I have been writing about the relative performance of the KBW Bank Index (BKX) relative to the market since May. I indicated that a relative breakdown of the BKX against the market was an indication of rising systemic risk, consistent with a Russia Crisis or Lehman Crisis. Since then, the relative breakdown did take place and things have gotten worse, a lot worse.
Despite a half-hearted rally from the Berkshire/BAC deal, the banks remain in a relative downtrend against the market.
Up until recently, the performance of the Regional Banks have been relatively well behaved. While the BKX, which is heavily weighted with Too-Big-To-Fail (TBTF) banks, had broken down on a relative basis, the Regional Bank Index had held steady. Now the Regionals have broken down and they are having trouble rallying above relative resistance.
FT Alphaville has been writing extensively about the short-term funding problems of European banks because of the withdrawal of money market funds from the eurozone banking market (example here), now it appears that the French banks are having trouble because of their heavy reliance on wholesale funding.
Look at this chart of the ratio of the Euro STOXX Banks vs. the EURO STOXX Index. The Europeans banks are in a relative downtrend and they have broken a major relative support line. The relative ratio is now at all time lows - a sign of trouble.
Signs of systemic risk are rising. Take a look at this chart of funding costs of various banks. Eeek!
How many bullets can you dodge?
Putting all this together, I interpret these conditions as:
- Systemic risk in the US banking system: The US TBTF banks are signaling rising systemic risk.
- High risk of a US recession: The relative weakness of the US Regional Banks is signaling a high risk of a US recession.
- Lehman/Russia Crisis warning in Europe: The combination of continuing stories of short-term funding problems at eurozone banks and the relative breakdown of that sector in Europe are signaling a very serious problem. No wonder IMF Managing Director Christine Lagarde warned at Jackson Hole that European "banks need urgent recapitalization."
Maybe the combination of the Fed, ECB, the Obama Administration, Congress and the EU can get together and kick the can down the road yet one more time.
Realistically though, how many bullets can you really dodge? With risks like these on the horizon and technical indications that the bulls are losing control, I would be inclined to stay long the US long bond.
Disclaimer: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
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