Tuesday, April 17, 2007

Market Review, April 16, 2007

I’ve been engrossed with the tragedy at Virginia Tech, so I’ll keep this post short. If anything, I’m reminded again the value of life and how insignificant money really is.

I have been anticipating a meaningful economic slow-down due to the imploding housing sector. I current hold some leap puts on XLF (SPDR for the financials) but no other short positions. However, I’m constantly on the look out for the possibility of being wrong. Long stories short, the signals are still conflicting, but if there is one way out, I believe it lies in growth opportunities outside the US.

Today’s market rally has been attributed to the March retail sales which at +0.7% was stronger than anticipated. Since I place a lot of weight on consumer spending, this was obviously a non-confirmation to my bearish view, even though on a YoY changes basis the trend is still pointing down. Nor does the data jive with the State tax receipts reported by Russ Winter.

The entire financial sector rallied strong today on the back of earnings from Wachovia (which was strong) and Citi (not so). The following paragraphs dealt with the increase of loan loss reserves at both banks.

Like other U.S. financial institutions, Citigroup has begun taking steps to deal with weakening consumer credit.

"Credit costs increased $1.26 billion, primarily driven by an increase in net credit losses of $509 million and a net charge of $597 million to increase loan loss reserves," the bank said. It said the $597 million charge compared with a net reserve release of $154 million a year earlier. This included higher losses and reserves in the U.S. consumer division, Citi said, reflecting "an increase in delinquencies in second mortgages and a change in estimate of loan losses inherent in the portfolio."

At Wachovia, the bank increased its provision for credit losses to $177 million in the first quarter from $61 million a year earlier. It said that net charge-offs rose to 0.15 percent of loans from 0.09 percent a year earlier, while nonperforming assets increased to 0.40 percent from 0.28 percent.

So loan losses are increasing. For Citi, 509 million is about 10% of the net income (~5 billion) on 25.5 billion of revenue for this quarter. Citi shot up 2.5% today following the announcement so apparently investors are saying “ho-hum” to the loan loss. But what if the loan loss continues to increase as the ARM reset schedule looms? The word “discontinuity” aptly describes recent price action of New Century, Nova Star and the like, so in my mind, this market’s pricing efficiency regarding spill-over news from the housing sector remains suspect.

On the other hand, world markets have been on fire: China, Malaysia, Germany, and Brazil, just to name a few. Both precious and base metals are doing well, while the US dollar is in the tank. The only conclusion I can draw is that the market is betting world growth to continue even if the US slows down. Whether the emerging economies can develop their internal demands quickly enough will be a key question going forward.