"Words from the Wise" this week comes to you in a shortened format as my traveling
in the US precludes me from doing my customary commentary. However, a full
dose of excerpts from interesting news items and quotes from market commentators
is provided.
On Friday, Federal Reserve regulators have released a white
paper outlining the criteria they used to assess the financial health
of the nation's 19 biggest banks. On the same day they also briefed the banks
about how their companies had fared in the examination. The banks will have
until Tuesday to dispute any of the results before they are made public on
May 4.
According to the Financial
Times, senior Fed officials said US authorities will ask some of the
country's biggest banks to raise more capital following the completion of
bank stress tests. The officials also indicated that a second, larger, group
of banks will be asked to improve the quality of their capital by increasing
their amount of common equity.
Last week investors' mood was also influenced by tentative signs of economic
stabilization in a number of countries and a barrage of earnings report - generally
better than feared. As the equity rally ground to a halt on some bourses, the
US dollar and government bonds offered little safety appeal and edged weaker.
Gold, on the other hand, advanced after China revealed it has almost doubled
its gold reserves since 2003. Treasury Inflation Protected Securities (TIPS)
also improved on the week.
The performance of the major asset classes is summarized by the chart below,
courtesy of StockCharts.com.
After rising for six consecutive weeks, global stock markets experienced a
volatile week, including the worst losses since early March on Monday. In the
end, the MSCI World Index gained 0.1% (YTD -4.1%) on the week and the MSCI
Emerging Markets Index 0.7% (YTD +14.2%), but the S&P 500 Index shaved
off -0.4% (YTD -4.1).
As far as the earnings season is concerned, Bespoke indicated
that 156 S&P 500 companies had reported earnings by Thursday, beating estimates
in 67% of the cases. Also, so far earnings are down 16.6% versus the first
quarter of 2008. While down, this is much better than the -37.3% expected at
the start of the earnings season. "The earnings season still has a long way
to go, but the current trend has investors optimistic," said Bespoke.
In an attempt to cast light on the debate of whether we are dealing with a
bull market or a bear market rally, William Hester (Hussman
Funds) highlighted the following: "Contracting volume is not enough evidence
to qualify that this is a bear-market rally with certainty. There are other
measures that are showing more strength - such as various indicators of market
breadth. But new bull markets, whether at their inception or soon after, have
a history of recruiting noticeable improvements in volume. So far this rally
lacks that important quality. Over the next few weeks stock market volume will
be a metric to watch closely."
The stock market will show its hand in due course, but it is crucial that
the lows of March 9 hold in order for base formation development to remain
intact. Should these levels - 677 for the S&P 500 and 6,547 for the Dow
Jones - be breached, further downside movements may be in store.
Next, a quick textual analysis of my week's reading. No surprises here, with
key words such as "banks", "market", "economy", "economic", "government" and "prices" featuring
prominently.
Economy
"Global business sentiment remains very poor, but it has taken on a slightly
better hue in recent weeks. Broad assessments of current and prospective conditions
have also moved up measurably since the beginning of the year," said the latest
Survey of Business Confidence of the World conducted by Moody's
Economy.com. "It is premature to conclude that businesses are turning measurably
more upbeat, but recent survey results are somewhat encouraging."
A snapshot of the week's US economic data is provided below. (Click on the
dates to see Northern Trust's assessment
of the various data releases.)
April
24
• New Home Sales appear to be stabilizing
• Durable Goods Orders report - weak, but pace of decline is moderating
April
23
• Sales of Existing Homes appear to be stabilizing at a low level
• Initial Jobless Claims erase part of the improvement seen in recent
weeks
April
22
• House Price Index points to moderation in pace of decline
April
20, 2009
• Leading Index - continues to send message of weak economic conditions
• Chicago Fed National Activity Index shows a small but noteworthy improvement
Week's economic reports
Click here for
the week's economy in pictures, courtesy of Jake of EconomPic
Data.
In addition to interest rate announcements by the Federal Open Market Committee
(FOMC) (Wednesday, April 29) and the Bank of Japan (Thursday, April 30), the
US economic highlights for the week include the following:
"To find yourself, think for yourself," said Socrates (hat tip: Charles
Kirk.) And we know the stock market is a dangerous place if you don't
think rationally and know your own investment personality. Hopefully the "Words
from the Wise" reviews will assist Investment
Postcards readers in crystalizing their thoughts to come up trumps with
their investment decisions.
That's the way it looks from Cape Town (or, more accurately, from beautiful
Dana Point, California, for the next few days).
Financial Times: IMF puts financial losses at $4,100 billion
"The deteriorating global economy means financial institutions now face total
losses of $4,100 billion on loans and other assets, the International Monetary
Fund said on Tuesday, urging governments to take 'bolder steps' to shore up
institutions - including nationalising them where necessary.
"The IMF said in its Global Financial Stability Report that many loans sitting
on institutions' balance sheets were eroding in value, not just the toxic sub-prime
securities which first triggered the crisis.
"The IMF estimated that total writedowns on US assets would reach $2,700 billion,
up from the $2,100 billion estimate it made in January and almost double what
it forecast in October last year. Including loans originated in Japan and Europe,
the writedowns would hit $4,100 billion, it added.
