News Flash: Major Market Turns Aren't Announced In Advance 48 comments
Tom Brown
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Financial Times: “Banks rally in face of gloom”
For its part, Reuters was completely undone, and tried to ignore the stocks’ moves altogether: “Wachovia, other banks post dismal results,” it simply said, with no mention until the sixth paragraph that “dismal results” or no, Wachovia’s stock price was zooming. The stock closed the day up nearly 30%; the S&P Financials overall rose by 8.4%.
I’m confused why everyone is so confused. Of course stock prices will rise well in advance of any material evidence of fundamental improvement. That’s the way the stock market works. If anyone thinks a bell will go off at the bottom to indicate all’s clear at last, he’s in the wrong business.
Which is why I’ve been amused over the past few weeks as wags have begun to come up with their what’s-got-to-happen-before- I-turn-bullish-on-the-financials lists. They are comical. As I mentioned here earlier this week, OpCo’s Meredith Whitney says she won’t turn positive until the banks can demonstrate they can “grow again,” which no one doubts won’t happen until, oh, 2010 or so. Thanks, Meredith. Helpful!
All very sensible. There’s just one problem. By the time DSB’s laundry list comes to pass—two straight clean quarters from the banks, an overhaul of the rating agencies—the stocks will have long since begun a tear.
In the real world, it’s not unheard-of for cycles to turn when no hopeful evidence is apparent to account for the price reversal. Or if there is any, it’s so subtle that, by definition, it’s overlooked by the vast majority of investors. “Defaulting debt returns to normalized levels” doesn’t fit the bill.
Even so, there’s been no shortage of signs lately that the worst of the credit crunch is past, or soon will be. As we’ve talked about here for awhile, new delinquencies among the loans that make up the ABX subprime mortgage index have been declining for months, while delinquency roll rates have been improving. Lower delinquencies now mean fewer defaults down the road. Bingo! End of problem in sight.
The latest figures contained one surprise: defaults -- the first step toward foreclosure -- rose by just 6.6% in the second quarter, down from a 39% spike the previous period.DataQuick President John Walsh said the reason was not immediately clear. Foreclosures may be "nearing a plateau," he said, but it could also mean that lenders are "swamped and can't handle processing any paperwork."
Sean O'Toole, founder of the data tracking firm ForeclosureRadar, thinks the leveling off may mean that defaults on subprime mortgages -- loans made to poorly qualified buyers -- are nearing a peak. [Emph. added]
Now, I’m perfectly willing to believe that defaults have stopped rising as a result of paperwork snafus. But I doubt it. Regardless, this is just the type of data point that, years down the road (after the stocks have zoomed and while Meredith Whitney is still waiting patiently for banks’ earnings growth to resume) people will look back on and say “Aha! That’s when we should have known.” And the news is certainly delivered the way this type of information arrives: tucked away in article that otherwise describes how awful everything is.
I have been struck these past two days that all the objections to my argument that the financial have bottom a) make no reference to the stocks’ valuation and b) repeat facts that have been widely known for months. (Some readers also basically say that c: it’s different this time.) That’s all interesting, but irrelevant. The fact is, signs have begun to emerge that incremental change on the credit front is happening, and is positive. No, the signs aren’t obvious. But that’s my point. They never are.
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This article has 48 comments:
The prudent will take positions now after big corrections, but still keep some powder try, maybe taking profits elsewhere, and leg into this beaten to a pulp sectors, banks, builders pharma, you've got prices here not seen in years, in some cases decades. If you can't enter a position now, stick with short term treasuries and watch your purchasing power evaporate 10 years from now.
Good post Tom.
You touched on valuations quickly but I think that is such an important point to speak on as to where financials are now.
Bears want to point to the fact that business models will have to change with de-levereging and the end of structured finance. Which is true!
But this simply means the stocks should not zoom right back up to their extreme levels of 18 months ago. Most financials are down 60-90% from those levels.
Bull case is that these companies just need to strip out the destructive divisions and let the core businesses shine again (Wealth management for the IBs and the deposit bases for the banks).
I think this recent run-up was the removal of a default premium in many of the financials. After the govt stepped in for FRE and FNM there is much less worry of a BSC repeat in another financial.
I see prices drifting at these levels (after IB earnings) for a bit of time while investors re-evaluate the pricing and financials continue to restructure their businesses.
Given that many CDOs and other crap are still tied to home prices how can the financials make a long term bottom before there is some more compelling evidence that home prices have started to bottom? Thanks.
Disclosure: Long IXG the iShares Global Financials since early Wednesday morning but ready to sell at any moment.
Likely:
1. Earnings drop as you expect and share prices move towards a 12-15x earnings price - say $12-15 if they can continue to make .25/Q. Things might worsen moderately while the share price stays more or less flat.
2. Earnings stay at .50/Q and the share price rallies back to 12-15x the current earnings level - maybe something in the range $24-30. It's possible that nothing changes in the fundamentals and the share price goes up.
