Stock market bulls aren’t concerned about the inevitable acceleration in bank failures — at least for now. Even though deposits will be insured against loss, the loss of local banks will still have a depressing effect on hundreds of small communities. These communities are going to lose their only access to business credit when their local zombie banks — loaded with toxic construction or commercial real estate loans — are liquidated or merged into other weak banks.

Meanwhile, the latest monthly figures show that commercial bank balance sheets are shrinking at a fairly rapid rate, due to a combination of several factors: loan charge-offs, older loans are being paid back at a faster rate than new loans are being made, and regulators pressuring banks to build larger capital buffers.

So credit-fueled growth in consumption or investment is not occurring. Combine this with stagnant or declining wages and corporate profit margins and it becomes hard to imagine how GDP will rebound on a sustainable basis. GDP is the stat that every money manager fixates upon — despite the fact that GDP does not accurately measure true economic progress; it’s like evaluating a stock purely on sales growth, without thinking about what’s driving sales, and whether these sales are sustainable or accretive to wealth.

Nominal GDP is calculated as “consumption + investment + government spending + exports – imports.” Then, government statisticians subtract a highly doctored CPI figure from annualized changes in the above variables to get “real GDP growth.”

Note that all the variables in the GDP equation can be pumped up by excessive credit growth. As I mentioned in the Sept. 4 alert, if GDP is growing at the expense of degraded balance sheets, the end results are never happy. Japan’s GDP stayed higher than it otherwise would have been in the 1990s despite the incredibly wasteful spending on bridges to nowhere. Its policymakers reacted to a huge misallocation of capital into real estate in the 1980s by misallocating capital into government projects and subsidies to favored industries.

U.S. policymakers are following this playbook even faster, only without acknowledging one crucial difference: Japan had a high household savings rate to finance its government deficits, while the U.S. does not. Plus, the U.S. has already “dollarized” the rest of the world, and there are signs international demand for dollars has reached its saturation point.

The gold and commodities markets are reacting to this unpleasant reality. These markets are starting to discount the fact that the Fed will be the aggressive buyer of last resort for all types of debt securities. We’ve likely only seen the beginning of growth in the Federal Reserve’s balance sheet. As long as it can get away with it, the Fed will keep creating new money out of thin air to finance the U.S. federal deficit. Plus, via its liquidity facilities, the Fed and the megabanks will keep swapping Treasuries for legacy toxic securities marked at fantasy levels.

A few wild cards could disrupt this benign “reflationary” environment we’ve been in since the March stock market bottom, resulting in the stock market taking another nasty leg down:

1. If the “audit the Fed” bill were to pass and result in more handcuffs on the Fed, it would help to slow the reckless debasement of the U.S. dollar. But if it put an end to the Fed’s exotic lending facilities, which would force the owners of toxic securities to retain and mark them down sooner, then we could see a return to the January-early March 2009 stock market environment — only most of the damage would be contained to the financial sector as equity of insolvent institutions gets wiped out or diluted.
2. Contraction in the real economy and state governments could easily overwhelm expansion in the “federal government economy.”
3. International holders of trillions in paper U.S. assets could accelerate the rate at which they diversify into real assets. That’s how we could see a spike in “money velocity” that the deflationist camp says is a necessary condition for the CPI to rise. Most of the price pressure will be felt in oil prices, especially later in 2010 and 2011, when today’s underinvestment in new oil projects leads to tight international supplies.

I’d like to bring to your attention one more thing about today’s investing climate, because it’s being used so often lately in the media to justify today’s nosebleed stock valuations: the “money on the sidelines” fallacy. Growth or contraction in the current balance of $3.5 trillion in money market funds depends on how much companies look to borrow in the commercial paper market — not on the level of the stock market, as so many seem to believe.

Those who point to the $3.5 trillion in money market funds as if it’s a bucket that can be “poured” into the stock market bucket to keep the rally going do not understand that money does not go “into” or “out of” the market, but through the market. Trader A sells every share bought by Trader B. Once this transaction settles, cash goes one way and shares the other. The price at which the transaction takes place depends on how badly Trader B wants to own shares, not how many money market shares are in his account.

