Friday, November 21, 2008

A few thoughts on banks


Just when you thought that Team 850 had managed to contain equity weakness, they pull their bid and stocks go down like a lead balloon. Yesterday's price action was frankly farcical, as Spoos caught a bid on news of a bilateral deal for the automakers....only to get cratered when news subsequently emerged that no deal will be passed any time in the foreseeable future.

CORRECTION: Yesterday in this space, Macro Man made some non-negative comments about the US Congress. This should have read "They're all a bunch of muppets." He regrets the error.

In any event, this was a particularly painful sell-off. While Macro Man was/is a strategic equity bear, he had expected to see a rally to sell into. As such, he has watched his view pan out without having a position (and therefore, a profit.) Very frustrating indeed.

The ruptures in fixed income markets alluded to yesterday picked up a significant head of steam, as the back end of the US curve engaged in what can only be called an uber-rally. 30 year Treasury yields fell by more than 40 bps....and they lagged 30 year swap yields by more than 25 bps! We have seen this movie before in Europe, with exotic interest rate structures blowing up and causing unprecedented volatility (and inversion) in swap curves. Needles to say, the movie doesn't end happily....though at least the US version won't be punctuated by a rate hike next month.

We are now at the point where the pricing of certain fixed-income markets appears to defy all rationality, and indeed belief. The chart below shows the US 2-30 swap spread curve, which compares 2 year swap spreads to 30 year swap spreads. An inversion shows that the environment is distressed- i.e., that bank credit is less desirable in the near term (2 years) than the longer term (30 years.) As you can see, despite 2 year swap spreads coming back in, the 2-30 swap curve has inverted massively. That's not good news.
One theme that's starting to get quite a bit of airtime to justify a bullish stance on equities is attraction of the dividend cover in the US. Incredibly (to anyone under the age of about 70), the current dividend yield of the S&P 500 is now higher than that of the 10 year Treasury bond. This is supportive of stocks, the thinking goes, because you get paid to hold them relative to bonds!

Perhaps, but there are two pretty good reasons why it would be very dangerous indeed to use this as a market-timing tool...or even a valuation device. The first, of course, is that a dividend paid last quarter will not necessarily be paid next quarter. Particularly in this uncertain environment, one in which earnings expectations remain too high, Macro Man would expect the realized dividend stream over the next twelve months to be less than the trailing divvy yield indicated on your Bloomberg screen.

More interestingly, those dividend yields need to be volatility adjusted. In case you hadn't noticed, equity volatility has gone up a bit recently. A 4% dividend yield on a 12% vol index isn't quite the same as a 4% yield on a 80% vol index. Hell, just ask the holders of structured credit turds how attractive their yields are!

In seriousness, this issue of volatility and risk premia has historically been an important one. From the beginning of the 20th century until the late 1950's, the SPX dividend yield stayed well above bond yields. It was only in 1959 (according to data from Robert Shiller at Yale) that the two yields crossed over, a relationship that they have held for the ensuing 49 years. But if we are talking about Deporession-style economic and market conditions...doesn't it make sense that the dividend yield/bond yield relationship reverts to type as well? Are equities not something of a damaged asset, as the business model of earnings growth funded by leverage is discredited?
Would it be that bad, or even surprising, if we reverted to a world where dividends explain a greater proportion of equity returns, and price appreciation less? It's certainly food for thought.
In any event, US banks are once again coming under pressure, with the once-mighty Citi looking like it's in trouble. Rumours of a merger (more on this below) are circulating throughout the market today, which have given futures a bit of a bounce. A number of punters that Macro Man speaks to are suggesting that banks now look cheap and worth a flutter from the long side.

In response, Macro Man asks them to have a look at the chart below. It is lagging, coming as it does from the Fed's flow of funds data- the last update was for Q2. And it is macro data- circumstances may be different for individual institutions. But insofar as the theme of 2008 has been "the great de-leveraging", it must be something of a concern that as of Q2, commercial banks' asset growth was a) still double digits, y/y, and b) still near the highs. Worrisome stuff, as it suggests still more pain in the pipeline.
Finally, Macro Man has a few quick-hit observations/tid-bits about banks and the market in general:

* Apparently, nearly 40% of the companies in the SPX no longer qualify for inclusion in the index. The S&P 314 doesn't quite have the same ring, does it?

