Market Commentary

Stocks came under pressure
January 22, 2010

Stocks came under pressure from President Obama’s proposed plan to limit risk taking at the largest banks and concern that China might take a more aggressive stance in curbing its growth. 

I would like to first discuss the former.  The President has proposed that banks be prohibited from running proprietary trading operations or investing in hedge funds and other private equity funds in an attempt to limit risk with depositors’ monies. 

Many blame these proprietary trading operations as major contributory factor of the last winter’s crisis.  I must also write that a large proportion of large money center banks’ earnings have come from this sector since the repeal of Glass Steagall 12 years ago.

A question I cannot answer is whether or not large bank lending would be further curtailed if these trading desks are prohibited following the elimination of a major profit center.  Perhaps a better answer, albeit it is not the populist answer, is to regulate trading in credit default swaps (CDS) and derivatives.  Create a transparent exchange and regulations/capital requirements regarding who is actually writing the swaps, a root cause I believe for the Panic of 2008.

The primarily markets collapsed because of the lack of liquidity predicated because of no transparency or confidence in the contra party.

What I did find interesting in yesterday’s trading session was the advance in the tier II and tier III financials.  These institutions do not have trading desks, deriving the bulk of their earnings from traditional banking.  In general, earnings for this sector have been positive suggesting a moderation in loan losses and subsequent provisions, an environment I thought would occur given the rebound in the economy.

Turning to China, as noted several times the Peoples Bank of China (PBOC) last January mandated its banks to lend 25% of its GDP in a six month period to spur growth.  The large surge in the Chinese growth rate is to be expected with such aggressive lending.  The markets are now concerned what will happen as this lending is reduced.

Are these fears a harbinger of things to come in the US?  I reiterate the next major obstacle the markets will face will be the inevitable change in monetary policy.  I think after enduring some duress, the markets will rebound as such action will be viewed as an “All Clear Sign” with the S & P posting a 2010 gain of around 10% to 12%.

What will occur today?

Last night the foreign markets were down. London was down 1.06%, Paris down 1.05%, and Frankfurt down 0.96%.  Japan was down 2.56% and Hang Sang down 0.65%.

The Dow should open nominally lower over earning concerns and the impact of the Administration’s progressive stance towards the largest banks.  The 10-year is off 6/32 to yield 3.61%.