The major indices began the day on a high note, after the Treasury and Federal Reserve stated they’d provide capital to the mortgage GSEs, if needed, but things deteriorated quickly after concerns grew over the status of the banking industry.
Considering the beating the financials endured, down 5.1% yesterday, the benchmark indices held in there pretty well as consumer-staple and energy shares recorded pretty nice results. Health-care, basic material and many industrial shares performed well on a relative basis.
Market Activity for July 14, 2008
Fact is the big banks are very likely well capitalized, in fact they are “well-capitalized” as defined by regulations, but they are also prepared for further deterioration in housing and on the consumer front, such as credit-card defaults – they’ve raised large sums of capital to guard against this likely scenario. However, there will be smaller banks that do go under; although, this is not something to panic over. (Of course, one can’t rule out one of the larger ones taking a header as well if depositors overreact.)To provide some context, during the S&L crisis of the late 1980s-very early 1990s close to 800 banks and financial institutions failed and the system hardly crashed – this didn’t even push the economy into recession, it took an aggressive Fed tightening campaign in1989 to do that; credit continued to flow. (To this point, I think a grand total of eight banks have gone under thus far – six of those with deposits of less than $60 million in assets –very small players.)
During that financial crisis the bulk of failures occurred 1988-1990, yet consumer loans rose at a 7% annual clip and business loans at a 6% pace. Now, we have the doomsayers – likely holding short positions, I’ll add – stating that the few failures we’ve had thus far will lead to a shut down in credit. Only if people disregard the current state of the economy to focus more on the hyperbole of the moment will credit availability truly crumble.
The charts below show loan activity for consumer and business loans.
Consumer Loans
Business Loans
One of the main problems right now is the way the press, and many analysts, frame things. They act as though depositors will make a run on banks, and that’s trouble enough, but keeping to this rhetoric things can become self-fulfilling. Overall though, we have been through much much worse that this and it’s rather pathetic that we have those of supposed credibility scaring the heck out of people.
Kicking these new concerns off was the seizure of Indymac Bancorp by U.S. regulators on Friday afternoon. But this is not your typical bank as it is a hybridthrift/mortgage bank that specialized in Alt-A mortgages – mortgages that do not require borrowers to document income. The hyperbolic press reporting over the Indymac situation resulted in large banks like Washington Mutual and National City feeling it necessary to release statements that “no unusual depositor or creditor activity” had occurred. And none will unless people become unjustifiably hysterical and cause it to occur. More banks will fail, no doubt about it, but as usual, the press seems to hold context in contempt.
We’ll get through this period, but it will take some time. The economy will have to deal with quarters of weakness squeezed between quarters of pretty decent growth over the next 12 months as I see it. But housing will end its correction at some point and a huge drag on the GDP readings will have passed.
For stocks, there are a lot of names out there that are trading at very low multiples, P/Es that are extremely attractive relative to long-term earnings growth. But one has to be patient as the Fed is not helping things. The administration carts out temporary rebate check schemes instead of jamming a stake in the ground and pushing for more appropriate tax reform and dollar intervention. Yes, Bush’s term is near its end, but one would be amazed at what can be accomplished in an election year. Simply forcing another extension to the current rates on capital, dividends and income – and lowering corporate tax rates, as most of the rest of the world has done – would propel stocks.
Moving on…
I noticed a quote from Senator Obama on Sunday stating, “there is little doubt the U.S. economy is in recession.” To be fair Senator McCain has made similar statements, although I believe he’s refrained from using the “R” word.
Well, that has yet to materialize – recession, that is, as most readers know. Yes, the unemployment rate has risen and corporate profits have been hit by a couple of industries that are in a world of hurt. But real business sales continues to rise, productivity levels remain elevated, the manufacturing sector remains remarkably resilient in the face of housing and auto-industry problems, and, most important, GDP remains positive.
I really don’t get all of the pessimism – I’m speaking of future growth perspectives, surely there are consumers feeling the pain of high energy prices and some pessimism is understandable. But beyond the here and now, all it takes is some policy tweaks, and a couple of industries to turn around slightly and this economy will roar. On a global scale, unless we make some really dumb choices, we will continue to blow everyone else out of the water over the longer-term. But it takes setting in place an appropriate tax policy that boosts after-tax return expectations, instead of an environment in which those that provide the system with capital expect tax rates to harm after-tax returns. It takes a Federal Reserve that actually cares about price stability.
And on this recession speak, which continues in a tone that seems the press actually desires this to occur, watch Q2 GDP hit 2.5% (real terms) as a rebound in consumer activity during April, May and June, strong export growth, decent capital spending increases and the production needed to rebuild low inventory levels overwhelm the drag from the housing sector. Sorry, but this is not recession. Challenges abound, but this amazing and dynamic economy is adjusting to these challenges quite well.
Now, if the market can get a signal tax rates will not change on them, a sensible energy policy is presented and the Fed can get back to focusing on price stability, the stock market will take off and so will the economy. Until then, we’re stuck.
A big day on the economic front this morning as we get producer prices – which will continue to jump to troublesome levels --, June retail sales, and business inventories. That inventory report should show the underlying business sales data remains on an upward trajectory.
The dollar is getting crushed this morning as Bernanke and Paulson will be on the Hill again this morning. Bernanke and the other members of the FOMC. need to signal some gentle rate hiking is coming in order to turn the dollar around and put a lid on oil prices – I sound like a broken record, sorry. Problem is, the market is pretty sure he won’t signal such a move. In short order, he will be forced to as all members of the FOMC are mugged by reality. Their Keynesian-textbook mentality had gotten us into this mess and their errors will be the cudgel with which beats them into submission to hike rates – gently.
Have a great day!
Brent Vondera, Senior Analyst
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