Also, money market fund balances represent very liquid short-term loans; they reflect an amount of money that’s already been spent in the economy and will be paid back over a very short time frame. John Hussman — one of the best mutual fund managers, in my view — refutes the “cash on the sidelines” fallacy best. It’s worth reading and remembering the next time you hear a talking head arguing that the rally can keep going because of liquidity.

Washington Federal Closes Offering; Now We Wait for Earnings

Yesterday, Washington Federal (WFSL) announced that its secondary stock offering would generate net proceeds of $333 million. This works out to a per share price of $13.79, including underwriting discounts and expenses and assuming full exercise of the underwriter’s overallotment. Here is an example of cash going “into” stocks, because these are newly issued, rather than existing, shares in the secondary market.

As I noted in Monday’s flash alert, I expect the offering will be necessary to absorb a mounting wave of net charge-offs in the future. It’s possible that this offering plan became a necessity after a friendly suggestion from regulators to raise more capital.

On Wednesday, WFSL stock rallied on high volume, but did not reflect organic demand for the stock. JP Morgan (NYSE:JPM) was the sole book-running manager for the Washington Federal offering. Knowing that it would likely receive a few million WFSL shares as a form of compensation in the underwriters’ overallotment, JPM’s trading desk probably established a short position that it plans to cover by delivering the shares it will receive upon the closing of the deal. This likely explains the bizarre trading moves in the stock this week: When institutions were more interested than expected, resulting in a higher offering price of $14.50, JPM likely covered some of their short position.

As for the analyst reaction to the offering, the two analyst notes I saw might as well be corporate press releases, because they expect this new capital to be deployed into an FDIC-assisted rollup of lots of zombie banks in the Pacific Northwest. Also, these analysts cite WFSL’s “strong” capital ratios without adjusting for future credit losses. One might suspect that these analysts have not even read the asset quality footnotes in Washington Federal’s SEC filings.

The big losses WFSL will take on construction loans are obvious, no matter how long management claims it will be able to sit on them. But what’s not obvious to the market — yet — is the rapid future loss formation in its $6.7 billion mortgage book. Management has set aside practically zero allowance for loan losses against its mortgage book. See the chart below for the allocation of WFSL’s allowance by loan type.

WFSL carries a mere $18.8 million loss allowance against its $6.7 billion book of mortgages — a ratio of just 0.28% of assets. The harsh reality of the mortgage crisis tells us that this $6.7 billion asset value is overstated, along with capital ratios (or equity); it should be marked down by far more than $18.8 million. Yet WFSL’s accounting translates as follows: Management does not expect more than $18.8 million in cumulative credit losses in mortgages (defaults, net of recoveries after foreclosure) through the rest of this credit cycle, despite the fact that the majority of these mortgages are now underwater and the job market remains weak.

As you can see in the chart, the ratio of loss allowance to nonperforming loans (by category) has shrunk dramatically. In December 2007, WFSL’s residential mortgage loss allowance was $13 million, and its nonperforming mortgages were also $13 million. As of June 30, this loss allowance had been built up to $18.8 million, but nonperforming mortgages had grown to $119 million (and will keep growing). This loss coverage ratio has shrunk from 100% to 16% over the past six quarters (as shown in the chart’s blue line) and needs to be built back up to a respectable level. And the only way for WFSL to build it up is to book large credit provision expenses in future income statements.

Washington Federal’s “strong” capital ratios are a function of hopeful accounting. I expect the market to come around to this view — not only for WFSL, but also for the entire banking sector. Ever since the loosening of mark-to-market accounting rules last April, the creators and users of financial statements have collectively chosen to deny reality and bury their head in the sand about the future direction of market values for collateral backing loans — and the value of the loans themselves.

Everyone is waiting and hoping for a miraculous rebound in housing prices and the labor market, when we have yet to see the bottom in either. When reality sets in, this will not end well for owners of bank stocks, REITs, and other financial stocks. These stocks are claims on assets that are marked to fantasy levels.