* There are only 9 stocks in the S&P 500 that are positive y-t-d.

* Goldman Sachs is now below its IPO price in 1999 (and waaaayyyyyyy below its capital raise offering price in September.) Hank Paulson hasn't done much right, but getting out of GS stock at ~$200 tax free was a sensational trade.

* Citigroup's market cap as of yesterday's close was $26 billion. Assuming headcount were reduced to 300,000 today.....that would still value each employee at only $86,666. Still, it could be worse...GM's market cap only values its workers at $6,578 a head...which is close to their hourly wage.

* Although Macro Man cannot verify this, apparently UBS stock is now trading at a lower price than a Big Mac in Zurich. Attention UBS employees: if your boss tells you that this year's bonus will be a "whopper", that's not necessarily good news.

* Finally, in case you haven't heard it, the hot rumour has Citigroup merging with Goldman imminently. Apparently the new firm will be called "Sachs and the Citi".


Anonymous said...

"UBS stock is now trading at a lower price than a Big Mac in Zurich."

Sounds bogus to me. The econmist says 6.36 USD in July (with a much higher Euro):

Managed to sell some bond futures today at 129-00. I hope that the market becomes rational before I become insolvent. :)

Charles Butler said...
This comment has been removed by the author.
sumedh said...
This comment has been removed by the author.
Charles Butler said...

The interesting possibility you raise, MM, is that stocks again be considered claims on future income, rather than on the dreams of future punters. Makes sense, given that the long term capital gain theory now is false in absolute terms over 11 years (with mass retirements looming). Now add the opportunity cost of the risk free rate to the mix and even Greenspan's 1% looks like mana from heaven.

It'll take a few years for that to sink in, however.

sumedh said...

"Sachs and the Citi"

Note to self: Avoid reading Macro Man's blog while drinking coffee.

Macro Trading Ideas said...

About 30yr treasury I suppose that this movement is due to unwinding of TOB structures (long 30municipal/short us30 treasury funded shortly), infact my index of this product has gone ballistic.
This morning we're seeing another huge flattening of 10/30. As you've told, it'so so similar at june/july European curve dislocation.

About Citi, mkt price is stunning, but at least if breaked up it could value a lot more. Citi needs to work as a traditional commercial bank, no more no less.
With Pandit, alternative investments divisions had 10 funds: do you want to know how many funds are collapsed now? 9!!!
With Old lane paid 700mln, it hasn't been a good deal!

Anonymous said...

Why do you speak about yourself in the 3rd person.

Macro Man said...

As the "about" tab says, it is purely an artistic device.

Anonymous said...

Macro Man,

You da bomb:)

You are spot on w/your usual witty observations.

Up and up day today will be in US equities yet can't say how long (days) would it last.


E said...


Damcanu said...

So far today, the FTSE is up and staying above yesterdays lows.

High volume come into the FTSE future yesterday afternoon, so it makes me think that maybe, some buying / short-term accumulation took place. Only time will tell if this is more than a little bounce.

bigjohnstud said...

Hey MM,

in the Wash Post this week Jim Coleman Cadillac ran this add:

175 New Cadillacs.

We're so proud of selling the Best America has to offer, buy any new or pre-owned cadillac
and we will give you...

100 Shares of GM Stock


....I half expect to see this as the next bailout strategy.

Anonymous said...

MM - thank you for the post. If the cornerstone of equity valuation is the Dividend Discount Model what happens if there are little dividends to discount? Best illustration of problem in relation to dividend yield argument, as you say, is development of CASH dividends going forward. To see how this market has collapsed look at DEDZ0 Index CT {go} on bloomberg. Listed dividend futures for Eurostoxx 50 components. Scary to think that the market is saying dividends will be half their 2008 level even in 2014. how pessimistic is that??? surely by this point we see a re-weighting of the index to allow in industries that have earnings/dividends. This index has of course become very finance heavy in recent years.

Macro Man said...

