Unstressed

What now? The much anticipated results of the financial stress tests have been released and greeted with a loud yawn. While the results point to a number of institutions having to raise significant sums of capital, the manner in which they were released, drips and drabs over these last few days, had the intended effect of eliminating the potential shock and awe. Had the suggested capital raise figures been released just 2 months ago, the tremors rumbling through the markets could have caused a retest of the march lows or worse. Now, not just a yawn, but a justifiable continuation in this quarter long rally in financials and the markets as a whole.

One thought on the financials to keep in mind is the steepness of the yield curve. This is an extremely favorable environment for banks. Consider again, banks can gain deposits for virtually nothing, 1/2%-1% on checking and savings accounts while lending at a minimum 5% on mortgages, 7%-8% on home equity lines of credit, and an even juicier 14%-24% on credit card balances. As you can see, as I've said many times, in this environment even a chimp could make money. The Federal Reserve Chairman, Ben Bernanke recognizes this as well. We simply need to keep the banks open and they, through their normal course of business, can recapitalize themselves. And, they will need every bit they can generate. Here's why. The market is reacting as if this mornings non-farm payroll reflecting a loss of 539,000 was actually a build in payrolls. Think about that 539,000 job losses. While understandable, it broke the trend of higher job losses we've experienced, and came in sub 600,000, but it is still quite a large number. Expect the delinquency rates on mortgages, auto loans and credit cards to gravitate higher the longer this job contraction continues.

While I'm am extremely optimistic about the potential for of the US economy to rebound along with the resilience and ability of our workers to adapt and our entrepreneurial spirit, this euphoria surrounding the financials seems to be getting a bit ahead of itself. I'm of the belief the lows we saw in March was a non-traditional capitulation trade, that drove the stock prices and valuations to levels they never should have seen. The fear was rampant everywhere. That fear has clearly dissipated. The snap back rally we've since experienced has been welcome and to some extent, long overdue. Short term we run the danger, however, of valuations getting too far ahead of the current fundamental backdrop. Longer term, I believe corporate America is positioned for an above average acceleration of earnings. Most companies, or should I say the survivors, have cut expenses close to the bone and are running extremely light on inventory and manpower. As the economy improves, adding to the workforce is one of the last things businesses are want to do. So, productivity explodes and drops right to the bottom line in the form of earnings.

On a closing note before we head off to the weekend, since it is one of major importance, is the China story. China's stimulus appears to be gaining traction across the economy. The China PMI broke a hair above 50 (a sign of neither expansion nor contraction) to 50.1. This continues the improving trend experienced over the last 5 months. These numbers are always met with some skepticism. Supportive comments came from Caterpillar, among others about the level of activity hitting record levels again within China. If indeed the global economy can return to growth mode without the US consumer doing the heavy lifting alone, we are in for a stronger and more sustainable economic recovery, as I believe, but perhaps a lot more quickly than most are forecasting.

Yours Unstressed.