Bank Stress Tests Revealed

citi bank stress testI think it is safe to say that whenever an expected significant announcement is scheduled to be made, we can most likely expect it to hit the media 2-4 days before the scheduled date. Indeed this was the case for the much anticipated bank stress test results. After rescheduling the public release date for the results three times, results from tests hit headlines almost two days before the scheduled announcement. Much to what I expected, there was nothing earth shattering that was revealed, as none of the 19 banks tested are deemed to be "insolvent." Five of the banks are believed to not need any capital (JPM, GS, RF, AXP, and BK), considering many of them went to their shareholders to raise their additionally needed capital, as they should.

Bank of America, Wells Fargo and Citi were the big question marks for many, as it was expected they would most likely be needing significantly more capital. Results came in to show that Bank of America will need $35 billion, Wells Fargo $15 billion, and Citi about $5 billion. Despite the rather large deficits in capital that still exists, markets opened up trading in the green after a horrible evening of pre-market trading, where the Dow was down around 200 points at one point. The reaction coming from investors boggle my mind, especially those that are just now buying into these institutions. We all knew this would be the result of the tests, and it should be no surprise.

This is one of the few times I have ever seen a deficit amount hit headlines, where then investors reacted positively in buying the company's stock. Despite over $45 billion that Bank of America has already received from TARP funds, plus the 0% interest money they are receiving currently from The Fed to loan out, they need another $35 billion according to "stress" conditions that have already been reached in our current economy to remain solvent. This is not too mention all the dollars saved from the mark to market accounting change. As a result, the stock closes up 17%. These are the times we live in. Many analysts say that it was the "clarity" investors received which sparked the positive buying in the stock. Give me a break. Clarity of a $35 billion deficit? There are many things going on behind the scenes that, unfortunately, you and I will never be able to see, which have a big influence of why the markets are moving the way they are.

In times past, we have seen the popular trend to Buy The Rumor, Sell The News. I think we will find this to be the case with financials. Even though we will be hearing from Bernie and Tiny Tim and the bunch tomorrow, the core of the news was released today, and the market reacted. In my opinion, people are just double and triple dipping into financial stocks that were over bought to begin with two weeks ago. Seeing a reaction of this multitude from the results of a "prospective test" that really has no fundamental meaning, gives me some strong desires to short. In fact, it took a lot of patience from me to not buy some heavy shares of FAZ and SKF as I believe this rally was for nothing. I did make some moves, which I'll talk about a bit later on in the post and in more detail in today's premium podcast (subscribe here).

Wall Street continues to be filled with manipulative trading, as we saw clearly at the close of trading today. After being up well above 100 for the day in the Dow for quite a while, we began to see a pretty strong resistance settle in towards the end of the day, bringing the Dow just up about 35 points. While seeing this, I warned many of you on chat the motivation to close this market above the 8500 mark. Many doubted me, especially when we were getting into the last 3 minutes of trading and the Dow was at about 8470. Never underestimate the PPT, while, literally, in the final seconds, we saw the Dow jump from about 70 points up to close up about 105 points at 8512 (see the huge V turn right at close below). You would think they would be more discrete about it, but at this point, I don't think they care anymore. It's not so hard to believe, when you consider that the government has spent trillions this year alone on bettering the economy. You don't think they will allocate several billions of that to lifting the most influential vehicle of our economy, the stock market? Of course they will, the only problem is you can never rely on it, because eventually it needs to stop, or it gets harder to manipulate with increasing volume.

dji 5-6-09 PPT
During the peak of the rally earlier in the day, I had to at least pick up a little bit of short position. Even though we're not quite out of the woods with all the fluff surrounding the bank stress tests, I just felt today's rally was much too over-zealous. As a result, I went in and picked up a few FAS Put Options at an $8 strike, expiring in October. At $2.25, I felt very comfortable with my odds. Plus, I feel that by October, we should be well into the first stage of commercial real estate problems, which should open up brand new wounds for many of the banks. Just from the change today, the option got up to $2.60, so hopefully we will see some exhaust come from this parade in financials.

My big doubts about financials are rooted in their remaining inability to lend. Sure, you can go in and get a mortgage loan for a house or even an SBA loan with good enough credit, but there is no money being lent for commercial real estate, small businesses and development. If right now, following the largest capital influx into the lending system our country has ever seen, has not de-thawed credit markets, why on earth should it get better, especially when many still believe economic conditions should get worse. The answer, in my opinion, is because the banks are hoarding and will continue to hoard any capital they receive until they have safely sailed through this upcoming commercial real estate storm. Of course they will loan on a home mortgage, because those loans are coming from The Fed with 0% interest. They should be approving everyone that goes in there with those kind of profits.

Just as we saw in the beginning of the real estate recession in the early 90's, we are once again beginning to see the demolishing of brand new houses. In parts of California and Texas and some other states, banks are demolishing brand new or almost completed homes, which have been foreclosed on, as a "safety precaution." When it is worth more to hire a demolition truck to raze brand new houses than it is to try and resell them to the public, then problems still very much exist in the residential sector. Yet, our officials say that we are nearing a bottom in the residential market. Just as soon as we plow over all those new houses, right?

I expected a response, like today's, from investors as I wrote about it in last week's post, so to see it fulfilled is not a surprise. I do still believe that we are seeing the finale of this rally and that we could see a turn as early as next week, maybe even sooner. Technically, the volume levels are not there to be building additional momentum on the bull side, and many stocks, especially financials, are severely overbought. Hopefully, we will see this market turn shortly, which at that point I will be ready with my shorts.

Remember, unemployment will be coming out on Friday, which as I said yesterday should be a "better than expected" number, nevertheless very discouraging for our economy. We have lost well over 2 million jobs this year alone, and the trend should not be changing anytime soon in my opinion. I am sure there are many of you which have experienced a change in occupation. If you are looking for a job, you might want to check out JMAC, who has Openings at $100K & Above! It is free to sign up and they can provide you with many opportunities to keep making a salary in a tough economy. Just remember one thing, every time you lose 50% of a stock price, it takes a 100% to bring it back, which we still remain 40% lower in the Dow from our October 2007 highs. A very critical principal to remember. Happy Trading.

4 comments:

  1. Anonymous Says:

    FF,
    Today was an interesting day to say the least, but what I noticed today is that we ran straight thru all resistance areas of the S&P. We have nothing other than 935 now to stop this "bogus" rally. If we go through that....then the game is definately rigged by the Gov. Every chart I see says we should have stopped this rally at 900 max and now we're right in the midst of what cold be a disaster for Bears. What are you thoughts ?
    Thanks.
    I am long a ton of SRS at $22 and still in awe of FAZ being at $5 now. It seems the Gov. is working behind the scene's knocking short ETF's to no man's land.

  2. Anonymous Says:

    FF,
    Sorry, I had one more question for you about the decay in SRS.......Is it something I can hold for a month or two or is it something I should consider getting out with minimal losses if the opportunity arises ? I am 22 points to zero right now and while I can't imagine it getting any lower, I thought the same when my friend bought FAZ at $12. Thanks for your input on this matter.

  3. Finance Fanatic Says:

    Anon,
    It all depends on the turn in the market. Like we are seeing today, SRS is performing strongly, up over 10% right. If the downward selling continues, than we should expect some big gains out of SRS, especially if VIX levels start rising again. Unfortunately that is the key, predicting the turn. If we do indeed see this market turn within the next week, than, Yes I believe both SRS and FAZ should perform well, even with decay.

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