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Tuesday, April 7, 2009

RCM Editorial: Is This Rally Sustainable? Goldman Sachs Gives Hints & Meredith Whitney Weighs In

The cause and durability of this equity market rally continues to be a hotly contested debate. I would like to throw my hat in the proverbial ring and offer some thoughts on durability.

Every market rally - whether it be a bull market or bear market bounce - has a group that leads the move. By studying this group we can get some insight into the strength of the overall move. In this case, the financial sector clearly led the markets off the bottom and an examination of the ability for this group to continue its rise may be helpful. The rise off the bottom for the financials can be attributed to a few main reasons:


1)Dramatically oversold conditions led to a much needed reprieve
2)Launch of TALF
3)Launch of PPIP
4)Fed monetizing of debt (announces $300 billion program to buy U.S. Treasuries)
5)Real estate numbers released by the government are "sold" as positive. (Only a sucker would buy this idea. Please see the 3/25/09 blog for more details.)

The question remains: can the financials continue their rocketesque launch off the lows and make it to orbit, or will they fall back into the ocean like a failed North Korean missile launch? I will offer up the following thoughts and let you be the judge:

1)Government initiatives can create near term excitement but historically cannot change the long term direction
2)Real estate reality will return and continue to be an issue that is hard to ignore. Read the story on U.S office vacancies before you debate this idea with me.
3)Earning season is starting and the numbers will highlight a glaring bifurcation in the financial sector. Those banks working with the government to unwind AIG will show "better than expected" numbers. Those banks on the periphery will not. I suspect this schism will lead to a selloff on the news and create a mistrust of the numbers.
4)Banks need capital and will use this recent rally to raise it at the expense of current holders

I offer the following two stories as support for the thoughts above:

Goldman Sachs considers share sale to payback govt loan - Daily Telegraph
Daily Telegraph reports the co, which will report its first-quarter results on April 14, is expected to announce on the same day that it is to submit a formal application to repay the sum given to it as soon as it passes the formal "stress test" being conducted by govt officials on all major US financial institutions. People close to the bank say that its management, led by chairman and chief executive Lloyd Blankfein, is assessing a range of options for repaying the money loaned to it as part of the US Treasury's Troubled Asset Relief Programme. These include orchestrating a new share sale or funding the repayment from existing capital resources, and it may still decide to pursue the latter route. Goldman, along with a number of its rivals, is understood to have enjoyed a spectacular first three months of the year in terms of its trading performance, according to insiders. The bank would not require additional capital to repay the Tarp money, having raised $11 bln from investors including Warren Buffett, the so-called "Sage of Omaha", last autumn. Some senior Goldman officials believe, however, that the ongoing banking turmoil means that it should continue to take a conservative view of its balance sheet and exploit further opportunities to raise additional capital if it is accessible on reasonable terms.

Meredith Whitney -
Meredith says shes not bullish by any case, but would be very careful pressing shorts here. She says all rules are subject to change once you bring in the government into the picture. She says the reality is tangible book values will go higher in the near term. When asked if she would commit capital to the financials she says this qtr is going to look stronger, perhaps private capital comes in to support some of these financials. Co says the new housing data is the "head fakes of all headfakes". When asked about earnings in the financial sector she says several technical and one time factors will lead to Q1 profits and capital creation. Meredith says some investors may buy into earnings and react the way they reacted to Friday's NFP number and think the worst is over. She believes these investors are incorrect and after the stress test findings come out, she says some decent size banks will not pass the stress test. She says be careful at the end of the month when the stress test findings come out, it will be another grim period for financials

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