Deep thoughts from David Rosenberg:

“If these folks want a fight, it’s a fight I’m ready to have.”

Eight years ago that would have been George Bush the son talking about terrorists. But today (yesterday actually) it is President Obama talking about the banks. For some reason, the bonuses on Wall Street were deemed to be “obscene” but no such mention was made of Fannie and Freddie, and no mention of the “excessive risks” and “binge of irresponsibility” being taken on by the FHA in its quest to promote homeownership with virtually no down-payment at taxpayer expense … wait for those losses to mount. No wonder a Bloomberg poll just found that 77% of U.S. investors polled see the President as being “anti-business”.

With credit demands dormant and the banks relying heavily on their proprietary trading capabilities, the big investment banks face the largest hurdles. Although Goldman Sachs and Morgan Stanley can sidestep the proposed trading restrictions and drop their bank charters – it was those same charters that saved them a year ago.

Indeed, yesterday’s selloff was “blamed” on President Obama’s stepped up attack on the banking sector. All 10 S&P sectors were down and the worst performer was basic materials, so China’s recent policy tightening moves were at play as well.  The earnings season thus far has been more mixed and the financials in particular have not fared all too well when it has come to top-line growth, loan loss provisioning and guidance.

Even decent reports that included nice top-line performance like we saw out of Google yesterday and G.E. today are not eliciting much of a giddy response as would have been the case during the “green shooty” days last spring and summer and that again attests to how much of the good news is already “in the price”. And what if the news doesn’t to turn out to be so “good”. The vagaries of an overvalued market – remember that Mr. Market chose October 19, 1987 to
plunge 23% in the same quarter in which the macro fundamentals could scarcely have been better with 7% real GDP growth at an annual rate and a 55% trailing trend in corporate earnings. The problem at the time was that the S&P 500 was overvalued on a Shiller P/E basis by nearly 30%, as is the case today, so sometimes good just isn’t good enough. In an overvalued market there is rarely much room for error. In an undervalued market, by way of comparison, rallies can occur on better sequential news even if you can’t feed your kids or pay your bills with less-negative data.

But as Bob Farrell always said, “it’s the market that makes the news; the news does not make the market.” So the recent giveback probably reflects a deeply overbought market that has hit the fatigue button. In other words, the buying power that propelled last year’s rally has likely exhausted itself.

As for President Obama’s plan to de-risk the banks, which was as inevitable as the Sarbanes-Oxley legislation that followed the tech wreck seven years ago, the timing is questionable (except that it quickly followed on the heels of the Scott Brown Senate victory). But just as the focus on health-care reform (as laudable a goal as that is) ended up freezing activity in the small business sector, which represents two-thirds of the employment pie, creating a heightened sense of uncertainty in the financial space, which, at this time, is only going to stand further in the way of creating jobs. After all, this is a sector that employs nearly three million people (the unemployment rate in New York City has soared to 10.6% and look for it to remain on the up-escalator).

Which brings us to this point; while the equity market and risk assets in general enjoyed an absolutely phenomenal year in 2009, the economy shed four million jobs, which was even larger than the three million that were lost in 2008 and that was the year that we lost Bear, Lehman and Fannie and Freddie as we had known them. Not only that, but the President’s first year on the job was the worst on record in terms of job loss, and by a long shot. To this day, with over six million or a record 40% of the unemployed having been out of work for at least six months, there is still no concrete plan out of Washington to deal with what is the most acute crisis – the utter lack of job creation.

Bashing the banks at this time is not very likely going to do much except perpetuate this very high level of uncertainty in the business sector and pose another roadblock on the way to better times in the labour market. The census hiring could not have come at a better time, but these are hardly full-time positions and not exactly part of any long-term strategy to stimulate employment and retool the swelling ranks of the unemployed.

In any event, the banks are going to get re-regulated and the banking analysts are probably going to be valuing the sector as utilities going forward. On this basis, a 4.1% dividend yield on the latter certainly looks a lot more attractive than the puny 1.5% yield that currently exists in the U.S. financial space. How about coming to Canada where the yield in the financials is 3.9% and 4.9% for the utilities sector.  Plus – you get a better currency.

Source: Rosenberg, GS

Cullen Roche

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