Mark-to-market suspension has slowed the rate at which losses are recognized, but this self-delusional accounting practice cannot make the losses disappear, and will likely make these cumulative, stretched-out losses even bigger in the future by rationing credit to the healthier parts of the economy.

Regards,
Dan Amoss

Source: GDP’s Debt to Credit

Three of the financial institutions that were key catalysts to the global financial crisis – and that owe the federal government billions of dollars as a direct result of those problems – have seen their shares triple in price so far this month.

That could signal that a big rebound in bank-sector earnings is just around the corner. Or it could be merely a speculative “short squeeze” that all but confirms that these stocks are basically worthless.

Shares of busted insurer American International Group Inc. (NYSE:AIG) have soared from $13.14 to $50.23, as of Friday’s close, a gain of 282.3% so far this month. Shares of mortgage giants Freddie Mac (NYSE: FRE) and Fannie Mae (NYSE: FNM) posted similar gains,MarketWatch.com reported. Fannie’s shares advanced from 58 cents to $2.04, an increase of 251.7%. Freddie’s shares zoomed from 62 cents to $2.40 each, a gain of 287.1%.

AIG actually gained for a ninth straight day Friday, reaching a 10-month high, as short-shelling speculators got squeezed and were forced to buy back the shares they’d sold short, traders told MarketWatch. AIG has 21% of its “float” – shares available to the public sold short, the sixth-highest proportion in the Standard & Poor’s 500 Index, according toBloomberg News.

But the gains might also sign that the banking sector is poised for a major profit rebound, according to some new analyst research.

“Dating back to 1995, bank-sector outperformance has typically preceded [earnings-per-share] growth outperformance by one to two quarters,” Stifel Nicolaus & Co. (NYSE: SN) analysts wrote in a market-research note last week. “With sector earnings growth expected to exceed that of the general market in mid-2010, we question whether we will see another leg down in this rally before year-end. On the other hand, perhaps we should question the current growth expectations for the sector?”

Trading in financial-services stocks has dominated the stock-market volume this month. So-called “day traders” have gravitated to once-questionable financial stocks and helped fuel those stunning gains – and huge volumes.

Citigroup Inc. (NYSE: C), for instance, has seen daily trading volume topping 1 billion shares this week. The stock closed above $5.05 on Thursday and $5.23 on Friday. That represents a 439% gain from its 52-week low of 97 cents a share.

Financial stocks have led the market’s slingshot higher from the early March lows. Trading has been fierce in beaten-down shares of some companies that participated in the bailout, such as AIG, Citi and Bank of America Corp. (NYSE: BAC).

The New York-based AIG is trying to sell assets to repay government loans after accepting $182.5 billion in U.S. bailout money. AIG recently reported a profit for its second quarter – after having posted six straight quarters in the red. It engineered a so-called “reverse stock split,” in which AIG gave investors one new share for every 20 they turned in. The company did this to avoid a delisting action. That enhanced the short squeeze, since there were fewer shares available to for short-sellers to repurchase and “cover” their bets.

Despite the torrid run that AIG’s shares have been on, the insurance company’s bonds still trade at levels indicating the company’s shares may be worthless, Peter Boockvar, an equity strategist at Miller Tabak & Co., told Bloomberg.

“The value of the company is still the same,” Boockvar said. “AIG bonds tell you that the equity is possibly worth nothing and that they may not be able to pay back the government.”

AIG’s $3.24 billion of 8.25% bonds due in 2018 are quoted at 79 cents on the dollar, to yield 12.2%, Bloomberg reported. The insurer’s $4 billion of 8.175% percent bonds due in 2058 are quoted at 49.5 cents on the dollar to yield 16.7% Bloomberg said.

The Financial Select Sector SPDR Fund (NYSE: XLF), an ETF tracking the financial stocks in the Standard & Poor’s 500 Index, has rallied nearly 30% over the past three months and handily outpaced the market.

