Monday, August 22, 2011

Friday Thoughts

Here is a good summary of this week's events from Miller Tabak's Peter Boockvar:


1. Gasoline prices fall another few pennies to a six-week low, relief for consumer.

2. IP rises greater than expected, 0.9%, but not sustainable, as auto snapped back after Japan and hot weather boosted utility output.

3. Multi-family housing starts bounce, helping to partially offset drop off in single family construction.

4. Refis rise 8% to the most since November.

5. Fitch says U.S. AAA is OK for now.

6. Thanks again to the ECB, Spanish and Italian debt trade well. What happens though when they stop? They do fully sterilize the purchases, and the euro continues to trade great vs. the Fed money printed backed U.S. dollar.

7. Japan's second-quarter GDP contracts only 1.3% instead of expectations of 2.5%


1. European markets get hammered again, bank funding sources are in question.

2. Merkel and Sarkozy break bread with no further bailout, as there's no change in the size of the EFSF, no Eurobond, and they throw down the hammer of a transaction tax just as the region is capital-starved, brilliant!

3. Initial jobless claims at 408,000, 8,000 higher than expected, but the four-week average falls to the lowest since April.

4. Existing-home sales are 230,000 below forecasts, Purchase applications fall 9% to a one-year low.

5. Philly manufacturing plunges to -30.7 from +3.2, and New York falls 4 points to -7.7.

6. Inflation figures all run hot, import prices, PPI and CPI. While all may back off with economic slowdown, stickiness will be theme, and the rest of us will continue to be force-fed real negative interest rates

7. Greek yields spike, everyone wants Finland's deal of collateral in return for funds.

8. Gold continues its amazing move up, paper currencies turning into paper towels.

I see the following buffers of support that could insulate the markets from further declines:

* There will be no double-dip (the negative feedback loop is hurting business and consumer sentiment) but other hard economic indicators don't signal a recession.
* Interest rates are anchored at zero;
* Inflation and inflationary expectations are contained.
* Strength of corporate balance sheets and trailing profits are strong.
* Valuations are reasonable.
* 55% of the all S&P stocks now yield more than the 10-year U.S. note.
* Risk premiums (the difference between earnings yield and corporate bonds are near record levels).
* Investor expectations are limited.
* Derisked hedge funds (ISI Hedge Fund Survey reports net exposure down to 45.8%, the lowest level in two years).
* The wholesale abandonment by the individual investor ($30 billion withdrawn last week alone).
* The possibility of a large reallocation out of low yielding bonds and into stocks.

" If you can keep your head when all about you
Are losing theirs …
[Y]ou'll be a Man, my son!"
-- Rudyard Kipling, If

Bank stocks - Weak business and consumer sentiment is indeed a byproduct of the negativity feedback loop. But I would emphasize that certain hard gauges of real-time activity (in production, retail sales and employment) are holding up far better than the sentiment numbers. For example, the leading indicators usually flash recession only when the numbers are negative -- but the LEI is up 6.2% year over year. Retail sales that were also holding up well through the middle of August. (As an example, Johnson Redbook sales were +4.7%.) Important gauges of employment also point to stability, not weakness. The four-week moving average of initial job claims is at the lowest level in four months and the rate of growth in withholding tax receipts have actually accelerated from under two percent to +2.7%.

1. Forced liquidations: Recent weakness is, in some part, due to forced hedge fund liquidations and high-frequency trading strategies that are exacerbating the sector's weakness. We are in a panic mode for the industry's share prices, in part reflecting concerns over Europe's fragile banking system.

2. Franchise Values or private market values are enormous relative to current stock prices. In housing, BAC and WFC will have the residential real estate markets to themselves in the period ahead. JPM and C will become the go-to lending institutions, not only in the U.S. but around the world.

3. Market Share Gainers: With the shadow banking industry obliterated, the European banks (many of which have U.S. branches) suffering and consumers less likely to expose themselves to banking in smaller, local banks, the largest banks in this country will dominate banking in the years ahead.

4. Improved Balance Sheets: The banking industry has delevered and is far better shape in terms of capital and liquidity than most investors realize. They are prepared for short-term funding disruptions.

5. Income Statement Strength: Pretax income before provisions is strong for the industry and very sustainable -- and I see the coming earnings reports as supportive of this and as a possible catalyst to higher prices. The stocks trade at absurd levels relative to 2013-14 earnings power. Today Citigroup is less than 57% of book value. And at $7 a share, BAC shares are implying another $70 billion of writeoffs and that the bank will only be able to achieve a mid-single-digit return on the depleted equity base.

6. Economic and Housing Concerns Are Now Consensus: My long-held concerns about the housing market, the impact of low interest rates on net interest margins and my view that economic growth would disappoint have now become consensus. And, with share prices down so far, those concerns have been largely discounted.

7. Low Interest Rates Have a Silver Lining: When the inventory of unsold shadow inventory is worked off -- and we are beginning to see it (that wonderful agency Standard & Poor's just came out with a 130-page report yesterday that shows that it is beginning to be worked off) -- low interest rates will probably accelerate the process. Low rates also improve the consumers' balance sheet and income statement (mortgage service is a large component of incomes), and this will allow for a continuation of the trend over the past 12 months of improving credit quality trends.

In summary, the largest banks that have scale are the best positioned.