Geithner’s key statement was that the “vast majority” of U.S. banks have more capital than required. I wasn’t sure at first why this had such a profound impact on investor sentiment, which was certainly low in pre-market trading, since the more than “well-capitalized” position of most banks has been a known. I ran this thought by Ryan Craft (our senior bond analyst) who correctly stated, “It’s not about the reality of the banks being more than “well-capitalized,” but rather whether or not the Treasury Department deems them ‘well-capitalized,’ and thus Geithner’s statement sends the signal that the government won’t take them over.”
And this is exactly the case, for today at least -- one day Geithner and Co. make statements that push stocks lower (such as the need to convert the gov’t’s preferred shares to common) and the next day they say things that juice the market (such as suggestions that remove nationalization concerns.) We are indeed at the whim of Washington and one only knows what they can say, or do, tomorrow or the next day to shift sentiment back in the other direction; this must change.
Stocks were also helped by technology shares after Texas Instruments offered guidance that was well-ahead of expectations. The second-largest U.S. chipmaker stated that semiconductor orders recovered and customers have begun to increase orders after finishing inventory liquidations plans. (We’ve spent plenty of time talking about how the inventory dynamic can catalyze growth in the not-to-distant future. While there are many other challenges for the economy to deal with, many of which originate from the political class, this is great news and hopefully signals a trend regarding overall inventory rebuilding.)
Financial shares led the charge. Basic material, industrial and consumer discretionary shares also outperformed the market. The consumer discretionary sector received a boost from Coach Inc. as the company stated sales trends are encouraging.
Market Activity for April 21, 2009
Just as stocks rallied on the Geithner statement, Treasurys declined (yes, this is the correct plural spelling in case you were wondering.) Bonds were in rally mode for a second-straight session before reversing course; the yield on the 10-year Treasury note was pushed higher by six basis points to 2.90% (the price of a bond and its yield are inversely related – price goes down, yield goes up and vice versa).
The 10-year seems to have found support at 3.00%, which seems to be viewed as the trader’s attractive entry point as the market knows the Federal Reserve is a buyer of Treasurys – as part of their quantitative easing plans.
One may wonder if this will prove an unintended consequence of quantitative easing. Will this place a burden on stock prices as money flows out of the equity markets and into Treasurys as traders see a 3.00% approach on the 10 as an easy opportunity to make a quick profit? (The magic number seems to be 1.00% on the 2-year, just for clarity.) We don’t know, certainly it’s dangerous to think the trade is a no brainer each time the note approaches 3.00% as the government is going to issue $2.5 trillion of debt this year and something like $1.7 trillion next year – I don’t think one can take for granted that bond prices will rebound off of certain levels for very long as massive supply will eventually put pressure on those prices. In any event, I thought the support level of 3.00% on the 10-year was interesting enough to mention.
One thing is apparent, when prices do fall as this enormous level of supply (debt issuance due to the massive deficit spending plans) comes to market, the move will be severe – yields will rocket higher. As the Fed focuses on keeping rates lower than they otherwise would be, they may be engendering the conditions for just the opposite -- an abrupt rise in interest rates. You get to a point in which there are no more rabbits to pull from the hat.
While this event would create a shock to an economy that may be in the midst of an expansion’s early stages, say a year out, it will be welcome news for the fixed income investor. Patience.
Stress Tests
Even with Geithner’s helpful comments yesterday, the administration’s actions continue to be perplexing. For the life of me, ignoring my skeptical side that sees ulterior motives that I won’t get into, it’s difficult to understand why the White House/Treasury has chosen to go down the road of the stress tests. (For those who may not know, stress tests are being conducted on the 19 largest U.S. banks to determine solvency based on a worst-case scenario economic conditions and loan quality.) What good can come of it? Say they deem a financial institution as insolvent under the worst-case scenario, which in terms of these government tests assumes something like 10.5% unemployment and significant and prolonged GDP contraction. What will follow is a perception of insolvency even if economic conditions do not deteriorate to the worst-case scenario inputs of the model. As a result of this perception, do you have runs on particular banks at that point – if not on deposits, then certainly on the stocks?
This whole exercise seems quite dangerous. Not to mention that they may use these tests to force banks to participate in the unnecessary PPIP (Geithner’s Public-Private Investment Program scheme) and as a way to disallow repayment of TARP funds.
(And on this last point, heck if you’re dead set on keeping TARP in place you should at least except the repayment -- without conditions -- from those strong enough to return it and use it for those institutions that need it. I’m not advocating this as the TARP has transformed into a beast that in no way resembles its original purpose, just acknowledging the fact that the administration isn’t letting go of TARP and touching on a better way. For goodness sake, at this point if a bank is actually insolvent, send it to the FDIC for clean up and sell it off to the private sector in quick order – a system that has worked quite well for decades. But this group demands the control, so you can forget about that idea.)
Economic Data
We’ve been without a serious economic release for a couple of days but get back to it this morning with mortgage applications (for the week of April 17) and one of the major home price indexes.
Then on Thursday things get very interesting with the weekly jobless claims number and existing homes sales data for March; we round the week out on Friday with durable goods orders and new home sales.
Have a great day!
Brent Vondera, Senior Analyst
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