Why I am Bearish on Financial Stocks Friday, Aug 28 2009 

After seeing quite a large rally from the March lows the market appears to be extended and indicators (stocks above 200 day moving average, market PE, bullish/bearish %’s) are signaling some rough seas ahead. While stock could conceivably move higher there are a few reasons why I am bearish at the present time.

Harkening back to 2007, I would like to give credit and thanks to Credit Suisse for the following graph.

As one can see the initial tsunami of bad loans has receded and financial stocks have been licking their wounds and repairing their balance sheets but we are at the beginning of the second wave. This second wave of option reset mortgages will do more damage because of the already weakened state of banks.

The relaxing of mark to market rules has helped repair balance sheets but there will continue to be problems throughout 2010 and into 2011 until the 2nd wave of resets recede.

As the resets continue, non-performing loans continue to rise, causing additional strain on an already weakened banking sector. It is unlikely that we will see a significant drop off in non-performing loans until the bulk of the option resets are completed.

Bank failures continue on a weekly basis with the problems being felt mainly by small and medium sized institutions. Some larger weakened institutions have succumbed to the pressure as well. Recent comments that the FDIC may need additional capital should sound a warning bell across the financial space.

While the housing data has been bullish due to buyers assistance programs, one needs to keep in mind that the reported figures are month-over-month data, not year-over-year. As we get into the fall and winter months the MoM figures will decrease as seasonal patterns take place.

Housing inventories continue at a high level, with many homes being taken off market and rented until the selling climate improves. As we continue through the resets, it is likely that inventories stay high until the potential overhang from option and agency ARM’s clears. Any spurt in new home construction will slow the housing inventories from being worked off in a timely manner.

Retail sales numbers continue to be disappointing, although we are entering a period where comparisons will be much easier. The year over year data shows a 9.4% decline in June and an 8.3% decline in July. Again the YoY data is more telling than the MoM data.

High levels of unemployment will constrain spending and GDP growth into 2010 and later. Government stimulus programs will provide the necessary counterbalance to weakness in consumer spending helping to guide the economy through this difficult period.

This is not an approval for the governments polices but one needs to note that a similar path is followed in every recession. The authors problem lies in the wasteful programs and high deficit levels that state and federal governments carried coming into the recession which only exacerbates the problem going forward. Spending that is targeted at areas to provide future growth is preferred over the construction of dog parks.

So while global economies are likely to come out of the recession without much problem (Japan will be an exception) GDP growth in the US is likely to be below normal levels.

Inventory restocking will give a bump to GDP growth in the coming quarter as will government stimulus programs. This combination will set the stage for renewed consumer and business confidence in the coming years but first we will need to get through the a possible double dip recession in 2010.

So while the market itself may move higher I see better value and higher upsides in the precious metals and agriculture sectors where there are some very interesting values globally. Quite often the best values are off the beaten path.

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Everything is Getting Better Tuesday, May 12 2009 

Back in the middle of the financial meltdown last October I penned a quick article entitled [url=”http://www.financialsense.com/fsu/editorials/urban/2008/1016.html“]Everything will be All Right in the End[/url]. At the time the world seemed to be falling apart but it is important to understand that although the skies seemed dark at the time, there is a light on the horizon.

Since then the banking industry has undergone stress tests, the creation of various governmental funding mechanisms, and the thinning of the herd in terms of smaller weaker banks being acquired by larger organizations. A sense of normalcy is slowly returning to the industry and as banks spend the appropriate time in recovery.

We are currently at the point where lending standards have tightened and banks feel that the risk/reward ratio is tilted in favor of holding government and corporate bonds rather than making loans. Good people with good credit can get loans in this environment however people who have no income and no job will have no access to credit as it should have been over the past five years. This has been lost in the noise about banks writing off mortgage balances and foreclosures.

We are in the same position today in terms of lending standards as we were at the bottom of every credit cycle going back as long as records are kept. What makes this cycle different from the rest was the movement of mortgages on the edge of the lending bell curve to the mean. Because these mortgages were securitized into illiquid MBS and then chopped and diced into even more illiquid securities the healing process in the banking system will take longer than normal.

So where do we go from here? The healing process will take a number of years as banks continue to deal with problem loans and rebuild their capital structures. The key is loss recognition. The quicker losses are recognized and put behind the bank the quicker they can move forward in terms of rebuilding the capital structures.

Once the capital structures are rebuilt, banks will continue to choose to hold bonds over making loans to less than creditworthy clients until the risk/reward ratio favors making loans to those clients. Any efforts by the government or private sector to return to the lending practices in the middle of this decade should be looked at as a worrisome sign. Even more worrisome would be a return to these lending practices by banks of their own accord.

One recommendation would be to allow Canadian banks, who have very strong capital bases, to acquire weaker banks in the United States. TD Bank made a sizable acquisition in acquiring Commerce Bank but other Canadian banks should be allowed to make acquisitions as well. After speaking with a number of professionals in Canada, they are showing a keen interest in expansion south of the border. Given the strong capital base and risk management practices employed in Canada, where the banking sector was recently rated the strongest in the world, the US government should be opening doors for our neighbors to the north. This would only strengthen the US banking system as a whole and strengthen any economic recovery.