Commentary by Eoin Treacy

An update on bank shares - This week has seen tumultuous moves by the majority of financial shares. The long list of shares which were breaking down, posted on Wednesday, is probably worthy of review today considering the rebound seen in the UK and US financial sectors. They can all be found in the International Equity section of the Chart Library in the Europe DJ Stoxx 600 section.

Today I would rather concentrate on the performance of financial sector indices relative to their parent indices. Financial shares are a lead indicator for the stock market and their outperformance is something of a prerequisite for any recovery in the current environment.

In the USA, the S&P Banks Index found support above the July lows and broke upwards yesterday from a 6-week consolidation. It would need to sustain a move below 200 to damage the integrity of this nascent uptrend. Against the S&P 500, the Banks sector broke upwards on the 17th and would need to sustain a move below 0.16 to question scope for some further outperformance. The S&P Diversified Financials Index rallied strongly in both absolute and relative terms over the last few days but has yet to break upwards.

The banning of new short positions in financial shares until January led to a spectacular rally in the FTSE-350 Banks. Relative to the wider Index, it found support in mid-August above the July lows and rallied from 2.25 once more this week. A sustained move below that level would be needed to question potential for an upside break.

The DJ Stoxx Banks Index found support near the July lows this week and is rallying strongly relative to the Stoxx 600. A sustained move above 1.075 would be needed to suggest a lengthier period of outperformance is likely.

The S&P TSX Banks found support in July and formed a consistent uptrend relative to the wider index. The sector found support at the top of the prior range this week and would need to sustain a move below 1.275 to offset scope for further upside.

The Topix Banks Index also broke upwards relative to the wider Index this week and would need to sustain a move below 0.205 to question scope for some additional upside.

The Swiss Banks Index briefly broke downwards against the SWX Supplement Index this week, but has since rallied significantly . A sustained move below 8 would be needed to question scope for some further upside.

The ASX 200 Financials Index lost downward momentum against the ASX 200 from March and bottomed in July. It continues to exhibit a progression of higher reaction lows and would need to sustain a move below 0.925 to question scope for further upside.

The Bombay Banks Index also found support in July and continues to outperform the BSE500 Index. A sustained move below 1.3 would be needed to question scope for further upside.

The Jakarta Finance Index found support relative to the JCI in June and continues to rally strongly. The uptrend has lost momentum somewhat over the last month but a sustained move below 0.105 would be needed to offset potential for some further upside.

The Hang Seng Financials Index found support in January and began to rally against the Hong Kong Composite in February. It remains in a consistent uptrend and would need to sustain a move below 1.22 to question scope for additional upside.

The FTSE/JSE Africa Banks Index found support against the FTSE/JSE Africa All Share in June and continues to rally strongly. A sustained move below 1.2 would be needed to question scope for further upside.

Banks in China, Thailand, New Zealand, Korea, Taiwan and Singapore are still lagging their wider indices and have some work to do before they can demonstrate meaningful outperformance.

Interestingly, banks where the credit scare has been focused are doing best relative to their indices and are most likely to continue to benefit from any short covering rally. The fact that bank shares are now beginning to outperform will not be lost on investors, as solutions are found to help banks improve their balance sheets.


Nordea Markets Contrarian opportunities: financial valuations positioned for an end-2008 recovery - Thanks to Jan Bylov for his informative and consensus challenging report which looks at the potential for a year-end recovery. Here is a section on the savings & loan era RTC:

(Slide 24)Resolution Trust Corporation (RTC)
Corporation set up by the US government in 1989 to collect assets from bankrupt savings & loans (S&Ls) at the end of the 1980s.
Assets were typically homes and mortgage loans.
Dissolved in 1995.
Managed to take over assets from 747 institutions totalling USD 520bn.
Assets were sold for USD 394bn - a loss to taxpayers of around USD 125bn.

(Slide 26) Solution?
An RTC-style solution is increasingly being discussed in the US. Obviously, that does not address the "moral Hazard" problem. But that is clearly not the most important to politicians (which the takeover of Fannie Mae, Freddie Mac and AIG shows.)
Everything suggests that Democrats and Republicans can agree on such a solution.
As such a solution is still only rumoured, the assets that the trust would buy are unknown (also equities?).

