Will the Banking Sector Bring Down the Rest of the Market ?

Some say a tale of 2 markets is beginning

April 6 (Bloomberg) — Investors are depending on banks more than at any time in at least 60 years to lead the U.S. out of the longest earnings slump since the Great Depression.

American companies will end more than two years of declining income by the fourth quarter, according to analyst forecasts compiled by Bloomberg. Banks will be responsible for all of the 76 percent rebound in the final three months of the year, because without financial companies, the gain turns into a 4.5 percent decline, the data show.

Rathbone Brothers Plc, MFS Investment Management and TD Ameritrade Holding Corp. say the reliance on banks is making them increasingly concerned that the 25 percent gain by the Standard & Poor’s 500 Index since March 9, the steepest rally since 1938, will dissipate. While rising home sales and durable- goods orders show the economy may be bottoming, unemployment and consumer debt as well as prospects that banks will be forced to write down more loans may halt the gain in equities.

“People should not get carried away,” said Julian Chillingworth, the London-based chief investment officer at Rathbone Brothers, which had more than $14.6 billion in assets under management at the end of last year. “We first need to see genuine signs of economic recovery.”

Futures on the S&P 500 fell 0.5 percent to 836.70 at 7:55 a.m. in New York after Mike Mayo, the New York-based analyst who left Deutsche Bank AG to join Calyon Securities, recommended selling banks because of his forecast that loan losses will exceed levels from the Great Depression.

Profit Drought

In 11 recessions since 1938, stocks have rebounded an average of five months before a recovery in earnings, according to data compiled by Bloomberg. The economy has contracted for 16 months, equaling the two longest slumps — between 1973-1975 and 1981-1982 — since the Great Depression.

The earnings decline that has lasted for six straight quarters will get worse before it gets better, with profits at S&P 500 companies decreasing for three more periods, Bloomberg data show. Companies from Microsoft Corp. to DuPont Co. already said profits will be disappointing.

Analysts predict banks, brokerages and insurers will earn about $21 billion in the last three months of 2009, compared with a loss of $65 billion a year earlier, according to estimates compiled by Bloomberg.

Bear Stearns, Lehman

Financial companies led the stock market’s plunge from a record high in October 2007 as Bear Stearns Cos. collapsed, Lehman Brothers Holdings Inc. went bankrupt and the government set aside at least $218 billion to prop up American International Group Inc. and Citigroup Inc. All four firms are based in New York.

Since the S&P 500 reached a record, financial shares have lost 73 percent, the biggest slump among 10 industry groups.

Almost $1.3 trillion in bank losses tied to subprime mortgages froze credit markets and led to a 6.3 percent U.S. economic contraction in the fourth quarter. The S&P/Case-Shiller Composite-20 Home Price Index tumbled 29 percent from a 2006 peak and the U.S. unemployment rate jumped to a 25-year high of 8.5 percent in March.

The first-quarter earnings season starts tomorrow with Alcoa Inc., the largest U.S. aluminum maker. The New York-based company will report an adjusted loss of $368 million, after making $341 million in the year-earlier period, analyst estimates show.

‘A Little Tougher’

For S&P 500 companies, profits will probably fall 37 percent, according to estimates from more than 1,700 securities analysts compiled by Bloomberg. Earnings may drop 31 percent in the second quarter and 18 percent in the next before gaining in the last three months of the year, they predict. The 76 percent jump would be the biggest quarterly increase in earnings in more than two decades, based on Bloomberg and S&P data.

Getting there will depend on financial companies. Bank of America Corp. and New York-based JPMorgan Chase & Co., the two largest U.S. banks, are already saying business wasn’t as strong in March as the first two months of the year.

Kenneth Lewis, chief executive officer at Charlotte, North Carolina-based Bank of America, said on March 12 that the lender was profitable in January and February. On March 27, he said “the trading book was not as good” in March.

JPMorgan CEO Jamie Dimon told CNBC on March 27 that the month had been “a little tougher” than in January and February. Dimon had said on the bank’s Feb. 23 conference call with investors and analysts that the lender was “solidly profitable quarter to date.”

Bank of America

Bank of America may bounce back from an adjusted $1.59 billion fourth-quarter loss a year ago to earn $1.92 billion in the last three months of the year, analyst estimates show. JPMorgan, whose profit plunged 76 percent in the fourth quarter of 2008, may report gains of 317 percent and 222 percent in the third and fourth quarters.

Analysts overestimated bank profits for at least six consecutive quarters, data compiled by Bloomberg show. Earnings may not materialize this time either because of declines in commercial real-estate values, which have yet to fully reflect the economic slowdown, according to Arlington, Virginia-based Friedman Billings Ramsey Group Inc.