Market Matters

While the past few months have been anything but dull for the markets (euphoric may be more appropriate), investors enjoyed a few slow days of peace and quiet.

Another stimulus program came to a close as “Cash for Clunkers” ended with a last-minute flurry of activity.  Analysts claimed that more than 700,000 cars were bought over the past month and August auto sales should rise on a year-over-year basis for the first time since mid-2007.

While dealerships enjoyed a nice rebound in activity (even if just temporarily), banks continued to experience challenges as the Federal Deposit Insurance Corp. (FDIC)reported that 416 institutions were on its “problem” list at the end of the second quarter, up from 305 on March 31, and also conceded that its insurance-fund reserves were dwindling.

Goldman Sachs Group Inc. (NYSE: GS) was in the news again as controversy has continued to surround the investment giant since the AIG bailout and LehmanBrothers Holdings Inc. (OTC: LEHMQ) failures.  Regulators are investigating its weekly “trading huddles,” where its analysts allegedly gave short-term stock tips to select clients and traders, though most other customers were not privy to such insight.

Dell Corp. (Nasdaq: DELL) posted lower quarterly profits, though
the result still beat Street expectations and management projected stronger performance in 2010 when businesses get back in technology buying mode.  Intel Corp. (Nasdaq: INTC) boosted its revenue projections for the next few months, another sign that chip demand is increasing and the business climate continues to improve.

The Dow Jones Industrial Average roared to eight straight days of higher closes, before hitting a stumbling block on Friday (though no one may have noticed as volume was so light) and the days of triple-digit moves ended (for a week at least).

The other indexes traded relatively flat during the week and even the positive news from Intel did little to generate any investor enthusiasm in the tech-heavy Nasdaq Composite Index. Fixed income fared better than most would have expected, considering another $109 billion in government debt hit the street.

Oil surged to a 10-month high before a larger-than-expected inventory report indicated that crude demand remained weak despite expectations of an economic recovery just around the corner.  In fact, natural gas plunged to a seven-year low.

Economically Speaking

In perhaps the biggest news of the week, U.S. Federal Reserve Chairman Ben S. Bernanke will manage to avoid becoming a part of the so-called “jobless recovery” when he was nominated for another term as central bank chair by U.S. President Barack Obama.

While Bernanke certainly has his critics among grandstanding politicos from both sides of the aisle, few Fed watchers expect Congress to hold up his confirmation.  For now, continuity seems to be the best thing.

The economic data of the week was relatively favorable with signs of renewed strength in both housing and manufacturing.  New home sales jumped for the fourth consecutive month and the S&P Case-Shiller Index even depicted higher home prices last quarter for the first time since 2006.  Durable good orders surged in July on increased demand within the transportation sector as both General Motors Co. (OTC: MTLQQ) and Chrysler Group LLC put bankruptcy in their rearview mirrors and boosted production, while other companies also benefited from the “Cash for Clunkers” program.

When second-quarter gross domestic product (GDP) was announced as a decline of 1%, many analysts expected a downward revision (perhaps significant) in the months that followed.  Well, the initial revision again showed a 1% decline, a negative showing, but one that many economists believe will be the last contraction in overall activity for a while.

The U.S. consumer remains one big wildcard for the strength of the economy moving forward.  Though the Conference Board reported a better-than-expected increase in its August consumer confidence report, the Reuters/U of Michigan sentiment index offered a contrasting view as it fell to its lowest level in four months.  Personal spending in July got a nice boost from the increase auto sales (“Cash for Clunkers” strikes again), though the income component of the release was unchanged and concerns about the labor picture continued to hinder consumer activity.

