The Banks: Bove versus Whitney
Sep 2, 2010
Posted by Jody Eisenman | Filed under Uncategorized
After the worst August in 9 years, stocks exploded to the up side yesterday, staging a 255 point rally. The stock market continues to follow a familiar pattern. Just when things look truly awful, and it looks like we are falling off a cliff, the market rallies. On the other hand, several days of rallies lead people to become bullish again, and then the market starts its’ decline. These trading cycles have frustrated trend traders, as no real trend can take hold for any length of time. As is often the case, yesterdays’ rally was led by the financials, most of which have been declining since July. The question is what’s next for this group?
There are two analysts who are frequent guests on CNBC who could not be more diametrically opposed to each other. On the one hand, we have Dick Bove from Rochdale Securities. Bove has been a major bull on the banks for years, including the 2008 debacle. Not surprisingly, he continues to be bullish, even stating that several US banks could actually quadruple in value over the next few years. He also believes that parts of the Dodd-Frank bill will be repealed.
On the other hand, we have Meredith Whitney. Whitney achieved her primary claim to fame in October of 2007, where she wrote a very negative report on Citigroup while she was employed at Oppenheimer. She then went on to be a very prominent bear on the financials as they collapsed. Whitney went on to found her own firm last year. Currently, she is very bearish on the financials and housing as well. She believes that European Banks have enormous exposure due to the overvaluing of sovereign (read: country) debt, while US banks continue to suffer from housing loans. She believes that a great deal of housing losses have not been factored into the banks’ earnings. As such, she stated “Avoid financials at all costs”.
I stand more in the middle. I can’t argue with Whitney’s loan analysis. On the other hand, bank profits are soaring. For the second quarter, the roughly 7000 banks under FDIC had profits of $21.6BB, as compared to a $4.6BB loss for the sector a year ago. In addition, as long as the Federal Reserve continues its’ Zero Interest Rate Policy (also known as “ZIRP”), banks can borrow money at virtually nothing. Therefore, unless they continue to make crappy loans, they should continue to have a very high spread between their cost of funds and their return on loans. However, I continue to believe that the leverage factor (which I have discussed numerous times) is still a potentially dangerous scenario. I believe that this leverage should be gradually reduced over time. Any time you allow banks to leverage their equity at up 35-40 times you give them rope to hang themselves. Unfortunately, as we have seen, their problems can become everyone’s problem.
