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Banks Rally as Obama’s Economic Team Waits On Deck

February 06, 2009 | About:
The stock market sustained a significant rally on Friday as the markets are anticipating President Obama and Treasury Secretary Geithner to outline a further iteration of the ongoing bank rescue package on Monday. Also demonstrating the interplay between politics the economy, January’s jobless data is adding to pressure on Congress to get the economic stimulus package pushed through. The unemployment data was grim, but better than some had predicted on Monday morning. In total the U.S. economy has lost 3.6 million jobs since the recession began more than a year ago, but the jobless declines have accelerated as half of those losses occurred in the last three months. The jobless rate now sits at a 16 year high and these results seemed to make investors believe that the Obama administration has no choice but to give another bailout to the financial system under the pressure of the worsening economy. In regards to the stimulus package caught in a partisan struggle in the house, the President said,

“These numbers demand action. It is inexcusable and irresponsible for any of us to get bogged down in distraction, delay or politics as usual while millions of Americans are being put out of work. Now is the time for Congress to act.”

Among some analysts, there is a sentiment that the worst is behind us now, as economic data has fallen off so rapidly in the last quarter that the pace is likely to slow or even flatten in the coming months. Many banks which have been among the hardest hit thus far in the recession spiked up as Bank of America (BAC) lead the charge up more than 26% with Wells Fargo (WFC), Citi (C), and JP Morgan (JPM) all up well over 10%. Bank of America’s CEO Ken Lewis strongly renounced any possibility of nationalization, saying he had never heard any government official mention it and that the rumors were “absurd.”

While Lewis may be right (Why would he lie?) and Senator Chris Dodd echoed his sentiment, but there are still significant concerns that there has not yet been a turn around in such fundamental problems in the U.S. economy as unemployment, slacking consumer demand, slumping home values and sluggish credit markets continue to weight the system down. We urge caution to those thinking about jumping head first into the financials that look so attractive based on historical valuations. While it may feel like a year, we are just 4 months removed from the breakdown of the financial system last October. A meltdown like that will take time to work its way through the financial system, even with a significant government effort. Furthermore, if you believe that this is more than a bear market rally, there are less risky ways to gain exposure to the depressed stock market.

This will be an interesting weekend for the stimulus plan, but we do not foresee either side giving up the fight anytime soon. As far as Monday’s speech by Timothy Geithner, it is speculation at this point, but the latest reports suggest the proposal will revolve around recapitalizing the banks. The government will take further equity stakes in banks but with more restrictions and higher dividends required of the banks receiving funds than in TARP I. Also expected is an easing of the Treasury’s short term lending facility to the banks.

President Obama will be careful not to make this look like a bailout of Wall Street, as a study released earlier this week from the Congressional Oversight Panel found that the first TARP program overpaid by $78 billion for the assets acquired. Henry Paulson would be quick to argue that the stakes he took in banks are investments and cannot be properly evaluated until they are redeemed. The much debated “bad bank” proposal has lost some steam among Obama’s advisors, although it has not been ruled out completely. Perhaps most importantly, the package is expected to include a foreclosure-prevention program, in an effort to stabilize the housing market.

Expect to see another volatile day of trading on Monday, as it will be very interesting to see if market likes what Geithner has to say or if the lack of emphasis on the bad bank taking toxic assets of the books presents a problem. Do not be surprised if the large banks give back all of their gains today. If you do choose to speculate on financials make sure you have the stomach for the wild ride that will likely continue for quite a while.

Ockham Research Staff

www.ockhamresearch.com

About the author:

Ockham Research Staff
Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th-century Franciscan friar, William of Ockham. We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Please visit www.ockhamresearch.com for more information.

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