Weekly Economic Calendar

Source: Soaring Prices for AIG, Fannie and Other Financial Stocks Sending Mixed Messages to Investors ]]> http://www.contrarianprofits.com/articles/soaring-prices-for-aig-fannie-and-other-financial-stocks-sending-mixed-messages-to-investors/20240/feed 0 http://www.contrarianprofits.com/articles/stocks-deliver-their-best-quarter-in-over-a-decade-so-what-now/18626 http://www.contrarianprofits.com/articles/stocks-deliver-their-best-quarter-in-over-a-decade-so-what-now/18626#comments Wed, 01 Jul 2009 15:15:29 +0000 Eric J Fry http://www.contrarianprofits.com/?p=18626 Woohoo!…U.S. stocks racked up their biggest quarterly advance since 1998! The Standard & Poor’s 500 Index soared more than 15% between March 31 and June 30 – lifting its year-to-date performance marginally into the black, and breaking a streak of six consecutive quarterly declines for the S&P 500, the longest since 1970.

This champagne-cork-popping performance obscures a few trends that should be worrisome to the celebrants. First, the S&P 500 has gained no ground whatsoever since May 8, the first trading day after the Federal Reserve triumphantly announced the results of its banking sector “stress tests.” Second, the BKX Index of financial stocks has DROPPED more than 16% since May 8. (As we have noted in prior editions of the Rude…

No matter what our government says about the true health of bank balance sheets, the real stress test for the U.S. stock market lies in what happens next to the BKX. I have a feeling the major averages will start following the banks should they continue moving lower, but who really knows? The safest prediction I can make is that the S&P 500 won’t be hanging around 850 much longer.

Reassurances over the health of the U.S. banking industry have sparked something of a recovery in investors’ appetite for risk and Wall Street looked set to join Asia and Europe with strong gains at the open.

Executives from Citigroup , Bank of America and JPMorgan Chase said last week their banks had been profitable for the first two months of the year.

Federal Reserve Chairman Ben Bernanke also said on Sunday that he sees the U.S. economic decline moderating and recovery beginning in 2010, though he said risks remain that politicians will lack the will to do everything needed to fix the fractured financial system.

Global stocks as measured by MSCI rose more than 1.3 percent, bringing gains to more than 11.5 percent since hitting a low a week ago.

“The eternal battle between the bulls and the bears will intensify this week,” said Chris Hossain, senior sales manager at ODL Securities.

“Whilst it is hard to say if we have seen the worst, we certainly haven’t seen a week like last week in a long time.”

European shares also rose for a fifth straight session, led higher by financial stocks.

The pan-European FTSEurofirst 300 and 14 percent this year after plunging 45 percent in 2008.

Earlier, Japan’s Nikkei average gained 1.8 percent to post its highest close in a month, with banks such as Mitsubishi UFJ Financial Group  jumping amid the easing fears about the health of U.S. lenders.

The benchmark rose 134.87 points to 7,704.15, its highest finish since Feb. 16. The broader Topix  climbed 2.4 percent to 741.69.

BONDS FOR SALE

The equity charge undermined demand for government bonds with June Bond futures down 73 ticks, two-year Schatz yields rising 5 basis points to 1.381 percent, and 10-year Bond yielding 3.127 percent, up 8 basis points.

“At least risk aversion is decreasing and there was no disappointment on the back of the G20,” said Patrick Jacq, interest rate strategist at BNP Paribas in Paris.

“Clearly, as financial stocks still remain the driving force, this is helping stock markets to rebound further.”

Over the weekend, finance ministers and central bankers from Group of 20 countries pledged to use their full fiscal and monetary firepower to combat the economic crisis, but the decisions taken focused more on funds for the IMF and regulating hedge funds.

The dollar fell broadly, reversing earlier gains made in the Asian session, as stock markets rallied.

The currency market was also looking ahead to policy meetings by the Federal Reserve and the Bank of Japan later in the week.

The dollar fell 0.65 percent against a basket of currencies to 86.687, while the euro rose 0.8 percent from U.S. trade on Friday to $1.3022 .

The U.S. currency, however, gained 0.49 percent to 98.43 yen .

March 16 (Reuters)

This week’s movement is Part 1 of the Elliott Wave Theory.

When the Wave 2 pullback begins, it should trade below its recent high for nine trading hours or more before Wave 3 takes it up to new recovery highs. The daily chart is also set up to give buy signals, but that could not occur until today (Monday) at the earliest.