Unlikely:
1. Bankruptcy/massive dilution -large loss for stockholders.
2. Return to growth from '07 earnings level - large gain for stockholders.
The underlying point is that the stock market isn't about what happened in the past or what's happening at this instant - it's about predicting the future. If a company puts forth accurate and expected news that the last 3 months were horrible and the present moment is a disaster, but the next year will show excellent improvement, the share price should rationally rise.
Tom addressed this point pretty well. By the time any fool can look at the market inputs and see that everything has bottomed, all the bad news is out, and the future looks great, share prices will already be way up from the bottom as speculators and long-term investors have bid them up in anticipation of the positive future events. You only really have two rational choices: ignore market movements or try to get ahead of them. Ignoring them limits you to the index return. Trying to get ahead of them exposes you to huge market risk and prediction risk. But following market movements is only a way to generate a lot of activity and expenses and decrease returns below index levels. If you need to see clear signs of recovery in progress before you invest in financials, you should be in diversified (probably indexed) mutual funds only and not even think about stock picks or sector bets.
I agree 100% that you can't simply wait for an "all clear" to call a bottom. At the same time, when there are so many atypical risks to the system, you would need a time machine to make the call you did on Tuesday. I only know one guy with a time machine. Najdorf, "Trying to get ahead of them exposes you to huge market risk and prediction risk" is right on the money.
Tom, in my opinion - the real risk in our markets is unknown. We will know more when we have more data, however, things like WFC extending it's window for delinquent debt before it has to report the loss suggests (to me) that there is a lot that we still don't know about the current rates of defaulting debt. In the last 5 weeks, 4 major financial institutions have warned that the US Banking system is in severe distress (and to take cover). In the last 2 weeks, there has been a ban on short selling certain financial stocks, BAC has decided to allocate $3.6B (of taxpayer money?) to support their share price, and Jamie Dimon has said that prime losses could triple from here. (ap.google.com/article/...)
Your logic is sound in a vacuum, however I feel that you are ignoring several inputs to the equitation that affect your thesis, and that the risks associated with these inputs must be taken into account.
Is the risk/reward tradeoff "worth it" at this point, even if valuations are great & the rate of defaults has slowed down? What about commercial defaults as small/medium businesses leave their spaces?
Have the banks written down enough? That is the Trillion dollar question.
www.bloomberg.com/apps...
Disclosure: Sold my IXG shares for a 17% gain and went long shares of SKF because I expect the economic data tomorrow to be bad.
You are spot on! Look forward to more of you thoughts on the Banking sector.
Tom knows an enormous amount about banks, and he was the top banking analyst on the street for seven years, if I am not mistaken. But he is clearly not objective in his assessment of this particular industry and the substantial risks it still faces.
There is also something deeply wrong with the culture of American banking. The incentive systems all revolve around volume rather than credit quality. At Anglo Irish Bank, one of the best-run banks in the world, you could get fired for bringing the central credit committee several risky loan proposals. At the typical large American bank, you might well get fired for trying to derail an unsound but temporarily lucrative corporate loan. A friend of mine had this experience at Citibank. He was saved only by a last-minute downgrade of the credit rating of the potential borrower. But the bankers he was supporting never forgave him. They didn't give a hoot whether the loan defaulted somewhere down the road. All they cared about was meeting their quotas.
It is possible that an investor might make money on some banks in the next three years. But why try to catch the falling knives and tomahawks when there are so many great companies, financial and otherwise, that don't have trillions of dollars of Level III capital and off-balance-sheet hanky panky? In the financial sector, I would point to Markel, Interactive Brokers, and CME, to name just a few. All three of those companies have managements that are not just prudent and ethical but visionary.
The ABX subprime mortgage index does not and will not include the ARM defaults.
Following this I decided that fundamental analysis and valuation is very limited in finding good and timely investment ideas. I developed a quant based system based on risk/reward analysis and now I have no trouble spotting interesting companies, and I invest when the signal says so and justify it later.
To date this signal says no the the banks, but I am with Tom. When the signal says go, then despite any other analysis, I will go.
However, be wary of the U.S. financials with crappy managements. These managers are the true morons.
This looks like something Kudlow would be saying about the "rally" yesterday, which was nothing but a suckers rally in a Bear market, in financials and everywhere, that has lots longer to go...........
I am sorry that you bet heavily on the sector rallying. But if your health is good you can continue working for many years to make up for the losses in your retirement portfolio. But please do not drag anyone else into your bleak situation.
Of course, if you keep calling a bottom in financials every few weeks, you will some day be correct, just like those who say the end is nigh.
In case you have trouble reading "obvious signs" like the Fed bailing out investment banks, the Secretary of Treasury demanding a "bazooka" full of dollars to lend to supposedly privatized institutions, or the 10 trillion dollar national debt, here's a clue, Tom: yes, it is different this time.
He also manages a hedge fund that is, and has been, primarily "long only" financial companies of all shapes and sizes.
Get my drift?
The 9 sector SPDR’s consists of 4 bull market sectors and 5 bear market sectors.
Materials, Energy, Utilities and Consumer Staples are the 4 sectors which have held a gradual upward sloping support line from Aug 2007 lows on the 1 year chart.
