No, the Financial Crisis Is Not Over

Includes: C, JPM, LEH, MER, MS, XLF
by: Green Griffin Analyst

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.