Friday, April 24, 2009

How Are The Banks Doing? It Depends Who You Ask

What is going on with the banks? What are they doing with all that government TARP money? Are they crumbling, are they lending, are they solvent, are the toxic assets causing them to fail or are they just fine? As usual the answer isn’t simple and depending who you ask you will get a different answer. It all depends on your perspective.
As a bank executive your job is keep your bank alive. The primary reason companies fail is they spend more cash than they collect, In other words, they are cash flow negative. Based on recent financial reporting announcements, banks are cash flow positive due to increased fees from transactions they have facilitated and increased deposits. Many still have negative earnings due to write downs (on bad loans) but they can pay their bills and keep the lights on. So bank executives are relieved that the panic seems to be over and their banks can remain viable ongoing concerns.
However bank executives aren’t happy that their pay has been limited by government regulation related to the TARP funds. They also don’t like being lumped in with big bad wolf - AIG. So they want to give the government back its TARP funds as quickly as possible. Bank execs could care less about lending more money and stimulating the economy because there few incentives to make a lot of new risky loans. From a bankers perspective it would be better to hold on to the cash and use it to pay back the government’s TARP funds.
To make matters worse for the bank execs, the government wants the banks to sell their troubled (toxic) assets in order to free up capital to make new loans. These toxic loans have not been written down to their current market price because execs view these prices as just a market glitch. The current market for these assets is essentially frozen. The few transactions that take place are at a greatly discounted price. Many of these securitized investments are receiving a large portion of the interest and principal payments on time. So bank executives see no reason to sell these assets for a loss when they are generating an adequate cash flow. Now that the panic in the credit markets has subsided, the bank executives see no reason to cooperate with the government if it is not in their best interests.
The government’s objective is to get the economy up and running. To do this they need the banks to be lending. It is the lack of liquidity in the markets that caused most of the panic. The banks were leant the TARP funds to show the financial markets that the Treasury and the Federal Reserve had no intention of letting any more of the larger banks fail. In return, the banks were supposed to increase lending to consumers and companies thereby stimulating the economy. However, the banks are not cooperating and lending has fallen. An analysis by the Wall Street Journal of Treasury Department data showed that the largest banks refinanced 23% less in new loans in February than in October 2008 when TARP was launched.
Supposedly the government is stress testing the banks to see if they can survive tough market conditions. However, it is not in the governments best interests to have any of the banks fail this test. If most of the banks failed the government would not be able to prop them up again. The stress test may only be a political tool the administration is using to make the banks keep the TARP funds.
The Treasury Department wants to avoid any political backlash stemming from the banks reduced lending. The Obama administration wants the banks more accountable. It wants them lending. Currently, the government has little say regarding how the banks operate due to how the TARP legislation was structured by former Treasury Secretary Paulson. Since bailout funds are dwindling the Treasury has few options and little clout with the banks. One option that the Treasury has begun to consider is turning the TARP loans into equity (stock in the banks). This costs the taxpayers nothing. The losers in all this will be the investors that own bank stocks. Investors will find their ownership positions diluted and the value of the stocks would fall substantially.
So how are the banks doing? It depends who you ask and what metric you use.

Monday, April 20, 2009

Don't Count on the Consumer

The U.S. economy remains mired in a deep recession. How deep, well fourth quarter’ GDP declined 6.3% which was the biggest drop in output in 26 years. GDP figures for the first quarter are not available yet but are expected to be down an equivalent amount. Earnings and profits will also be down substantially in the first quarter after falling 20% in the fourth. These are horrendous results.
There have been encouraging signs in recent weeks and the panic has subsided but the recession is not over. The economy is still contracting and though the rate of decline seems to have moderated there are still problems to overcome. Hope is growing that things will improve even though the banking system is not yet operating normally. In Federal Reserve Chairman Ben Bernanke's words, there are signs of "green shoots," through snow in early spring. The economy is no longer in free fall but it is still in intensive care and the markets may be getting ahead of themselves.
The outlook for jobs however remains bleak. The unemployment rate is officially 8.5% in the U.S. and 11.2% in California. However, the real national unemployment rate is over 10% when you add in those that have been looking for a full time job for more than a year and those under employed (working part time but seeking full time). One out of every ten adults is unemployed and it will only get worse before it turns around.
Unemployment will continue to move higher as businesses downsize in response to falling sales and constrained credit. We have at least eight more months of rising unemployment before it starts to turn around. The unemployment rate is a lagging indicator because businesses will not begin hiring until the economy is expanding and well into recovery.
The lag is usually significant as the charts of previous recessions show below. These graphs were compiled by JP Morgan Asset Management which allows their charts to be reproduced. The gray bars are recessions and the black lines show the market low. The green line is the total return of the S&P500 which increases from the market lows. It is interesting to look at the orange line representing the unemployment rate because it typically builds higher even after a recession is over and the markets have moved significantly off their lows. In many cases, unemployment remains high for months after a recession is over.

