Enzio's Clock

Background

1. How the Economic Time® affects financial stocks

In our recent piece on why one should be vigilant about America's financial stocks, we cited two mechanisms by which the Economic Clock® impinges on this sector. 

• In the monetary economy, there is an excess demand for money: individuals want to de-leverage, so they scramble to the banks and in their savings accounts to shed debt. That, of course, creates an excess supply of goods: nobody goes shopping.
• In the real economy, therefore, companies that are producing goods have to de-stock. 

Thus, the de-leveraging of the consumer creates the de-stocking of the producers. So how can turnover or margins increase in such an atmosphere of an excess supply of goods?

What does this have to do with the outlook for financial stocks? We know that we have been dead wrong on this sector: it has risen sharply, while our recommendation to short this sector has hurt those following our advice.

We have not given-up, however. Recent events in Spain confirm our pessimism.All of this despite Wells Fargo's profits net income having risen by 50% and other lenders doing very well due to an 88% boost to re-mortgaging, courtesy of lower rates. But does the Economic Time really change just because mortgages are  cheaper? Who has the money to service even this cheaper debt, ultimately?

2. Spain: a recent example

According to The Economist of 4th April 2009, p. 73, Spain's small savings banks, or cajas, are having problems. Turns out that they have been at the epicenter of financing an unsustainable building boom in Spain: in 2006, three quarters of a million homes were built there. That is "half the number in America, whose population is seven times as large." Talk about what an excess supply of money can do to asset markets!

Because these cajas lent about half of what the property developers needed to borrow, and because these developers are going bust, the cajas are having problems. So one result is that on 29th March, the Spanish government had to inject about USD 12 billion to keep banks afloat.

The upshot, pointed out in said Economist, is that "...the banks' woes have moved on from mark-to-market losses on esoteric trading assets to big hits on traditional  loan books. Spain may undertaken the first bail-out of the second act of the banking crisis."

That "second act" was reinforced in an op ed in the Asian Wall Street Journal of 7th April ("From Bubble to Depression" by Prof. Vernon L. Smith and Steven Gjerstad), p. 13. Their view is that "...a financial crisis that originates in consumer debt, especially consumer debt concentrated at the low end f the wealth and income distribution, can be transmitted quickly and forcefully into the financial system." Indeed, Prof.Vernon attributes the Great Depression to precisely this type of financial tsunami, originating in consumer debts based very much on wobbly mortgages that require servicing. 

In the context of recent, stellar performance of America's financial stocks: so now that mortgages have been re-financed, who has the money to service this cheaper debt? Yes, banks' margins have widened because of lower funding costs, and their turnover has increased because they collect hefty fees when re-financing. But what about that unemployed consumer who still has to keep paying-off that debt?

3. How to Make Money Off This Idea

1. Always consult your financial adviser first.
2. Have a look at a long-term position in an ETF through which you can short the financial sector in America, SKF:US
3. It has lost sharply of late; this  entices a short-term macro trading idea.