For more, take a look at the chart below…

As you can see, the 50-day moving average happens to coincide with the top of a trading channel drawn from a high point last September. Both these technical tools currently show the $9.05 area as a significant level.

If XLF undergoes a decent pullback, short-term traders could try the long side with an upside target of $8.60 or better.

However, if the stock can manage to close above the $9.05 level a couple of times, there’s a good chance that the daily chart will trigger buy signals and we could see additional movement to the upside.

Source: Ticker Of The Week: Financial Select Sector SPDR (NYSE: XLF)

A recovery in equities indicates a pick-up in appetite for risk and may divert investment from gold, analysts said.

Spot gold slipped to $955.90/957.90 an ounce at 0941 GMT from $862.45 late in New York on Tuesday.

“The gold price is a fear indicator,” said Commerzbank analyst Eugen Weinberg. “As the chance of us seeing problems on the (equity) markets is lower than it was yesterday, some risk aversion has been taken out of the market.”

Holdings of the world’s largest gold exchange-traded fund, the SPDR Gold Trust, were also unchanged for a fourth consecutive session on Tuesday, fuelling fears burgeoning demand for gold to back ETFs may have stalled.

“There is no demand for gold other than investment demand into ETFs and into small bars and coins,” said Weinberg.

Bernanke said on Tuesday major banks should weather the recession without being nationalized. His comments that he believed the Fed could head off rising inflation was also seen as negative for gold

“If, as Chairman Bernanke believes, consumer price growth is likely to remain tepid for the next several years, then low prices are likely to present a major headwind to further gold advances,” said HSBC analyst James Steel.

Equities bounced overnight in Asia as Bernanke’s reassuring comments sparked a rebound in financial stocks. European shares tracked gains in Asia and the United States, snapping a three-day losing streak.

The dollar weakened against the euro on Wednesday, but firmed to a three-month high versus the yen. Gold typically trends in the opposite direction to the U.S. currency, to which it is often bought as an alternative asset.

However, they have moved in line in recent months as both have benefited from a flight to safety among investors.

The other main external driver of gold, oil, was steady, having shed much of the last session’s 4 percent gains.

PICK-UP

Gold buying in India has picked up as prices have retreated from the record highs they hit last week. A further dip below 15,000 rupees per 10 grams may rekindle buying interest, dealers said.

“We are getting calls for the first time after gold dipped below $1,000,” said a dealer with a state-run bank in Mumbai.

India’s buying of the precious metal tailed off as gold soared, leading some to speculate that a depression in jewellery demand could prove a major drag on prices, despite the strength of investment buying.

On the supply side, analysts say the recent increase in the gold price is likely only to slow the decline in mine production. Figures released on Tuesday showed output in South Africa fell 13.6 percent in 2008 to its lowest in 86 years.

“Long-term trends show that production in the United States, Canada, Australia and South Africa is in decline,” said Johannesburg-based Credit Suisse analyst David Davis.

“The expected increase in production from South America, Indonesia and China is unlikely to offset the decline in production from (these countries) in the long term.”

Traders will be eyeing January existing home sales data due out in the United States at 1500 GMT for clues as to the health of the economy, and further testimony from Bernanke later in the session before the House Financial Services Committee.

Among other precious metals, spot silver eased to $13.71/13.78 an ounce from $13.74. Holdings of the largest silver-backed ETF, the iShares Silver Trust, were also static on Tuesday, albeit at record levels.

Platinum was steady at $1,036/1,041 an ounce from $1,040.50. Ridge Mining PLC said its Blue Ridge Platinum unit has closed out all its hedging arrangements.

Palladium slid to $195.50/198.50 an ounce from $198.

LONDON, Feb 25 (Reuters)

Meanwhile, on Wall Street, analysts are slashing profit forecasts that still look way too high to me.

Already, high-profile investment firm Lehman Brothers (which, like some other brokers, closed its books May 31) plunged in value because the market anticipated a large loss for this quarter. It will be Lehman’s first loss in nearly 25 years – and more asset write-offs are likely. Lehman will fess-up on June 16…stay tuned.

