“Financial Services Reform” 1 year later…

   

Back in the fall of 2008 I wrote an article regarding regulatory reform. Back then I stated that we needed to address regulatory reform immediately after the new administration took office because in my opinion, there would not be a better opportunity for some time . While many issues are of paramount importance to our nation, I feel regulatory reform of the financial industry is one of the most important for the future well being of our nation. While healthcare reform is also important as is addressing the status of social security, financial services reform, addresses issues that affect all Americans in one form or another.

 

These loopholes in the regulatory body have been the root causes of not only this particular crisis but just about every financial crisis going back to the Great Depression. This in turn has led to cycles of “boom and bust” and has created an economy dependent on “bubbles” for wealth creation for some and unfortunately, wealth destruction for most.

 

This crisis was particularly severe because it affected the primary asset of most families not only here in our nation but worldwide and that is the housing industry. This crisis was not in the making in 2004 as many would suggest but in the late 1990’s when  the long standing Glass-Steagall act of 1933 was partially repealed by congress. The Gramm Leach Bliley act of 1999 or the “Financial Services Modernization Act” as it was called, took down the barriers that prevented traditional depository banking institutions from participating in the securities and insurance businesses and vice a versa.

 

This allowed banks such as Citibank, Bank of America and Chase to take much higher risks in the business of investment banking and insurance. This was very profitable for many years and great fortunes were created by this legislation. The greates “beneficiaries” of this act were the banks as traditional banking activities are not very profitable and many banks in the 1990s found it difficult to attract private investment capital.

 

What also transpired from this legislation is the loosening of regulations and standards which were enacted after the Great Depression to safeguard banks from insolvency. Capital requirements where relaxed and several loopholes in the law allowed for banks to “hide” investment loses in their balance sheets. Insurance companies could issue securities such as CDSs or “Collateralized Default Swaps” which basically provided what was supposed to be a hedge (insurance) against losses in bonds backed by real estate. This unregulated market grew to about 70 Trillion dollars worldwide and many of these swaps today are just about worthless (think AIG folks).

 

Combine that with the deplorable performance of the rating agencies which issued AAA ratings to paper that was barely investment quality, an SEC that was, and still is,  poorly funded and at times inept at regulating Wall Street (Madoff anyone?) and you have the makings of a crisis every few years on alternating asset classes.

 

I am asked often why I am so bearish on the longer term prospects for the stockmarket and the economy. To be clear, there have been and should continue to be tremendous trading opportunities in equity markets. A Weak dollar and near zero interest rates will benefit larger multinationals and commodities should continue to do very well. In the long run, if reform isn’t addressed, the prospects for sustainable long term economic growth are not very good.

 

The political capital necessary to reform financial services is being spent on reforming healthcare and I am not sure this administration will have enough political capital left to tackle financial services reform once a healthcare bill is passed. As we near the congressional elections of 2010, the ability of the President to negotiate the necessary elements to put forth a real financial services reform package will be greatly dimished.

 

Status quo will make financial services companies very well off again and with the enormous liquidity injected into these firms, stock prices should skyrocket in the near term. The longer term outlook, in my opinion, is a bit more cloudy.  

Gold, Stocks and Bonds All Up

I was commenting today to a subscriber how “crazy” it is to see the market rally in the face of rumors regarding some oil producing nations establishing a trade currency to replace the dollar based on several global currencies and Gold. In the past, such rumors would have sent the market down quite a bit but today, it inspires a stunning rally.  Such are the times we live in when  short term stock market ‘benefits” outweighs the longer term perils of a weak dollar.

 

The stock market as a discounting mechanism prices in an outlook for equities in the time frame of 3 to 6 months. A weaker dollar is going to allow for corporations to post better short term operating results so it is not surprising that stocks have rallied. The Bond market on the other hand is a better indicator of the longer term prospects for the economy. The bond market is telling us that the prospects for the U.S. economy longer term are much less rosy.  As stocks have rallied over the past several months, interest rates have actually declined. Even factoring in governmental manipulation of long term rates via “quantatative easing”, the trend towards safe U.S. Treasury notes, bonds and bills has been on the upswing.

