NightBlogger

Bennet Sedacca
Minyanville.com
What strikes me the most about impaired companies, whether they are automakers, airline companies, banks, brokers or GSE’s is that they seem to sing the same tune, that there is a pattern of behavior. This is how I have attempted to identify in the past what would be in trouble in the future (whether that was just to avoid their stocks and bonds from the long side or to try to profit from their missteps on the short side).

It’s a pattern that isn’t terribly dissimilar from the emotion charts I like to focus on so much. But in the graphic below, I will run this analysis on banks. I call this cycle the “Dead Man Walking Cycle.”

The first “tip-off” or “tell” is when a company releases earnings or some sort of positive announcement and the stock falls. Another important tell is the credit spreads of the debt of the company begins to widen. Then, the company will usually announce that “all is well and is so great that we will buy back stock and not cut the common dividend.” After this comes the “acceptance” phase and write-offs/write-downs are announced and that some sovereign wealth fund or private equity firm will inject capital or that a company within the same group will buy a “strategic stake.” After a brief pop in the stock and short covering rally, the stock begins to fall further and credit spreads begin to blow out and preferred shares get hammered. Then, more write-downs and more write-offs and another capital raise and finally a dividend cut to “preserve capital.”

Sound familiar yet? More

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Source: Seeking Alpha.com
We are a year into the financial pain and virtually no systemic problem has been solved. Markets have entered into a new unsustainable cycle. The new dance is a two-step. Home prices slide, delinquencies rise, defaults rise. This puts additional pressure on housing going forward. Financial firms announce greater write-offs. Retailers slump and contagion goes global. Selling grips the markets, the good and the bad are sold off indiscriminately. Commodities rise, fear escalates and reaches a crescendo as at least one major institution nears or reaches insolvency. Forecasts of impossible return to the good old days are debated and rebound timetables are pushed back. In the depths of the swoon, the Fed opens the discount window to some new and previously barred set of institutions. Bail-outs are readied, Treasury checks are cut and we rebound off the lows. Bad news becomes good, commodities sell-off and financials soar.

We are at least three episodes deep. Discount window borrowing is open to anyone not convicted of a federal crime. Interest rates are under half the official rate of inflation. House prices keep falling, delinquencies keep rising and losses keep mounting. Mountains of dubious debt have and will be parked on the Government’s books. Bad mortgages, mortgage bundles and sundry cycle on and off Fed books as the Treasury writes checks to the public, maybe JPMorgan Chase (JPM) and likely Fannie Mae (FNM) and Freddie Mac (FRE). The dollar rallies when folks ignore that the Greenback is ever more backed by home mortgages. Interest-rate jawboning replaces inflation management and traders adapt to buying policy driven rallies and shorting on rising fear and fading intervention. Fear returns, babies are tossed with bath-water, commodities rally and short attacks batter firms based on rumor and trend.

Each round sees lower lows and greater intervention. Early on, reassurances and rate cuts rallied the believers. When that failed, new regulation and credit action were added. When that failed, Treasury assisted liquidation, greater assurance and rebate checks were put into motion. As that failed, direct mortgage aid, tightened regulation and enforcement of short position mixed with explicit assurance of implicit guarantees. New housing assistance is now forthcoming and another round of rebate checks appears increasingly likely. Now that we know this cycle is not working to solve any systemic or structural problem, we will do more. How much bad debt can Uncle Sam paper over or eat? How much household and financial pain can be pushed onto government books? How much more will the Fed, Treasury, SEC and Congress have to do to reverse the next leg down? Are we flirting with disaster? With a loss of confidence in state intervention to slow or reverse the slide?

There are distinct patterns emerging. Slides are lasting longer and falling to new lows. More dramatic and extensive interventions are required to generate shorter rebounds. These factors do not augur well. Fed and Treasury actions stall downslide and nibble at the edges of larger problems. Nothing like an actual solution is in the offing. Time buying and slide soothing will have to continue long enough for an organic turn around to take effect.

Otherwise, we will ride this unsustainable wave into the rocks. Rates are below comfort levels. Consumer, producer and import price inflation are well above stated target levels and recent historic norms. Deficit spending is rising fast. There are few candidates left for discount window action that have not already been invited. Recent slides in oil and commodity prices are creating some rotation back into equities and financials in particular. There is no meaningful improvement in fundamentals - yet.

The weakness of US and EU demand has put downward pressure on oil futures prices. This is combining with housing policy, Fannie Mae and Freddy Mac assistance to breathe new life. Folks are buying on oil and commodity declines. There has been some dollar strength as US economic weakness pressures oil and commodity prices. Does that sound sustainable? The dollar has done some strengthening - further pressuring oil and commodities - as Congress and candidates get down to promising spending and tax cuts that can not possible be paid for out of tax revenues? Oil is down on declining demand from economic pain. Federal Deficit spending is spiking on bail-outs, bail-ins and rebate checks. This is good news for American equities and the macroeconomic outlook?

If this bounce is like those leading into it, I expect a real show as it reverses and greater drama is called for form the Fed, the Treasury and traders. Who will get creative temporary assistance next? Who will be attacked suddenly by a rabid short crowd on 3 month old news? What further guarantees are forthcoming? What will they say when the discount window gets a “billions served” sign a la the golden arches?

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