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Are Financials Mounting a Comeback?

Many have suggested that the recovery from this historic bear market will, and needs, to start in the financial sector.  While we at Hennion & Walsh do not believe that financials, in and of themselves, can drive the economy out of this particular recession, we do recognize that they are at the epicenter of the current global credit crisis and remain a necessary component of the economic rebuilding efforts taking place on a global basis.   In this regard, we observe encouraging technical trends with respect to the performance of the common stock of some of the more recognizable financial companies.


Source:
  Bloomberg L.P., April 14, 2009.  Past performance is not an indication of future results.

With the exception of Wells Fargo, as illustrated in the chart above, 2008 was a catastrophically difficult year for financials.  To summarize, Bear Stearns became part of J.P. Morgan, Lehman Brothers filed for bankruptcy protection (the largest to date in U.S. history), Merrill Lynch became part of Bank of America and Goldman Sachs and Morgan Stanley became bank holding companies.  The bailout of insurance giant AIG by the Federal Reserve and seizures of Fannie Mae and Freddie Mac by the Treasury Department rounded out some of the more noteworthy events that took place during 2008.

Continued strains in the credit and housing markets, eroding investor confidence and uncertainty over the details of Treasury Secretary Geithner’s plan to tackle the toxic mortgage assets plaguing the balance sheets of many of these financial entities resulted in more stock price decreases for financials during the 1st quarter of 2009.

However, glimmers of hope started to appear in the financial sector around mid-March following statements by Citigroup CEO Vikram Pandit in terms of positive 1st quarter revenue projections for his banking conglomerate in addition to positive business climate sentiments expressed by JP Morgan CEO Jamie Dimon.   Further fuel was added to the short-term rally in financials when a compromise was reached with respect to mark-to-market accounting rules and prospects for the reinstatement of the now infamous “Up-Tick Rule” improved.  In this regard, I still contend that a plausible argument can be made that a large part of the pain experienced in financials over the course of the last 15 months was exacerbated by existing mark-to-market accounting rules and the lack of the Up-Tick Rule.  Hence, we view these developments favorably.

The chart above seems to follow these previously described trends in the financial sector.  All of the financials, with the exception of Wells Fargo, listed in the chart registered relatively significant losses related to the price of their associated common stock in 2008.  As we moved into 2009, Citigroup, Bank of America and Wells Fargo (three of the more “traditional” banking entities in this chart) experienced more losses while JP Morgan Chase, Goldman Sachs and Morgan Stanley appeared to reverse course by starting to mount an upward recovery.  April 2009 appears to be shaping up as the most promising evidence that a recovery may be starting to take form in financials with all of the company stocks posting positive month-to-date performance thus far – some significant.

However, our view on the recovery in financials is still skeptical at this point as we still see some potential bumps in the road ahead.  We are still concerned with future potential sub-prime mortgage related problems (i.e. Alt-A and Option ARM loans) and the effect that these problems may have on the financials.  We also anxiously await the results of the Government’s stress tests and the complete 1st quarter earnings recap and forward looking guidance from the major financials.

With all of this short-term skepticism we recognize the criticality of the restoration of profitability to financials, due to their direct involvement in the flow of credit within our economy, and are encouraged by a lot of the recent news and developments related to financials.