The Tycoon Report

Ignore This Week's Bank Earnings at Your Own Peril

Monday, January 18, 2010 | Chris Rowe

We've got a great big earnings week ahead of us, and investors finished up last week in a nervous mood. This may be a good time to hedge your portfolio by selling covered calls or buying protective put options.

The market is still bullish, and demand is still in control. More and more advisers are joining the bullish camp after a disappointing wait for a market correction to jump in.

And sure, the market might trade higher if the big banks scheduled to report this week surprise with more upbeat comments about their loan losses moderating, but the Street isn't very optimistic about it after last Friday's earnings report from JPMorgan Chase (Symbol: JPM).

And that's why you might consider preparing for some volatility.

'Every Good Lie Includes a Lot of Truth'

Last Friday, JPM reported strong earnings but traded lower based on CEO Jamie Dimon's and CFO Mike Cavanagh's comments saying they're still uncertain about when loan defaults will start to moderate.

Although overall earnings were strong and beat expectations, the strength came from fees from underwriting debt and stock offerings. CFO Mike Cavanagh said the bank is unsure whether some early signs of stabilization in home-loan delinquencies are just temporary.

Here in The Tycoon Report, we've been talking about why we think the banks and government have just been pushing the problems down the road.

And JPMorgan's comments show they aren't willing to give us TOO MUCH B.S. on the record. Apparently, every good lie includes a lot of truth.

It was clear how nervous their comments made the market on Friday, as we saw a broad-based sell-off. Even after strong earnings from Intel (Symbol: INTC) on Thursday, which beat expectations on earnings and revenue, Friday's market was down after the bank's outlook was publicized:

Losses from failed loans still haven't changed and, perhaps more chilling, neither has its view of the overall economy!

Cavanagh said they are unsure whether some early signs of stabilization in home-loan delinquencies are just temporary.

Will the Banks Boost or Bring Down This Week's Market?

Because JPMorgan has been the bank that investors use as a barometer of the financial sector's health, many are frightened about what this week's big bank earnings will bring.

Here are some reports that could move the markets during the shortened trading week:

This morning, Citigroup (Symbol: C) reports its financials before the bell; tomorrow we have Bank of America (Symbol: BAC) and Wells Fargo (Symbol: WFC) reporting before the bell.

Perhaps the biggest day is Thursday, when we've got Morgan Stanley (Symbol: MS) AND Goldman Sachs (Symbol: GS) reporting before the bell, and then American Express (Symbol: AXP) after the close.

Friday we have General Electric (Symbol: GE) before the bell. (GE Capital, its financial division, could have a significant impact on earnings.)

The Devil -- and the Opportunity -- is in the Details

While the entire earnings reports will be important to investors, the primary focus will obviously be on loan losses -- what the results are, what the future estimates are and the clarity (or lack thereof) the banks admit to having.

There is clearly a big problem in the financial sector. This is something the market has been ignoring, or at least it seems that way with all of the artificial stimulus from the government.

But the problems still exist.

About 1% of all U.S. citizens in "troubled mortgages" (which are about 14% of those with mortgages) have received REAL help (permanent loan modifications).

And, amazingly, investors seem to be ignoring the mortgages out there that will readjust at higher rates this and next year -- that will, in turn, force even more into foreclosure.

You've been hearing us talk, for months, about the ways the banks -- with the help of your democratically elected officials -- have been hiding losses from the average investor.

We've been talking about the way the government has been artificially keeping the stock market afloat through government stimulus, permanent open-market operations, printing of cash, and the Financial Accounting Standards Board's (FASB) allowance of "mark-to-make-believe" as opposed to the "mark-to-market" valuations.

(That is, allowing banks to report assets on their balance sheets as having valuations to be worth several hundred percent higher than they would actually sell for if they had to sell.)

The bet by the government is that the manipulation will at least stoke enough positive sentiment to stop the panic. That may sound silly, since the last time we witnessed panic was nine months ago.

However, the force of panic is so strong that, like a deep wound, it's not enough to just slap a bandage on it and walk away. It requires tons of followup and care.

But the fact is, the problems didn't go away. The government has been attempting to stop the bleeding, buying enough time to put several measures in place, but many of those measures have been failing.

