Nervousness sets in

April 20, 2009 — Mitul Kotecha

Over recent days a number of banks including Citigroup, JP Morgan Chase, Goldman Sachs, and Wells Fargo and most recently BoA have revealed a return to profitability in Q1.   In Citigroup’s case it has been reported that earnings were helped by an accounting change that allowed it to post a one off gain of $2.5 billion.   However, it’s stock price was unlikely to have been helped by the announcement of a delay to the planned sale of a stake of 36% to the US authorities until the results of the bank stress tests are known. 

There is no doubt that US banks are being helped by strengthening mortgage demand due to low interest rates, improved liquidity in markets and the huge amounts of money that the government is pumping into banks.   High volatility has also helped boost trading revenues.   Nonetheless, uncertainty about the outlook in the months ahead continues to grow due to the risks from corporate loan defaults, a slide in the commercial real estate market and rising consumer loan delinquencies. 

This suggests it will be difficult for markets to get too bullish even if banks continue to report decent Q1 earnings.   Perhaps demonstrating this, even Citigroup’s better than expected earnings failed to prevent its shares falling on the day of its earnings announcement.   This was followed by a fall in BoA’s shares today in pre-market trading despite revealing that profits tripled in Q1.

Indeed, there are appears to be a degree of nervousness creeping back into markets, indicating that the improvement in risk appetite over recent weeks could be stalling as uncertainty about what lies ahead intensifies.  BoA’s increase in provisions for credit losses in Q1 highlights where this nervousness is coming from.   The results of US bank stress tests is the next hurdle for markets and if anything this could lead to more market tensions, especially if some of the banks are found to be requiring additional capital which looks increasingly likely to be the case.

Posted in bank rescue, Economics, equity markets, Financial crisis, US, US administration. Tags: , , , . Leave a Comment »

10 questions to ask…

April 14, 2009 — Mitul Kotecha

…before you return to the stockmarket.

Equity markets have undergone their biggest 5-week rally since the great depression but there are several questions that should be considered to determine whether the gains will last.

1) Why is the rally in equities broad based? On the face of it a broad based rally should come as good news but it also appears indiscriminate with investors rushing to buy any stocks regardless of the underlying factors. This suggests investors are jumping in without looking where they will land.

2) Why are financial stocks rebounding so strongly? Surely all the problems have not been resolved so quickly. Even if the removal of toxic assets are starting to gain traction markets are unlikely to have anticipated the likely problems coming from a new wave of credit card defaults, and comsumer and corporate loan delinquencies as economic conditions deteriorate and unemployment rises.

3) Have markets factored in the outcome of the results of the stress tests on US banks? These results will be known in about three weeks. Although no bank can fail the tests from a technical perspective, there is every chance that some will be found to be in bad shape and in need of more capital.

4) What effect will the impact of accounting changes have? The relaxation of industry accounting standards in the US mean that it will be difficult to gauge losses on a variety of debt. This could add to the uncertainty surrounding valuations rather than help to end it.

5) How will tensions between banks and the administration impact stocks? There appears to be growing tensions between the US administration and banks over repayment of bailout money and the speed at which banks are removing toxic assets from balance sheets. Many banks in the US are reluctant to announce further writedowns despite pressure to do so.

6) How long will positive data surprises continue? Clearly expectations for economic data had become overly bearish over recent months. Data releases have actually come in better than forecast recently as reality has not been as bad as expectations. This in turn, has helped give more fuel to the market rally. Once expectations become more realistic markets will find little support from positive data surprises.

7) Are markets full pricing in the depth and breadth of the recession? It appears that markets are looking at the current economic downturn as if it was the same as past cyclical downturns. This is unlikely to prove correct as economic conditions will not improve anywhere near as quickly as experienced in recent recessions. Moreover, the jobs market is likely to continue to worsen for many months to come. At best, economic recovery is unlikely until early 2010 and even this may be optimistic whilst any recovery is likely to be slow and mild relative to past recoveries.

8)How compelling are valuations? Although the price side of the P/E ratio has dropped sharply the earnings outlook continues to be negative. Analysts have forecast Q1 earnings to drop by around 37% but as the economy worsens and unemployment rises the earnings outlook could like quite bad for some time to come.

9) Are stocks rallying too quickly? Historically equity markets do not rally so rapidly following such a shock on the downside. Any rally is usually slower.

10) Are stocks rallying too early? Stocks rally around 5-6 months ahead of an upturn in economic conditions but as noted above any recovery in the economy is unlikely before early next year, which suggests the stock rally is premature.

