Thursday 26 March 2009
Bear market rally unlikely to last
So on most counts, the worst is far from over for US banks and by extension, the global economy. But there will be rallies in bear markets. In the past, these have ranged from 13 per cent to 61 per cent and lasted one to seven months. Investors might enjoy them while they last, but should not mistake them for the start of a bull market.
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Bear market rally unlikely to last
26 March 2009
Stocks, especially of financial institutions, rallied after US Treasury Secretary Tim Geithner gave details of a Public-Private Investment Programme (PPIP) to invest in the troubled assets clogging up banks’ balance sheets. Cleaning up this mess is seen as a pre-requisite for financial and broader economic recovery. This latest plan is seen as meatier, more feasible, than anything that’s been proposed before.
The goal of the PPIP is for the Treasury to invest alongside private investors in funds that will buy bad loans and assets from US banks. With debt funding or guarantees from the Federal Reserve or the Federal Deposit Insurance Corporation, the aim is to mobilise US$500 billion to US$1 trillion of funds for the purpose. Observers suggest that US$1 trillion will be enough to cover all the remaining toxic sludge on US banks’ books, assuming its value is sufficiently marked down.
Hence the markets cheered. The Dow Jones Industrial Index rebounded 19 per cent off its low on March 9. Similarly, the Straits Times Index shot up 17 per cent from its March 9 low. So is this the turning point? Have financial institutions seen the worst? Banks will turn the corner when the real economy turns. But as of now, there are still a number of concerns, which Goldman Sachs detailed in a sobering report recently.
One, the markdowns by the banks of their assets are nowhere near enough to reflect the economic reality out there now. According to Goldman Sachs, on average, the banks it covers still carry 96 per cent of the value of their commercial and industrial assets in their books. The average carrying value for commercial mortgages is 95 per cent, and for mortgage and home equity, 91 per cent.
Meanwhile, home prices have fallen by 28 per cent so far, and Goldman Sachs reckons that there is another 15 to 20 per cent to go. As at the end of last year, 20 per cent of borrowers were in negative equity, with another 5 per cent near negative equity. It is estimated that the trough will be reached in early 2010 when 40 per cent of borrowers will be in negative equity. The greater the proportion of those in negative equity, the greater the likelihood of loan delinquencies. Consequently, distressed homes coming up for sale could reach 7.9 million between 2009 and 2011. This compares with existing home sales of five million in 2008.
In addition to the bleak picture on the housing market front, there is the grim employment picture. US unemployment could hit 10 per cent by next year, which points to a further rise in non-performing loans, including credit card delinquencies. In total, US banks could be staring at credit losses of more than US$2 trillion. Only US$1.1 trillion has been recognised to date.
So on most counts, the worst is far from over for US banks and by extension, the global economy. But there will be rallies in bear markets. In the past, these have ranged from 13 per cent to 61 per cent and lasted one to seven months. Investors might enjoy them while they last, but should not mistake them for the start of a bull market.
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