Re-pricing Banks

It’s clear that investors are re-pricing stocks for the possibility that the proposed restrictions on banks’ trading practices will impact their profits in the future. The UltraShort Financials ETF (SKF) has rallied 11% in 2 days.

Yes, bank stocks are getting hit pretty hard. But Obama’s proposed restrictions aren’t yet law, and there’s plenty of reason to believe he won’t get everything he wants. More about that in a minute…

But first, I want to point out that this situation is how the "buy the rumor, sell the news" dynamic starts. Now, granted, this is a reverse example because investors are selling stock in anticipation of bad news rather than buying ahead of good news. Still it’s a good example of how investors are pricing in a worst case scenario now, before any proposals have become law.

I think we can expect to see bank stocks rally once the reality of ay proposed restrictions is finalized. But as we know, investors don’t like uncertainty.

*****Now for some reader responses. Harry J. writes:

"…if I understand what is being said, isn’t that what should [have] been done 12 or so months ago? Not let these Banks just proceed any way they want… with their depositor’s money??!! I guess I am confused… shouldn’t this be a positive thing…? Or does the Market not want ANYTHING changed at this time so it can continue to progress positively!!??

Harry’s got a pretty good handle on it. Yes, the market does not want to see any changes to the way banks operate. Let’s face it, we can look at the bonus pools for banks and see clearly that the big banks make a lot of money for their key people. There’s no doubt that earnings will suffer if these banks’ trading practices are limited.

It’s also true that any restrictions should have been put in place 12 months ago, when these banks were getting bailed out. But the President deferred to Treasury Secretary Tim Geithner’s plan to help the banks earn their way back to health.

James H. gets at the political motivation for the timing of Obama’s speech last week:

"…this should have been on the top of his agenda when he came into office. I suspect action is being taken now because his approval rating has dropped so much and there is much grumbling even by his supporters. I also think he realizes his health care plan has such little chance of going any further. 

And let’s not forget we have mid-term elections coming up. I suspect they figured it’s better to deal with the market uncertainty now with this, Bernanke’s confirmation or not by Congress due at the end of this month, and I think Geithner is going to be replaced. He’s become a real liability to Mr. O. and I’ll bet he becomes a scapegoat and perhaps deservedly so in some respects, as in the AIG deal.

PS: I believe the US Global Investors team and you have the best understanding of China and stock selections from there.

God bless and have a prosperous 2010."

First, I want to thank Mr. H. for his compliment. My staff and I work hard to provide top-notch research and stock analysis.

It does appear that Obama is trying to save his political bacon by cracking down on the banks now. But I also can’t help but wonder if the recovery we’ve had would have been possible if banks earning potential had been limited.

I think investors, and bank CEOs, forget that banks were literally on the verge of collapse. In addition to a liquidity crisis that made it impossible to meet their liabilities, those liabilities were growing larger by the day as the now famous "toxic assets" were plummeting in value.

The government had two choices: take over insolvent banks and back absorb all those toxic assets; or, give the banks the cash they needed and then create an environment where the banks could start earning their way out of the hole. The government chose the latter, and was essentially forced to encourage the banks to make as much money as possible to pay their debts, including TARP loans.

From this perspective, the rally was "engineered" because the banks received so much aid. It’s ironic that bank CEOs have taken the stance that they did it themselves.

*****One thing I am wholly in favor of is the administration’s philosophical switch from Tim Geithner to Paul Volcker. It may not be good news for the banks, but Volcker has experience that Geithner simply lacks.

******My most recent video investment conference is ready for your on-demand viewing pleasure. You can watch China Inc.: Understanding China for Outstanding Profits by clicking HERE.
To top