“Clearly, vacancy rates are going up,” said Larry Adam, Baltimore-based chief investment strategist at Deutsche Bank Private Wealth Management, which has $232 billion in client assets. “I don’t think it’s just close your eyes and buy. The economy isn’t as good as some people are saying.”

Real Estate

Commercial property loans in default or foreclosure jumped 43 percent in the first quarter as the contraction reduced occupancies and the credit crisis stymied refinancing, data from New York-based research firm Real Capital Analytics Inc. show. Commercial real estate values have fallen at least 30 percent since the 2007 peak and may drop 11 percent more this year, Frankfurt-based Deutsche Bank AG’s real-estate unit said in a March 25 report.

The decline may force banks to increase loan-loss provisions and write down the value of commercial property loans, which Citigroup, Bank of America and JPMorgan are all carrying at 100 percent of face value, according to estimates in a March 24 report by Richard Ramsden, an analyst at New York- based Goldman Sachs Group Inc.

After losing more than half its value, the S&P 500 took 19 trading days to rally 25 percent starting March 9, the sharpest since President Franklin D. Roosevelt’s New Deal policies helped pull the U.S. out of the Great Depression.

Obama, Bush

In the past month, the S&P 500 has bounced back from a 12- year low as confidence increased that $12.8 trillion pledged by the administrations of Barack Obama and George W. Bush and the Federal Reserve to rescue the financial system will end the recession. The S&P 500 climbed 3.3 percent to 842.50 last week.

Stocks gained as Treasury Secretary Timothy Geithner unveiled a plan on March 23 to finance as much as $1 trillion in purchases of banks’ distressed assets to end the 20-month freeze in the credit markets.

Economic reports in the past month persuaded some investors the worst of the recession was over. Sales of new and existing homes unexpectedly rose in February, according to the Commerce Department and the National Association of Realtors, while durable-goods orders increased.

“I’d be a buyer before I’d be a seller,” said Leo Grohowski, chief investment officer at Bank of New York Mellon Wealth Management, which oversees $139 billion in New York. “This is more than an oversold bounce. We are seeing some very, very early signs that the economy may be bottoming.”

Consumer Spending

Stephanie Giroux, chief investment strategist for TD Ameritrade, the Omaha, Nebraska-based online brokerage with $210 billion in client assets, isn’t convinced.

The government’s plans to kick-start growth don’t guarantee a rebound in earnings and stock prices because consumer spending, which accounts for about 70 percent of the U.S. economy, will stagnate for years as Americans pay debts and businesses cut jobs, she said.

The unemployment rate may rise to 9.4 percent by year end, according to economists’ estimates compiled by Bloomberg, as companies from Detroit-based General Motors Corp. to Microsoft and DuPont fire workers to cope with plummeting demand.

A controlled bankruptcy by GM would squeeze production and may help eliminate about a third of the 3 million jobs in the auto industry, Joseph LaVorgna, the New York-based chief U.S. economist at Deutsche Bank, wrote in a report on March 30.

Proxy for Growth

Americans’ debts have remained near all-time highs even as they reduced spending, because people thrown out of work are depleting savings and tapping credit cards. U.S. household borrowing, which has ballooned almost 11-fold since 1980, equaled $13.8 trillion at the end of 2008, or 0.5 percent less than the record reached earlier in the year, according to data compiled by Bloomberg.

“You’ve taken a big engine of growth out of the system for a while,” TD Ameritrade’s Giroux said in an interview. “We are going to be confronted with sub-par growth as we dig out of this hole. The consumer has really driven growth in the economy, and the stock market is a proxy for that growth.”

Software makers and chemical producers are also being hit by diminishing sales.

Microsoft, the world’s largest software supplier, said in January it would cut as many as 5,000 workers in the first companywide firings in its 34-year history. Sales and profit will probably drop as the recession reduces demand, the Redmond, Washington-based company said. Analysts project Microsoft’s profit fell 22 percent in the three months ended in March and will slip 17 percent this quarter, versus year-earlier periods.

8,000 Jobs Cut

DuPont, the third-biggest U.S. chemical maker, lowered its full-year profit forecast in January and eliminated 8,000 contractor jobs as global demand deteriorated and sales to the automobile and homebuilding industries declined. Wilmington, Delaware-based DuPont’s earnings dropped 58 percent in the first quarter and will tumble 42 percent in the current period, estimates compiled by Bloomberg show.

“The market doesn’t have any evidence now that it’s not getting worse,” said James Swanson, Boston-based chief investment strategist at MFS, which oversees $134 billion. “We still are dealing with much worse unemployment and much worse housing numbers. This stock-market rally that we’re seeing, people need to be cautious about it.”