No, the Financial Crisis Is Not Over

On Tuesday, many financial stocks rebounded, thanks to a drop in oil, the Consumer Confidence Index coming in above expectations, and a Merrill Lynch (NYSE: MER) offering. Does this mean we found the bottom and are now on our way to a solid recovery? Some say yes. I say absolutely not.

Out of the three pieces of “good news” that sparked Tuesday’s rally, only one can actually be considered good news, and that one isn’t even close to a tell-tale sign of a bottom.

Drop in Oil

As you might have expected, the drop in oil prices was the sole piece of “good news” that was actually good news. As oil prices go down, gas prices go down, and thus consumers send less money overseas to oil producers. But until we actually solve the real reasons behind the spike in oil, a continual and gradual decline back to the $80-$100 per barrel will not occur.

What real reasons am I talking about? Well, this is a classic case of supply and demand. Not simply “speculation” as many would like to believe. The world produces around 85 million barrels of oil per day, and consumes roughly 87 million. That’s an incredibly small amount of leeway to account for any demand growth or supply decline. And demand is certainly growing. Consider this:

• 750 out of every 1000 people in the US have a car
• 44 out of every 1000 people in China have a car

Scary, right? As the Chinese (not to mention individuals in all the other rapidly growing countries) continue to break out of poverty and into the middle class, those numbers shown above will grow, and the demand will naturally follow suit.

Furthermore, all the above is assuming no major catastrophes / attacks / wars / terrorism disrupts the supply of oil. That’s a silly assumption, as far as I’m concerned. Why? Here’s why:

• We are in two separate wars with Iraq and Afghanistan
• We are on the verge of war with Iran
• Venezuela is close friends with Iran
• Russia has been increasingly friendly towards Iran
• Iran is strategically located to disrupt oil shipments from Saudi Arabia and other Arab nations

So a war with Iran could (and likely will) lead to massive oil disruptions from Iran, Venezuela, Russia, Saudi Arabia, Kuwait, Iraq, just to name a few.

While it was good that the price of a barrel of oil dropped a few bucks, there is absolutely no reason to believe that the trend will continue. Oh and if you think drilling offshore will help, think again. That extra 200,000 barrels per day will be available for use in 6-8 years MINIMUM. By then, demand will have grown by millions per day. If you think a speculation bill will help, as some Democrats do, it might. But to think it might drop the price of a barrel of oil by 30-60 dollars per barrel? That’s just silly.

Consumer Confidence Index boost

The second glorious piece of news was a surprise boost in the Consumer Confidence Index for this month. It unexpectedly came in at 51.9 from 51 in June, and an expectation of 50. I’m not sure why this was such a big deal, I guess bulls are constantly on the lookout for information that supports their case. From CNNMoney:

While the consumer confidence number increased in a month-over-month comparison, the reading was still much lower than it was even in May, when the reading stood at 58.1.

"In arithmetic terms, yes it is higher, but in economic terms this is still bad, severely depressed," said Robert Brusca, chief economist at Fact and Opinion Economics. "This is certainly not a rebound in economic terms," added Brusca.

"We are kind of focused on month-to-month changes," said Brusca. "That is a relative standard."

In order to really understand how the reading fits into a bigger picture, however, Brusca said that the Consumer Confidence measure for July needs to be considered "in absolute terms."

Consumer confidence in July 2007 stood at 111.9. "Up and down the line, these are extraordinarily weak numbers," said Brusca.

Ok, so it increased slightly over last month. Not a big deal. My guess is they revise it downwards later in August anyways.

Merrill Lynch offering

This little piece of “good news” I understand even less than the previous. Merrill Lynch is basically screwing over all of their shareholders by selling more stock at prices below the open market, diluting every single shareholder. Someone please explain to me how this makes a stock go up.

Merrill Lynch is in its death throes, as Bear Stearns was, and as Lehman Brothers (NYSE: LEH) is. Perhaps investors were cheering because they think Merrill isn’t going to go down? I don’t know. I’ll never know. What I do know is that they’re wrong. Are they also wrong about Citigroup (NYSE: C), JP Morgan (NYSE: JPM), and Morgan Stanley (NYSE: MS)? I think we will see a lot of hurt for these companies in the next few quarters.

So how do you profit from all this?

As I wrote in a November, 2007 piece entitled: Profiting from the Housing Bubble, purchasing Ultra Short Financials Proshares (AMEX: SKF), an exchange traded fund [ETF] that goes up 2% for every 1% the financial sector falls, is a great idea. Since that piece, it has done almost exactly what I said it would do. Score one for the home team!

Of course, you could always stay away from the entire financial sector altogether. There are many great businesses out there that are undervalued. 

Disclosure: The author of this article holds no positions in any of the companies mentioned.

Comments

[noni1:]

Better cover, dude. Your index puts are going to be, um, worthless. USO is going to $65 and SKF to $88. You are about two moves behind the curve and this little articles only seeks to demonstrate my point.

2008 Jul 30 05:06 AM

[rca2007:]

Hi, I think that maybe it's not over, but it's very close to it. And I'm referring to the finantial crisis, and not to the markets in general. I consider, next bear movement will be lead not by the finantials but by other sectors.

thanks for your profitable contribution!

Best Regards

2008 Jul 30 05:37 AM

[RCK:]

In a bear market, all sectors go dowm, some more and some less. How come IBM is still untouched and many more are slightle affected in sympathy with the financials. Nobody knows how ong or how much the financials are to suffer and when it will be over.
tjis is all guess work.

