Monday, September 03, 2007

The problem with financials / Hussman

It is not hard to understand why common sense from Hussman is obviously not good for the business of Wall Street. I wanted to add another point that doesn´t makes thing better. I think if the financials would be forced to account conservatively the lots of the earnings would fall apart. If you want an example of how "creative" this process has become make sure you read Wells Fargo Gorges on Mark-to-Make-Believe Gains

Es ist aus nicht weiter verwunderlich das der gesunde Menschenverstand der jede Woche von Hussman unters Volk gebracht wird nicht gut für das Geschäft von Wall Street ist. Ich habe noch einen Zusatz zum Report zu machen. Ich bin mir ziemlich sicher das die Gewinne schon jetzt deutlich geringer ausfallen würden wenn die Finanzkonzerne konservativer bilanzieren würden. Als anschauliches Beispiel wie weit die "kreative" Auslegung der Bilanzvorschriften inzwischen gediehen ist bietet sich dieser Link an Wells Fargo Gorges on Mark-to-Make-Believe Gains

The problem with financials
We continue to carry a very low weight in financial stocks. Though the recent weakness in these stocks has prompted a great deal of interest in “bottom fishing,” my impression is that such efforts are based on the same untempered assumptions of high and growing earnings in this sector that existed months ago. P/E ratios ought to be well below historical norms when those P/Es are based on record earnings and record profit margins. In my view, existing valuations are based on untenable assumptions of permanently high profit margins in this sector, with optimistic growth assumptions as well.

In 2000, this was the essential problem with the technology sector. It was some time before Wall Street's expectations caught up with the reality that profit margins are cyclical and that early declines off of overvalued peaks do not constitute bargains.

I expect that in the next year or two, we will observe at least one quarter, and more likely a full year, in which the entire profit of the U.S. banking sector is consumed by loan losses.

Consider, for example, the latest FDIC Banking Profile, which was published based on June 30, 2007 data (before the recent liquidity crisis emerged). In that report, the FDIC noted that the ratio of loan loss reserves to total loans remains at a 32 year low. As for the portion of those loans that are in trouble, the FDIC notes “for the fifth quarter in a row, reserves failed to keep pace with the increase in non-current loans.” The industry's “coverage ratio” of reserves to non-current loans fell to the lowest level since the third quarter of 2002, while non-current loans posted the largest quarterly increase since the fourth quarter of 1990. Recall that 1990 and 2002 were periods when recessions were already well underway. If we're already seeing these signs of credit stress at the peak of an economic expansion, the figures we observe in a recession are likely to be a lot worse.

> Make sure you read Is WaMu the Next Countrywide? to see how ugly the situation and the quality of earnings already is.

> Ich kann jedem empfehlen Is WaMu the Next Countrywide? zu lesen um zu verstehen wie übel die Lage selbst bei einigen großen Instituten inzwischen aussieht.

> The impact on total S&P 500 earnings is if you take this table from Bespoke already over 30 percent. I have seen charts that include the impact of the financial arms from companies like GE, GM, F, Harley etc and the number is closer to 30 perecnt and 40% of the profits. Either way you look at it this number is going to decline significantly.

> Der Gewinnanteil an den gesamten S&P 500 Gewinnen liegt wenn man nach der Übersicht von Bespoke geht bei über 30%. Ich habe auch schon Aufstellungen die zusätzlcih die Finanarme von GE, GM, F, Harley usw miteinrechnen. Dann verschieben sich die Zahlen Richtung 30 und 40 Prozent. Wie man es auch dreht und wendet diese Anteile werden sich in den nächsten Jahren massiv gen Spüden bewegen.

