Market Commentary

Stocks staged an impressive rebound
July 21, 2010

Stocks staged an impressive rebound following rumors that FRB Chairman will announce during his semiannual congressional testimony banks will cease earning interest on excess reserves.  I can not underestimate the magnitude of such a change in policy.

As penned a gazillion times excess bank reserves are around $1.3 trillion versus the historical norm of $1 to $2 billion.  In my view it is not a question as if but rather when banks will begin to lend this money. Earning 0.00% on a trillion dollars is not profitable.

 Secondly a strong case can be made the Central Bank believes systemic failure of the banking system is low and the financial system is essentially recapitalized.   As noted several times banks are minting money with virtually no risk as it is borrowing funds at close to 0.00% and lending it to the government at 3% with no risk to principal if held to maturity. 

However there is one question that cannot be answered.  Will the regulatory entities permit lending?  Based upon firsthand experience the regulatory entities are strangling the banks, especially the smaller community banks via burdensome regulations and draconian examinations.  For example for years it was a guideline commercial real estate lending should not exceed 300% of capital unless certain criteria were met.  Today it is a hard and fast regulation with no flexibility thus strangling lending regardless of the institution.

Does the FRB have the ability to change this environment?  We are not China where the government mandated its banks to lend 25% of its GDP in a six month period to ensure growth.

We will know early afternoon if there is any validity to this rumor.

Commenting briefly about earnings, profits and revenues are beating expectations by 21% and 4% respectively as per Bloomberg.  I had opined expectations were low given the 2 month 16%-20% plunge in the averages.  At this juncture it appears my observations were wrong…expectations were indeed lofty as the market volatility has returned.

I again ask how much of this volatility is the result of algorithmic trading which represents about 82% of volume?  Goldman Sachs commented in their earnings release this volatility is impacting customer activity as its accounts are sitting in cash unable to discern possible direction.

Is Goldman—one of the largest algorithmic traders—killing one of its major revenue sources under the proverbial guise as penny wise pound foolish?

What will happen today?

Last night the foreign markets were up.  London was up 1.59%, Paris up 1.58% and Frankfurt up 10.2%.  Japan was down 0.23%and Hang Sang up 1.10%.

The Dow should open moderately higher as profit reports are exceeding expectations.  The 10-year is off 1/32 to yield 2.95%.