Stock-index futures were down meaningfully yesterday morning, but reversed course when those preliminary reports on the employment situation were released. That data was the main driver, even for the banks, as less severe job losses will certainly show up in lower levels of consumer credit default rates.
But the stress test leaks also helped. Initially, I found the way the bank stocks rallied on the stress test news stunning. The firms that were stated as not needing new capital were not expected to need it, so no upside surprise there; the banks that were reported to have need to raise additional funds will have to do so in a way that dilutes the shareholder (converting preferred shares to common). If that’s not enough, the White House spokesman stated the administration may choose to remove the management from certain institutions – this degree of government control wouldn’t seem to be market friendly but hey, maybe the market is beginning to embrace the socialist tendencies. I’m obviously being facetious here.
But then we learned of the type of preferred shares the Treasury Department has magically created: mandatory convertible preferred shares – talk about financial engineering. Remember, yesterday we mentioned the government would seek to minimize the concern that they’ll have more control over the banks (as a result of the conversion to common, which has voting rights, from their current preferred-share stakes. Well, this is how they are doing it. These mandatory convertible preferred shares will convert to common shares only as capital is needed – very fancy legerdemain. This may be what sparked the rally in banks, the fear of government control has eased a bit. Personally, I remain skeptical; Washington will continue to direct the way in which banks compensate top employees and provide loans, I don’t think they’ll be able to resist.
Financials and energy were the best performers – a reversal from yesterday when they were the biggest drags on the broad market. Energy stocks got back on their horse as the price of oil shot up 4.45% to blow past the $55 per barrel handle.
The traditional sectors of safety, healthcare and utilities, were the laggards.
Market Activity for May 6, 2009
More on the Stress Tests
The government says the banks that they deem deficient of capital must develop a plan to raise additional funds by June and implement that plan by November. From there they must keep their Tier 1 capital ratio at a minimum of 6% (Tier 1 being the traditional measure of capital adequacy until the government changed the rules of the game to also include Tangible Common Equity, which does not count preferred shares as capital) and TCE at 4% through 2010. Just for color, Bank of America has a Tier 1 ratio of 9.15% right now.
I’m not sure the banks will actually devise a real plan now that we’ve got the spiffy new mandatory convertible preferred shares – it’s really so sweet if you think about it; a government official, say Mr. Geithner, can just make up a new security. But from an investors standpoint it kind of feels like you’re walking across a busy street blindfolded.
This whole game is going to be very interesting to watch. The government says certain banks are deficient capital, yet at the same time they state they must lend – in fact Barney Frank and Co. call bank executives up to Capitol Hill for the explicit purpose of vilifying them in front of the cameras for taking government money while not lending to a degree at which Mr. Frank thinks is appropriate.
The economic environment is still quite fragile, delinquency and default rates continue to climb. Therefore, if banks are going to guard capital then lending activity needs to slow. Bank managers understand this; investors who provide much of the funds essential to keep the lending channels flowing understand this. Government officials do not care to understand this, it’s all of sophistry and pretense to them. This is why when the government decides to push the market aside and allocate resource as they see fit, bad things occur. This indeed will be very interesting to watch unfold. I shouldn’t be this negative as the stock market moves higher, but it just feels like something isn’t quite right.
Mortgage Applications
The Mortgage Bankers Association reported their mortgage apps index for the week ended May 1 rose 2% after the 18.1% decline in the prior week. Purchases jumped 5.0%, marking the first increase in a month, and refinancings increased 1.2%.
Refis continue to dominate the index, but make up just 75% of the total (down from 80% that had been the average for a while) thanks to the nice gain in purchases. Fixed mortgage rates below 5% will certainly help activity over the next few months, but the job market will have to improve markedly before a substantial rebound occurs.
Challenger Survey
The Challenger Job Cuts Announcement survey stated U.S. layoffs increased 47% from the year earlier, down from the 180% increase posted in March.
Firing announcements rose 132,590 compared to 90,015 in April 2008, according to Challenger. Automotive, retail and financial sectors led the cuts. While this rise in job cut announcements is a big number, this is a massive improvement from the huge increase we’d seen over the previous few months.
ADP Report
In another preliminary employment survey, the payroll services firm ADP stated the economy shed 491,000 payroll positions last month (it was forecast to show a decline of 645,000) – again, while this is a huge level of job losses it is also a serious improvement from the 650,000-740,000 decline in payrolls over the last five months, if this survey is measuring things accurately – it’s been a darned good indicator of late so there’s little reason to believe it’s off by a wide margin.
If these two numbers are in the ballpark, we could be setting up for a much better-than-expected April jobs report from the Labor Department on Friday. The consensus estimate is for another 600K decline in payroll positions. If we get a decline of just 500K, as ADP is suggesting, that would be a very nice sign that the labor market has seen its worst and is stabilizing – albeit at very depressed levels – and should provide the impetus for stocks to go meaningfully higher as the market has been expecting worse. Conversely, this also sets the market up for a major disappointment. If what we saw in the preliminary readings fail to show up in Friday’s official numbers…look out.
Following the last two monthly employment reports we’ve talked about how the rate of job losses will ease. U.S. firms have shed jobs for 16-striaght months and the losses have been huge over the past five months – 75% of the 5 million jobs lost over the past 12 months has occurred since October. This pace cannot last, although my view was that it would take another few months before the improvement began to show up. It may be occurring sooner than that.
Initial jobless claims will remain a very important figure to watch, we get the latest reading this morning. Jobless claims continue to show that the labor market is very fragile and we’ll have to see this number move solidly into the 500K handle (last post was -631,000) to provide complete evidence the labor market has stabilized and improve in such a way that we reduce the losses to 300,000-350,000 per month..
Have a great day!
Brent Vondera, Senior Analyst
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