> Here Bear Stearns as an example. I´ll bet that the real number for 07 and 08 will be much lower. How can any Analyst come up with another conclusion is a mystery to me. They should know that Bear is viewed as the most vulnerable as it generated 44 per cent of its revenue from its fixed-income business, according to Bernstein Research. It also has least exposure to less troubled markets outside the US. Here is another good story why a slump in earrnings is very likely American Investment Banks "Shots In The Dark" Economist

> Nehmt Bear Stearns als Beispiel. Ich gehe jede Wette ein das die tatsächlichen Gewinne in 07 und 08 deutlich niedriger sein werden. Wie ein Analyst hier zu einer anderen Meinung kommen kann ist mir schleierhaft. Ich gehe davon aus das denen der Fakt bekannt ist das Bear 44% seiner Umsätze im Anleihebereich macht und fast ausschließlich auf die USA beschränkt ist. Hier ein guter Link der zeigt warum dei Gewinne aller Investmentbanken wohl demnächst deutlich niedriger ausfallen dürften. American Investment Banks "Shots In The Dark" Economist

EPS TrendsCurrent Qtr
Next Qtr
Current Year
Next Year
Current Estimate 2.323.1912.7313.62
7 Days Ago 2.783.4813.4314.47
30 Days Ago 3.364.0514.6915.76
60 Days Ago 3.394.0414.7215.78
90 Days Ago 3.504.2115.2815.95

> And when you look at this table of pending LBO deals via the NYT it should be clear that the investmentbanks are also facing "loan" trouble.....

> Und wenn man sich diese Übersicht der noch zu finanzierenden LBO Deals von der NYT ansieht kann man sich leicht ausrechnen das die Investmentbanken ebenso wie die gewöhnlichen Banken einige "Kreditprobleme" zu lösen haben.... The Banks Behind the Biggest Buyouts

James Grant put it this way – “Benjamin Graham and David L. Dodd, in the 1940 edition of their seminal volume ‘Security Analysis,' held that the acid test of a bond or a mortgage issuer is its ability to discharge its financial obligations ‘under conditions of depression rather than prosperity.' Today's mortgage market can't seem to weather prosperity.”

As of June 30, 2007, the net income of all FDIC insured banking institutions totaled $36.8 billion. At an annual rate, that represents about 2% of all loans outstanding. Meanwhile, net charge-offs for bad loans were already running at an annual rate of about 0.50% in June. That's in a strong economy, before the recent problems, and loan loss reserves didn't even budge from a 32-year low. Net charge offs could easily quadruple in a mild recession.

Importantly, the problems go far beyond sub-prime. In its June 30 report, the FDIC noted “all of the major loan categories posted both increased net charge offs and higher net charge off rates.” Overall, net charge-offs jumped by over 50% from year-ago levels, with a jump of over 60% for consumer loans and over 70% for industrial loans. These percentage jumps are so high because they are off of such a low base, which underscores the extent to which observed profits in the financial sector have been unhindered by loan losses in recent years. Charge-off rates have not soared as much for credit cards, but this is because the existing level of charge-offs is already high (representing over 3% of the total amount volume of credit card balances, year-to-date). In short, the problems are in all categories, and given the thin coverage of the banking system for such losses, rising charge-offs and loan loss reserves are likely to bite deeply into earnings.

For some financials, relatively high dividend yields are being touted as a measure of safety and quality for investors. The difficulty is that if earnings come under pressure, a greater share of earnings will be required to cover those dividends.

> Let us hope that the Analysts are not so far behind the curve as they were with the homebuilders Number Of The Day ....Earnings Estimates for Homebuilders..... But as i said before....Common sence isn´t good for business......

> Bleibt zu hoffen das die Analysten in diesem Fall nicht ganz so daneben liegen wie bei den Buildern Number Of The Day ....Earnings Estimates for Homebuilders..... Wie ich aber schon vorher angemerkt habe ist der gesunde Menschenverstand nicht förderlich um Geschäfte an Wall Street zu machen.....

Now the bust is taking a brutal toll. In January, industry analysts predicted that the 10 biggest builders would have average earnings per share of $3.69 for 2007; the latest forecast is for a loss of $1.18.