Also, two leading banks just sacked their CEOs amid mounting sub-prime losses. Wachovia got rid of Ken Thompson, who had the misfortune of buying California lender Golden West Financial for US$25 billion…pretty much at the top of the sub-prime boom two years ago.

That acquisition turned out… badly, to say the least. Meanwhile, Washington Mutual’s Chairman will “step down” according to the bank.

These are just the latest casualties from the sub-prime credit crunch, but rest assured, more heads will roll before this financial reign-of-terror is over.

So what’s ahead for earnings this quarter?

Financial stocks are expected to fare the worst, once again this quarter (surprise, surprise). Consumer discretionary shares are next in line, with an earnings hit of -10% expected this period.

There is some good news however. Energy sector stocks should post 16% earnings gains, which is no surprise with sky-high oil and gas prices. Tech-sector profits are also expected to shine this quarter, which is a pleasant surprise to investors amid a slowing economy.

Technology stocks are enjoying a healthy export boom, due in part to the falling buck, but also from healthy demand from overseas markets. Also, tech companies just aren’t as impacted by soaring raw-material costs, like rising oil prices, which does impact so many other sectors of the economy.

The result is likely to be 15%-plus profit gains for technology shares this quarter. That’s a very nice showing amid the Wall Street gloom.

MIKE BURNICK, Senior Editor & Global Markets Analyst

EDITOR’S NOTE: Right now, Mike is researching several key ways to play the technology sector for a possible double or triple-digit gain in the coming months. Keep an eye on his Market Shock Trader alerts for more updates on these stellar plays.

Source: Why More Heads Will Roll Down Wall Street

The Journal points out that after “a reign that began in February 2002, the financial sector” is no longer #1 in the S&P 500 Index. Last week, banks, brokers and other financial shares in the blue-chip index slipped to a 16% weighting.

That puts financial shares in second place, just a shade behind the technology sector that now makes up 16.4% of the index.

That’s the first time in six years that the leadership has changed in America’s most widely followed stock index.

As the article points out, this change at the top isn’t due as much to strength in tech – as to the shellacking financial stocks took in the past 12-months.

The S&P financial sector index has plunged more than 30% – or US$814 billion in lost market value since June 1, 2007. That’s the biggest loser by far among any of the 10 major sectors.

There’s a cautionary tale here for investors who believe that big financial stocks like Citigroup will quickly rebound from sub-prime woes. The technology sector was far and away the biggest sector in the S&P 500 back in the 1990’s, but suffered a long and painful fall from grace.

Tech shares peaked at nearly 35% of the S&P 500 back in 2000 then fell victim to a violent bear market that saw tech shares lose nearly 80% of their market value in less than three years. Tech stocks made up less than 13% of the S&P 500 by October 2002.

Judging from the dramatic reversals of fortune suffered by tech shares in the recent past, financials may have a lot more room to decline in the years ahead.

And since they are well represented in popular indexes such as the S&P 500 and the Dow Jones Industrials, financial sector shares could be a major drag on overall stock market performance for quite some time. Stay tuned.

MIKE BURNICK, Senior Editor and Global Markets Analyst

Source: The First Shall Be Last

Just kidding. Obama looks like he has locked up the Democratic nomination today. Wall Street may not like the prospect of an Obama Presidency.

It’s kind of amusing to watch CNBC as analysts try to explain why the market has taken a sudden turn for the worse. Lehman Brothers is down 8%. Uh oh. GM’s monthly sales were off by 30%. Uh oh.

Of course none of this should have too much of an affect on Australian stock prices. The Reserve Bank elected not to raise the cash rate from 7.25%. The RBA concluded that the last eight rate hikes have made borrowing sufficiently expensive that household and business credit will not contribute to overheating in the economy. Phew!

