Given the fact that this site is called Credit Writedowns, you would expect me to take a fairly skeptical view about the growing consensus regarding a rapid recovery in 2009. I do, in large part because I understand that banks face many risks in the coming months due to souring loans and investments which will impair capital through large credit writedowns. The central tenet of this site is that writedowns = reduced capital = reduced credit = reduced growth prospects.
Deutsche Bank has been one of the few banks to have foreseen this problem from the start and they are not singing a V-shaped recovery tune.
Loan losses for U.S. commercial banks are expected to rise to 3 percent by the end of 2010, from 1.5 percent in the third quarter of 2008, hurt by an increased percentage of bad loans, greater consumer leverage and faster problem recognition by banks, Deutsche Bank said.
Loan losses might even surpass the 3.4 percent loss levels reached in 1934 during the Great Depression as the industry has taken on increased structural risk in addition to mortgages that should become more apparent during the cyclical slowdown, the brokerage said.
Internal capital generation may not be enough to cushion losses, Deutsche Bank said and cut its earnings view on 16 large commercial banks, including Citigroup, Bank of America Corp and JPMorgan Chase & Co.
Earnings for the group will experience further pressure in the form of lower revenue in the near term, given lower economic growth and consumer spending, the brokerage said.
“Moreover, additional securities losses or tougher requirements from regulators and ratings agencies may constrain existing capital, potentially forcing a bank to limit balance sheet growth and/or pay dividends,” Deutsche Bank wrote in a research note.
Edward here. One should note that this view significantly at odds with a growing consensus. At a minimum, analysts on Wall Street are calling for a rebound in stocks as they jump from depressed levels o the back of a stimulus-induced second half recovery. Byron Wien is a perfect example. The 75-year old investor is famous for his annual list of Ten Surprises which he has compiled for 24 years, first at Morgan Stanley and then at Pequot Capital run by Art Samberg of Barron’s Roundtable fame. He expects stocks to jump a massive 33 percent in 2009.
Byron Wien, the investment strategist who predicted a recession would drive U.S. stocks lower last year, says the Standard & Poor’s 500 Index will rebound 33 percent in 2009 as the economy recovers.
Wien, the 75-year-old chief market strategist at Pequot Capital Management Inc., forecast the S&P 500 will rise to 1,200 in his 24th annual “10 Surprises” list. He also predicted gold will climb to a record $1,200 an ounce and oil will advance to $80 a barrel.
“In anticipation of a second-half recovery in the U.S. economy, the market improves from a base of investor despondency and hedge fund and mutual fund withdrawals,” Wien wrote. “The mantra changes from ‘fortunes have been lost’ to ‘fortunes can still be made.’”
A year ago, Wien’s predictions included a 10 percent decline for the S&P 500 and onset of the first U.S. recession since 2001. The main benchmark for American equities sank 38 percent, the most since 1937, as financial shares collapsed and energy and metal producers tumbled. The National Bureau of Economic Research said last month that a recession began in December 2007.
Wien, a former senior market strategist at Morgan Stanley who joined Pequot in December 2005, says more than half of his predictions have come true in the past.
Right, Wrong
Wall Street strategists tracked by Bloomberg predict the S&P 500 will increase 17 percent this year, the biggest annual increase since 2003. Wien’s projection for 1,200 is eclipsed only by David Bianco of UBS AG, who sees the index climbing to 1,300.
This kind of bullishness explains why the conventional wisdom is that Treasury bonds will fall (see the second article below for more on Wien’s views on oil, gold and China). You have seen the posts I wrote demonstrating extreme bullishness. I do not dismiss the bullish scenario at all. However, I have my eye firmly fixed on the writedowns. And they spell trouble for the banking sector and portend a weak lending environment – hardly the stuff of massive stock rallies. David Rosenberg and Bruce Kasman take this thinking to an extreme.
Policymakers in Japan drove long-term yields lower to counter deflation in the 1990s through a policy of so-called quantitative easing in which the central bank bought government securities. The Fed announced plans to buy up to $700 billion in bonds backed by home and consumer loans and said in December that it may purchase longer-maturity Treasuries.
Buying Treasuries
“It’s more likely than not that they buy” Treasuries, Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York, said in a Dec. 19 interview. “It will be a strategy, in a world where the economy is going to be in recession for the first half of the year, to keep long-term interest rates low.”
JPMorgan, one of the two firms most bullish on U.S. debt, expects two-year yields to fall to 0.5 percent. Merrill Lynch chief North American economist David Rosenberg forecast a decline to 0.4 percent. Merrill Lynch sees the 10-year yield at 1.50 percent, and JPMorgan expects it to drop to 1.65 percent.
None of the 62 economists polled by Bloomberg a year ago expected 10-year yields to end 2008 below 3.5 percent. Rosenberg, who called the recession that was officially declared to have started in December 2007, predicted a yield of 3.7 percent.
The economy will likely shrink by 1 percent this year after expanding 1.2 percent in 2008, according to the median estimate of 58 economists surveyed by Bloomberg. By year-end, the economy may be growing at a 1.8 percent pace, the survey shows.
You should note that the Federal Reserve can and will buy as many Treasury securities as it deems necessary to keep interest rates low because of its commitment to quantitative easing. If you think stocks are going to zoom and Treasury bonds are going to tank, you are ether expecting a huge economic recovery or you are betting a against the Fed. I am doing neither.
As for the economy and stocks, remember the writedowns of which Deutsche speaks. They will play a crucial role in how quickly the U.S. and global economies recover.
Sources
Bank loan losses may double by 2010-end: Deutsche – Reuters
Pequot’s Wien Predicts Rallies in Stocks, Oil, Gold – Bloomberg
Treasuries to Post 1st Loss in 10 Years, Dealers Say – Bloomberg
Pequot’s Wien: 2009 Won’t Be That Bad – CNBC
Byron Wien Announces Ten Surprises for 2009 – The Earth Times