The Wells Fargo (band)wagon

Good Evening: The U.S. stock market was able to shake off an early decline to finished mixed today, as financial stocks continued to bask in the afterglow of last week’s “earnings” pre-announcement from Wells Fargo. Those with doubts about both the recent equity rally and the veracity of the WFC results stand in stark contrast to the views among many that the arrival of the Wells Fargo wagon brings not only a turnaround for the banks, but also a bottom for our markets and our economy.

Though most markets in Europe were closed today, the majority of the bourses in Asia were on the frisky side overnight. These gains did not translate into upside for U.S. equity index futures, however, and stocks opened with losses of approximately 1%. A lack of economic news out today enabled market participants to debate the merits of chasing the ongoing rally in financial stocks. A positive cover story in Barron’s over the holiday weekend helped American Express (+ 8.66% today) to buck the early undertow, while shares of Citigroup (+25%) caught fire and singed a few shorts. Market participants have been told more than once during this bear market that “the worst is behind us” by executives at financial companies, but today’s 7.9% gain in the KBW bank index leaves the BKX almost exactly 100% above the low tick set back on March 6. I guess investors must believe the outcome will be different this time.

Buttressing these very hopes was an annoucement by Goldman Sachs that it had raised more than $5 billion to buy up private equity stakes from distressed investors (see below). It is indeed different to see private funds devoted to what is supposed to be the private task of cleaning up the debris left by a down cycle, so I applaud them for it. Furthermore, the seeming ease with which Goldman raised these billions led to speculation that GS itself would soon be able to pay back its TARP funding. After the bell today, Goldman jumped aboard the Wells Fargo bandwagon by releasing positive earnings news ahead of schedule. It will be interesting to see how investors react to this news, as well as to Goldman’s plan to boost its capital base by selling more shares. Considering the 55% leap in GS common during 2009, one would think investors were expecting a stock buyback instead of the dilution they now face.

The corporate news wasn’t uniformly positive, as BA, GM, and WFR all disappointed to varying degrees. In addition, there were stories aplenty about the return of bullish sentiment among individual investors and how the speed and scope of the run up during these last six weeks could soon leave these new bulls wishing they had taken profits. Market participants with this type of pessimistic outlook held sway for most of the morning, while the optimists were in control for most of the afternoon. A small sell off in the final half hour left the averages mixed on relatively low volume. The gain of 0.25% for the S&P paced the indexes finishing in the green, while the 1% loss for the Dow Transports was the worst performer among the laggards. Treasurys rose in response to the Fed’s sizeable $7.37 billion purchase of 2 and 3 year notes today. Yields fell between 5 and 10 basis points. The dollar reacted as if it was allergic to the resulting monetization and fell 1.4% against a broad basket of competitive currencies. Precious metals finally reacted to the Fed’s money printing by going higher, but the rise in gold and silver wasn’t enough to push commodities higher. Crude oil and its products fell between 2% and 4%, causing the CRB index to decline 0.5% today.

Of the many proud moments I’ve had as the father of three fine sons, I particularly enjoyed watching my middle child play the title role in a community production of “The Wiz” last fall. His show opened on November 20th, and while I noted to myself at the time that investors were also hoping for some wizardry from Hank Paulson and his TARP, I neglected to write about it. I will rectify this oversight this evening by describing the possible investment lessons to be learned from my son’s more modest role in an upcoming performance of “The Music Man”. Of this musical’s many songs that have been wafting through my house in recent weeks, “Wells Fargo Wagon” is particularly instructive.

Set in opening years of 20th century America, the Music Man is the story of a con man who hopes to fleece the good folks who live in the fictional town of River City, Iowa. Ring any bells with the opening years of the 21st century? Arriving as it did with all the goods not available in small towns one hundred years ago, the Wells Fargo wagon literally carried the hopes and dreams of rural America when it pulled into town. Consider the first and final chorus from the song:

“Wells Fargo Wagon” — from the Broadway play, “The Music Man”

Opening Chorus:
O-ho the Wells Fargo Wagon is a-comin’ down the street,
Oh please let it be for me!
O-ho the Wells Fargo Wagon is a-comin’ down the street,
I wish, I wish I knew what it could be!

Final Chorus:
O-ho, you Wells Fargo Wagon keep a-comin’
O-ho, you Wells Fargo
Wagon, keep a-comin’.
O-ho you Wells Fargo Wagon, Don’t you dare Ma(k)e a stop
Until you stop for me!

More than a few fast-talking mortgage brokers went traipsing through American towns large and small between 2003 and 2007. They were selling the American dream on the cheap; it eventually became an expensive nightmare for all of us. And yet, just last week, the modern day Wells Fargo wagon rode to the rescue! Now taking the form of a huge upside earnings surprise in the first quarter by the banking giant of Broadway fame, investors hope this wagon is laden with good news from other financial firms as well. WFC’s announcement was so shockingly good that many investors are starting to wonder what all the fuss has been about with America ‘s large banks. Why should we even bother subjecting these firms to a stress test at all? Certainly the WFC results mean the bottom is in for the banks, the markets, and the economy, right?

Perhaps, but it seems to me that investors have short memories. Remember all the bank executives who said in June of 2007 that “the problems are in subprime and they are contained”? The problem soon grew worse, but it didn’t stop these same executives from making similar claims in October of the same year. Gullible investors believed these claims enough to push both the Dow and S&P 500 to new record highs during that same month. After Bear Stearns was forced into the waiting arms of JP Morgan in March of 2008, a chorus of “the worst of the financial crisis is now behind us” went up that spring among the head honchos at these same firms. Citing the tremendous values the battered shares of their firms represented, bank executives used the resulting bear market rally to raise capital. When Fannie and Freddie hit the reef in the summer of 2008, we were once again treated to “the worst is over” song. Then Lehman went under and the music stopped.

Now that the banks have received their wish in the form of relaxed mark-to-market accounting rules, we are hearing it all again. Wells Fargo is merely the vehicle for this latest outbreak of investor credulity, but now even the analysts not named Mike Mayo or Meredith Whitney are sounding the alarm about WFC’s true capital needs (see below). Since most of these firms will, like Goldman Sachs, try to raise capital now that their stocks are rallying, please remember what these firms do best — sell. Many times during the great financial crisis of 2007-2009 the banks have spun tales that would make “Professor” Harold Hill blush in order to raise the funds they needed to stay in business. And each time has turned out to be a less than opportune time to buy stocks.

Ultimately, Harold Hill comes clean and his redemption in “The Music Man” leads to a happy ending for everyone in River City . Perhaps today’s banks will do the same and we’ll all live happily ever after, too. But have an eye peeled for the next banks that try to jump on the Wells Fargo bandwagon by delivering “earnings” in Q1. They’ll be looking to sell; shouldn’t we be looking to do the same?

— Jack McHugh

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