Still Too Early For Banks

One thing about Jim Cramer, he is quotable. Take this short bit from his piece, Graybeards Get It Wrong on Financials [$]:

One of the loudest and most pervasive themes by a lot of the graybeards is that there is still much more pain ahead in the financials.Let me explain why that is wrong. First, the group is down from a year ago. It’s been hammered mercilessly.

More important, every time the stock market rallies is another chance for these companies to refinance.

Remember, as they go up, the companies are in shape to tap the equity market again because those who bought lower are being rewarded, psyching others to take a chance. In fact, other than the monoline insurance faux bailouts, people who pony up are doing pretty well.

Now, he might be right, and me wrong on this point (with my gray beard, though I am younger than he is). But let me point out what has to go right for his forecast to be correct.

1) The inventory of vacant homes has to start declining. Still rising for now, another new record. Beyond that, you have a lot of what I call lurking sellers around, waiting to put more inventory out onto the market, if prices rise a little. They will have to wait a while, and many will lose patience and sell anyway. There is still to much debt financing our housing stock, and though most of the subprime shock is gone, much of the shock from other non-subprime ARMs that will reset remains. Will prices drop from here by 20%? I think it will be more like 12%, but if it is 20% there will be many more foreclosures, absent some change in foreclosure laws. Foreclosures happen when a sale would result in a loss, and a negative life event hits — death, divorce, disaster, disability, and unemployment.

2) We still have to reconcile a lot of junk corporate debt issued from 2004-2007, much of which is quite weak. Credit bear markets don’t end before you take a lot of junk defaults, and we have barely been nicked. Yes, we have had a sharp rally in credit spreads over the last five weeks, but bear market rallies in credit are typically short, sharp, and common, keeping the shorts/underweighters on their toes. You typically get several of them before the real turn comes.

3) We have not rationalized a significant amount of the excess synthetic leverage in the derivatives market. With derivatives for every loser, there is a winner, but the question is how good the confidence in creditworthiness between the major investment banks remains. Away from that, Wall Street will be less profitable for some time as securitization, and other leveraged businesses will recover slowly.

4) Credit statistics for the US consumer continue to deteriorate — if not the first lien mortgages, look at the stats on home equity loans, auto loans, and credit cards. All are doing worse.

5) Weakness in the real economy is increasing as a result of consumer stress. Will real GDP growth remain positive? I have tended to be more bullish than most here, but the economy is looking weaker. Let’s watch the next few months of data, and see what wanders in… I don’t see a sharp move down, but measured move into very low growth in 2008.

6) What does the Fed do? Perhaps they can take a page from Cramer, and look at the progress from private repair of the financial system through equity and debt issuance. It’s a start, at least. But the Fed has increasingly encumbered is balance sheet with lower quality paper. Two issues: a) if there are more lending market crises, the Fed can’t do a lot more — maybe an amount equal to what they have currently done. b) What happens when they begin to collapse the added leverage? Okay, so they won’t do it, unless demand goes slack… that still leaves the first issue. There are limits to the balance sheet of the Fed.

Beyond that, the Fed faces a weak economy, and rising inflation. Again, what does the Fed do?

7) Much of the inflation pressures are global in nature, and there is increasing unwillingness to buy dollar denominated fixed income assets. The books have to balance — our current account deficit must be balanced by a capital account surplus; the question is at what level of the dollar do they start buying US goods and services, rather than bonds?

8 ) Oh, almost forgot — more weakness is coming in commercial real estate, and little of that effect has been felt by the investment banks yet.

As a result, I see a need for more capital raising at the investment banks, and more true equity in the capital raised. Debt can help in the short run, but can leave the bank more vulnerable when losses come. The investment banks need to delever more, and prepare for more losses arising from junk corporates and loans, housing related securities, and the weak consumer.

Comments

[Ryan Freund]

Good article. Thanks for sharing your insights. I happen to agree with everything you said!