Of course, the long-term return is equal to the dividend yield plus the long-term growth rate of dividends. Though I don't expect forced dividend reductions for major U.S. bank stocks, I do believe that the growth rates assumed by Wall Street here are overstated. And while a well-covered dividend can produce a lower “duration” and therefore a smaller sensitivity to broad market fluctuations, it does not in itself produce an undervalued stock. ....

In any event, my impression is that the problems for financials are just beginning, and that the risk premiums demanded by investors are likely to rise. As investors have seen throughout market history, stocks having rich valuations, weakening fundamentals, and rising risk premiums typically don't constitute great bargains.

> Now compare this to the "call" from Wall Street finest.... They obviously didn´t use any realistic earnings estimate. The only way they can justify this target is probably the "Fed Model". But as Hussman also has pointed out in "Fed Model"Knowing What Ain't True every body that has to use this argument is at best clueless (try to stay polite)........

> Nun vergleicht diese Aussagen mal mit den unvermeindlichen Zielen und Prognosen für den S&P 500. Anhand von realitischen Gewinnschätzungen sind diese Ziele sicher nicht erstanden. Die einzige Erklätung wäre das das brüchtigte "Fed Model" eine gewichtige Rolle gespielt hat. Wie abermals Hussman in "Fed Model" Knowing What Ain't True geschrieben hat ist jeder der dieses Argument heranzieht im besten Fall ahnungslos ( höflich formuliert).......

Disclosure: Short KBW Mortgage Finance Index

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Anonymous Anonymous said...

Morgen JMF,

Ich hoffe dass er recht hat.

Because I am short the finanicals (SKF).


12:34 AM  
Blogger jmf said...

Moin Eh,

I think the problems with the loan loss provision and the tsunami of bad loans during the next few years will be a drag on the entire sector and the financials will underperform significantly.

We have had the same problem after our "bubble" in East Germany after the reunion popped. The balance sheet of the Germany banks were loaded with bad debt. (just ask the HVB...)

12:50 AM  
Blogger jmf said...

Deutsche Bank pipeline of loans to sponsors 29 billion euros

1:54 AM  
Anonymous Anonymous said...

Property Shares Slide as Outlook Worsens

Still not sure how best to short the UK Immobilien market, however.


2:18 AM  
Blogger jmf said...

Cheapest Stocks in 12 Years Greet Investors After Summer Swoon

"The S&P 500 Diversified Financials Index last month was valued at 10.6 times earnings, the cheapest since at least 1995, according to Bloomberg data."

Compare this to Hussman.....

Spin, spin, spin......

2:19 AM  
Anonymous Anonymous said...

Dazu eine andere Meinung:

Be Wary of Scary Headlines - Buy Banks Now

I believe the best strategy today is to buy stocks -- especially the banks that Wall Street is downgrading.

How to make sense of such differing views? This is what makes trying to trade this interesting, confusing, frustrating, risky, etc usw.


2:27 AM  
Anonymous Anonymous said...

Deutsche Bank CEO sees signs of markets stabilizing

"Despite an environment of higher spreads and a focus on the short end, availability of funding has not been a problem for Deutsche Bank in recent weeks," he said. Turbulent market conditions affected the bank's sales and trading and corporate finance arms, which have impacted mark-to-market valuation in its trading and leveraged loan books. He added the bank doesn't have any U.S. subprime mortgages within the 32 billion euros of asset-backed commercial paper conduits it sponsors. Deutsche Bank shares rose 2.4% in Frankfurt.

And how big was the effect? I am not so sure I trust Ackermann.


2:35 AM  
Blogger jmf said...

Moin Eh,

I have the same problem.

I have had a small short trading position in BCO Santander ( 80% of the credit book located in Spain and the UK via Abby)

Sold with a nice profit.

When i look at the housing charts and the debt in the uk i think that the British pound is overvalued.

