Meredith Whitney appeared on CNBC Monday afternoon with some insightful comments on the recent rally in banks.
Via Clusterstock:
They were overdone all the way into this rally. What happened was the government — I call this the great government momentum trade — the government enabled the banks to have better than expected, better than even the banks could organically deliver, first-quarter earnings. That looks like it could continue into the second-quarter and the third-quarter. The banks rallied from well below tangible book multiples to almost two times tangible book multiples. It was something, even though I said it was going to happen, I couldn’t believe it with my own eyes because the underlying core earnings power of these banks is negligible.
For fundamental investors you invest on what you know to be the rules of the market. With the government involved no rules of the market apply. … And things that I never imagined that I would see in my lifetime you’re seeing in terms of government intervention. So shorts covered because they couldn’t play, shorts covered after they lost a lot of money because they couldn’t play, and then the long-only guys are grossly underinvested and so they see the rally and they’ve got to reweight and so it’s a crazy positive momentum based on no fundamental improvement. Zero fundamental improvement.
Last year you had the market impact the economy and this year you’re going to have the economy impact the markets. So however manufactured these earnings are going to be you’re still going to have unemployment come in worse than expected, you’re still going to have consumer defaults worse than expected and you’re still going to have consumers not spend money … More people are going to lose their jobs and have less available credit lines to spend and that’s a ruse (?) that no great government momentum trade can really guard against.
I will be the first to admit I don’t know the rules, what the government’s going to do. I mean, I think that on a core basis I absolutely would not own these stocks. When the market turns, and I think that stocks are grossly overvalued, when the market turns and how it turns hard and fast investors are going to be furious. The saddest thing is that how this thesis I had would play out is tangible book values would increase because the government bought back agency paper, remember, and relaxed FASB rules, so tangible book values would increase and so you saw money start to come in. Now the long-only money’s coming in and the long-only money came in last year and they got their heads chopped off. You’re going to see the same thing happen. The biggest danger we face here, from a market point perspective, is having the retail investor shut out for a protracted period of time. They just feel abused again and lied to again.
Disregarding the rather uneven tone of the above (“I saw this coming” but “I admit I don’t know the rules” of the new regime), Whitney is making some good points.
As she notes, the government is now firmly on the side of the banks, helping them earn vast sums in their fixed income units and relaxing accounting rules to assist their earnings (crucially, banks will be able to earn their way out of the SCAP capital requirements). Investing in banks now is placing your faith in the power of the US government to force through a recovery in the sector.
If that’s too much for you then you can watch the rest of the CNBC interview, with Whitney’s recommended (non-bank) investments, here.
Related links:
Charting the suckers’ rally – FT Alphaville
M2M Change = Time to buy banks? – FT Alphaville
Dissecting bank results – FT Alphaville