Not Buying This Rally
by: Thomas Ryan May 21, 2009
This The sharpest rally since 1933, which started March 10th in U.S. equities, looks like it has finally come to an end. The leadership sectors of banking, insurance, REITS, retail and casinos have all started to roll over, and look like they are going lower.
There is a good reason for this. The outlook for these sectors is absolutely terrible. While TV pundits seem to see green shoots everywhere they look, we see more problems ahead for the U.S. and world economy. The government used every tool available to goose the market for the release of the stress tests, allowing America’s biggest banks to raise capital at much better rates than would have been possible a few months back. Those of you who expect a swift recovery, and buy this rally will soon be severely disappointed.
False Jobs
The jobs number that came out last Friday was heralded as the first sign the economy was getting better with only 539,000 jobs lost in April. Nothing could be further from the truth. The first 140,000 U.S. Census workers started in April according to Bloomberg, and the government added 72,000 workers to April’s unemployment report. The census workers will be hired for a few weeks to up to a few months depending on the position and paid anywhere from $10 to $25 an hour. The total budget for the project is 14 billion dollars. This means that the average census worker will earn less than $10,000 total in this new job if 100% of the budget is allocated to hiring as 1.4 million are scheduled to be hired over the next year. Removing the census workers would bring the job losses to 679,000 workers.
The infamous birth death adjustment added 226,000 jobs to the total as well. This adjustment is supposed to account for job growth by small businesses that are not counted in the main survey. Does anyone in their right mind honestly believe that small business added jobs last month? Taking out this ridiculous number brings job losses to 905,000 for the month. If you think jobs lost by small businesses totaled more than 95,000 the economy lost over 1,000,000 jobs in April. Individual federal income taxes collected in the first four months of 2009 are down 34.37% from a year ago. The consumer is dead, not just resting. No green shoots here, just tricks to make the numbers look better.
Insolvent Banks
The government stress test of America’s largest banks was a farce, and will have terrible results. We did an analysis of the 163 largest publicly traded U.S. banks that have more than 100 million in assets and at least 50,000 shares traded daily, and then removed bankrupt banks from the list, leaving 158 banks. These banks make up 93% of the bank loans in the U.S., and have a combined 10.273 trillion in assets. We added the common stockholder equity to the loan loss reserves and subtracted goodwill and intangibles then divided this total by nonperforming assets.
These are just the losses on regular loans not mark to market losses on structured financial products. This ratio shows ability of the banks to absorb future losses. We consider non-performing loans to be a good predictor of the banks pending losses. I would consider a bank that has a ratio of three dollars of common equity and loan loss provisions to every dollar of non-performing assets to be adequately capitalized for the moment. Only 53 of the 168 had this 3 to 1 cushion of tangible equity and reserves against non-performing loans.
The 38 best capitalized banks totaled only 427 billion in assets. 57 of the banks had ratios of 1 or less, meaning tangible common equity and loss reserves are less than current nonperforming assets. These banks had 2.763 trillion in assets. Banks with less than a 2 to 1 ratio have assets of 5.927 trillion. 116 of the banks have loan loss reserves that are less than current nonperforming assets, even though we all know that losses are going much higher. Banks have not set aside enough reserves for these coming losses because many would fail to meet the FDIC’s capital adequacy measures if they set aside this money.
The data does not show a healthy banking system, but rather an insolvent one. As for the regulators favorite metric, tangible common equity, Citibank (C), Bank of America (BAC) and Wells Fargo (WFC) all had a ratio of less than 4% before the latest round of capital raises. These banks as a group have 124 billion of tangible common equity and loan loss reserves after subtracting current loan losses, goodwill and intangibles. The capital raises from the stress tests this brings these banks up to 200 billion in tangible equity.
A 2% increase in losses will effectively wipe out all the tangible equity in the U.S. banking system. Unemployment, a leading indicator of loan losses, has gone up from 5% to 8.9% in the past year and is going higher. The banking sector as a whole is severely undercapitalized for the tsunami of losses that are coming. This does not include the mark to market games that the banks are playing with the so called toxic assets. Citi has assets marked $70 billion above where they would sell in the open market today. Allowing banks to put false marks on their books in hope of price recovery does not make that price real. This is the equivalent of an individual buying a stock at $100 and saying he has no loss even though the stock is trading at a dollar because he hasn’t sold. Marking assets to market would wipe out the 200 billion as well. Amazingly Europe’s banks look worse.
Insolvent banks don’t lend. They sell profitable business units to raise capital. They sell stock every time the market rallies. They raise rates on credit cards; don’t forgive overdraft fees, and nickel and dime the poor. They reduce bank lines of credit and raise interest rates. The banks try to buy time, and earn their way out of the jam. The whole game is delay, delay, delay. We have an entire nation of zombie banks today ensuring that no recovery takes place as lending continues to tighten for the average American and small business owner. It is a recipe for disaster. And Europe is worse. I don’t want to own any company that uses a stock market rally as an opportunity to raise capital. No green shoots here either.
Trade and Transports
U.S. exports have now fallen 26.18% from their peak in July 2008. While Chinese exports dropped 22.6% in April from a year ago. Japan’s exports were down 45.5% year over year in March, the most recent data available. Germany was also down 15.8% year over year. India’s exports are down 33% year over year. U.S. Rail traffic is off 26% in the first week of May from a year ago. Industrial production had its biggest drop on a year over year basis since 1946. European retail sales just had the biggest monthly drop on record. U.S. retail sales declined 8.77% year over year in April. We don’t see green shoots in the economy, and we see the rally failing from this juncture. The Federal Reserve and Treasury seem to be blind to the problems that the country faces, and are continuing failed policies. Don’t buy the rally. Take your gains if you have them. This is going to have a painful ending.
Just my opinion...
