Asia Holds Their Gains Overnight, Europe Plays in the Flatline Territory, & U.S. Futures Trade Down on Banking Concerns

WFC & JPM get downgraded as loan loss provisions expected to hit depression levels and the IBM JAVA deal falls through

April 6 (Bloomberg) — U.S. stock futures fell as analyst Mike Mayo said bank loan losses will exceed levels in the Great Depression and concern grew that International Business Machines Corp.’s talks to buy Sun Microsystems Inc. have collapsed.

Wells Fargo & Co. and JPMorgan Chase & Co. slid more than 1.4 percent after Calyon Securities’ Mayo gave an “underweight” rating to banks and said new government actions to shore up the financial system may not help as much as expected. Sun Microsystems sank 24 percent as people familiar with the matter said negotiations with IBM have fallen apart.

Futures on the S&P 500 expiring in June retreated 0.4 percent to 836.90 as of 7:42 a.m. in New York. Dow Jones Industrial Average futures slipped 0.3 percent to 7,957 and Nasdaq-100 Index futures decreased 0.4 percent to 1,311. Stocks in Europe and Asia advanced.

Earnings at companies such as Alcoa Inc., which will kick off the first-quarter reporting season tomorrow, and Dow Chemical Co. may show the first signs of recovery in the second quarter after profits at S&P 500 Index members fell 37 percent in the first three months of 2009, according to estimates compiled by Bloomberg.

U.S. stocks capped the fourth straight week of gains April 3 after the economy showed signs of improvement and Group of 20 world leaders agreed on measures to halt the recession. The S&P 500 Index extended its rebound from a 12-year low to 25 percent.

Four-Week Advance

The four-week surge was spurred by Citigroup, Bank of America and JPMorgan Chase & Co., which said they made money in January and February, and Treasury Secretary Timothy Geithner’s plans to finance as much as $1 trillion in purchases of distressed assets from financial firms.

In 11 recessions since 1938, U.S. 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.

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.

Mike Mayo’s banking sector downgrade

April 6 (Bloomberg) — Mike Mayo, who left Deutsche Bank AG to join Calyon Securities, assigned an “underweight” rating to banks on expectations that loan losses will exceed levels from the Great Depression.

“While certain mortgage problems are farther along, other areas are likely to accelerate, reflecting a rolling recession by asset class,” Mayo wrote in a report today. “New government actions might not help as much as expected, especially given that loans have been marked down to only 98 cents on the dollar, on average.”

Mayo gave “sell” ratings to BB&T Corp., Fifth Third Bancorp, KeyCorp, SunTrust Banks Inc. and U.S. Bancorp, while “underperform” ratings were assigned to Bank of America Corp., Citigroup Inc., Comerica Inc., JPMorgan Chase & Co., PNC Financial Services Group Inc. and Wells Fargo & Co.

Is this a pump on Bernanke speak or a genuine good faith rally ?

April 6 (Bloomberg) — Asian stocks rose for a fourth day, led by banks and electronics makers, after U.S. Federal Reserve Chairman Ben S. Bernanke said policies to unfreeze credit markets are working.

Mizuho Financial Group Inc., Japan’s second-largest publicly traded lender, climbed 1.5 percent in Tokyo. HSBC Holdings Plc, Europe’s biggest bank, added 1 percent in Hong Kong as the company raised about $17.7 billion from the U.K.’s largest ever rights offer. Panasonic Corp., the world’s biggest maker of consumer electronics, jumped 4.6 percent after Nomura Holdings Inc. raised the shares to “buy” and the yen weakened to a five-month low.

“I’m getting encouraged by what’s happening,” said Paul Xiradis, who manages the equivalent of $8 billion as chief executive officer of Ausbil Dexia Ltd. in Sydney. “The signs are that recovery will occur some time later this year, if not early next. I was looking for signposts and now we’re starting to get them.”

The MSCI Asia Pacific Index gained 1.5 percent to 87.97 as of 11:14 a.m. in Tokyo, paring its drop this year to 1.8 percent. The MSCI Asia Index has rallied 25 percent from a more than five-year low reached on March 9. A gain of more than 20 percent indicates stocks may have entered a bull market.

Japan’s Nikkei 225 Stock Average jumped 2.3 percent to 8,949.94. South Korea’s Kospi Index rose 2 percent even after North Korea launched a rocket yesterday that flew over Japan. All markets open for trading advanced. China is shut today for a public holiday.

Rising Valuations

Futures on the U.S. Standard & Poor’s 500 Index added 0.5 percent. The measure gained 1 percent on April 3, as the VIX index, an index of market volatility known as Wall Street’s “fear gauge,” fell below 40 for the first time since January, indicating traders are becoming more confident about the market advance.