2008 Jul 30 06:14 AM

[daily_reader:]

Good article, thanks

2008 Jul 30 06:57 AM

[Jase:]

non1: sorry mate, SKF will break $300 by the end of the year. USO is undergoing a time-correction, you'll see it rally by week's end and continue next week. Sure it'll hover around the $100/barrel mark, but a barrel of oil will break $150 before it breaks $80. Ultimately, however, I do believe that by the end of 2009 we could be back down below $75/barrel.

2008 Jul 30 07:07 AM

[EE:]

Thanks Richard for introducing your site. Going to spend some decent time there. The financials have lied repeatedly to hold stock value so they can sell more, they even fooled Cramer that stock action yesterday signals a bottom because big money went into MER. He probably is correct for the next 20 days. Odds are he'll have egg on his face again in 60 to 100 days.

2008 Jul 30 07:19 AM

[investor88:]

Conclusion of the article is that the outlook is negative. I agree. In a bear market going short is a good idea although there will be good undervalued stocks for investors with a longer term horizon.

2008 Jul 30 07:57 AM

[messy:]

Its nice to know that the price of financial stocks and banks are tied to the price of oil....since when has that happened? Any more words of wisdom like this statement coming tomorrow. If oil and gas go back down to $88 dollars, does that mean banks and financial will increase in price like crazy?

2008 Jul 30 09:13 AM

[Kelly Liebe...:]

FYI...One of the best investments that has played out this year unknown to most of the stock analysts is the domain market.
That's right. ireport.com - undeveloped website and concept sells to CNN for $750,000. Property.com - a parked website, is sold for $10,000,000+ by Rick Schwartz to the owner of Foreclosures.com. Fund.com sold for just short of 10 million this year. Action.com sold this week for $230,000!
If you want to see sales to date for this year or priors go to dnjournal.com. Click on YTD Sales Charts on the left side. Some of you may change careers today.

2008 Jul 30 10:00 AM

[kkin365:]

According to today's (7/30) Investors' Business Daily, over a 3-month period, SKF was up by 24.5%, second only to BHH (B2B internet), among ETFs, which gained 38.1%. The problem with SKF is that it is so volatile: + 9.38 Monday, - 18.32 yesterday, and was down about 5 dollars by 10 am today.

2008 Jul 30 10:08 AM

[User 119459:]

It's still a "crap-shoot"

2008 Jul 30 12:13 PM

[Ryan:]

And as they cut off at the end...

"Ocourse, you could always stay away from the entire financial sector altogether. There are many great businesses out there that are undervalued. We highlight many of them in both our Investment Advisor Newsletter (freundinvesting.com/in...) and our Small Cap Momentum model portfolio (www.fiportfolios.com)."

In fact, our Model Portfolio is outperforming the S&P 500 by 15% in the two months since it's inception. Our Investment Advisor newsletter is also outperforming and boasts a 70% accuracy. Check em out.

2008 Jul 30 12:23 PM

[Ryan:]

make that www.FIPortfolios.com

2008 Jul 30 12:24 PM

[Kunst:]

ABC is going to 43.12 and XYZ will be at 115.64 by Monday.

Now you know as much as you did before.

2008 Jul 30 05:46 PM

[naturalsol:]

Oil will fluctuate, maybe it dips below 100 in the short-term. Ultimately, its non-renewable, 'civilization' has about 40yrs left of oil in the ground. If we don't develop algal fuels or some hydrocarbon substitute, practically everything falls apart. I highly doubt it will get that bad...since we are holding a solution with the algae.

On financials, on hope they keep dropping cause my shorts are around my ankles after this fucking rally.

2008 Jul 30 10:57 PM

[Old Trader:]

messy,

I can't even believe you posted that comment!!!! Uhhh...how about the fact that very high oil prices are a "drag" on the economy, meaning business activity slows way down, hence no loans made by banks...the loans they have start going into default, etc...(moron)

old trader

2008 Jul 31 12:40 AM

[Jmar11:]

GS may take a hit in the fall anyway, when a central clearing house for credit derivatives is launched; some more details here:
www.greenfaucet.com/th...

2008 Aug 01 01:13 PM

[Fish Gone Bad:]

Nice article, I enjoyed it.
There are two reasons why I both love and despise the financials. I love them because they have so many important and influential people on their side, if not in their pockets. If something isn't working out, then pass a new bill fixing it. If their debt is accumulating, then change the accounting rules definition of nonperforming loan. Change the accounting rules to show that the $(fill in number) billion in nonperforming loans that are now worth even less, is indeed a good thing, and then book that difference in money as a profit (and take a 50% bonus)!
I despise them because they continuously do new and creatively dishonest things over and over again, and seemingly do not get held accountable for their ruthless greed.
That said, I see absolutely no reason to own any of these companies other than JP Morgan, the architect of the Bear Sterns collapse. I am long SKF and have a rather large cash position. If SKF goes up substantially, I will take my profit and be very happy. If SKF falls to $65, I will add to my position.

2008 Aug 02 03:06 PM

[Fish Gone Bad:]

Now some words on oil and housing.
What would happen if oil went so high, that no one could buy it? Oil producers would have all the money in the world and everyone else would have no money. So what would happen to the value of the money that the oil producers had? My extreme guess is that the governments that produced it, would not honor it.

When the value of money falls, the only things that are truly valuable are things. As the value of the dollar falls, housing prices would be expected to pick up because money just does not buy as much as it once did and more money is now needed to buy "things".

Clark Jenkins
FishGoneBad.com

2008 Aug 02 03:18 PM