Everett Dirksen Would be Horrified

Good Evening: U.S. stocks enjoyed a broadly based rally today, as investors took a Meredith Whitney upgrade of Goldman Sachs prior to its earnings release tomorrow as a cue to buy not only financial names, but the rest of the tape as well. Volume was light, and measures of volatility melted like a San Antonio snow cone as July options entered expiration week. That stocks were able to shake off early jitters about CIT group and turn early losses into large gains by the close may indicate a ready-to-speculate mindset among investors heading into the upcoming Q2 earnings season. To pick just one index, the S&P 500 could rally back to (or even surpass) the June highs if market participants are willing to drink pretty whatever results corporate America posts during the next few weeks. No matter what happens, I’m pretty sure the late Illinois Senator, Everett M. Dirksen, would not be pleased with what is happening in Washington, D.C. these days.

Stocks in Asia were once again on the weak side last night, and our index futures were thus struggling during the wee hours of Monday morning. This early weakness was reversed when bank analyst, Meredith Whitney, issued her first-ever “buy” rating of a financial stock since opening her own firm earlier this year (see below). Goldman Sachs was the recipient of these glad tidings, which were amplified when Ms. Whitney appeared as a guest host on CNBC this morning. Though she could hardly be called a raging bull about the financial stocks in her coverage universe, Ms. Whitney does expect GS to report a blowout quarter and she even tossed a “cheapest among the bank stocks” bouquet to Bank of America. Investors took her less bearish than usual posture to heart and pushed stock index futures into the green prior to this morning’s open.

After an early pop, the major averages then sank bank until they were down on the order of 0.5%. Stories were flying that CIT, a lender to many small and mid-sized businesses, might some day be forced into bankruptcy. Riding almost immediately to the verbal rescue, however, was your federal government in the form of a statement issued by Treasury Secretary, Tim Geithner. When posed a question about CIT in London this morning, Mr. Geithner implied the feds will be able to address CIT’s issues without disrupting the many businesses that depend upon it, saying:

“I’m actually pretty confident in that context we have the authority and the ability to make sensible choices,” he said in response to a question at a press conference in London. “We have a significant interest generally in trying to make sure the financial system gets through this, adjusts where it needs to adjust and emerges stronger.” (source: Bloomberg article below)

Translation? “We’re not sure what steps we’ll take, but we’ll do something”. CIT, which had traded as low as $1.10 in the early going, then began a slow and uneven rally that erased 2/3’s of those initial losses. That comeback, coupled with the strength in Goldman and Bank of America, proved contagious. The previously moribund financial stocks seemed to all perk up, and they led today’s persistent rally in the main indexes.. The KBW bank index (BKX), for example, resumed its former leadership role in rising 6.5%. By day’s end, the gains in the major averages ranged from 1.1% for the Dow Transports to 2.5% for the S&P 500 and Russell 2000. Treasurys also reversed course today, as early gains in the long end of the yield curve turned into losses by the bell. Yields were flat at the short end, but yields from 5 years to 30 years rose by 3 to 5 bps. The dollar followed the same script, turning modest early gains into modest late losses. The turn in the greenback revived gold and other commodities as the CRB finished flat after being down 1% this morning.

Last week I asked whether Alcoa, its earnings “beat”, and the subsequent reaction in the stock market (up…then down) would set the tone for the Q2 earnings season. I thought the set up was particularly interesting in that financial stocks would report early (e.g. GS is tomorrow), and that good news from this sector could propel the whole tape higher. Furthermore, the averages had already dipped almost 10% coming into this morning, leaving any recent shorts in a vulnerable position. As this morning’s reaction to the GS upgrade shows, investors are willing to buy financials even before they report, so this move might only just be getting started.

Sentiment indicators could also provide a little dry tinder for a rally, since the latest reading from the American Association of Individual Investors (the AAII) shows bears outnumber bulls 2 to 1 in the latest poll. Another way to gauge sentiment can be found in watching how market participants responded to the woes facing CIT. CIT lends in places the sales forces from Goldman, Morgan Stanley, and JP Morgan rarely tread, and its demise would leave a tough-to-fill hole in middle market lending. I don’t think CIT is too big to fail, but it will take time for capitalism to work as many smaller (and better managed) institutions take CIT’s place. This aspect of creative destruction is as messy as it is necessary if our economy is to ever stand up without Uncle Sam’s help.

Speaking of which, it simply took some less than clear assurances about CIT from Tim Geithner, and everyone went back to buying their favorite names. I guess that’s what passes for good news when an entire nation adopts a bailout mentality. The costs are starting to mount, though, as the BAC-MER piece below points out. The budget news today revealed that it has taken a mere nine months for the fiscal ’09 federal deficit to breach the Trillion dollar mark. Tellingly, April always sees net inflows due an important date on the 15th of that month. It was actually a net negative month this year for the first time in memory. The cost of all these bailouts may not come home to roost during the Q2 earnings season, but I can only imagine what the late Illinois Senator, Everett M. Dirksen, would say if he were alive today. It wouldn’t be “a trillion here, a trillion there, and pretty soon you’re talking about real money”. No, my former senator would likely gasp before roaring something like the following shot across the bows of his successors in the U.S. Senate: “Do you mean to tell me it took you guys less than half a century to devalue the U.S. dollar so much that now a trillion is the mock trivial sum a billion used to be? Do you guys even know that a trillion is a thousand billions? Pretty soon you’re talking about unreal money…”

— Jack McHugh

U.S. Stocks Advance, Led by Banks, as Whitney Says Buy Goldman
Whitney Gives Goldman Her Only ‘Buy’ Recommendation
Geithner Says U.S. Has Authority to Address CIT
Deficit woes.pdf

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