On top of this the financials in London account for roughly 7% of total GDP in the country. And when you watch this
London´s Market share Of World Financial Markets"
table at the bottom of the post it is safe to say that London / UK will take the major hit when the market turmoil will worsen.

So i´m still holding on to my bet short pound vs the € despite my opinion that the € is also "not cheap"....

2:38 AM  
Anonymous Anonymous said...

Fort Worth, Texas-based D.R. Horton Inc., the second-largest U.S. homebuilder, has tumbled 43 percent this year and traded at 1.96 times earnings on Aug. 28, the lowest since at least 1992.

What earnings? How could anyone believe that DHI will be profitable any time soon? I cannot imagine writing such a thing about DHI at this point in time.


2:44 AM  
Blogger jmf said...

"I believe the best strategy today is to buy stocks -- especially the banks that Wall Street is downgrading"

That might be true if you want to trade.

But if you have a longer term view this advice will kill you.

This kind of comments and attitude has lead to several "we hit the bottom" rallies in the homebuilder complex. In the end they went lower. But the "pain" as a short during this time was severe....

I have sold almost all my trading positions and will increase my longer term bets probably 1 or 2 weeks after the first rate cut.

I have to admit that Deutsche Bank so far has done very well. They also pulled the plug that has lead to the IKB bailout.

On the other hand they have bought several subprime players in 2005 and 2006....

I think the next earnings season from all major investment banks will be very very interesting.

2:47 AM  
Blogger jmf said...

DHI earnings LOL!

1.96 times earnings....

In January, industry analysts predicted that the 10 biggest builders would have average earnings per share of $3.69 for 2007; the latest forecast is for a loss of $1.18.

Maybe this guy excludes "special items" like write offs and impairments......

Needless to say that there is a high chance that such kind of "ex number" will be reported in the MSM.... :-)

2:59 AM  
Blogger jmf said...

Bear, Lehman hardest hit by credit crunch

Investment banks are expected to report sharp drops in quarterly profit when they report results in the week starting September 17.
Those most reliant on fixed-income sales and trading, such as Bear Stearns and Lehman Brothers, are likely to take the biggest hits from the credit crunch. Bear is viewed as the most vulnerable as it generated 44 per cent of its revenue from its fixed-income business, according to Bernstein Research. It also has least exposure to less troubled markets outside the US.

Deals backlog nears $500bn

According to the latest figures from Dealogic, the data provider, the amount of deals delayed or stuck in the pipeline has risen to $470bn. This is made up of $385bn in leveraged loans, $81bn in equity business, including IPOs and rights issues, and $4bn in delayed new bond issues

3:09 AM  
Anonymous Anonymous said...

But the "pain" as a short during this time was severe....

Ich weiss. I shorted XHB (which wasn't easy at my broker) back in June '06, and was sehr frustriert in the following months, although I never seriously considered covering (sondern I did not add to my short). I finally covered back in Aug '07, and have since traded it a couple of times for smaller profits. But that is risky and I do not like to hold such positions more than a couple/few days. And after Aug 17 I am much, much more cautious.

There really should be an SEC investigation of the market action from late on Aug 16 into Aug 17 -- the news of the discount window move was definitely leaked. IMO it is a mark of how crooked Wall St can be that there is almost no mention of that, despite such very heavy circumstantial evidence.


4:06 AM  
Blogger jmf said...

"IMO it is a mark of how crooked Wall St can be that there is almost no mention of that, despite such very heavy circumstantial evidence"


5:40 AM  
Blogger jmf said...

Merrill slashes banks' profit forecasts


Although Merrill cut its 2008 profit estimates for large-cap regional banks, it left its investment ratings on the stocks intact


7:58 AM  
Anonymous Anonymous said...

it left its investment ratings on the stocks intact

Genau was ich gesehen habe.

You should see some of the 'analysis' I have access to thru my brokerage account -- unglaublich.


11:19 AM  

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