Sunday, April 5, 2009

Financials Have Run Too Hard and Fast- Tread With Caution

No doubt that the recent FASB decision to relax certain fair-value/mark-to-market provisions, along with the excitement of a short-seller uptick rule reinstatement smackdown, coupled with a few of our major banks having said they were "profitable" for the first two months of the first quarter 2009- and with some bright spots signaling a macro-economic bottoming-out underway, all have contributed to the remarkable punch up of the stock market since early March, led by financials.

Mutual funds have spent the last couple of weeks toying with the day-trading shorts (and perhaps a few brave hedge-funds stragglers). Just when shorts are certain they've picked a top, the behemoth mutual fund monsters let the financials drop, then blow the clueless shorts out with a time-tested short-squeezed mission statement: do not short on our turf.

Moreover, the fixed-income markets have shown an ever-increasing resilience- and, in fact, some real strength. This always bodes well for the long bull haul.

Yet, there are some reality checks here. First-off, one of things FASB did NOT do, was go retroactive on legacy bad assets. This is a huge letdown (although to have been expected), and the mods they did approve will therefore not have the real punch we mark-to-market mod proponents had wished for. And, of course, although the changes made by FASB will begrudgingly facilitate establishing a market for certain bad assets, if at a higher price than the PPIF's potential private investors might have liked, there will be many bad or depressed assets that will now not be offered up for sale, and kept in our large-bank black-hole boxes instead. On the other hand, the PPIF is such a sucker's bet for American taxpayers, why in the world wouldn't banks unload everything they've got while they've got Uncle Sam playing the shill.

There is an estimated $20-30 trillion in bad assets held by US and Europeans banks. Using a trillion dollars alongside some private investment money to wipe these bad assets of the books is akin to using a fly-swatter to whack away the flies on a dying elephant. And, then of course, we aren't even talking about the CDS market that expects payouts rain or shine. Think of these as the hyenas and vultures waiting to swoop down on our giant toxic elephant once he dies and his carcass is up for grabs.

Rest-assured, no one in the know in government or on the inside of the world's big banks and institutions want to talk about the black-box. Suffice to say, they'd rather just leave it at "too big to fail"- and, more than anything else, don't want any outsiders poking their noses inside the black-box- else that would mean true taxpayer outrage (which is why, when I hear all this talk about "transparency for investors," I really do have to chuckle, sadly).

Then again, as the taxpayers are being led to believe they can buy pieces of the dying elephant as part of the PPIF- then bet on more of where that came from- until the entire elephant is in the Smithsonian and no longer in the banking zoo. The shadow banking system is dead. Long live the banks.

Back on the ranch- FASB-mod inclusive/legacy assets excluded, first quarter balance sheets for the big banks will, therefore, be improved only marginally. How these assets are treated by the bank regulators as to cap reserves is, to me, a black-hole in itself. The stress-test results, about to be completed, will not be made public- leaving investors to guess wildly about the specifics- and even more wildly about the generalities- except that certain banks will be required to hold more reserves.

Moreover, the operating "profitability" of the big banks are cosmetically TARP-buttressed- fortified by the old sporting event called The Musical Chair Swap Meet between our institutions.

Rather, credit asset write-downs will continue to be horrific. Credit card defaults will continue to rise, especially as unemployment rises. Performing loans continue to deteriorate. Commercial real-estate continues to tank. Private mortgage insurers are going to continue to get hit from defaults and other impairments that have not yet shown up on their books. Their access to government program "bailout" relief will also be limited, if at all- and those dealing directly with Fannie Mae could face suspension in light of ongoing credit agency downgrade triggers.

So investors in financials, who have been basically day-trading stocks on daily news and hopes- are now getting suspicious of a sustained rise from here, although mom and pop investors out in the burbs are now wanting to get in while they hear that the gettin' is good. Institutions (always the last to know) are coming in just because they can (and this is big money).

But, my feeling is that, although there will be more upside to come over the next few months- there may now be a pause- even some real downside to financials. Mutual funds are going to buy lower and lower- as will institutions- as they realize they can do so. They're slow, but not stupid. And yes- swaps are raging. Puts on some of our large banks are on fire- and growing. Bets on a tank have been placed.

So, as fantastic as the recent run-up has been, it's a bit overdone for the time-being. Some profit-taking is in the cards for smart traders. And then simply wait April out. See what's what. Yes- there are those traders who refuse to take a break from the craps tables- but these are the suckers that the house looks to clean out and hand out free rooms as consolation prizes toward that trip to the casino next year.

Remember, if you've really been listening to Bernanke, Bair and Geithner (sounds like a law firm), you'll notice that the financial heavyweights with their fingers on the puppet-strings in Washington have NOT dismissed the notion that some institutions may need to be wound down if necessary. This is a polite way of saying, "We won't let anyone fail in one fell swoop like Lehman Bros, but that doesn't mean certain large banks won't fail slowly, like AIG (AIG)- pumped up with taxpayer money as their assets are slowly sold off, leaving vastly-smaller leaner, meaner banking entities."

As to which large banks would be involved to this extent, I am not going to speculate. Wells-Fargo (WFC)? Bank Of America (BAC)? Citigroup (C)? Who knows. But, any announcements or leaks forthcoming that certain big banks already TARPED could require more capital injections in the event of a downturn would be a complete downer for the pumped up financial longs. And the financials could turn south in violent fashion. Actually, I will speculate: I like Bank Of America's chances of staying strong and proud- it only makes sense- after all, they handle, in some capacity, pretty much everyone in this country. Now that's too big to fail! I like Ken Lewis. He may be part of the old guard, but he don't take no mess from Obama. In fact, if they move in on Bank Of America's boardroom, I'm moving to Thailand- because that'll be the final nail in the free-market capitalist coffin.

The results of the stress-tests are apparently going to be completed by the end of April. And our large banks are announcing first-quarter earnings, for the most part, beginning the week of April 13, 2009 through the week following. So, I look at any more ramp up in financials as longs trying to milk some quick profits off of funds and burb-people who haven't read this article, before the bottom falls out.

I was the first to initiate this whole market-to-market suspension/modification craze. I was the first to initiate this whole restoration of the uptick rule craze (and to take on short-selling manipulation relating to changing the price test). I have engendered an army of investors to write their Congressional Representatives in regard to mark-to-market and the uptick rule. I have people from certain networks reading my articles and then expounding about them on-air within hours (God Bless Them). And I have many in power in D.C reading my articles and then using them to hit home-runs in their neck of the woods.

I was also the first, back in January, to call a bottom, and for a long bull run to start on Valentine's Day in February (although I was 3 weeks early)- which was scoffed at.

Now I'm telling you all to tread carefully. I hope I am wrong. I hope this market keeps going until it hits 16000.

Meantime, I'll leave you all with a quote from everyone's favorite farmer- Thomas Jefferson:

"Government big enough to supply everything you need is big enough to take everything you have..."

Don't believe me? Ask General Motors (GM), the UAW, the bond-holders and the good hard-working citizens of Michigan.

GT McDuffy

(Disclosure: author holds no positions in any of the stocks mentioned in the article above)

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