“Relieving disruptions in credit markets and restoring the flow of credit to households and businesses are essential if we are to see, as I expect, the gradual resumption of sustainable economic growth,” Bernanke said the same day. “So far the programs are having the intended effect.”

Mizuho climbed 1.5 percent to 208 yen. Finance companies, the worst performers as a group on the MSCI Asia Pacific Index in the past 12 months, contributed to 31 percent of the gauge’s advance today.

HSBC gained 1 percent to HK$49.95 as investors bought 97 percent of its rights offer. HSBC on March 2 said it would seek the money after its North American operation posted a 2007 pretax loss of $15.5 billion.

‘Degree Of Relief’

The four-week stock rally has boosted the average valuation of companies on the MSCI Asia Pacific Index to 18 times reported profit, the highest since Nov. 30, 2007, according to data compiled by Bloomberg.

“The comments Bernanke made pointing to calmer credit conditions are delivering a degree of relief,” said Masaru Hamasaki, a strategist at Toyota Asset Management Co., which holds about $3.3 billion. “We’ve had a good run recently as the intense bearishness has receded, but for markets to continue higher we’ll need to see some data confirming that stimulus measures are having an effect.”

Panasonic jumped 4.6 percent to 1,270 yen. The shares were raised to “buy” from “neutral” by Nomura analyst Eiichi Katayama, who cited the focus of Panasonic’s management on profitable business segments.

Japanese exporters climbed after the yen weakened to a five-month low against the dollar and the euro, as last week’s worldwide equities rally added to speculation that the global financial crisis is easing. A weaker yen boosts the value of overseas sales for Japanese companies.

Nissan Motor Co., Japan’s third-largest automaker, added 5 percent to 487 yen. Koichi Sugimoto, an analyst at Merrill Lynch & Co. in Tokyo, lifted his target price on the shares to 350 yen from 250, citing the recent weakness of the yen versus the dollar.

South Korea’s Kospi has risen 9.5 percent in the past five days. North Korea launched a Taepodong-2 rocket yesterday purportedly to orbit a communications satellite. The United Nation’s Security Council adjourned yesterday without agreeing to additional sanctions on North Korea called for by Japan and the U.S.

look out now

As the first quarter earnings season begins, a debate rages over whether stocks will be able to rally on or instead roll over on weak corporate profits and dismal economic news.

Traders have argued for several weeks now that the current rally, which started in early March, is a bear market rally and will soon fade. Instead, it has defied naysayers and brought in buyers looking for a turn in the U.S. economy later in the year.

“What is happening in the market was likely to happen. You had a deeply oversold condition. You didn’t know what the sparks would be. You had a dried out forest, and you just needed some kindling. Then you had a number of them,” said Tobias Levkovich, chief U.S. equities strategist at Citigroup.

“My sense is the earnings numbers are going to be very poor, but who does not expect that,” he said. “So, it gives you some idea, I think, that we’ve got some legs still, and to some extent many, many people have missed it.”

In the coming week, first quarter earnings kicks off with a report form Alcoa [AA 8.17 -0.01 (-0.12%) ] on Tuesday. A handful of other reports are due during the week, including Bed, Bath and Beyond [BBBY 27.60 0.95 (+3.56%) ] Tuesday, and Constellation Brands [STZ 12.20 0.02 (+0.16%) ] and Family Dollar [FDO 31.90 -0.23 (-0.72%) ] Wednesday. Chevron [CVX 70.48 0.17 (+0.24%) ] gives an interim update on Thursday.

From ‘Mad Money’:

* Cramer: Rally Latecomers Should Sit Tight

The economic calendar is fairly light, and the release Wednesday of minutes from the Fed’s last meeting is one of the more important items. Also on Wednesday, the Securities and Exchange Commission considers restoring the uptick rule or other price measure. The uptick rule could allow short sales only when the last sale price of a stock was higher than the previous. Some investors believe the SEC’s reversal of the rule in 2007 allowed short sellers to unfairly drive stock prices lower.

From ‘Fast Money’:

* Your First Move for Monday, April 6

Chain stores provide a window on the consumer’s recent activity when they report March sales Thursday.

Markets Mayhem

Stocks finished their fourth up week with a gain of more than 3 percent, scoring their longest winning streak since October, 2007. The Dow, up 241 at 8017 in the past week, was up 21 percent in the past four weeks, its best move of that duration since May, 1933. It was also the Dow’s first close above 8,000 in two months. The S&P 500 rose 26 points, or 3.3 percent for the week, to 842. The Nasdaq rose 76 points, or 5 percent to 1621.

Investors last week poured money into the financials, which were best performers with a 6.4 percent gains, but they also bought consumer discretionary stocks, which gained 6.3 percent. Defensive issues were the worst performers, with health care down 1.6 percent and consumer staples down a slight 0.1 percent.

