The market has a major recovery since it's March lows and is current stagnant, the major players trying to decide where the economy is actually going. Is this the start of the recovery? Or is there still hidden skeletons in the closets. Why is it that recent bank results from Citibank, JP Morgan, Bank of America were positives with the banks turning in a profit for the first time since last year and yet the market behaves as if it never happened. Why is the US government going through great effect that the stress test results are actually positive, with a few bad factors of course, when things could be worse. This issue, we will explore the facts, myth and conspiracies that will determine when we will recover.
The Recovery of Banks? Truth or False
The verdicts are out. Some of the biggest banks in US are earning around 1 billion dollars of profit for the first quarter of 2009. It is the first profit seen since the start of the subprime crisis. The market rallied 29% on news from an internal memo that Citibank is making money for the first 2 months. The rest of the banking giants came along and reassure the investors that they are making money. The market recovery should be in place with banks now making profits, but the rally simply fizzled right after the banks announced their results.
International Monetary Fund (IMF ) adjusted their assessment of the extent of the toxic subprime from 1 trillion dollars in 2008 to 4 trillion dollars in 2009. That means the banks should be reporting losses given that the write downs should worsen instead of making a profit. One of the key factor is the change of the accounting rules for the toxic assets. Citigroup recorded revenue of $2.5 billion from a decline in the value of its own bonds. A 2007 change in accounting rules allowed the company to gain from its investors' loss because the company conceivably could buy back the debt at the lower value, paying less than it originally expected. Earlier this year, accounting rule-makers also loosened the rules that determine when a company must recognize a decline in an asset's value as a permanent loss. Citigroup said that change added about another $600 million to its bottom line. Goldman Sachs last reported earnings through the end of November. It reported a profit for the first three months of 2009, then separately reported a large loss during the orphaned month of December. The company switched its reporting periods as a consequence of its decision to become a bank.
With all these manipulation going on, it is not surprising that most of the banks record a good profit for the quarter. The real test comes after the second quarter. If the banks still continue to report such stellar profits, than we are indeed in a recovery stage. Any sharp profit drops will remind the world what creative accounting can actually do: That is to help the balance sheets of a company.
The US Banks Stress Test
A stress test is conducted on 19 of the largest financial institutions in US to examine the survivability of these banks in the face of a worsening toxin environment and how many of them can withstand any other shocks similar to the collapse of Lehman Brothers and the unwinding of even more leveraged products. The interesting observation is that President Obama is initially reluctant to release the results of the stress test. However, under great pressure from the public, it is announced that stress test results will be announced on 6 May 2009. Other observations includes VIP coming out and declaring that US banks are "well capitalized" with a few "exceptions" and the banks are "recovering" and most will not "need more help" with a few "exceptions". It seems that the government are on a public relations spree to assure the world that the banks are generally in good shape. What's strange is the initial reaction to withhold the results and the excessive propaganda about the "fine banks" make all this a bit suspicious. Are they trying to smooth over the fact that the results are "fine" when in actual fact, many of the banks may be in risk of liquidation and collapse? Are they trying to reinforce the confidence setting a new benchmark such that a bad bank years ago can be considered as a "fine" bank in today's context. Well, 6 May will tell us the answers. If the government delivered what they declared without any creative accounting, the banks may be true and well. If the darker prediction of the stress test results comes true, the market will be in for another dive.
Practical Singapore
One interesting observation was made by a fellow respected Singaporean, our Minister Mentor Lee Kuan Yew, says, ".. if you believe what Bernanke and Geithner say, there are 'green shoots'; American banks are beginning to show a little bit of profit. But that may be because they've changed their method of reckoning, per quarter instead of December which counts from January."
"So I have my doubts. But anyway, it's good to be optimistic. The Americans are always optimistic, which is good."
Minister Mentor Lee effectively downplayed the impact of the recent optimism and also predicted that the subprime will last till 2011. Being a small country, we have no room for rosy prediction and positive thinking. Given, that we are in the worst recession since the founding of modern Singapore. We have to be practical about the extend of the crisis and react accordingly to the severity of the recession. It seems the US government is trying all means to turn the economy around, including positive propaganda that things are getting better. After all, we are in a confidence led crisis. It is the lack of confidence on the banking system that lead us to this mess, from a small subprime problem. Positive thinking may help US but not for us. Perhaps, our leaders have a more realistic outlook on when this crisis may really end.
Strategy For Now
I mentioned in the last article that we are probably in for a minimal "W" shape recovery before we commit all our capital into more aggressive funds. We are currently at the brink of turning back down, all eyes on the bank stress test results. Meanwhile, latest economic data remain mixed. Some are worse, some are getting better. Getting better means these results are falling less. Falling less still means falling. It also means that things are worsening at a slower pace, that's all. Most major traders and investors also believed that a "W" shape recovery is "suitable" in this market. With self fulfilling prophecy at work, it is not hard to follow the crowd and go along with the belief of a "W" shape recovery. Of course, measures are in place, just in case it is not a "W" but a "V" or even a "L"
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