|
Even as that inflation poses one of the greatest threats to our deeply indebted nation in decades … Alan Greenspan and the Federal Reserve have just decided NOT to do very much to stop it — just a meager, quarter-point hike in rates and no stern warnings of the dangers ahead. Some investors may greet this as “good news.” They think it will help them postpone a while longer the day they have to swallow the bitter pill of a bigger rate hike. So, based on this “good news,” you’d think most of Wall Street would be very relieved this afternoon. But it isn’t. After the Fed made it’s announcement at 2:15 pm, stock investors did not rush in to buy stocks. And bond investors certainly did not rush in to grab up more bonds. Quite to the contrary, after a short-lived flurry of buying, most stocks have sagged a bit. And bond prices are falling. The reason: Smart investors see through the Fed’s sugar-coated statements, and through the Fed’s virtual denial of the inflation dangers. Two weeks ago, they saw the dangers in September’s Consumer Price Index. They saw even more blatant signals in the Producer Price Index. And just this morning, they got still another warning — from the Institute of Supply Management, with one of the highest readings of higher prices in a decade. They know that the Fed’s meager quarter-point rate hike today is too little, too late to stop raging inflation. Which sector will be among the first to feel the pain? As Tony explains today, it could be those same giant banks that I warned you about yesterday …  Are Bank Stocks on theBrink of a Great Fall? by Tony Sagami My father is 91 years old, and the only person he reveres more than his local banker is the minister of his local church. He learned that after many decades as a vegetable farmer. And although he hasn’t farmed for years, he still talks about how his banker used to helped him through the tough challenges he faced — the low wholesale price of onions and radishes … the high cost of fertilizer … the negative cash flow between spring planting and summer harvests. I remember those days well. Once every spring, I would watch him shave, dab some Vitalis in his hair, put on the one suit he owned and march down to the bank for a loan to buy seed, fertilizer, and fuel. If weather and crop prices cooperated, he’d return proudly in the fall to pay back the loan in full. If not, he’d somberly plead for an extension. Unfortunately, the bad summers seemed to outnumber the good ones. And throughout it all, the banker was always held in the highest esteem. Today, I value highly the life lessons my parents taught me and use them almost every day in my business life. But when it comes to banking, times have changed. I feel modern bankers know less about prudent financial planning than my own humble and hard-working father.
How Some of America’s Largest Banks America’s largest banks have placed huge wagers on the markets, risking double, triple, even six times their capital. And this is not just a guess on our part. It’s based on data provided by the Office of the Comptroller of the Currency (OCC), a division of the Treasury Department. Martin gave you the hard numbers yesterday. But in case you missed them, here they are again … Start with JP Morgan Chase, the biggest player of them all.
That’s over six times the net worth of the entire corporation, adjusted for some other risk factors. Citibank and HSBC are not far behind in this risky business — with $3.10 and $4.07 of risk per dollar of capital, respectively. Bank of America may be risking relatively less, but it’s still exposed to the tune of $1.68 per dollar of capital. That’s over one and a half times its adjusted net worth. And these are just the risks they’re taking regarding the credit-worthiness of the counterparties (their partners in each trade). On the trades themselves, they’re risking additional sums! Now, here’s why I say they’re betting the farm on interest rates: According to the OCC, 85% of their bets are on the future direction of interest rates. If rates go the right way, they can make a fortune. If they go the wrong way, they could lose a fortune. Plus, I see …
4 More Credit Cracks in Our team here at Money and Markets has written several times about the risky lending practices of many banks — no down payment, overvalued collateral, or even “stated income” loans, loans that don’t require income verification. These are now causing major cracks in the business of these banks. And they’re not the only cracks I see … Credit Crack #1: Capital One Financial is one of the largest issuers of Visa and MasterCard credit cards in the United States. At the end of 2004, it was holding almost $80 billion of consumer loans. Of that, 61% of its revenues come from credit cards and 13% from auto lending. Now, Capital One has reported that its September net charge-offs increased by “an unusual” 145-basis-point jump to 4.86%. Credit Crack #2: AmeriCredit reported worse-than-expected Q3 results last week and increased its loan loss reserves from $98.7 million to $165.9 million. AmeriCredit expects the defaults to get even worse — it took down its 2006 forecasts to $1.67 to $1.85, well below the $1.95 the Wall Street gang was counting on. Credit Crack #3: According to Moody’s Investors Services, the global default rates on high-yield bonds increased from 1.8% in Q2 to 2.0% in Q3. That may not sound like a lot, but it represents an additional $14 billion of junk bond defaults. At the same time, Standard & Poor’s reported that 36 companies have seen their debt downgraded from investment grade to junk status so far in 2005 — 15 more than last year. Credit Crack #4: In the FDIC’s most recent quarterly report, it reports that, despite the increase in defaults, the amount of loan loss reserves that banks are holding have declined for six quarters in a row and are now sitting at 19-year lows. What’s happening right now? Are bank stocks going down and properly reflecting all these pressures? Not quite.
