Good Evening: Most U.S. markets reversed their recent trends today, as 2009’s laggards became leaders and vice versa. Equity short sellers finally ran into a rally that didn’t fail, commodities actually advanced, and gold was tarnished. The proximate cause came in the form of Fed Chairman Bernanke’s testimony before the Senate. His remarks may indicate that a wholesale nationalization of the U.S. banking system isn’t in the cards for now, so investors flocked back into financial stocks. Whether this nascent return of risk appetites has any staying power may depend in part of what President Obama says tonight, but while knowing what our government doesn’t want to do is somewhat helpful, investors will likely refuse to commit capital in any serious way until they know what our government will do.
Neither the news overnight nor the economic releases this morning had any bullish portents in them. JP Morgan’s decision to slash its dividend, along with further retreats in bourses overseas elicited little more than a yawn from stock index futures traders. Likewise the horrendous drop in both the Case-Shiller home price index (- 18.5% yoy) and consumer confidence (25 vs an expected 35 — see below) were mostly ignored. Given that the major U.S. averages have been under pressure almost all year and looked ready to drop off the page yesterday, the 1% rally at this morning’s open looked very much out of place. Even when the shorts smacked this initial pop back to unchanged, the S&P never buckled and never did breach its November 21 low of just below the 740 mark.
The rally that followed was almost as tepid as Chairman Bernanke’s written testimony before the Senate (for BAC-MER’s take, see below), but it did manage to set a new high just before lunchtime. At some point, however, Mr. Bernanke was asked to provide some details about the concept of “stress testing” banks and whether such a test would simply provide political cover for a large scale nationalization of financial institutions. “I don’t see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalize a bank when it just isn’t necessary,” Bernanke said at the Senate Banking Committee hearing (source: Bloomberg article below). His response seemed to ease investor fears and stocks never did revisit their lows.
As the day progressed, stocks went from strength to strength before closing near their highs for the session. Some market participants pointed to Robert Prechter’s “cover your shorts” call this morning as one of the precipitating events, but Mr. Prechter holds far less sway over the markets today than he did two decades ago (see below). Perhaps our Fed Chairman’s testimony helped, as did the prospects for a presidential bombshell tonight, but whatever the reason, the major averages almost exactly reversed yesterday’s steep losses. The gains ranged from the Dow’s 3.3% to a 4.75% rise in the Dow Transport index. Treasurys mostly shrugged off the comeback in equities and a so-so two year note auction to finish mixed. Yields rose 4 to 7 bps in the short and middle sectors of the coupon curve, while the yield on the long bond actually fell a basis point. The dollar was off a bit and commodities followed stocks higher. Though precious metals and their associated equities were abandoned, oil and the rest of the CRB components rose enough to allow the index itself to post a gain of 1.75%.
To Nationalize or Not to Nationalize — is this the question we should continue debating? Judging by the sell off in bank stocks when the trial balloon of nationalization was floated above the corner of Wall and Broad streets, as well as the lift off in those same financial shares when Chairman Bernanke seemed less than enthusiastic about doing so, Mr. Market seems to be taking sides. Rather than tackle this issue on my own, I refer everyone to the points and counter-points made in print today by former FDIC Chairman, William Isaac, and Fusion IQ’s Barry Ritholtz (see below). Mr. Isaac is against the type of nationalization he oversaw during the unwind of Continental Illinois Bank, while Mr. Ritholtz points out that Citibank, Bank of America (now the owner of the former Continental Illinois) and the troubles that face them are nothing like what helped give birth to the “too big to fail” doctrine a quarter century ago.
What separates these arguments has more to do with semantics than it does philosophy. We all acknowledge doing nothing is not an option. We all know, in the wake of Lehman Brothers, that straight liquidation of our troubled banks would suffocate a financial system already gasping for air. We all know allowing the U.S. government to fully own and operate our nation’s banks is, to put it kindly, short-sighted and suboptimal. And we all know government will have to play at least some role; Uncle Sam in fact already owns stakes in many financial institutions. The real debate here turns on just what government should do next — and how we get there from here. As we wait for the Obama Administration to make up its mind and choose a course of action — soon, please! — I would hope we all start to realize we’re all in this together.
Via the TARP and other programs, taxpayers are going to shoulder some of this burden, but I hope we don’t do so alone. Shared sacrifice seems to be called for here if depositors are to retain what’s left of their confidence in our fractional reserve banking system. Equity holders, preferred, trust preferred, and convertible preferred owners, as well as junior debt holders should probably be prepared to take haircuts of some sort. They do, after all, own securities that are junior in the capital structure and are supposed to entail some risk (the details of which are listed in the various prospectuses many investors never bothered to read). Shared sacrifice of some sort will also allow the millions of nonfinancial types in our society to feel less like the chumps they believe they’ve been played for thus far. I hope President Obama takes the opportunity to address these issues tonight because all this debate itself creates a corrosive form of uncertainty that benefits none of the constituents mentioned above. When asked whether our government can play a reluctant but constructive short term role in our financial system, I hope that in addition to his usual, “yes, we can”, he also offers “and here’s what we propose to do about it…”
— Jack McHugh
U.S. Stocks Gain Most in Month as Citigroup, Bank Shares Surge
U.S. Economy: Consumer Confidence, Home Prices Slump
U.S. to Get Bank Ownership Stakes Only as Losses Rise
Prechter Advises ‘Closing Shorts’ on U.S. Stocks
Bank Nationalization Isn’t the Answer
Citi and BofA Ain’t No Continental Illinois Bank
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