Welcome to the middle of April. March began with stocks heading even further into the doldrums, falling over 9% in the first week of trading. The turnaround in share prices can be pinpointed to a single catalyzing event: On March 10th an announcement from Citigroup CEO Vikram Pandit, started a wave of optimism in the market that sent bank stocks soaring and the markets soon fell in step. An internal email stated that the company was profitable in the first two months of 2009, and had passed internal stress tests with flying colors. Stocks responded dramatically, with the S&P 500 gaining over 6% on the day and the KBW Banking Index more than doubling that result, rising 15.6%. Over the following two days, the CEOs of JP Morgan Chase and Bank of America made similar comments regarding their companies. Equity markets never looked back, ending March with substantial gains, led by the banking sector.
On the heels of that good news another announcement by the Treasury Department which fleshed out more of the details of Secretary Geithner’s Plan helped to keep the market momentum moving in a positive direction. This latest stimulus packaged is designed to address those toxic assets know known as “legacy assets” on bank balance sheets.
The essence of the plan is an opportunity for select financial institutions to partner with the government to buy these assets from the banks using up to 6-to-I leverage in the form of non-recourse financing from the Treasury and loans guaranteed by the FDIC. While the jury is still very much out on the effectiveness of the plan, private investors are expecting to demand high rates of return to bear the risk of holding these assets. This will have the effect of driving down prices on these assets, but there is some speculation that banks, through the use of shell companies, will actually attempt to drive up prices to improve their profitability, while removing the assets from their balance sheets.
The deadline for institutions to submit their credentials so that they can participate has been pushed back once. If prices on these legacy assets are bid up to near book value, one can probably assume that the participating entities are going to do very well. The problem is that we again are finding the financial firms and their highly compensated employees making out very nicely. All of this is being promoted to get the credit system moving again and the economy back on track. That begs the question: is the cure worse than the illness.
A key component of the various stimulus packages is the drive to fix the mess in the residential mortgage market. Recent data from the White House suggests that their efforts to clean up distressed mortgages are working. However, there are a number of reasons why we should expect to see that activity subside. First, none of the programs allow for any cash out provisions. Second, most if not all of the latest mortgage options are not available any more. Forget refinancing into ARMS, interest only or no documentation loans. Those type of loans created a sizeable rush into the home ownership field and those types of loans simply do not exist in the current government programs. Third, loan originators are still operating under capacity constraints as a result of downsizing and warehousing limits. Finally, while high, the loan to value requirements on many loans are way above the limits of Fannie Mae and Freddie Mac. Declining property values across the nation have had a huge impact on this ratio. All of these reasons will keep loan refinancing well below historic levels.
Flying under the radar for the time being are the difficulties in the commercial real estate markets. In this arena, loan tems are much shorter and as those loans come up for renewal, the declining market values will again drive down the ability of many investors to renew their loans. This will in turn cause them to let properties go or consolidate loans. With the increasing vacancies that one can see just by driving through the business parks in our area, one can only expect this sector to get much worse before it gets better.
The final point to raise is the declining tax revenues. With less personal income and less business income being generated for 2008 and 2009, tax receipts will be down. This translates to a combination of less government services or more borrowing to fill in the gaps.
All in all one can only wonder about the strength of the March rally. Perhaps it is simply a matter of the euphoria of a little bit of good news being sandwiched around months of bad news that has investors feeling a bit more comfortable about returning to the market. We have held key technical levels so far, but our confidence in this rally is not high. We are however, seeing good performance in a number of Asian funds and as a result we have tossed our hat into that ring. We will continue to ride the strategy we have laid out in previous emails yet will not be content to simply stand idly by.
See you at month end….
Mark G. Neil, ChFC, CLU
Northwest Wealth Advisors, Inc.
Office: (503) 478-6632
Fax: (503) 296-5635