Enzio's Clock

Background

1. Why G-3 banks must be avoided

First, The Economic Time™ is worsening in the G-3. For profits, this means two things:

• Turnover gets hurt in that an increasingly pronounced excess supply of goods mean that demand slackens
• Margins get hurt for a variety of reasons. Particularly in the United States, unit labour costs are rising. Add to this that in the US and in Japan, weaker exchange rates exacerbate the prices of input commodities. More so in Japan than in America. With input costs rising, we believe that particularly in America, stagflation - rising cost push inflation plus no growth - will rear its head yet again. When there is an excess supply of goods, companies cannot push cost increases on to the consumer: already, he/she is groaning under an excess supply of goods. But, should the company decide to pass costs on, the Central Banks will raise rates again in order to counter inflation. This is extremely relevant to the EU, whose Central Bank remains an inflation hawk. But also to America, where Congressional bitching at China will increase import costs from there, plus falling rates will keep driving up import costs from elsewhere, e.g. Europe and non-China Asia. This means that while US rates will fall for now, don't be surprised to see the Fed tighten later next year due to cost-push inflation returning...
• Banks cannot thrive when there is an excess supply of goods. As we are seeing now, they don't want to lend. Besides, who wants to borrow if business is drying up? The sub-prime mess will exacerbate such despondency.

In addition to these thoughts of our own, more recent reports in The Economist magazines of 15th and 22nd September have led us to advise extreme caution on buying banks in such submerging markets. We refer to both issues of The Economist below.

According to Chris Watling of Longview Economics, the clout that financial companies have in macro earnings is rising. Currently, the financial sector accounts for 27% of all profits made by S&P 500 companies - up from 19% in 1996.

Profits of the financial sector rely heavily on markets, particularly on the volume of transactions: banks and brokers earn fee income off "...arranging, underwriting and advising on deals."

Such fee income is set to dry-up:

• banks don't want to do such deals that involve underwriting, or indeed even lending;
• banks are stuck with plenty of structured products that they had hoped to on-sell, meaning that -if they have not been sold at a loss already - these artifacts now are part of their balance sheets and thus subject to capital adequacy ratios imposed by regulators;
• that The Economic Time™ is worsening in the G-3 implies more defaults, further heightening banks' and brokers' anxieties, and
• finally, submerging home prices will infect consumer confidence, further affecting peoples' ability to borrow and indeed banks' willingness to lend....

Thus, banks' turnover diminishes. As do their margins: less business is the bottom line, and with funding costs rising, the client will not accept higher charges.

And don't think that this misery is restricted to America. Remember how some avaricious German, British and Spanish banks have taken a mud bath, too.

The upshot is that G-3 banks have underperformed

• Emerging Markets' banks by 30 (US and EU) - 60% (Japan), and
  
• China's banking sector by 85% (USA and EU) to 105% (Japan) since the start of the year.

2. How to Make Money Off This Idea

1. Always consult your financial adviser first!
2. Get ETFs through which you can short the G-3's banking sectors.
3. If you must remain in G-3 markets, then buy recession - proof sectors with high dividend yields, e.g. consumer staples, food or indeed utilities.