2 steps down, 2 step up that's what the markets made this 3.5-day week on light volume trade in a wide trading range as all the participants were eyeing the next week, rich of corporate earning figures (Goldman, J&J and Intel on Tuesday). While we all expected a quiet day, the Dow jumped almost 250 points up closing at 8083, this kind of daily variation sounds more and more common now. The equity market rally which started yesterday on (essentially my guess) lack of volume/participants , stop gunning ("gimme your short!") and short covering ("here it is!") before the break and the earnings season, gained strengh overnight with a jump in Asian stock with a surprise 1.4% MoM rise in Japanese machine order in February (vs -7% expected) . The Dow jumped again of around +100 points in a few minutes at 13.00 GMT after Wells Fargo posted a first quarter record profit, beating the highest estimates (formal results on the 22nd of April). The bank stocks then climbed in a vertical way (Wells Fargo +32%, BofA +35% and JPMorgan +19%) until the close, helped in addition by a report from the New York Time that all the 19 banks examined by the US government will pass the stress test.
I know that the stock market generally discounts the future at a 6-month to 1Y horizon and moves with the crowd's expectation of what will happen at that horizon, I know that the short positions have become quite expensive too. The thing is, as the gov interventions and the events are unfolding, I feel more and more comfortable on my bearish position in the medium term and I believe my view is still below the already very bearish crowd's consensus. OK, I know I will need to give you more details on the reasons why, I'll do it gradually as I'll be posting in this blog (actually I think I need to make them clear for myself first !). For now the question is more whether this rally will sustain in the short term or not. A few thoughts on this :
- It is more than likely that the WFC figures have benefited from the FASB MtM regulation change (cf a previous post) and that the earnings that will be announced by the banks will be much higher than what the analysts expect for the same reason. To me, it is already (at least most of it) priced in today's bank rally and then a "perverse effect" of the regulation change could play a key role in the short term : the lack of transparency will lead the investors to doubt the good results and what is perverse is that the results could be actually good! For the skeptical, what is not said is bad news and now who is NOT skeptical ? [A later addition to the post, one day after : as seen on Bloomberg (it is the most read news of the day) "the FED is said to order banks to stay mum on stress test results"... if it's true, it's bear, remember "what is not said is bad news".]
- Now a personal experience : once upon a time... It was in 2001 or 2002, in France, I was then new in the Structured Credit & CDO business (Criminal ! Yes... I need to confess a few crimes). I remember one day my boss asked me to attend a meeting with 2 guys from Wells Fargo & Co. All day before the meeting, I was very excited as I was wondering if the two cowboys from the Wells Fargo would come in a red stagecoach at this meeting, like in an old good Western. No need to say that I was quite disappointed when the 2 guys came: no horse, no guns, no hat but a suit, a tie and a shirt, probably a Ralf Lauren as 99% of the shirts in the Financial fashion those years for those old enough to remember. A powerpoint (that had the Cowboy and the red stagecoach at the front page! yeeeeheeeee) summarized the role of the WFC in the CDO business : they are Trustees. My point is here : the Wells Fargo (if we exclude here Wachovia in the argument) is implied in the CDO business mainly as a Trustee among the few Trustees available (the Bank of NY Mellon is the main player, after its merge with JPMorgan Chase which used to be a big player too). The trustees have a recurring fee business from the CDO (like the rating agencies) when everything is OK. When everything goes bad the Trustee takes care of all the administrative tasks related to downgrades, payment of flows, notices, liquidation, Credit Event, etc. Those additional tasks are of course not free ! I have an idea where a fraction of the profit comes from but to be frank, I need to investigate a bit further at that stage. The other thing is the Trustees have definitely not the same exposure to the CDOs as the investment banks, one needs to be careful when comparing.
- Last but not least : the banks are part of the real economy but are not THE real economy. My guess is that sooner or later, the financial crisis will spread to the corporate world, the highly leveraged SME first. This earning season has to be monitored very closely, a lot of bad news are already anticipated and in the prices but we are likely to start seeing the real impact of the recession now, in particular the decrease of the consumer spending.
Now where the threat comes from for the Bears ? To me, the main danger comes from the equity mutual funds. They were hurt, they are cash long and they're waiting desperately to come back. If a few of them come back long stock as low earnings may mean for them undervalued stocks, their "never-be-the-only-one-wrong" logic can drive lots of them to follow as sheep, giving some strength to to bulls.
We'll have a lot of fun on next week for sure! Have a good Easter break!
I know that the stock market generally discounts the future at a 6-month to 1Y horizon and moves with the crowd's expectation of what will happen at that horizon, I know that the short positions have become quite expensive too. The thing is, as the gov interventions and the events are unfolding, I feel more and more comfortable on my bearish position in the medium term and I believe my view is still below the already very bearish crowd's consensus. OK, I know I will need to give you more details on the reasons why, I'll do it gradually as I'll be posting in this blog (actually I think I need to make them clear for myself first !). For now the question is more whether this rally will sustain in the short term or not. A few thoughts on this :
- It is more than likely that the WFC figures have benefited from the FASB MtM regulation change (cf a previous post) and that the earnings that will be announced by the banks will be much higher than what the analysts expect for the same reason. To me, it is already (at least most of it) priced in today's bank rally and then a "perverse effect" of the regulation change could play a key role in the short term : the lack of transparency will lead the investors to doubt the good results and what is perverse is that the results could be actually good! For the skeptical, what is not said is bad news and now who is NOT skeptical ? [A later addition to the post, one day after : as seen on Bloomberg (it is the most read news of the day) "the FED is said to order banks to stay mum on stress test results"... if it's true, it's bear, remember "what is not said is bad news".]