What You Must Do Now

Folks -- the thing to do here is to play the market, and not the economy. The market is currently bullish, but this is a week to exercise caution.

It may be confusing but just look, for example, at what's gone on in the real economy as opposed to the stock market for the last nine months.

The market doesn't always reflect reality. But you have to keep the economy in mind anyway so you don't make the mistake of eating what the government is feeding you.

You have to understand what's really going on. You have to understand that the market moves based on sentiment (and manipulation). But at some point, everyone will focus on the reality of the situation, and that may not happen until it's forced upon them.

The question is whether this week will be just one more step toward reality -- a dose that's strong enough to break the newly established uptrend line, or more smoke and mirrors that sends the market higher.

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Until next Tuesday, when we talk again, stay safe and stay hedged.



“Profit from the Trend”

Chris Rowe
Chief Investment Officer
The Trend Rider



WEDNESDAY, JAN. 20

8:30 a.m. PPI: Producer Price Index

    * Importance (A-F): This release merits a B-.
    * Source: Bureau of Labor statistics, U.S. Department of Labor.
    * Release Time: Around the 11th of each month at 8:30 a.m. Eastern for the prior month.
    * Raw Data Available At: http://stats.bls.gov/news.release/ppi.toc.htm

The Producer Price Index measures prices of goods at the wholesale level. There are three broad subcategories within PPI: crude, intermediate and finished. The market tracks the finished goods index most closely, as it represents prices for goods that are ready for sale to the end user.

Goods prices at the crude and intermediate stages of production often provide an indication of coming (dis)inflationary pressures.

At all stages of production, the market places more emphasis on the index excluding food and energy, referred to as the core rate. Food and energy prices tend to be quite volatile and obscure trends in the underlying inflation rate.

Highlights

    * The November Producer Price Index came in hotter than expected, with total PPI up 1.8% (consensus 0.8%) and core-PPI, which excludes food and energy, up 0.5% (consensus 0.2%).

    * The Bureau of Labor Statistics attributed the spike in finished goods prices primarily to higher prices for energy goods.  The jump in core prices was fueled by higher prices for cigarettes and light motor trucks.

    * The 0.5% increase in core prices was the largest increase since October 2008.

    * Prices for intermediate goods were up 1.4% while prices for crude goods increased 5.7%.

Key Factors

    * The market may overreact to the spike in PPI.

    * While the increase is significant, a closer look at the data shows very little influence on consumer prices.

    * The jump in light truck prices (4.2%) comes after a 5.2% decline in October. Further, it is very unlikely that auto dealers have enough leverage on the consumer to pass along the higher prices.

    * The increase in the price of tobacco products (2.2%) is a little less reassuring. While tobacco products don't make a large portion of the CPI, the low price elasticity for tobacco makes it more likely that producers will pressure the consumer into paying more for cigarettes.

    * Beyond tobacco and light trucks, the only significant mover in the PPI was energy prices. While energy prices were well-above consensus' estimates, oil prices have already dropped significantly over the last month and it doesn't seem like the energy price spike is the start of a new trend.

Big Picture

    * PPI trends were highly volatile in 2008, mirroring the trends in global oil prices.  Falling global commodity prices and weak economic demand will keep inflation in check at the producer level.  If global economies remain weak, as is widely expected, inflation at the producer level will be insignificant.  There may even be concerns about global deflation.


8:30 a.m. Housing Starts and Building Permits

    * Importance (A-F): This release merits a B-.
    * Source: The Census Bureau of the Department of Commerce
    * Release Time: 8:30 a.m. Eastern around the 16th of the month (data for one month prior).
    * Raw Data Available At: http://www.census.gov/const/www/newresconstindex.html

Housing starts are a measure of the number of residential units on which construction is begun each month. A start in construction is defined as the beginning of excavation of the foundation for the building and is comprised primarily of residential housing.

Building permits are permits taken out in order to allow excavation. An increase in building permits and starts usually occurs a few months after a reduction in mortgage rates.

Permits lead starts, but permits are not required in all regions of the country, and the level of permits therefore tends to be less than the level of starts over time.