The Strange Saga of Take a look at almost any bank stock. You’ll see that when interest rates are going down, the stock usually goes up. When rates are going up, the stock goes down. Sound familiar? It should. Because that’s precisely how bonds behave, as Martin explained yesterday. Bonds do the same thing as bank stocks — they go up with falling rates and down with rising rates. So, in a way, bank stocks are a kind of proxy for bond prices. And it makes sense: Banks own lots of bonds themselves. Or they own other assets that are more or less the equivalent of bonds. Plus, as I told you, they have all those bets, which are also tied to bonds in various ways. That’s why, typically, bank stocks and bond prices move up and down in tandem. Think of them as a ballroom couple dancing across the stage.
And sure enough, bank stocks were doing the same. That made sense. Now, however, since around October 12, bond prices have continued to go down, but bank stocks are surging. And individual investors are running into the same thing these days. For example, investors who own bank stocks in recent weeks have done quite well:
Since October 12, investors holding Bank of America’s shares are up 4.8%. And those holding J.P. Morgan and Wachovia are up 10% and 8.2%, respectively. Citicorp shareholders are up only 2.6% during the period. But if they bought in late August, they’re up more.
In contrast, investors in bond funds have done poorly, especially if they started in late August: If they bought Dreyfus U.S. Treasury Long Term bond fund, they’re down 5.5%. And if they bought PIMCO’s, they’re down 5.7%. Their losses on American Century Target 2025 and the Rydex U.S. Government Bond Fund are even greater — 8.7% and 8.8%. These are big declines for funds that don’t put a penny in stocks. So … what gives? These investments are supposed to move more or less together. So how come bank stock investors are making money but bond fund investors are losing money? Something’s very wrong here — either with the bond markets … or with the bank stocks. Which is it? I say it’s the bank stocks that are whacky. I believe that …
Bank Stocks Have Got to Follow Bond markets are much bigger. There’s far more money invested in bonds than in bank stocks. So if there’s a false move driven by some over-anxious buyers … or if there are some behind-the-scenes maneuvers to goose up prices … it’s far more likely to be in the stocks than in the bonds. Bond investors are also smarter (usually). While stock investors can be temporarily deceived by this or that earnings promise, bond investors are more focused on the big picture — the danger of inflation, the economy, etc. Most important, history shows that bonds rarely follow bank stocks. It’s almost always the bank stocks that follow the bonds. So I will be surprised if bond prices rally very far. I will not be surprised if bank stocks tank.
This Has Potentially Big Consequences. Specifically:
Bottom line: Stay safe. Take protective action. And never bet the farm with debt or any single investment. Best wishes,
Tony Sagami About MONEY AND MARKETS MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Michael Burnick, Beth Cain, Amber Dakar, Scot Galvin, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.
© 2005 by Weiss Research, Inc. All rights reserved. |
Even as evidence of raging inflation continues to pour in, and …
For every dollar Morgan has in capital, it’s risking $6.25.
For example, in September and early October, bond prices were zigzagging down.