- Now a personal experience : once upon a time... It was in 2001 or 2002, in France, I was then new in the Structured Credit & CDO business (Criminal ! Yes... I need to confess a few crimes). I remember one day my boss asked me to attend a meeting with 2 guys from Wells Fargo & Co. All day before the meeting, I was very excited as I was wondering if the two cowboys from the Wells Fargo would come in a red stagecoach at this meeting, like in an old good Western. No need to say that I was quite disappointed when the 2 guys came: no horse, no guns, no hat but a suit, a tie and a shirt, probably a Ralf Lauren as 99% of the shirts in the Financial fashion those years for those old enough to remember. A powerpoint (that had the Cowboy and the red stagecoach at the front page! yeeeeheeeee) summarized the role of the WFC in the CDO business : they are Trustees. My point is here : the Wells Fargo (if we exclude here Wachovia in the argument) is implied in the CDO business mainly as a Trustee among the few Trustees available (the Bank of NY Mellon is the main player, after its merge with JPMorgan Chase which used to be a big player too). The trustees have a recurring fee business from the CDO (like the rating agencies) when everything is OK. When everything goes bad the Trustee takes care of all the administrative tasks related to downgrades, payment of flows, notices, liquidation, Credit Event, etc. Those additional tasks are of course not free ! I have an idea where a fraction of the profit comes from but to be frank, I need to investigate a bit further at that stage. The other thing is the Trustees have definitely not the same exposure to the CDOs as the investment banks, one needs to be careful when comparing.
- Last but not least : the banks are part of the real economy but are not THE real economy. My guess is that sooner or later, the financial crisis will spread to the corporate world, the highly leveraged SME first. This earning season has to be monitored very closely, a lot of bad news are already anticipated and in the prices but we are likely to start seeing the real impact of the recession now, in particular the decrease of the consumer spending.
Now where the threat comes from for the Bears ? To me, the main danger comes from the equity mutual funds. They were hurt, they are cash long and they're waiting desperately to come back. If a few of them come back long stock as low earnings may mean for them undervalued stocks, their "never-be-the-only-one-wrong" logic can drive lots of them to follow as sheep, giving some strength to to bulls.
We'll have a lot of fun on next week for sure! Have a good Easter break!
Nice Post Sauros,
ReplyDeleteYou bring up a nice point about the financial sector, things in the short term (next few weeks) i'd say are looking a bit more rosy, but this is id say people ignoring actual fundamentals of the economy (look at the recent housing and job market reports). And I'm sure earnings are better for banks, but I would say one would have to look carefully over their balance sheets and income statement to see where these better earnings are coming from (the gov't maybe?). I wouldn't say these earnings are due to actually loaning or organic business generation. So maybe this rally does have more steam IF this is not already priced in.
All in all, I would love to hear more thoughts on this from you.
PS. (could you define time frames for short term and medium term)
-Alex
2 Alex
ReplyDeleteThanks Alex for your comment,
To answer your question, my definitions of short, medium and long term are a bit flexible depending on the market conditions but roughly short term is from one to a few weeks, medium a few months and long one to a few years. I tend to consider the intraday as a "noise" particularly with the current market high volatility (I use as a measure of the volatility the 14-day ATR ) due to the lack of participants. I'm not able to trade that noise and make consistently money scalping as there's no rational (it's more accurate to say I didn't find one) and my analysis (notably the economic datas as you mentionned) merely don't work.
One word on the MtM regulation, I would compare it with the pain in the Human body. The pain signals when there's something wrong in the body. If you take out the pain, you will feel immediately better but nothing signals to your brain that something is wrong in your body and you can easily live without caring about it. Until it gets worst and you can't recover. If you take out the fair value, the financial system will immediately look like it recovers until it collapses.
Now my problem is to know WHEN it will collapse and if it does it early enough for my short positions to stay alive. It's likely that they will be hurt the next few days (as I'm writing those lines, it is rumoured that GS will smash their earnings, showing their second best results ever) but the thing is I don't want to miss the big swing down.
Now my personal guess regarding the timing (a very difficult exercice indeed!). In a few words, I believe, and this for a few months now, that the US have no choice but to find a way to nationalize their banks. The DIP (debtor in possession) process allows this in the framework of a supported bankruptcy, ie put the priority on the taxpayer while letting the company keep running its business. My guess is the US Government will DIP Chrysler first at the end of its 30-day last chance period to test the market reaction before considering it with GM. While those companies banruptcy are already priced for a while, I think the reaction will be very negative and it could trigger a major downtrend particularly for the banks as speculation that the gov will DIP the banks as well will grow. I need to detail more all this in a post but in a few words : "Sell the DIP" ;-)
Finally, back to the banks, I really recommend the reading of Mike Mayo's report I referred to in my previous post "the Guru effect", I find it really excellent.
cheers