Anon @ 2.01, thanks, I'd not seen that before. Scary indeed. Pity it's not more liquid...would be a neat proxy for betting on the trajectory of future economic growth.

Lemmiwinks said...


what does commercial bank asset growth suggest to you?
Actually I think it is a good sign now that everyone starts talking about recession, that the commercial banks havent deleveraged.
You can get weekly data on commerical banks balance sheets from the FED here
Its been the shadow banking system that has deleveraged as can be seen from the CP market.
Lets pray the commercial banking business wont contract much.

Lemmiwinks said...

correction: that everyone starts talking about deflation..

Anonymous said...

Re: Citi / Goldman

e-mail going around suggesting that Citi will soon get a capital infusion from Somali pirates, who need a place to receive and store their ransom money

Anonymous said...

MM - think you'll find liquidity is ok (what's great at moment?) on the dividends. you price it OTC and then cross on exchange. possibly a steepener is trade. but nothing easy at moment. good luck and thanks again for blog comments.

Anonymous said...

Why not just trade divi swaps? Or no liquidity left there, now?

drchaos said...

e-mail going around suggesting that Citi will soon get a capital infusion from Somali pirates, who need a place to receive and store their ransom money

Citi depositors notice the pirates in the teller queue, and besiege them for tips on secure burial of chests.

Bennanon said...

The recent fall in US 10 year bonds is quite alarming. The flight to quality and panic selling is amazing. The bounced we had today in the SP500 feels like it was meant to come but my guess is it won't last. SP500 earnings seem under pressure, no real visibility of earnings which makes it had to predict, the market is pricing in $60 eps for SP500 but what if its actually $ be safe maybe the SP500 hits 650 in the next down leg before the buyers real start to come out of hibernation...

Banker said...

Great ending to your post! It brought a smile to my Face.

I enjoy your insight.

Chidambaram said...

I’m worried that beginning Monday (tomorrow) or sometime later this week, the US dollar might go into a free fall collapse. The world will change overnight if that happens.
In fact I’ve been worrying about this all weekend so far …
We’ve all been looking at the data on increased demand for US Treasuries and interpreting it as increased global faith in the US Treasury. What if that interpretation is not valid?
Consider what would happen if China, France, Russia, Argentina, etc … the countries that have been rather openly issuing challenges to the US dollar … trigger a sell off in their Treasury holdings …
The rest of the market will have no choice but to follow, since these official holders of Treasuries are the largest there are …
A sell off in the Treasuries will collapse the US dollar for sure
What we’re going by is China’s statement that they’re interested in preserving the value of their forex reserve. What if that game has already ended?
Once the US dollar collapses, all the other countries in the world will be free to pursue a completely independent monetary and fiscal policy to promote their own domestic economic growth rapidly.
Besides right now we’re still on Sunday, November 24, 2008 and as of today there’s only a lame duck administration in place. The new administration has yet formed itself officially, and the old one is on the way out.
What better time for them to trigger a US Treasury sell off than now, if at all they’re considering that option?
I’m no expert on interest rate swaps. Please could anybody comment on the 30 year swap? Even if you’re not an expert, but just clever at reasoning things out, your analysis would really help.
If the market is expecting reduced interest rates in future, can that imply the above market position? I might have made a terrible mistake in my reasoning above.
If Friday’s market movements are really showing the market doubting the full faith and credit of the United States in the fixed interest rate leg of the interest rate swap, what it implies is that we’ve been terribly wrong, thinking all along that since foreign official and private players seem to be buying a lot of Treasuries, it shows their confidence in the US and the US dollar!

Anonymous said...

Re dividend swaps versus listed dividend futures. fair to say that increasingly market participants are looking to move their derivative exposures from OTC (bank facing i.e a swap) to listed exposures that are exchange facing. long dated dividends for those with a longer investment horizon look like good value but near term volatility could remain high given the exposures that have built up in this instrument in recent years that need to work through the system. suppose that rational can be applied to a lot of products now i.e the multi month risk versus multi year value.

Anonymous said...

Comparing bank to food price...... the Swedish bank SEB actually hit its low in 1993 at a price less than a hot dog (SEK 3 vs 5)!! The rally that followed was impressive 3 - 59 in four months time.