Financials, Industrials and Consumer Discretionary are the 3 sectors which have set new 52 week lows on their downward sloping support line in July 2008. The Technology sector downtrend bottomed in Jan 2008 and the Health Care sector bottomed in March 2008.
The Jan 2008 correction was easier to identify an interim bottom as all 9 sectors corrected simultaneously with a 37 reading on the VIX. The Mar 2008 correction was reminiscent of Jan 2008, but to a lesser degree with a VIX reading of 35. The July 2008 correction is more confusing because it was a staggered one due to the fact that Technology and Health Care have joined the Bull camp, adding 2 more sectors. Therefore the Bear market has matured with 6 Bull market sectors versus 3 Bear market sectors.
If you are looking for leadership, it is happening in stages. The next sector to join the Bull camp will be the Industrials as the July 2008 lows were in line with Jan 2008, marking a double bottom support line on the chart. Financials and Consumer Discretionary sectors are getting much closer to the worst of their losses and will gradually be pulled along by the leading sectors and emerging market strength. Don't look to Financials for leadership, look to the leading markets for leadership.
The crap C, LEH, GS have is 10 times worse. Paulson can't rescue them all. No more 30 percent pops because the shorts can't get in anymore.
Another hopelessly hopeful bottom caller that will fade away as the deflation continues. This country was ruined beyond belief and it's still the 2nd inning of this nightmare.
Or, if you prefer, look at a chart of the NIKKEI from 1988 to present.
A twenty year bear market that has not recovered.
True, dividends added some, but the 50% decline of the dollar puts the GE and Intel investor in the red, after subtracting for inflation, after a decade.
The point, you say? No one predicted that, back in 1998, two premier, world class companies would fail to produce positive returns in ten years.
No one predicted in 1988 that the Nikkei would lose more than 2/3 of its value and not recover in two decades.
Many, many, many predicted that the recovery of the NIKKEI was imminent, or that the recovery of Intel and GE was imminent. These stories were written weekly, for years.
Bear markets descend a wall of hope.
Furthermore, a lot of what I see passed of as financial analysis is hopeful thinking, and nothing more.
Question: If inflation is rising, and interest rate will be much higher in a year, and global wealth funds are gradually de-dollarizing their assets--what effect will this have on the earnings power of banks as capital becomes more expensive, and ARMS reset at higher rates?
We are looking at 10 to 15 years of global credit contraction.
I should add that I am an optimist, by nature.
Even if this is a bottom the market won't double next week. Bear markets just don't turn on a dime like that.
If you miss the bottom you'll miss, what, a 25% run up? These days we can 25% runs up and down all the time. You can't know which one's going to be the one to "stick".
You have way more potential downside than 25% by calling the wrong bottom. Just study prior bear markets, pick a bottom, and see study what the odds are that your turn will be better than if you just pick a date when the long-term trade has change.
Just wait for the trend to change - nobody cares that market bottoms aren't called in advance because you don't HAVE to call them.
Alt-A and even Prime ARM resets are going to occur thru 2012, and there are TONS of these high LTV deals out there that will become problematic.
Everyone is focused on subprime, but subprime is pretty much over and behind us. Alt-A and Prime ARM loans are the next big tuna, and the write-offs will be substantial. This is round 2 coming our way whether we like it or not, and financials might have a run here and there meanwhile, but it will get mighty ugly my friends. You don't hear about this on the news.... yet, but you will.
(Who are the group of 19?)
On Jul 25 04:45 AM neophyte wrote:
> I'm bullish on XLF. The Group of 19 now have unlimited resources,
> they will buy and buy until exuberance returns. They will do the
> Fed's work of monetizing smaller failed banks through aquisitions.
> In their hands, all assets go back to face value. Equity holders
> of a failed bank will loose close to everything, but XLF will go
> back to 40.
Also, I forgot to mention that OpCo's Meredith Whitney is both smarter and prettier than Tom Brown. Additionally, it would be helpful if Tom could tell us something useful about credit derivatives exposure.
Disclosure: long smart blonde chicks and short Tom Brown. Actually, I sold my SKF position this morning for a quick two day gain of 11% because I was wrong that today's economic data would be worse than expected (but at least I am willing to admit that I was wrong and flexible enough to adapt to change).
Poof, there goes your theory about defaults not rising. I'll see your Sean O'Toole quote, and raise you a Rick Sharga:
"Falling home values, led by states such as Nevada and California that have the biggest default rate, have prompted RealtyTrac to almost double the projected number of foreclosures this year to about 2.5 million, said Rick Sharga, executive vice president for marketing. "
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"Even so, there’s been no shortage of signs lately that the worst of the credit crunch is past, or soon will be. As we’ve talked about here for awhile, new delinquencies among the loans that make up the ABX subprime mortgage index have been declining for months, while delinquency roll rates have been improving. Lower delinquencies now mean fewer defaults down the road. Bingo! End of problem in sight."
The G19 are the 19 big banks who can borrow from the Fed.