The recovery from this recession will be held back by weak consumer demand. The American consumer will not be rejuvenating the economy by borrowing and spending. In fact the consumer isn’t consuming. He has started saving again and paying off debt. Americans have recognized that they need to have a contingency plan in case they lose their jobs or ever want to retire. The current argument that the average taxpayer will spend their tax refunds is faulty. Most taxpayers will save their refunds in case their salaries or jobs are cut. After watching their portfolios self destruct and the equity in their homes disappear, the average American is not spending recklessly. For the first time in twenty years the personal savings rate is on the rise. Debt payments as a percentage of disposable income have begun to fall. The American consumer is scared of losing what they have worked so hard to achieve and is finally planning for that rainy day.

Monday, April 13, 2009

Emerging Market Recovery

Stocks have now advanced around 35% from their lows in early March. The Dow and S&P indices are down only in the mid single-digits for the year while the Nasdaq is actually up 5%. I fully expect that we will give some of this back. It is normal for the markets to bounce around like this when the market is making a bottom. Volatility will remain high and the market bounces will be erratic and chaotic until the economy is clearly in recovery.

The emerging markets are beginning to come back to life especially China. The government’s massive stimulus program has helped China avoid sliding into a very severe recession. The Chinese economy is not hampered by many of the same problems plaguing the U.S. The state-dominated economy was able to successfully implement a massive stimulus program in November and without any delays started massive infrastructure projects. This has partially offset slumping export of Chinese goods. One note of caution, in order for China to have a sustained rally, demand for Chinese products from the rest of the world must begin to recover.

In addition, Chinese consumers are very thrifty and are not burdened with heavy debt unlike their western contemporaries. So Chinese consumers are unencumbered by large credit card bills, loans and/or mortgages and are starting to spend again.

The emerging market stock exchanges have moved up sharply maybe a little too sharply in recent weeks. The MSCI Emerging Market International ishares (EEM) are up almost 13% year-to-date. This recovery has been very rapid but the fundamentals do not support such a large swing. I would not be surprised if we gave some of this back.

The Chinese have historically been ravenous consumers of commodities. A rapid recovery could spark an increase in commodity prices and inflation. Currently, we are in a slightly deflationary environment but this could change if demand for commodities increased rapidly. It is difficult to tell if the rally in China and other emerging countries is sustainable. At least the panic is over and the global economy can begin to heal. As the recovery takes hold it will be important to closely monitor commodity prices for signs of inflation.



Thursday, April 9, 2009

One Out of Every Ten Americans is on Food Stamps

Our recent economic woes have hit everyone but it has impacted those with the least the most. Nothing brings home the plight of many Americans as recent the recently released government statistics on SNAP/Food Stamp participation. As of January one out of every ten Americans (32 million) is receiving food stamp assistance, the highest participation rate ever. How does this compare to the good times when the economy was humming along in 2000? Well, the number of people participating in Food Stamps in July was 16.8 million individuals, 15 million less than today.
As the economy has continued to weaken and unemployment has surged many households are in trouble. It has hit every region of the country with every state reporting a year-over-year increase in families requesting and receiving aid. The pain was not felt by just the families living in the Sunbelt states and the industrial heartland. In fact, you may be surprised by some of the states that have been hit the hardest.
Eleven states reported greater than 20% increases in their caseloads from the previous year. Idaho experienced the highest year-over-year increase surging 32% followed by Utah (29%), Florida (29%), Nevada (29%), Arizona (25%), Wisconsin (25%), Georgia (23%), Vermont (23%), Maryland (22%), Texas (22%) and Massachusetts (21%). Below is a chart prepared by Food Research and Action Center which shows by state the annual increase in Snap/Food Stamp participation.
The non-profit and private sectors food banks have been overwhelmed by the surge of people needing help. Many local food banks are struggling to stay open because contributions have dried up.
Granted that Food Stamp statistics are lagging indicators like the unemployment rate but it does show the pain that many Americans are experiencing. It will likely get worse so it is important for all of us to look around our own communities and help. Our lives are so busy that it is easy to miss that others need your help. So on this Christian holiday weekend make a donation (of time or money) to your local food bank or food pantry and help combat hunger.


Monday, April 6, 2009

Weekly Market Recap

The U.S. markets rallied for their fourth week. We are now well up from the lows experienced in early March. Last week the S&P 500 rose 3.3% to 843 and the Nasdaq Composite advanced 5.0% to 1,622. Value stocks finally showed strength because the Financial Accounting Standards Board revised the mark-to-market rule giving bank stocks a boast. Value stocks however still lag growth stocks year-to-date. In fact, large to mid-cap growth stocks are now positive for the year.

