I’m here to tell you that’s a bunch of bull. The carnage in the credit markets started spreading well beyond the oil and gas sector last year, and now the same thing is happening in equities. One sector I follow the closest is really getting battered now — banks.
Just look at this chart of the SPDR S&P Regional Banking ETF (KRE). This $1.7 billion benchmark fund owns 91 regional and super-regional banks, including PNC Financial Services Group (PNC), KeyCorp (KEY), BB&T (BBT) and SunTrust Banks (STI) …
|The ailing financial sector.|
You can see that KRE knifed through an uptrend line that dated back to 2011. Then it took out horizontal support this week. That means every penny of gains bank investors racked up since the summer of 2013 has now gone out the window.
What’s going on? A couple of things …
First up are collapsing interest-rate spreads. Many investors thought the difference between short-term interest rates and long-term rates would increase in late 2015 and 2016. That helps support bank income by making the core business of deposit-taking and lending more profitable.
But instead, rate spreads are collapsing amid increased concern over deflation and economic weakness. For example, the crucial 2-10 Treasury yield spread just collapsed to its lowest since 2007. That’s putting pressure on industry-wide profit margins.
Second are worries about rising credit losses. If corporate borrowers can’t pay back their loans and credit lines, particularly in the energy sector, it’s going to take a major chunk out of bank profits. JPMorgan Chase (JPM) just added to its loan-loss reserves for the first time since the end of the last credit crisis, and other banks are following suit.
|The financial sector is feeling the heat now.|
But it’s not just energy. The major bank regulatory agencies warned in December that banks were overly exposed to aggressive commercial real estate lending. I’m very concerned about overly aggressive auto lending as well.
It’s also worth pointing out that shares of the major mortgage insurers are collapsing. To just give you one example, Radian Group (RDN) has lost roughly half its value since last summer. It’s now trading for the lowest in 34 months. Could investors be anticipating more problems in the housing market going forward, perhaps because of a weakening domestic economy? You bet.
So what does this mean for stocks? Well, the deterioration in credit markets last year foretold the equity turmoil this year. It was a key reason I told my subscribers last spring and summer to pare their stockholdings dramatically, raise a large amount of cash, and hedge against — or target gains from — deterioration in vulnerable companies.
Going forward in 2016, I don’t see how the broader market can mount a lasting rally unless and until financials stabilize. That’s because the financials are the glue that holds the capital markets (and the economy) together.
Just consider: Banks have already started tightening credit standards on new loans because of worries about old loans going bad. That’s starting to choke off the flow of credit to the economy, and it’s only going to get worse if delinquencies and defaults jump.
Credit-reliant sectors like autos, housing, and commercial real estate are particularly vulnerable. That’s because activity in those industries was turbocharged by excessively cheap and easy money over the past few years.
In other words, keep an eye on ETFs like KRE — and the health of the underlying banking sector. I believe they hold the key to the broader markets.
So what do you think about the action in bank stocks, and what it may or may not signal? Is the meltdown in regional banks a big concern for the S&P 500 overall? Or do you think that some soothing words from central bankers might be able to stem the declines? Are defaults a major concern outside of the energy sector? Share your views online when you get a minute.
Yesterday’s column about what the richest of the rich are doing with their money prompted quite a few comments at the Money and Markets website.
Reader Ted F. weighed in on the absurdity of paying so much money for various toys and trinkets: “I’m beginning to think that a great many people have no concept of what money is and what things should really be worth. Tens of millions for a car? Can anything really be that rare or ‘collectible’?
“Can you imagine the cost to insure that thing? Wouldn’t you be too scared to drive it? What would someone do with it? Park it in their living room? Does somebody want to be buried in it?”
Reader Gordon said the squirreling away of money in assets is a sign of fear about what’s to come: “It shows a trend where the moneyed people are running scared, afraid their paper wealth will evaporate. They are trying to be first out of the starting gate or out the door of a burning house before it collapses. They gained their wealth by being smart, not stupid.”
As for whether the wealthy are right to get out of the markets, Reader Robert C. said: “We are in for a deflationary period. As you said, there is a total disconnect from the stock market and the real economy. I believe that this so-called recovery was fake.
“The way to grow an economy is by creating real wealth by increasing productivity. This comes from the creation of new businesses, low taxes and regulation. Our economic problems are structural, not cyclical. We and the rest of the world are floating with too much debt.”
Reader 151 picked up on that thread, saying: “I think your intuition is right. There is nothing now that the Fed bankers can do. Interest rate manipulation and more cash, while we hover just above zero, will not influence anyone for more than a day or two.
“The bottom line problem for the Fed is that everyone is getting jaded to their machinations. Their supposed power is now being seen as nothing but empty rhetoric. The problems are just too big.”
Finally, Reader Ronald B. said: “We are in the first stages of a bear market. The overall trend is down for the next 12 to 18 months. The velocity of money is at record lows, and printing more seems to only add to bank reserves, never going to public coffers.
“Most consumers are fully satiated in goods and supplies, including corporate investment goods for mining, agriculture and transportation. Like 1932, we see every stimulus effort just pushing on strings that buckle but don’t deliver! These conditions offer little upside. All we can do is wait, hold our cash, and seek out bargain stocks.”
Thank you for the feedback. I have no doubt that policymakers will keep trying to fight the deflationary/contractionary economic forces at work in the markets. But over the last several months, investors have stopped playing along because they can see that futility of those efforts.
They know that more QE, negative interest rates, programs to stimulate lending, etc. don’t work. So they’re using central banker-driven rallies to sell and/or re-load short/inverse ETF/put-option positions before the next leg down. That’s the polar opposite from how they used to buy into CB rallies between 2009 and early 2015.
I believe that approach makes all the sense in the world, by the way. It’s one I’m using to deliver profit opportunities to subscribers in my premium service. In the meantime, keep those comments coming in the discussion section below.
(Editor’s note: Click here if you want more details on Mike’s Interest Rate Speculator premium service.)
Chinese stocks tanked overnight, with the Shanghai Composite Index falling more than 6% to a 13-month low of 2,749. Several industry groups lost ground, helped along by reports that capital outflows jumped in December. That pushed outflows to an estimated $1 trillion in 2015, a record high.
Vague chatter about non-OPEC and OPEC countries working together to cut oil production kept the overnight trading session from being a bloodbath for U.S. stock futures. But that still seems to be pie-in-the-sky talk, given the fact the Saudis aren’t playing along.
What’s more, U.S. production isn’t under the purview of government officials like production overseas. So OPEC is reluctant to cut its own production in a move that would just cede market share to U.S. shale oil producers.
The financial conglomerate American International Group (AIG) attempted to placate dissident shareholders like Carl Icahn by announcing restructuring plans. It plans to sell its broker-dealer network, attempt to IPO its mortgage insurance business, re-organize into nine business units, and cut more costs. But considering the pressure on financials — and the fact mortgage insurance stocks are collapsing — that plan could be tough to execute.
President Obama is pushing for changes to retirement plans. He wants to offer tax credits to small businesses that auto-enroll workers in 401(k)s and to allow multiple businesses to pool their plans in an effort to bring down costs. We’ll have to see if Congress acts on the suggestions in the months ahead.
What do you think of the latest carnage in China? How about the talk of foreign oil production cuts — realistic or not? Do you think expanded 401(k) availability would help solve America’s savings crisis? Let me know in the comment section.
Until next time,