But if people can’t or won’t borrow more, that doesn’t meant they won’t have more money in their pockets. There’s always an increase in income to drive domestic spending. That income—in the aggregate—comes from Australia’s record terms of trade, as we mentioned earlier this week. As far as we know, there’s not a lot the Reserve Bank can do about that. Wage pressures have to be building.

The share market didn’t find the rate news much of a relief from the weakness in U.S. financial stocks. The Aussie financials were down and so were the miners. If the miners and the banks are down in Australia, the index is down. The only exception is energy, where Santos is making waves in the LNG market.

For the record, we still think banks stocks are dogs. Globally, banks continue to de-leverage and raise capital. You might make a spirited argument that the worst of the housing-related losses have been taken. But, even if that point were generously granted, you’d still have to ask where in the heavens bank earnings are going to come from?

The only possible answer is that the credit cycle is reversing and interest rates are headed lower. This may possibly be true in Australia. But it can’t possibly be true anywhere else in the developed world. The ECB remains hawkish. The Fed never got tight in the first place. And the Bank of Japan is in no position to raise rates with the Japanese economy in a fragile state of expansion.

So once again, Australia is the weird looking kid on the global block, with a cycle that seems to be at odds with everyone else’s. What will it mean for the Aussie dollar? Well, the RBA won’t cut rates until it sees signs that inflation is slowing down. And it’s going to be months before that happens (if it does happen, that is.)

In the meantime, you’d expect traders to sell the Aussie dollar if they don’t think interest rates are headed higher. Yet that did not happen en masse yesterday. On the economic front, building approvals were up 7.8% on a seasonally adjusted basis. This gave the Aussie a little nudge and countered the prospect that interest rates may have topped out.

Since we’re going on the record today, we can’t see the Aussie getting a lot weaker against the greenback this year. The rate differential between the two currencies favours the Aussie. And if rates aren’t driving the pair, then it would economic growth.

You can go ahead and forecast a bottom in housing, a top in oil prices, and a major rebound in the U.S. in the second half—all of which would drive the greenback higher and probably lead to a significant rally in U.S. stocks (and selling in BRIC and emerging markets, including Australia.) But it is easier to write out that scenario and actually believe it.

Still, there are some folks who believe that the U.S. is scraping along the bottom, albeit in prolonged fashion. We think these people fail to realise that the world is witnessing a structural reallocation of capital away from Western markets and toward developing markets. Granted, this theory allows for big rallies in U.S. shares.

However, for our money, it’s best to focus on the long term compound growth in earnings available in the emerging and developing world, than trying to trade rallies in the U.S. stock market, where a decade of managing corporations for short-term profit has put U.S. companies on the back foot in global competition. The game has changed.

There was more perplexing news on the economic front. Australia’s current account deficit was up 4% to $19.49 billion, according to the Australian Bureau of Statistics. The deficit on goods and services rose by $1.4 billion, or 22%.

It’s pretty strange that you have a country in the middle of arguably the greatest export boom of all time—and you’re running a current account deficit. The trouble is, despite its continental size, Australia is small in terms of population. It is hard for an economy of this size to produce the diversity of goods available in the world. There are not enough human resources for a truly diverse economy.

And with globalisation, why would you produce things locally you can buy on international markets? There are some things you want to do locally so you don’t have to rely on trading partners (energy, food, banking). But Australia’s trade and current account deficits seem to be structural in nature. The country will always import capital goods, textiles, and consumer electronics—things not likely to ever be made competitively in Australia.

Is it time to look at base metals again? Zinc, lead, nickel, and copper all came off the boil last year. Meanwhile, energy and bulk commodities (coal, iron ore, phosphate) all zoomed ahead. But now, maybe things are heating up in the base metals again.

Melbourne-based Jervois Mining announced that is has been approached by a Chinese consortium to develop the Young nickel deposit in NSW and produce 50,000 tonnes of nickel a year. When we get back to Melbourne next week, we’ll ask Gabriel and Al what they think of base metals prices and base metals stock and report back to you.

Dan Denning
The Daily Reckoning Australia

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Source: Australia’s Current Account Deficit Up 4%