"Banks would bear about two-thirds of the losses, it said, with insurance
companies, pension funds, hedge funds and others taking the rest.
"Efforts to cleanse these bad assets from balance sheets and replenish viable
institutions with capital had so far been 'piecemeal and reactive', the IMF
said, calling for more decisive government action.
"'The current inability to attract private money suggests the crisis has deepened
to the point where governments need to take bolder steps and not shrink from
capital injections in the form of common shares even if it means taking majority,
or even complete, control of institutions,' it said."
The New York Times: Regulators disclose criteria for bank "stress tests"
"Federal regulators released the criteria they used to assess the financial
health of the nation's 19 biggest banks on Friday, but provided little new
information for investors to distinguish the industry's weak players from the
strong.
"In a 21-page report, the Federal Reserve regulators broadly laid out the
tools they used to project bank losses if the economy worsens, and officials
established an unspecified baseline to measure how much additional capital
the banks should add as a buffer against higher losses. But they provided no
concrete metrics to assess the depths of the troubles facing the industry or
specific banks.
"Still, the Federal Reserve report suggested that regulators are focusing
on the amount of capital that they want banks to hold in common stock, which
makes it easier for them to absorb future losses as the recession wears on.
That could force at least a handful of the 19 banks to raise significant amounts
of new capital and could lead to greater government ownership stakes in the
banks.
"'Losses associated with the deepening recession and financial market turmoil
have substantially reduced the capital of some banks,' the Federal Reserve
report on the stress test said. 'Lower overall levels of capital - especially
common equity - along with the uncertain economic environment have eroded public
confidence in the amount and quality of capital held by some firms, which is
impairing the ability of the banking system to perform its critical role of
credit intermediation.'
"The stress test criteria were released as federal regulators started briefing
top executives from the 19 large banks about how their companies fared on the
examination. In closed-door meetings at the regional Federal Reserve Bank offices,
the regulators plan to review their preliminary findings and inform bankers
if they need additional capital. The banks will have until Tuesday to dispute
any of the results before they are made public on May 4."
The New York Times: US may convert banks' bailouts to equity share
"President Obama's top economic advisers have determined that they can shore
up the nation's banking system without having to ask Congress for more money
any time soon, according to administration officials.
"In a significant shift, White House and Treasury Department officials now
say they can stretch what is left of the $700 billion financial bailout fund
further than they had expected a few months ago, simply by converting the government's
existing loans to the nation's 19 biggest banks into common stock.
"Converting those loans to common shares would turn the federal aid into available
capital for a bank - and give the government a large ownership stake in return.
"While the option appears to be a quick and easy way to avoid a confrontation
with Congressional leaders wary of putting more money into the banks, some
critics would consider it a back door to nationalization, since the government
could become the largest shareholder in several banks.
"The Treasury has already negotiated this kind of conversion with Citigroup
and has said it would consider doing the same with other banks, as needed.
But now the administration seems convinced that this maneuver can be used to
make up for any shortfall in capital that the big banks confront in the near
term.
"Each conversion of this type would force the administration to decide how
to handle its considerable voting rights on a bank's board.
"Taxpayers would also be taking on more risk, because there is no way to know
what the common shares might be worth when it comes time for the government
to sell them.
"Treasury officials estimate that they will have about $135 billion left after
they follow through on all the loans that have already been announced. But
the nation's banks are believed to need far more than that to maintain enough
capital to absorb all their losses from soured mortgages and other loan defaults."
Financial Times: US to put conditions on Tarp repayment
"Strong banks will be allowed to repay bailout funds they received from the
US government but only if such a move passes a test to determine whether it
is in the national economic interest, a senior administration official has
told the Financial Times.
"'Our general objective is going to be what is good for the system,' the senior
official said. 'We want the system to have enough capital.'
"His comments come as Goldman Sachs, JPMorgan Chase and other relatively strong
banks are pressing to be allowed to repay their bailout funds. On Sunday, Lawrence
Summers, President Barack Obama's top economic adviser, told NBC's Meet the
Press that repayments could eventually help the government provide further
resources to help the sector. Such a move could also allow healthier institutions
to differentiate themselves from weaker banks and free them from constraints
on executive pay, and other activities, that come with bailout money.
"'Not surprisingly different banks are in different situations; they are going
need different levels of assistance of taxpayers,' Mr Obama told a press conference
at a summit in Trinidad on Sunday, while promising: 'I'm not going to simply
put taxpayer money into a black hole.'
"The official, meanwhile, said banks that had plenty of capital and had demonstrated
an ability to raise fresh capital from the market should in principle be able
to repay government funds. But the judgment would be made in the context of
the wider economic interest. He said the government had three basic tests.
It needed first to 'make sure the system is stable'. Second, to not create
'incentives for more deleveraging which would deepen the recession'. Third,
to make sure the system had enough capital to 'provide credit to support the
recovery'."
Source: Krishna Guha and Daniel Dombey, Financial
Times, April 19, 2009.
Fox Business: Will banks make the grade?
"Rochdale Securities analyst Dick Bove on the 19 banks receiving government
'stress test' results today [Friday]. Bove says the results could be dangerous
to the overall economy and wonders if the banks that fail could raise capital
either from the government or the marketplace."
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