 

So who is right? well they both are. Short term the depressed dollar and extremely accomodative stance by the Fed is the “sweet” spot for equities especially those which derive a large portion of their revenues from overseas. Short term that is good for equities. Bonds prices are signaling that the U.S. economy is headed for a double dip of the recession or  at the very least a weak recovery. With unemployment still rising and consumer spending on the decline, the prospects for a quick recovery in the U.S are not very good which will keep interest rates low for a prolonged period. At least that is what the bond market seems to be saying.

The spike in gold on the other hand is a direct result of inflation fears down the road because of the massive amount of debt that we have accumulated. Gold , and most commodities in general, are usually  assets that investors run to when there is a sense that paper assets are overvalued and risky. The traditional flight to quality trade into U.S. Treasuries is being partially replaced by the flight to Gold trade because investors feel insecure about the dollar.

So how does that relate to trading? Well in my opinion there has never been a better trading market but also a terribly “deceiving” market for “long Term” investors. Again longer term you have to believe that the bond market is a better indicator of the real prospects for the economy and the bond market is telling us to be careful because there is substantial risk of a prolonged downturn.

All About Earnings!

Well it is that time of the year again when Wall street hears from corporate America in regards to how they are performing in these difficult times. Earnings season kicks off on Wednesday with Alcoa set to report earnings for the third quarter of 2009.

 Many analysts are predicting another round of positive earnings especially from the financials who continue to benefit from low borrowing costs and favorable accounting changes which allow for advantageous recognition of losses. Giants such as Goldman Sacks and B of A should come in with strong performance on continued trading gains and favorable market conditions.

 What remains to be seen is how top line revenue comes in and more importantly, how the market will receive overall earnings “meets and beats” on the back of anemic revenue and continued cost cutting. Bottom line if a company is adjusting their costs effectively to provide shareholders with strong earnings isn’t that what it is all about? If a firm is finding a way to make money in this environment it will be hard for the market to punish them too severely. On the other hand, this would be the second quarter of anemic revenues and the market may not be kind to those companies that post much lower top line revenue than last quarter. In an any case, earnings is what it is all about and we will get a good glimpse of the global picture in the coming 3 weeks.

 The fact that the market has found a way to grind higher in the face of poor economic prospects at home is not necessarily a new or unexpected outcome. As the global economy takes a increasing role in overall economic activity, the contributions to corporate profits from overseas now account for nearly 50% of earnings from the S&P 500.

 The current weak dollar policy and zero interest rate stance by the Fed is also a windfall for corporations. The weak dollar provides a “cushion” when repatriating foreign denominated profits and borrowing costs are at all time lows. The Fed seems to be inclined to keep this stance for as long as needed and that has kept a kept a strong bid on the market.

 Obviously the big question is how long can all the stars align in this fashion and at what future costs. For now, most in the administration are willing to do what it takes now and worry about the outcomes later…

Confused About The Economy?

 

There is lot of confusion out there regarding the economy and the our prospects for a quick recovery. Sure there is ample talk of “green shoots” on Wall Street and in the financial media but as we have seen this past week there is good reason to be concerned and some what skeptical of a quick rebound.

 

On Tuesday the Conference Board, an industry group, reported that its index of consumer attitudes fell to 53.1 in September from a revised 54.5 in August. The news surprised Wall Street, which had been expecting the index to rise to 57.0.  This report was surprising because it offered conflicting signals from the prior week;s University of Michigan survey which found consumer sentiment improving.

 

So what is it? are we improving or are we headed for a dreaded “double dip” in the recession. According to Federal Reserve chaiman Ben Bernanke who stated several weeks ago that “from a technical perpective, the recession is very likely over at this point”, but in the same sentence stated “It’s still going to feel like a very weak economy for some time because many people will still find that their job security and their employment status is not what they wish it was”.

 

These statements reflect a growing sentiment amongst economists that the recovery will not be nearly as robust as many on wall street have expected. On Friday, the Labor Department released a jobs number that was substantially weaker than what analysts expected. The consensus figure was for the economy to have shed 175,000 jobs and the number came in at 260,000. Again this calls to question the strentgh of the recovery.

 

Nonetheless, there have been many economic signals that validate the most optimistic scenarios for the economy. Housing for the most seems to have at least stabilized and there is some evidence that government sponsored credit for potential home buyers is helping chop down the inventory of unsold homes that has hampered the housing recovery.

 

 Only time will tell but for the time being, a slow but steady improvement should be in store for 2010.