Though the current rally has provided much needed relief, it does not mean the markets are only headed up. We have seen rallies galore since we started this ascent into hell last year. This is the fifth 10%-plus move we have seen in the past year and the previous rallies did not hold. For this rally to be sustainable the banks and the credit markets have to be functioning and stable.

The economy is still deteriorating. Last week, the official national unemployment rate reached 8.5% (an additional 660,000 jobs were lost in March). The real rate of unemployment is over 10% when you add in those that have been looking for a full time job for more than a year or those under employed (working part time but seeking full time). One out of every ten adults is unemployed and it will most probably only go get worse before it turns around.

This and other data suggest that the economy contracted in the first quarter by approximately 5%. Luckily some of the recent economic data related to housing sales, retail sales and consumer confidence is pointing to a moderation in the rate of decline. The Federal Reserve is also doing its best to pump money into the system and bolster up the banks. The economy is beginning to bottom out but the data is not pointing to a robust or steep US recovery. The economy will begin to stabilize the second half of the year but the going will be rough.





Thursday, April 2, 2009

First Quarter 2009 Market Performance

I was quoted in yesturdays Contra Costa Times article on the First Quarter Performance.

Hope you enjoy!

Area stocks outperform market indexes

The stocks of Bay Area and East Bay public companies out-performed their counterparts on the national stock markets during the first quarter — but only by falling less than the Dow Jones 30, S&P 500, and Nasdaq Composite.
By the time the January-March period ended on Tuesday, the East Bay 50 index had fallen 2.7 percent and the Bay Area 100 index was down 0.2 percent. The Dow Jones Industrial Average plunged 13.3 percent, the S&P 500 slid 11.7 percent, and the Nasdaq fell 3.1 percent.
Those three-month losses came despite a general upswing in the stock markets towards the end of the first quarter.
"We seem to have gained some traction in the stock markets in March," said Libby Mihalka, president of Altamont Capital, a Livermore-based financial planning firm. "But we're not out of the woods yet."
The big problem now is financial gremlins continue to haunt broad stretches of the nation's economic landscape. And that has spooked investors.
"Short-term, there are so many things that are unknown," said Royce Charney, president of Oakland-based Trust Administrators, a financial company. "You still have all the bank and financial institution issues, and now we're dealing with the auto industry. But for long-term investors, the market still looks attractive."
Charney defined the long-term
"The collapsing financial system and the problems with the auto companies are hurting consumer psychology the most," said Richard Welty, president of Lafayette-based Welty Capital Management.
Among industry sectors during the quarter, the best-performing national index was the Morgan Stanley Retail Index, which rose 6.3 percent. The weakest sector was the Bloomberg Real Estate Index, which lost 33.7 percent of its value.
The best-performing East Bay companies during the quarter were primarily in the high-tech and biotech industries:
 Novabay Pharmaceuticals jumped 188 percent. Emeryville-based Novabay said a deal it struck to develop and commercialize one of its dermatological compounds could produce $50 million in milestone payments for Novabay.
 Zhone Technologies soared 130 percent higher. Oakland-based Zhone lost money in its fourth quarter, but the loss was in line with expectations. The wireless communications also landed some key deals and moved forward with plans to serve the rural United States.
 Neurobiological Technologies was up 116 percent. The Emeryville-based biotech company said it would seek the sale of the company or its assets.
 Socket Mobile was up 79 percent. The Newark-based maker of mobile-computing devices reported record annual sales in 2008, although the company lost money during the year and the fourth quarter.
 SYNNEX Corp. jumped 74 percent. Fremont-based SYNNEX, a technology services company, announced fourth-quarter profits that beat analysts expectations by a wide margin.
Walnut Creek-based PMI Group was the worst-performing East Bay stock, falling 68 percent. The mortgage insurer reported a smaller fourth-quarter loss. PMI also was jolted by a downgrade by Fitch, which warned that PMI faces more losses and reduced liquidity.
Concord-based Pacer International fell 66 percent. The freight logistics company's fourth-quarter results fell short of estimates for earnings and revenues.
The best-performing Bay Area company was XTENT Inc., a Menlo Park medical devices company whose stock rocketed 367 percent higher. But the improvement may have been due to XTENT's disclosure during the quarter that it had hired an advisor to help it sell some core assets, sell the entire company, or seek a merger partner. XTENT also decided to eliminate 115 jobs, or 94 percent of its workforce.
Investors should be prepared to confront more volatility during the second quarter of this year, financial planners said.
And even after the volatility fades, and the economy starts to look better, it's still quite possible that a rebound won't produce much to cheer about.
"We're going into a slow-growth economy," Mihalka said. "Things will stay slow. And then we may have inflation.