Crude oil [[email protected] 52.51 -0.13 (-0.25%) ] was up fractionally and grains and some metals rallied in in the past week as the dollar index lost about a percent. But there was also some interesting action in the Treasury market, where traders bucked up against the Fed’s buying program and the promise of more new issuance. In the coming week, tens of billions of dollars in 3-year and 10-year notes will come to auction.

“My assessment of it is the whole Treasury complex is adjusting itself to the consequence of traction from the Fed and the budget situation,” said Kevin Ferry of Cronus Futures Management. Treasurys were under selling pressure. On Friday sellers dumped the 10-year, which saw its yield rise to 2.909 percent from 2.753 the day earlier.

Is this an attempt to keep money in the system fro reflation purposes ?

I must be naive. I really thought the administration would welcome the return of bank bailout money. Some $340 million in TARP cash flowed back this week from four small banks in Louisiana, New York, Indiana and California. This isn’t much when we routinely talk in trillions, but clearly that money has not been wasted or otherwise sunk down Wall Street’s black hole. So why no cheering as the cash comes back?

My answer: The government wants to control the banks, just as it now controls GM and Chrysler, and will surely control the health industry in the not-too-distant future. Keeping them TARP-stuffed is the key to control. And for this intensely political president, mere influence is not enough. The White House wants to tell ’em what to do. Control. Direct. Command.

It is not for nothing that rage has been turned on those wicked financiers. The banks are at the core of the administration’s thrust: By managing the money, government can steer the whole economy even more firmly down the left fork in the road.

If the banks are forced to keep TARP cash — which was often forced on them in the first place — the Obama team can work its will on the financial system to unprecedented degree. That’s what’s happening right now.

Here’s a true story first reported by my Fox News colleague Andrew Napolitano (with the names and some details obscured to prevent retaliation). Under the Bush team a prominent and profitable bank, under threat of a damaging public audit, was forced to accept less than $1 billion of TARP money. The government insisted on buying a new class of preferred stock which gave it a tiny, minority position. The money flowed to the bank. Arguably, back then, the Bush administration was acting for purely economic reasons. It wanted to recapitalize the banks to halt a financial panic.

Fast forward to today, and that same bank is begging to give the money back. The chairman offers to write a check, now, with interest. He’s been sitting on the cash for months and has felt the dead hand of government threatening to run his business and dictate pay scales. He sees the writing on the wall and he wants out. But the Obama team says no, since unlike the smaller banks that gave their TARP money back, this bank is far more prominent. The bank has also been threatened with “adverse” consequences if its chairman persists. That’s politics talking, not economics.

Think about it: If Rick Wagoner can be fired and compact cars can be mandated, why can’t a bank with a vault full of TARP money be told where to lend? And since politics drives this administration, why can’t special loans and terms be offered to favored constituents, favored industries, or even favored regions? Our prosperity has never been based on the political allocation of credit — until now.

Which brings me to the Pay for Performance Act, just passed by the House. This is an outstanding example of class warfare. I’m an Englishman. We invented class warfare, and I know it when I see it. This legislation allows the administration to dictate pay for anyone working in any company that takes a dime of TARP money. This is a whip with which to thrash the unpopular bankers, a tool to advance the Obama administration’s goal of controlling the financial system.

After 35 years in America, I never thought I would see this. I still can’t quite believe we will sit by as this crisis is used to hand control of our economy over to government. But here we are, on the brink. Clearly, I have been naive.

It is a toss up. Plus remember the AIG story of taking a hit on the taxpayers dime for the “profits” that kicked off the recent bank stock rally.

U.S. bank operating earnings are going to have a hard time outrunning credit losses, making the massive rally in bank shares look ready to be marked-to-market.

A series of positive statements about profitability in the early part of the year from major U.S. banks, notably Bank of America, Citigroup and JP Morgan helped to spring a rally in the beaten down sector, as investors bet that with government assistance they could earn their way out of their troubles.

The KBW bank index has enjoyed a blistering rally, rising 51 percent from its March 8 low, though it is still down almost 40 percent from where it ended 2008.

To be comfortable with that, you have to believe two difficult things; that investors will value the earnings banks are now making as if they were sustainable and that banks won’t be swamped by credit losses and potential forced dilutions of shareholders.

“We are unconvinced that the banks have turned a corner,” FBR Capital Markets analyst Paul Miller wrote in a note to clients. “Investors who believe that the recent financial rally is here to stay expect that most banks will remain profitable.

We expect that profitability at these banks will be driven by favorable fixed-income trading revenues, as well as mortgage banking revenues.”

In some ways, balance sheets aside, it’s a pretty good time to be a bank in America. Competition has thinned out and margins should fatten commensurately.

U.S. bank profits from trading and mortgage banking are both problematic. Trading income, because it varies wildly, is hard to predict and hard to value.

