Hopefully someone will post a link to his article.)

Sep 25 08:22 AM

[David Braun...:]

Good article. Playing with accounting rules is playing with investor confidence in the long run. Good analysts see the bad loans on the banks books and likely did not recommend bad banks. Therefore, if smart money likely did not buy them. Maybe you are right, could it be the Fed? Interesting idea.

Sep 25 08:29 AM

[Steve in TN:]

In keeping with the author's theory, do the trading arms of the banks know when to pull the plug on their stock investments? I wish I were 90% right on those kind of decisions.

Sep 25 11:38 AM

[ewing:]

In what time frame do you see the banks start leaving the market?

Sep 25 11:46 AM

[Mad Hedge F...:]

they should. The one absolute, take it to the bank, bet the ranch fact you can count on right now is that there is no value in the stock market. We are at a lofty 20 X earnings, and historically, when the market sported such a rich valuation, a 7% drop ensued in the following year. But what is history, but the ravings of an angry, frustrated old trader? Maybe having seen the best bargains in a century only six months ago, I’m spoiled. I have always been a tightwad. I must be the only guy around who flies his own private plane to garage sales for the sheer love of the deal (where else can one find Dean Martin records in decent playable condition for 25 cents each?). I just reviewed all of the stocks and sectors I liked at the beginning of the year, and a more picked over field you never saw. (Click here for my New Year list ) The list of big winners is long: FCX, FXI, BYDFF, BIDU, X, gold, silver, copper, crude, oil services, junk bonds (JNK), (HYG), emerging markets (EEM), BRIC’s, Korea (EWY), with shorts in long dated Treasuries (TBT), volatility (VIX), and the dollar (UDN), (ULE). Even tax exempt munis have been on a tear. Many of my core positions are up over 400%. When everything in your portfolio has done so well, it’s time to go hide. The problem is that my more loyal, even fanatical followers have taken out paid subscriptions for up to two years, so I must keep dancing. Hence, the recent increase in book reviews, political pieces, or just outright frivolous stories. What you do here is deep research and list building, so when the window opens you can jump through with both feet, and without any reservations. I hate being out of the market. But I hate losing money even more.

Sep 25 12:20 PM

[Graham and ...:]

Wouldn't put anything of this sort past the bankers.

Sep 25 04:13 PM

[THofler:]

In answer to your question about how your California friends live in their homes with making mortgage payments: A couple of SA commenters explained that banks have two obvious choices, foreclose or not. The catch is that in foreclosure there is no recourse, but in the absence of foreclosure there IS recourse. Who knew?

The catch to the catch is that it may take years in court to pursue recourse & the outcome is not certain.

Sep 25 10:36 PM

[Michael Clark:]

When did we decide that the world had to serve the banks rather than the banks serving the world? This situation needs to end. The banks are the tail wagging the dog.

Sep 26 08:39 AM

[philzuco:]

Hey Timmy. How's that long UUP/ short SP-500 position going? I'll buy those dollars from you.... in 3 year's time -- and wipe my ass with them.

Oct 06 01:21 PM

[Tim Ayles:]

Just fine philly - thanks for asking. Down less than .2% at the moment, I can live with that.

Not sure I will still own the USD in three years, if you want it from me - you'll have to take it about 10-20% higher in the next year. It is then that the inflation trade will be on.

Looking to short gold soon for a trade as well.........

reading your previous comments to others - like one in June or July if I remember, you lambasted someone for calling the top in financials when they got long. Looks like that trade worked out and you were yet again quick to be critical. You will see....... ;)


On Oct 06 01:21 PM philzuco wrote:

> Hey Timmy. How's that long UUP/ short SP-500 position going? I'll
> buy those dollars from you.... in 3 year's time -- and wipe my ass
> with them.

Oct 13 01:59 AM

[philzuco:]

Looking to short gold? hehe So you're part of the clueless Prechter crowd. Just a piece of advice: gold just broke out of an 18-month base. When commodities break out of major consolidation zones, they go higher for sustained periods of time. When oil broke above $40 some years ago, everybody kept trying to call the top. It proceeded to go as high as $150 before breaking down to $30.

Your dollar thesis of deflation is predicated on the idea that just because there's lot's of USD debt outstanding and the government can't print fast enough to offset the destruction of the currency, that the dollar must appreciate. The problem with your thesis is you assume that global store-of-value demand for USD will remain stable.

The problem with the USD is that foreigners have caught on to the fact that America will be a bloated, slow-moving deadbeat for decades to come. Bilateral trade arrangements are also beginning to be made in local currency (China-Brazil announced agreements in that direction a few months ago). Foreign currency flows into Brazil right now are higher than they were before the credit crisis began (needless to say, the Brazil, my home country, is on fire).