[fxtrader07]

well, the only ones doing fine on their capital injections into banks are those who got great terms on convertibles and preferreds. those who simply bought common are doing not so well.
nobody knows how much pain is to come down the road but from a macro perspective the consumer is trapped. so the best case scenario here is a prolonged period of a subdued economy with little power to stage a return to significant growth path. denographics, savings rates debts etc. are all pointing towards this and for all the magic tricks that tinkering with money supply and interest rates combined by increased government borrowing and spending can produce - they cannot fight these powerful factors and trends. not a crash, not a boom anytime soon. wonder how the banks will make any significant money in that kind of environment

[ajhough]

Still too early to nibble at banks, small or large. I have suffered the losses on financials during the first quarter and didn't see the train coming. Pardon the metaphors...

[b_d]

If we wait until all eight of your points are answered, we will be here a long time........ Especially since the chance of the US righting the balance of payments will likely take decades. As you are aware, the markets usually look out 6 to 12 months and overall I think the worse is over - not that I would jump in with both feet, but some institutions are looking attractive; for example NLY. In any case I believe Cramer is talking about the larger institutions since he has repeatedly yapped about the amount of unknown write downs coming from the small to mid size banks.

[fatcat]

poster is right all around.Speaking as a greybeard,with 35 yrs in the market, you're better off avoiding obvious dilutions like the financials.

I wish i could count the times I've had my ass handed to me listening to guys like Cramer,especially if they are saying what I want to hear.

I don't blame him,thats his job..but you have to understand his motivation for working at a halfass tv station..wonder if he can't make it in the market on his own??

He spends a lot of time kissing up the ceo's of various companies spouting their horseshit and pumping their stock..once again you can't blame them...Just beware.

[Ceviche Fund Partners LP/Dan Jacome]

Bridgewater Associates -- a top quant shop -- is very bearish on banks -- they shot out a letter to clients TODAY and it brings home the point people keep wanting to tuck under the rug: the debt creation infrastructure has been debilitated and bank's ability to generate new income isn't going to return to normalcy for SEVERAL more quarters.

[Pangaea]

Cramer, Cramer, hmm that name sounds familiar...

Hey, waitaminnit, isn't that the guy that said "Bear Stearns (BSC) is fine, Bear Stearns is not in trouble -- don't move your money"...??

[wallawallabingbang]

Cramer has ulterior motives. The SEC should do something about him and his merry posse of 'fast-money' bandits.

[DSX Lover]

Banks are way to cheap right now, but you can't owe them, you can only rent them. They aren't going broke, and not all are the same, but the resets peak in June and July, they are worth the risk. Totally Agree with Papa Bear Doug Kass comments (The value of the Franchises are intact and the earnings power is there), Buy the DIPS sell the RIPS. You must owe some of these, because when housing inventory starts to decline they will be up 20-40% from where they are now and you will be late to the party.

[tom kern]

Well, when a bank goes bankrupt, nothing is really lost. they either merge or walk away or "disolve". the consumer still needs to continue. "Bailout "to the rescue. everyone deserves a break, but it's hard to let the controllers of the tap see the forest for the trees.

[Tom B]

"If we wait until all eight of your points are answered, we will be here a long time...."

Agreed. Right now is still "catching the falling knife". IMHO, a few more quarters, some less negative housing inventory news, and I'm ready THEN to look at banks.

The economy should trend up when we get someone in the White House who isn't an alcoholic big-oil man.


Anyone have an opinion on VNQ-- commercial/rental REIT? Less scary than banks and builders, but is it ENOUGH less scary? Nice 5% yield.

[User 165905]

By the time this guy and Cramer decide to get bullish, the news will be good and smart money will be selling. Dumb money is last to find out. He went bearish on brokers in mid march near the lows. Some people never learn the lessons. The market is way ahead of the news, these guys follow the news. The worst part about this is that this guy is trying to feed off Cramers success. Don;t worry, he will self implode, the first televised version of a hari-kari