About Turn

So yesterday, no sooner had I sent a piece out saying that the path of least resistance appeared upwards, when out came some worse economic numbers and down we went. Given that the markets were being led by financials and the basics, a lower PPI saw the inflation trade sectors sell off and GS put paid to the financials rally. When the smartest guys in the room try to sell you something; caveat emptor. Risk assets in general sell off although the safe haven of gold failed to catch a bid, the lower PPI winning over its qualities as a place to hide.

So the question of the sustainability of this rally is yet again posed. The market sold off a couple of percent but nothing major (and since writing has now rallied back). A few things I’ve seen read over the past days have started to get me very worried about the outlook for the market. I, like many/most believe this is a bear market rally and it won’t be long before we head back south. Even if the rate of deterioration of the economic data is slowing (although things don’t go down in a straight line forever, bounces do occur, often of the moribund feline variety), this isn’t going to be a V shaped recession, it will be U or L shaped. So we could stabilise but not recover, so to speak. The peak earnings of yesteryear become confined to history and a not so belle epoch emerges where the standard is lower earnings, not buoyed by excess leverage. However, the longer term view is just that, and much can happen contra to that before it pans out. It was difficult to see perhaps, what would be the catalyst that would bring the market back to earth. Q1 earnings perhaps? Very possibly. One thing that sticks out for me as a real banana skin for the market, is the stress test results.

This is all over the press today and we’re seeing an about turn from the Administration on it. The WSJ and NYT are today talking about some of the results of the Stress Tests being made public. This could be down to GS forcing their hand by raising capital to pay off the TARP money. The logic being this, if you are strong enough, you tap the market and pay off your TARP money, if you’re not, you don’t. So the banks that aren’t raising money must be in a very bad position, they get smacked and this causes fear and uncertainty in the markets. There was talk before of giving some aggregated information on the stress test results but that was never going to cut the mustard as the outliers would skew the results. We don’t know what or how much is going to be disclosed but according to these articles, it is something which has been debated by the regulatory agencies for a number of weeks now. If the news was good, I can’t imagine it would take so long to work out what to say. Just as a potential example, KBW, expects Wells Fargo (which posted pretty good numbers, right?) to show $120 billion in "stress test losses", meaning losses under the assumption of a supposed worst case of recession through the first quarter of 2010 and unemployment reaching 12%. To put it in perspective, as of year end, Wells had $1.3 trillion of assets and shareholders equity of $99 billion. So, should these losses materialize, all is not Wells, it is insolvent.

I think it’s interesting to note too that GS is not planning to pay back (any time soon) the $28bn it borrowed from the credit markets and which is backed by the Federal Govt. Funnily enough, this didn’t come with conditions attached capping executive pay.