The money center banks industry has lost more than 16% since January of this year significantly underperforming the market. It appears that every time the industry releases good news or shows internal strength something negative is not far behind. The market reacts to this industry with such panic as the financial crisis is still fresh on every investors mind. Tuesday's loss within this industry had little to do with American banks and more to do with the European debt crisis.
I believe the market's loss, and more specifically the banks loss, on Tuesday was a result of leaders in Europe giving very few solutions in the euro crisis. Below are a few developments which came out of the meeting that were agreed upon.
- joint euro bonds in the immediate future were denied
- The leaders believe the EFSF ( European Financial Stability Facility ) is correctly modified in size to handle the debt issues
- A future proposal for taxes on financial transactions
Although loss within the markets was not substantial in comparison to what we have experienced, it still raised questions and created additional doubt. The eurobond and EFSF is what I believe to be most important that could affect our markets in a more direct way.
The idea of a eurobond had been floating around for quite some time and while it was unlikely I believe that a good portion of the market expected it to occur. Many analysts believe a eurobond could help regain stability within the European market. Analyst also expected for leaders to make suggestions to raise the EFSF limit so that the fund could handle future issues. I do not believe the EFSF bailout fund is big enough to handle the many problems, or future problems that Europe is sure to face. Some analyst have said that banks saw a hit today because investors believe if the EFST fund is not large enough to handle the economic issues then the sovereign crisis could move into the banking system. I do not believe this to be accurate, it is possible, but I do not believe it will occur as the decision from European leaders today was not written in stone it can be revisited at anytime during the future.
German Chancellor Angela Merkel called the idea of a eurobond a "last resort." This indicates to me that while the leaders did not appear to make progress they have some kind of plan in place for if the situation was to get worse. This could mean that eurobonds could be one of many "last resorts" to correct future problems that may arise. I believe the idea of the sovereign crisis moving into the banking system is incorrect and that there will be actions taken before a realistic chance of this occurring.
Regardless of the choices that European leaders decide, the speculation is enough to heavily affect our financial system. The recession in 2008 was a domino effect which included many of the world's largest countries whose financial systems all experienced a near breakdown. This fact is well known by all investors who still have this thought in mind and refuse to be caught off guard by another recession. Therefore, news relating to the European economy deeply affects the American stock markets as investors now look at every small piece of economic information and base their investment decisions off this information regardless of its relevance. This has created another domino effect which has led to extreme volatility near levels in which we have never experienced. This market reaction has led several industries such as the automotive and banking industries to be significantly oversold.
These two industries experienced the most "pain" during the recession and as the recession weighs heavily on the minds of investors they are incapable of seeing a stock for it's true value. The banking system is not perfect but I believe it is in better shape than in 2008. Strong selling has caused this sector to trend lower and I am not as optimistic about when the downtrend could come to an end.
Investors are very defensive when it comes to financial stocks. Some investors believe the companies should be bought while others say sell, very rarely is there someone in the middle. It is possible to break a bank down 100 different ways as it has many different divisions and areas of its income statement or balance sheet. Rather than deciphering through all the information that is used to judge the success or growth of a bank I will look at only the basics and use a common sense approach to decide if these financial institutions are undervalued or if the loss is justified. The reasons may go more in depth but the base of the argument centers around simple finance from investors who are not sold on banks. My goal is to try and conclude if these banks are falling for a fundamental reason or if the fall is emotionally driven panic.
CitiGroup (C) has a market cap of $87.36 billion and has experienced a great deal of loss during the last month with more than $25 billion removed from its market cap. With the exception of earnings that beat expectations with an EPS of $1.07, I can find no considerable news to cause any substantial price action. Net income in 2010 increased to $10.5 billion a gain over negative $1.606 billion year over year. The company's assets and debt for both 2010 and 2009 have remained fairly consistent with little changes in total amounts. From a financial perspective the company has many issues related to debt but it should be expected after less than five years from a major financial recession. Earnings were released on July 21 and most believe it announced progress within the company. I do not believe it is realistic to believe this company would not have a high level of debt at this point. The question to ask is if the company is moving forward and if the loss of $25 billion is justified?
Morgan Stanley (MS) has a market cap of $32.83 billion and has lost almost $8 billion from its cap over the last month. The company announced earnings on July 21 which posted negative EPS of 0.38, better than analyst expected. This loss was the company's first in seven consecutive quarters. The loss came after the conversion of the company's series B preferred stock held by Mitsubishi UFJ Financial Group (MTU). During this period the company also agreed to pay $6.5 million to settle a series of anti-trust lawsuits. Debt to assets has remained fairly consistent year over year in a range around 25%. The company has increased both total assets and debt since 2007 year over year. But posted a much higher EPS in 2010 compared to 2009 which show improvements through operations.
Bank of America (BAC) has a market cap $74.99 billion and has lost $28 billion from its cap over the last month. The company is now trying to sell some of its assets which include it's credit card business in Canada for $8.6 billion. I believe the company is in the worst financial position of the three companies. In 2010 the company did not produce positive net income but posted a positive EPS higher year over year. There is optimism surrounding this company's future as investors believe it is positioned to sell more toxic assets and produce higher levels of profitability. Debt along with assets has continued to increase since 2007. In 2010 the debt to assets ratio was better year over with the company having more assets and less debt. This shows the company is making an effort to correct some of the issues surrounding its balance sheet. Once again, there are several issues but the question is if the company is making progress and if $28 billion is justified.
All three of these companies produced earnings that were higher in 2010 versus 2009. This showed the companies were making progress and seeing growth within the economy. For this last quarter both MS and BAC announced negative earnings but had seen gains up until that point. Debt to assets is still much higher than I would like to see, which has been a popular complaint among investors.
There is no doubt that all three of these companies have problems. However I do not believe that anything has changed within these companies during the last month to justify the large loss. Each company posted a loss of more than 4% on Tuesday which accounts for a minimum of $1 billion off each company's market cap. There have been no developments within these companies to justify a loss in this amount. The only reasonable explanation for the loss is the news in Europe concerning the countries debt.
I believe that the majority of the loss experienced by each company has been the result of economic uncertainty and panic within the markets with very little relating to individual company performance. In the last month our economy has endured debt negotiations, a new credit rating, various economic reports, European turmoil, and a massive sell off within the markets related to the uncertainty of our economy. As I previously stated the banks are among the first industries to go down. The recession of 2008 is clear in our minds causing us to forget that our economy, while it still has problems, is better than it was in 2008. I do believe these financial stocks are oversold, undervalued, and will see large returns over the next five years. But I also believe this market is nowhere close to being secure and still presents many hurdles in which we must overcome, this means investors can not know for certain how low it may drop or when it will recover. Any opinions or estimations regarding the bottom for financial stock prices are irrelevant as it is difficult to predict human behavior in mass quantity and it is what you have to predict to be capable of playing this financial market. Investors who are patient should see large returns but the stocks may continue to drop and see new lows before rebounding to see the light at the end of the tunnel.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in C over the next 72 hours.