As for gold, the Shanghai Daily has repeatedly reported that China is reluctant to sell treasuries to avoid an exodus out of the dollar. However, to hedge their massive dollar exposure, the government is now committed to building a sizeable gold position (as inversely correlated asset to the dollar) as a hedging instrument. The gold market is relatively small one. With a sovereign player like China going for a dollar hedge, your intention to short gold (especially in the initial stages of a major consolidation zone breakout) could not be more misplaced.

Oct 13 09:15 AM

[Tim Ayles:]

"The problem with the USD is that foreigners have caught on to the fact that America will be a bloated, slow-moving deadbeat for decades to come."

And you are part of the clueless gold bug crowd that regurgitates this same statement over and over and over and over and over.......

Yet the facts are in direct contrast to your fear mongering:

finance.yahoo.com/news...=

Yet again foreign demand for US assets rises in the face of ever growing supply.

I agree that the US $ is doomed. But we are decades away from that, it's not happening in the next few quarters as you think.


On Oct 13 09:15 AM philzuco wrote:

> Looking to short gold? hehe So you're part of the clueless Prechter
> crowd. Just a piece of advice: gold just broke out of an 18-month
> base. When commodities break out of major consolidation zones, they
> go higher for sustained periods of time. When oil broke above $40
> some years ago, everybody kept trying to call the top. It proceeded
> to go as high as $150 before breaking down to $30.
>
> Your dollar thesis of deflation is predicated on the idea that just
> because there's lot's of USD debt outstanding and the government
> can't print fast enough to offset the destruction of the currency,
> that the dollar must appreciate. The problem with your thesis is
> you assume that global store-of-value demand for USD will remain
> stable.
>
> The problem with the USD is that foreigners have caught on to the
> fact that America will be a bloated, slow-moving deadbeat for decades
> to come. Bilateral trade arrangements are also beginning to be made
> in local currency (China-Brazil announced agreements in that direction
> a few months ago). Foreign currency flows into Brazil right now
> are higher than they were before the credit crisis began (needless
> to say, the Brazil, my home country, is on fire).
>
> As for gold, the Shanghai Daily has repeatedly reported that China
> is reluctant to sell treasuries to avoid an exodus out of the dollar.
> However, to hedge their massive dollar exposure, the government is
> now committed to building a sizeable gold position (as inversely
> correlated asset to the dollar) as a hedging instrument. The gold
> market is relatively small one. With a sovereign player like China
> going for a dollar hedge, your intention to short gold (especially
> in the initial stages of a major consolidation zone breakout) could
> not be more misplaced.

Oct 16 11:07 AM

[philzuco:]

Tim, I suggest you actually do you homework...

Per the WSJ article below (on your bullish read on foreign appetite for Treasuries).

And by the way, I'm no gold bug -- in fact, I don't own a single ounce of gold. I have, however, been accumulating emerging market names in Brazil (I like in Rio) since 1999 and purchased more earlier this year (Vale, Petrobrás, Gafisa Aracruz, CDB, Klabin and Grupo Votorantim) straight off iBovespa. I haven't owned a single US stock for over 15 years. I'm up hundreds to thousands of percent in the select names on my pension fund portfolio -- thank you very much.

You see, I could care less about deflation or inflation in the US or about the doctored numbers coming out of Citigroup or Bank of America (while their loan books crumble behind the scenes). What I see is a long-term trend higher in developing nations (with stable governments and low debt-to-GDP ratios) that will last decades. What is going on is a redistribution of financial flows away from mature, over indebted economies and into developing nations.

It has nothing to do with ideology, fibonacci sequences or Elliott Wave cycles. America is done -- and you don't need to be a gold bug to figure that out.

------------
Is Foreign Demand as Solid as It Looks?

By MIN ZENG

JUNE 26, 2009

The sudden increase in demand by foreign buyers for Treasurys, hailed as proof that the world's central banks are still willing to help absorb the avalanche of supply, mightn't be all that it seems.

When the government sells bonds, traders typically look at a group of buyers called indirect bidders, which includes foreign central banks, to divine overseas demand for U.S. debt. That demand has been rising recently, giving comfort to investors that foreign buyers will continue to finance the U.S.'s budget deficit.

But in a little-noticed switch on June 1, the Treasury changed the way it accounts for indirect bids, putting more buyers under that umbrella and boosting the portion of recent Treasury sales that the market perceived were being bought by foreigners.

On Wednesday, the indirect bid for the $37 billion five-year note jumped to a record high of 62.8%, compared with 30.8% last month. And in Tuesday's, the $40 billion two-year note garnered an indirect bid of 68.7%, compared with 54.4% from the previous auction in May and the average of 36.4% for the past 11 auctions.

Foreign buyers hold more than half of Treasurys outstanding, and have become increasingly important as the Treasury sells larger quantities. This week the Treasury is selling a record $104 billion of notes.

The new definitions are deep in the arcane world of Treasury auctions. The change involves buyers who place orders through primary dealers. Those had been counted as direct buyers, but as of June 1 they were classified as indirect buyers, making that group larger than before. Because investors view that group as being dominated by foreign buyers, they assumed foreign demand was higher.