If the past two years has taught us anything, it’s that paper profits can evaporate and risks can be hard to spot.

On the positive side, the fact that banks are now putting less balance sheet to work as market makers means that those banks which still operate can make considerably more on the difference between where they buy and sell securities. But given the huge uncertainty about who will be around in a year’s time, especially given the by its nature unpredictable role of government, its hard to know how much competition there will be or even how much capital banks will be forced to hold against trading activities.

LOAN COLLECTING BLUES

Mortgage banking is also going to be bigger this year. The Mortgage Bankers Association predicts refinancing will total $1.96 trillion and purchase loans increase $821 billion, which could make it the fourth-biggest year on record. This is mostly because the Fed has driven interest rates down in a bid to reflate the economy. That makes it profitable for many Americans to refinance their mortgages and is luring a much smaller number back into the house purchase market despite falling prices.

But again mortgage banking is a notoriously tough business, and though a scarcity of lending capital has driven fees up, the record of banks in the U.S. engaging in it profitably is not good.

Mortgage banking, as distinct from mortgage lending, is the business of originating loans, these days almost exclusively for Fannie Mae or Freddie Mac in exchange for a fee and the right to earn more fees by collecting payments in exchange for servicing the loan for the lender.

But the mortgage servicing right that a bank gets when it makes the loan is usually recognized as income based on the current value of the cash it is expected to generate over time.

That means that banks that originate lots of mortgages show huge gains in income during refinancing booms. It does not mean, however, that they necessary make money out of the deal. Servicing rights can go wrong in many ways.

First, people can stop paying their loans back. The servicer usually has to advance the first few payments if a borrower is late and doesn’t get the money back until the loan is resolved. It’s also a lot more expensive to service bad loans than regular payers, making the economics of the business particularly tough right now.

Banks can also lose out if loans are refinanced sooner than they expect, robbing them of the future fees they were counting on.

And what about credit losses? Unemployment, which drives losses on commercial loans, on mortgages and on consumer loans, will be going up for some considerable time.

For example, the baseline forecasts released by the Organization for Economic Cooperation and Development (OECD) this week were considerably more bearish than even the “more adverse” numbers being used to run the U.S. stress tests now being run on banks.

Blog Calculated Risk does a nice job running the numbers here, but the highlight has to be the third q here, but the highlight has to be the third quarter, where the OECD is predicting an economy shrinking by 1.9 percent, as against a rather miraculous recovery to minus 0.2 percent in the “tough” scenario used by Geithner et al. Similarly, the unemployment rates predicted by the severe stress test are lower than the OECD base case all the way out to the end of 2010.

So then, it won’t be the stress test that undoes many banks, it will be reality.

Limits on pay is gay

WASHINGTON (Reuters) – U.S. Treasury Secretary Timothy Geithner denied on Sunday the Obama administration was crafting bailout initiatives to allow companies to evade limits on executive pay and other restrictions imposed by Congress.

“No, that’s not true,” Geithner said when asked about a report in Saturday’s Washington Post that the White House was trying to allow some exceptions.

“Now, our obligation is to apply the laws that Congress just passed on executive compensation and we’re going to do that,” he told the CBS program “Face the Nation.”

“We’re also going to make sure that these programs are as effective as possible in making credit more available to businesses and families across the country.”

The Post said President Barack Obama’s administration believes it can sidestep the rules because it has in many cases decided not to provide federal aid directly to the financial institutions, instead setting up special entities that act as middlemen to channel the funds.

Executive pay restrictions are among efforts by Congress to claw back bonuses and curb pay amid public anger over executive bonuses at insurer American International Group, which has received a bailout worth up to $180 billion.

The “Pay for Performance Act of 2009” was passed by the House of Representatives last week and now goes to the Senate.

Some financial firms have said the prospect of compensation limits make them reluctant to join in the Treasury’s financial rescue package, which could diminish its power to cleanse toxic assets from banks’ books and jump-start lending.

Obama senior adviser David Axelrod told “Fox News Sunday” the president does not want to discourage companies from participating in the Treasury programs but has a tough set of standards on executive pay.

“On some of these programs, we’re asking financial companies to come in and help solve this problem by providing more lending, by buying up toxic assets and so on,” he said.

“We don’t want to create disincentives and undermine the program,” Axelrod said.

“So we have to look very closely at this, making sure that we’re not rewarding people for irresponsibility, that people — that firms that get extraordinary help — aren’t getting, aren’t giving out huge bonuses.”

Geithner said the White House was committed to enforcing the restrictions approved by Congress.

“Absolutely, because we want the American taxpayers’ assistance going to generate greater lending — not providing excess compensation,” he told CBS.

“It is very important to us that every dollar of assistance to provide goes to expand lending.”