My view - This weekend is likely to prove pivotal to how financial shares are likely to form a recovery. The decisions made about how any new institution will acquire and divest itself of illiquid credits will be important for confidence. The shape of any recovery for financials will also be impacted. I believe the current talk of moral hazard and the cost of bailouts is beside the point. When markets become disorderly and panic is allowed to set in, it is the responsibility of the authorities to intervene and help restore confidence. Suspect companies should be allowed to go to the wall, but not at the cost of the rest of the financial system.

Fed to Help Meet Fund Redemptions, Buy Agency Debt - This article by Scott Lanman for Bloomberg covers measures being put in place to protect deposits at money market funds. Here it is in full:

The Federal Reserve said it will lend to banks to meet demands for redemptions from money-market mutual funds and plans to buy agency debt from primary dealers to aid financial-market liquidity.

The Fed will extend loans to banks to purchase ``high- quality'' asset-backed commercial paper from money market funds, the Fed said in a statement in Washington. The loans will be at the discount rate, the Fed said. The rate is currently 2.25 percent. The Fed didn't provide a size for either initiative.

Investors pulled a record $89.2 billion from money-market funds on Sept. 17, according to data compiled by the Money Fund Report, a newsletter based in Westborough, Massachusetts. The U.S. Treasury separately said today it will use as much as $50 billion from the government's Exchange Stabilization Fund to temporarily protect investors from losses on money-market funds.

The central bank said it will buy short-term discount notes issued by Fannie Mae, Freddie Mac and the Federal Home Loan Banks ``to further support market functioning.'' The New York Fed will conduct the purchases of debt through ``competitive auctions'' over the ``next several weeks,'' the district bank said in a statement.

The actions came a day after Treasury Secretary Henry Paulson and Fed Chairman Ben S. Bernanke proposed moving troubled assets from the balance sheets of U.S. financial companies into a new institution, the most sweeping action aimed at ending the crisis.

Paulson, Bernanke Push New Plan to Cleanse Books - This story by Alison Vekshin and Dawn Kopecki covers the potential for a new agency to deal with bad debts being formed. It is posted without further comment but here is a section:

Options that U.S. officials are considering include establishing an $800 billion fund to purchase so-called failed assets and a separate $400 billion pool at the Federal Deposit Insurance Corp. to insure investors in money-market funds, said two people briefed by congressional staff. They spoke on condition of anonymity because the plans may change.

Another possibility is using Fannie and Freddie, the federally chartered mortgage-finance companies seized by the government last week, to buy assets, one of the people said.

``We will try to put a bill together and do it fairly quickly,'' House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, said after the meeting. ``We are not in a position to give you any specifics right now'' on the proposals, he said when asked about the potential cost.

The likelihood of the government taking on yet more devalued assets, after the seizures of Fannie, Freddie and AIG and the earlier assumption by the Fed of $29 billion of Bear Stearns Cos. investments, may spur concern about its own balance sheet.

Debt Concern
The Treasury has pledged to buy up to $200 billion of Fannie and Freddie stock to keep them solvent, while the Fed agreed Sept. 16 to an $85 billion bridge loan to AIG. The Treasury also plans to buy $5 billion of mortgage-backed debt this month under an emergency program.

``It sounds like there's going to be a giant dumpster for illiquid assets,'' said Mirko Mikelic, senior portfolio manager at Fifth Third Asset Management in Grand Rapids, Michigan, which oversees $22 billion in assets. ``It brings up the more troubling question of whether the U.S. government is big enough to take on this whole problem, relative'' to the size of the American economy, he said.

Senator Richard Shelby of Alabama and some other Republicans have criticized the takeovers of AIG, Fannie and Freddie for imposing a potentially high cost on taxpayers.