Highlights

    * Housing starts jumped 8.9% in November from 527,000 to 574,000. That was in-line with the median estimate.

    * In November, multi-family starts rebounded and grew 67% as 92,000 multi-family units were started.

    * Single-family units rose from 472,000 in October to 482,000 in November.

    * Building permits increased 6.0% to 584,000 as single-family permits rose 5.3% to 473,000 units and multi-family permits increased 8.8% to 111,000 units.

    * Housing completions rose 8.7% to 810,000. The lackluster number of starts over the last few months will slowly drain the number of completions.

Key Factors

    * The rise in starts came in the face of declining sentiment among homebuilders.

    * In fact, the main reason for the increase was due to the movement back to equilibrium in multi-family construction.

    * Over the previous six months, multi-family starts averaged 96,000, including a drop to 55,000 in October.

    * Without the reversion back to the mean in multi-family starts, total housing starts increased only 2.1%.

    * After briefly breaking out above 500,000 in July and September, new single-family starts seem stuck at their current level.

Big Picture

    * Housing starts are at extremely low levels and the outlook is not likely to improve any time soon due to high levels of inventories of unsold new homes.  An uptrend in construction will require an improvement in employment and income, and then take some time as inventories need to be reduced.  Government action to boost mortgages seems to have helped, and starts have begun to stabilize.


THURSDAY, JAN. 21

10 a.m. Philadelphia Fed Index

    * Importance (A-F): The Philadelphia Fed Index merits a B.
    * Source: The Philadelphia Federal Reserve bank.
    * Release Time: Third Thursday of the month at noon Eastern for the current month.
    * Raw Data Available At: http://www.phil.frb.org

There are many regional manufacturing surveys, and they tend to be ranked in order of timeliness and the importance of the region. The Philadelphia Fed's survey is first each month, actually coming out during the third week of the month for which it is reporting.

Several smaller surveys are then released before the Chicago purchasing managers' report on the last day of each month. These surveys can be of some help in forecasting the National Association of Purchasing Managers' report -- particularly the Philadelphia and Chicago surveys, which are more closely watched due to their timeliness and the fact that these regions represent a reasonable cross-section of national manufacturing activities.

Highlights

    * The Philadelphia Fed Business Outlook rose to 20.4 in December from 16.7 in November. The median economic forecast predicted the index would increase to 17.5.

    * The index has remained positive for five consecutive months and signals continued growth in the manufacturing sector.

    * The increase in the index came in spite of a slowdown in new orders. The new orders index, while still showing positive growth, fell from 14.8 to 6.5. Shipment growth remained stable.

    * The biggest surprise from the details came from the labor sector.

    * For the first time since the end of 2007, the number of employees index broke through the zero threshold as the index settled at 6.3. While growth prospects in manufacturing labor look anemic (77.3% of companies reported no change in their labor demand), it is very encouraging to see more firms reporting an increase in hiring than firms reporting layoffs.

    * Further, the growth rate in the employee workweek is on the rise as the index increased from 2.0 to 6.4.

    * In other good news, the inventory situation is getting better.

    * While the index is still below zero, the index rose from -17.3 to -7.4. We expect inventories to begin posting positive growth within the next 3 months.

    * The situation for prices remains potentially problematic.

    * The prices paid index increased from 14.9 to 33.8 as 38.7% of firms reported higher prices for their supplies.

    * Unfortunately, consumer demand remains muted and firms are unable to pass on the higher supply costs. The prices received index fell from -1.5 to -1.8 in November.

    * Until the relationship reverses for prices, firms will have difficulties maintaining profits.

Key Factors

    * Please note: the Philly Fed Business Outlook does not provide a strong gauge of national manufacturing activity. In general, all Federal Reserve surveys only provide microeconomic information regarding the region in which the bank is located.

    * Correlations between regions in close proximity are also low. For example, the New York Fed's Empire State Manufacturing Survey dropped from 23.51 in November to 2.55 in December, which obviously did not play a role in boosting manufacturing in Philly.

Big Picture

    * The Business Outlook does not accurately predict nationwide manufacturing and its usefulness is limited to what is going on in the Philadelphia region.

Source: Briefing.com