Then there’s oil. The black goo rose 87 cents to $137.61 a barrel in electronic trade this morning.

MarketWatch has S&P 500 futures down 6.5 points to 1,311.80 and Dow industrial futures down 54 points.

Dan Denning in The Daily Reckoning Australia expects a ‘highly differentiated’ performance in stock markets for the rest of the year. Behind the grim stock index headlines lie individual winners and losers. For investors, it’s all about picking the former…

There’s just one full week left in the financial year. And what an awful year it’s been! The All Ordinaries index is down just over 14% for the year. It’s the worst showing for the benchmark since 1982.

But when you thin-slice the performance, you find something interesting. Specifically, you find local evidence of the global battle between the forces of commodity inflation and asset deflation. The big Aussie banks are down by nearly 30% for the financial year. Meanwhile, the big resource stocks are up 24%.

Aren’t the valuations on bank stocks cheap? Yes! National Australia Bank (ASX:NAB) trades at 8.47 x trailing earnings, Commonwealth Bank (ASX:CBA) at 11.22x, ANZ (ASX:ANZ) at 8.93x, and Westpac (ASX:WBC) at 9.7x. Those all look cheap.The trouble is you need to know what the forward earnings multiples are. You need to know future earnings. Of course no one can actually know what next year’s earnings will be. But the banks could offer us projections. Analysts would have their own opinion as well.

Our analysis? Cloudy. The earnings picture for banks is still very cloudy. If high oil and energy prices send Australia’s economy into recession, demand for loans is going to fall. Banks make money by lending money. You do the maths. Without an increase in lending volumes, banks have to generate earnings from higher fees.

On the other hand the resource stocks-as we’ve mentioned before-seem to have moved to the head of the cyclical queue. Copper and aluminium prices were up nearly seven per cent last week. Tin was up eight per cent. And those laggards lead and zinc were up nearly six and three percent, respectively.

You’d think that would be good news for resource stocks, specifically base metals. And it is, in a general sense. But part of the price rise comes from production disruptions due to higher energy costs. That’s not good. In your stock selection, then, you have to focus on low-cost producers.

What you’ll find for the rest of the year, we reckon, is highly differentiated performance. The general direction of the market will be apathetic. After all, it looks like we’re in for another wave of losses in the credit markets. Stocks will have a hard time rallying with recurring write offs and high oil prices.

Source: Big Australian Resource Stocks Up 24% in 2008

The news that’s all the rage today is Westpac’s $19 billion bid for St. George. It would create the biggest bank, by assets, in Australia. So… should we care? Big five? Big four? Big deal!

Is it a big deal if you’re an investor? That depends on whether you believe the banks are a buy. If one bank is buying another bank, then at least one bank thinks banks are a buy. But why? And is what’s good for one bank good for the investor?

The question, as always, is where earnings growth is going to come from? In that light, the Westpac move is all about growing the loan book through acquisition. Growing the loan book means putting more Australian in debt. We’ll get that in a minute. But let’s take a quick look at the details first.

First, if you exclude non-recurring items, cash profits at Australia’s big five banks grew by just 1.1% in the first half of 2008 compared to the year before. During the biggest credit crunch of the last thirty years, that’s not awful. But it’s not good either. By the way, all the data that follows, unless otherwise indicated, is taken from the KPMG survey “Major Banks: Half Year 2007/08.” It’s an excellent read. Seriously.

Aussie banks didn’t face massive losses from bad housing loans (although at least one bank, ANZ, took big losses on loans to stock brokers). So what ate into profitability? The “net interest margin” declined for all five banks in the first half of ‘08. The interest margin is the difference between what Aussie banks pay to borrow and what they pay out interest on deposits.

The credit crunch has raised the cost of “wholesale borrowing.” ANZ’s interest margin decline from 2.24% to 1.99%, Commonwealth Bank’s from 2.22% to 2.17%, NAB’s from 2.33% to 2.18%, Westpac’s from 2.25% to 2.05%, and St. George’s from 2.07% to 1.92%.

So here’s the question, dear reader: if you’re making less money lending money because the cost of money has gone up, how do you make more money? You make it up on volume.

Despite the decline in net interest margins, total net interest income actually increased by 9.8% in the first half to $17.6 billion. The banks managed that by growing assets by 19.9% in the first half compared to ‘07. Growing assets by that much is an accomplishment during a bear market in credit. How did the banks do it?

The banks grew their lending portfolios by 16.1% in the last twelve months ended March. Consumer lending (housing, credit cards, personal loans) grew by 11.2%. Business lending grew by 24.5%. Total bank assets in Australia now exceed $2 trillion.

Now THAT’s how you grow your way out of a credit crisis. You lend more. It could, of course, be troublesome if you look at bank assets as other people’s liabilities. Debt levels are already high at the household level. For banks to grow assets, household debt levels would have to grow even more and business borrowings would have to rise as well.

The trouble with growing your assets to drive your earnings is that you take increased credit risks to do it. This was the problem for the Government Sponsored Enterprises in the States and led to massive blow outs in their balance sheets (the regulators came in late to restrict the growth in balance sheet assets).

Eager to drive earnings and please shareholders (and make some money on stock options tied to earnings growth) bank managers in the States grew the balance sheet with little to no regard for asset quality. That is one simple explanation for how a mortgage lending bubble gets started.

Here in Australia, if banks are going to continue growing assets, the housing boom will have to keep booming. This is problematic too, with housing already so unaffordable. For example, the Australian Bureau of Statistics reported today that the number of home-loan approvals fell by 6.1% in March.

Higher interest rates are discouraging demand for housing loans. Yet the banks have to loan more to make up for declining margins. But the more they loan, the bigger the risk they take that the loans will be non-or under-performing.

Is there any way out for the banks? Well, they could hope for an increase in net interest margins. This would lead to a decline in the cost of borrowing money. The banks could leave the interest rates they pay on deposits fixed, and benefit from the lower cost of funding. An end to the global bear market in credit would help, then.

Of course, there’s another way banks can grow earning without growing loan volumes. You know it well! Fees!

If profitability on loans is declining (and it is), the banks could make it up charging you more fees (not that they would ever do that). The growth rate in bank fees has actually declined, if you peruse the data from the Reserve Bank. But bank fees, as you can see from the chart below, contributed nearly ten billion to bank’s income in 2008-basically half of a full year’s profit.

Source: Reserve Bank Statistical Tables, Domestic Banking Fee Income, Table F6
http://www.rba.gov.au/Statistics/Bulletin/index.html

There’s consolation in that massive income from fees if you’re a bank shareholder getting a dividend and some capital appreciation. But if the worldwide model of growing asset values through debt is under massive attack in the U.K. and the U.S., then why would it be terribly different in Australia?