SwissTrust (A subsidiary of Interhold): How I spent my evening - Thanks to a subscriber for acquiring permission to post this well-balanced report by Dan Kohler covering the climactic pace of this week's sell off and the potential ramifications. Here is a section from the conclusion:

It is normal that when counterparts in financial markets no longer trust each other, and especially when investors no longer trust the financial intermediaries, the system freezes up. All note and bond issues, even those who are not contaminated, are met with suspicion. In the absence of trust there are no trades, and thus no market. In this situation the rules forcing banks to "mark their portfolio to market" become insidious time bombs. The rules demand that if there is no market price for assets, these assets have to be written off or at least provisioned against. In other words, if there is no market now, the asset is "worthless".

If one contrasts the enormous write-offs banks had to take in the application of this rule with the essentially health condition of the debt and mortgage markets, where the problems forcing these write-offs are supposed to lie, one quickly notices a disconnect. It is simply not possible that all these write-offs are economically justified in a generally healthy credit environment where most loans are still serviced normally and default rates are no higher than average.

The write-offs are necessary, however, to comply with the rule that an asset which cannot be traded right now has to be considered "worthless". That the underlying credit may still be healthy, may still be serviced normally is almost irrelevant. The accounting and audit profession is dancing around the golden calf of "marking to market" and loses sight of true value. I am pleading here for a "fair value" approach that allows establishing a fair value for an asset, even if it is not traded right now. The distinction is at least as important as the distinction between valuing a company as an ongoing concern or at liquidation prices. Why an otherwise healthy financial company should be forced to value its portfolio at liquidation prices is beyond me.

If you surmise from this that I see value in the beaten down stocks of financial companies, you are right. I am of the contrarian belief that in the short- to midterm financial stocks are a good buy. In the long run, however, I am seriously concerned about the nationalization trend which distorts the financial sector, as I explained above.

I am convinced that in not too long a time we will look back to this current period as the buying opportunity of the decade. Remember that Prince Waleed of Saudi Arabia purchased a solid junk of Citibank at the last major financial crisis and that his adjusted acquisition price is today somewhere between USD 1.00 and 1.50. This, by the way, is something that could happen again. Investors from the oil exporting countries could seize the opportunity of putting some of their oil money to work.

In the medium to long term, however, I see more value in the natural resource sector than in Financials. The shares of commodity producers have been battered by the double whammy of an extremely unfriendly stock market environment and falling commodity prices. This trend, however, is being reversed. Oil is off its low and approaching USD 100 again and in the general flight to safety gold posted its biggest one day gain ever yesterday. In the stock market 21 out of the 43 companies in the S&P 500 index that did post a gain yesterday 21, i.e. almost half, were natural resource companies.

My view - I found this to be an enlightening report but I'm not as a worried about the nationalisation of the banking sector over the long-termas the author. Governments are not as well equipped to manage banks as the private sector, although this is necessary in some cases at present. They will eventually allow these banks back onto the open market; having had their wings clipped somewhat.

We have discussed on a number of occasions that the current crisis was resulting in some companies being priced at ridiculous levels and that credit markets were producing bargains not seen in years. One of the most interesting moves today has been in the resources sector, which was one of the most overextended.

Rules have been introduced to stop short selling of financial shares in the UK, USA and Ireland, but the short covering rally has also fed through to the commodity markets. The FTSE-350 Banks Index was the biggest mover today, advancing 39% but it was followed by the Mining Index up 12.47% and Oil & Gas Producers up 10.64%. These latter two indices have been some of the most heavily shorted and were looking particularly overextended. They would now need to sustain moves to new lows to offset scope for some further upside.

Considering the extent of the decline, a 'V' shaped recovery is probably too much to hope for. Once the short-covering rally runs its course, which may take a number of weeks, support building is needed before they can sustain a moves to test and exceed their highs.

ICBC, China Banks Rise By Limit on Government Support - This article by Luo Jun for Bloomberg covers today's surge in Chinese shares. Here is a section:

China's banks surged by the most in almost 12 months after the government said it will buy shares of the three largest lenders on the open market to shore up investor confidence in the world's second-worst-performing stock market this year.

China Investment Corp., the nation's $200 billion sovereign wealth fund, will buy stakes in Industrial & Commercial Bank of China Ltd., Bank of China Ltd. and China Construction Bank Corp., through unit Central Huijin Investment Co. starting today, according to the official Xinhua News Agency. The nation's 14 publicly-traded banks all rose by the 10 percent daily limit in Shanghai and Shenzhen.