Posted in bank rescue, Economics, equity markets, Financial crisis, US, US administration. Tags: , , , , , . 1 Comment »

Q1 earnings in focus

April 10, 2009 — Mitul Kotecha

Equity markets have continued their ascent albeit with continuing volatility around the Q1 earnings season. Other indicators of market stress have also improved whilst bond yields haved edged higher. Next week will test the markets optimism with a plethora of banks set to release their results for the past quarter. Wells Fargo provided a boost to financials today with its earnings report. Banks will benefit from the changes to mark to market accounting regulations allowing banks more flexibility in valuing their dodgy assets. Although I am somewhat concerned about the political push for the change in these accounting rules it will no doubt ease some of the pressure on banks and their estimates of writedowns.

Meanwhile the economic news continues to be less negative as the bigger than expected narrowing in the US trade deficit reveals. This adds to the run of better than expected numbers over recent weeks that is perhaps showing that the pace of economic deterioration globally is easing. The economic news has also contributed to the better tone to equities and improvement in risk appetite.

Action to prevent the economic and financial crisis from deepening is also creating a floor under markets. The Bank of England left interest rates unchanged but maintained its commitment to conduct asset purchases having done around 1/3 of the planned GBP 75 billion so far, with the remainder to be undertaken over the next couple of months. Elsewhere Japan will provide further fiscal stimulus to boost its flagging economy although the unstable political situation could yet derail such plans. Nonetheless, the picture is clear as policy makers continue their battle to boost sentiment and thaw credit markets.

If markets can get through Q1 earnings without a major set back there maybe hope that the rally really has got legs. I still think there is a whiff of a bear market rally going on but I would happy to be proved wrong.

Posted in Bond markets, central banks, Currencies, Economics, equity markets, Financial crisis, UK, US. Tags: , , , , , , . 1 Comment »

Pricing in recovery

April 1, 2009 — Mitul Kotecha

As was pointed out to me in one of the comments following my last article there are some signs that the market has become increasingly resistant to bad news. Indeed, it is encouraging that a host of weak economic data, more bad news on the banking sector front, bickering by leaders ahead of the G20 meeting, and the likely bankruptcy of a couple of US automakers has not prompted a more negative reaction.

Is the market tired of selling? It’s highly possible. Having faced an onslaught of bad news over recent months perhaps market players are simply exhausted. Adding weight to this is the fact that any pullback in equities has been relatively small compared to the gains over recent weeks whilst technical indicators are suggesting a more positive picture emerging.

I am not convinced. I will grudgingly admit that the market looks in better shape than it has done for months but this is far from a sustainable rally. Retail investors have yet to get in on this rally and like past equity crashes such as that following the Nasdaq bull burst, it took a long time for many investors to get back into the market having been burned so badly on the way down.

As I write this the US ISM manufacturing and pending home sales data have been released and both have come in on the positive side of expectations. The caveat is that the ISM is still in contractionary territory, consistent with falling GDP. Even if the data coming out now is less negative economic stabilisation is unlikely to take place until at least the end of the year. Based on past trends equity markets begin pricing in recovery around 6 months ahead of actual economic recovery, suggesting that we may only be a few months away from a more sustained turnaround in equity markets.

My only concern with this theory is that this is unlike any previous recession and so the equity market signal may be false. The current US recession has already lasted around 16 months, which is already a few months longer than the average for past recessions. It will need banks to be healthy before the economic outlook improves. If banks continue to remain in bad shape then past history will be a poor guide to the current path of the US economy.

Posted in bank rescue, Economics, equity markets, Financial crisis, US. Tags: , . 1 Comment »

Tough week ahead

March 30, 2009 — Mitul Kotecha

It looked as though it all went wrong today as the bad news just kept on coming. Following reports on Friday that JP Morgan and BoA had a more difficult month in March following a stronger start to the year, reports that UBS would be shedding thousands of staff and would announce billions more in writedowns as well as news of the takeover of a Spanish regional bank by the Bank of Spain hit market sentiment hard. Topping all of this were comments by the US administration that some banks would need more capital in addition to that already provided. The administration also said that bankruptcy may be the best option GM and Chrysler.

This sets up a difficult week ahead, with risk aversion set to rise further and the news unlikely to get any better. Economic news is likely to add to the market’s gloom as US releases such as the ISM manufacturing survey for March and the jobs report will likely reveal further deterioration. Expectations for another hefty drop in payrolls in March could see a total of over 5 million jobs lost so far in the current cycle with many more to go.

The news in Europe will not be much better and as today’s Eurozone sentiment indicators have shown the outlook for the economy remains gloomy. The ECB is likely to cut interest rates but will refrain from embarking on the quantitative easing policies followed by other central banks such as the Fed or BoE. As risk aversion rises the USD is set to continue to strengthen against most currencies this week.

Posted in bank rescue, central banks, Currencies, Economics, equity markets, Europe, Financial crisis, UK, US, US administration. Tags: , , . 6 Comments »
« Older posts
Newer posts »