Treasury officials didn't respond to requests for comment.

Getting a better sense of investors' appetite, especially overseas, is imperative to the U.S. at this time when it needs to sell record amounts of debt in order to tackle surging budget deficits and fund massive stimulus programs to revive the economy.

Some big creditors such as China, Russia and Brazil have expressed concern about the value of their dollar-denominated holdings because they are worried that swelling public debt and aggressive monetary policies may generate inflation and weaken the U.S. currency. That, in turn, may put their massive Treasury holdings at risk of sharp losses.

Oct 16 03:29 PM

[Tim Ayles:]

I've done my homework and we can spend countless hours throwing articles from other people on this site to prove our point. Here is one for you: www.bloomberg.com/apps...

Bottom line, I agree the US is in for a world of hurt, I just don't agree with you that it will happen overnight. If you spent time reading what I have written in client newsletters, you would understand I think things get ugly by 2012. My models say Dow 3800-5000. Stagflation could make things worse. But - we are still decades away from the. $ being replaced. Once again - it will happen, just not in the next few months as you seem to think. My clients are long emerging market debt at the moment which has done well, but the emerging markets are also in for another blood bath imo. When we lose a few hundred points on the Dow - we lose the equivalent of an emerging market country in value. So the fact remains, when we sneeze - the rest of the world catches cold. And that will change - just not instantly.

Regards


On Oct 16 03:29 PM philzuco wrote:

> Tim, I suggest you actually do you homework...
>
> Per the WSJ article below (on your bullish read on foreign appetite
> for Treasuries).
>
> And by the way, I'm no gold bug -- in fact, I don't own a single
> ounce of gold. I have, however, been accumulating emerging market
> names in Brazil (I like in Rio) since 1999 and purchased more earlier
> this year (Vale, Petrobrás, Gafisa Aracruz, CDB, Klabin and Grupo
> Votorantim) straight off iBovespa. I haven't owned a single US stock
> for over 15 years. I'm up hundreds to thousands of percent in the
> select names on my pension fund portfolio -- thank you very much.
>
>
> You see, I could care less about deflation or inflation in the US
> or about the doctored numbers coming out of Citigroup or Bank of
> America (while their loan books crumble behind the scenes). What
> I see is a long-term trend higher in developing nations (with stable
> governments and low debt-to-GDP ratios) that will last decades.
> What is going on is a redistribution of financial flows away from
> mature, over indebted economies and into developing nations. <br/>
>
> It has nothing to do with ideology, fibonacci sequences or Elliott
> Wave cycles. America is done -- and you don't need to be a gold
> bug to figure that out.
>
> ------------
> Is Foreign Demand as Solid as It Looks?
>
> By MIN ZENG
>
> JUNE 26, 2009
>
> The sudden increase in demand by foreign buyers for Treasurys, hailed
> as proof that the world's central banks are still willing to help
> absorb the avalanche of supply, mightn't be all that it seems.<br/>
>
> When the government sells bonds, traders typically look at a group
> of buyers called indirect bidders, which includes foreign central
> banks, to divine overseas demand for U.S. debt. That demand has been
> rising recently, giving comfort to investors that foreign buyers
> will continue to finance the U.S.'s budget deficit.
>
> But in a little-noticed switch on June 1, the Treasury changed the
> way it accounts for indirect bids, putting more buyers under that
> umbrella and boosting the portion of recent Treasury sales that the
> market perceived were being bought by foreigners.
>
> On Wednesday, the indirect bid for the $37 billion five-year note
> jumped to a record high of 62.8%, compared with 30.8% last month.
> And in Tuesday's, the $40 billion two-year note garnered an indirect
> bid of 68.7%, compared with 54.4% from the previous auction in May
> and the average of 36.4% for the past 11 auctions.
>
> Foreign buyers hold more than half of Treasurys outstanding, and
> have become increasingly important as the Treasury sells larger quantities.
> This week the Treasury is selling a record $104 billion of notes.
>
>
> The new definitions are deep in the arcane world of Treasury auctions.
> The change involves buyers who place orders through primary dealers.
> Those had been counted as direct buyers, but as of June 1 they were
> classified as indirect buyers, making that group larger than before.
> Because investors view that group as being dominated by foreign buyers,
> they assumed foreign demand was higher.
>
> Treasury officials didn't respond to requests for comment.
>
> Getting a better sense of investors' appetite, especially overseas,
> is imperative to the U.S. at this time when it needs to sell record
> amounts of debt in order to tackle surging budget deficits and fund
> massive stimulus programs to revive the economy.
>
> Some big creditors such as China, Russia and Brazil have expressed
> concern about the value of their dollar-denominated holdings because
> they are worried that swelling public debt and aggressive monetary
> policies may generate inflation and weaken the U.S. currency. That,
> in turn, may put their massive Treasury holdings at risk of sharp
> losses.

Oct 16 11:09 PM