The CSI 300 Index has slumped more than 60 percent this year as an equity bubble deflated and the economy slowed, undermining earnings growth and threatening to spark a rebound in bad loans. Industrial & Commercial Bank of China on Sept. 17 ceded its position as the world's most valuable bank to HSBC Holdings Plc after shrinking by $241 billion in less than a year.

``This is a shot in the arm to stem the hemorrhage and may lead to a 10 to 20 percent rebound of share prices,'' said David Liao, a Shanghai-based bank analyst at HSBC Jintrust Fund Management Co., which manages $975 million. ``But it won't be a turning point -- the concern over an economic slowdown and rising corporate defaults is materializing.''

Banking stocks across Asia-Pacific are climbing today after the U.S. government said it was considering a plan to shore up the financial system after Lehman Brothers Holdings Inc. collapsed and the government stepped in to rescue the country's biggest insurer, American International Group Inc.

My view - This is the latest of a number of measures to stimulate bullish interest in the stock market and resulted in 488 of the 807 Shanghai A-Shares rising the daily limit of 10%. This is one of the Index's largest rallies and it would need to sustain a move to new lows to offset scope for further upside. It remains likely that the low will be tested as the extent of the government's intent to support markets is probed. However, it should not be forgotten that the advance from the 2005 lows was also sparked by a government support program and it may not pay over time to bet against the CIC's deep pockets.

Email of the day (1) - on panic:

"I am really scared. This morning I saw my company stock dropped from $68 to $54 even the Dow was rallying at that time. I felt there were something wrong and immediately tried to unload my shares but the web site to trade my stock grants crashed apparently due to extremely heavy volume. In the next one hour, the stock plunged to $23! This is a 20 billion dollar world wide financial service company!! Unbelievable!

"But if the market can manage to close up, I think this has to be the bottom as the fear just became hysteric!"

My comment - Thank you for this highly personal email which shares the feelings associated with profit erosion shared by most investors. I'm sure it will be appreciated by the Collective. With no knowledge of which share you are referring to, I presume it will also be covered by the ban on shorting of financials, so a bounce may be at hand.

Panic is seldom a good condition from which to make financial decisions, although when hysterical fear is rising, it is hard not to act. However, these extremes of sentiment are transient and we are now in a position where shorts are being covered following intervention by the US and UK authorities. Confidence is built slowly, but is easily destroyed and it will take time before faith is restored in the banking industry.

Email of the day (2) - on avoiding financial news channels while trading:

"A few words to tell you how I lived the reversal of September, 18th. I was trading, my son who was watching Bloomberg in another room came at 12:15 saying "they say that gold is going to soar, everybody is rushing to gold and flying from equities!"

"At this moment, I could see gold going through the roof, and I was short gold, long equity. Fifteen minutes later, gold collapsed and equities made a huge bounce.

"morale de l'histoire": never watch a financial media while trading, only to unwind at night.

"Good trading to all the subscribers."

My comment - Thank you for this insight which I'm sure many of us have experienced at one time or another..

Today's interesting charts - The Chart Library is bursting with interesting chart patterns after an exciting, if nerve wracking week. A click through of one's favourite sectors would be time well spent.

Switzerland - finds support above the July lows and rallies strongly. A sustained move below 6500 would be needed to hinder scope for additional upside.

Spain - failed downside break as it rallies firmly back above 11,000. A sustained move below that level would be needed to question scope for at least a test of 12,000.

Ireland - looking like a failed downside break which makes a retest of the 4600 level more likely. A sustained move to new lows would be needed to question potential for some additional upside.

Russia - rallies spectacularly from deeply oversold territory. A sustained move to new lows would be needed to question scope for further upside.

US Treasuries - falling back abruptly from the highs near 124 and would need to sustain a move above that level to question scope for some additional downside.

Gold - continues to hold Wednesday's phenomenal advance and, while it is likely to remain volatile, a sustained move below $750 would be needed to offset scope for further higher to lateral ranging.

Dollar Index - continues to range lower and would need to sustain a move above 80 to hinder potential for some further downside.


Please note - David will be away until Monday 29th September.

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