Commentary by David Reilly
March 18 (Bloomberg) -- This may end up being the Seinfeld rally. After all, the stock market’s recent rise seems to be based on nothing, aside from empty chatter.
Over the past week or so, the president and his minions, members of Congress, and a host of bank chief executives have made a concerted effort to spin the market. The message has been clear: It’s time to get on board with Team America where the glasses and bank balance sheets are officially half full.
That is working some temporary magic. The Standard & Poor’s 500 Index is up almost 14 percent from early last week. The KBW Bank Index, meanwhile, leapt about 40 percent.
For all that, investors should be on guard. While hot air got markets off the ground, it isn’t enough to sustain them. Nor is it likely that any rally, even if recent lows were a bottom, will lead to the kind of V-shaped recovery some investors still dream is possible.
The reason? The economy still looks lousy. Banks haven’t worked their way out from underneath toxic assets and souring loans. Debt markets remain fragile. Even Federal Reserve Chairman Ben Bernanke’s measured comments over the weekend about the prospect for a better 2009 second-half are tempered by expectations the Fed will have to increase efforts to drive down long-term interest rates.
One sign the six-day surge stands on such shaky ground comes from the way it started -- the disclosure early last week of an internal memo from Citigroup Inc. Chief Executive Vikram Pandit.
Looking Up
In it, he said the bank was profitable in January and February and is enjoying its best quarter since the financial crisis started in 2007. The missive also said revenue, excluding certain writedowns, in those two months came to $19 billion.
Later in the week, Bank of America Corp. Chief Executive Officer Ken Lewis dropped into a speech that the bank expects “more than $100 billion in revenue this year, and close to $50 billion in pretax, pre-provision earnings.”
At first blush, this all seems to be a sign of a turnaround. If that’s the case, the banks choose a pretty strange way to convey such important and material news.
Strange, unless they didn’t want to provide detailed information for which they might be held accountable. No surprise that neither Citigroup nor Bank of America filed their market- moving information with the Securities and Exchange Commission. Had they done so, investors could put more faith in the numbers.
True, Citigroup included its memo in a regulatory submission to the SEC. The bank noted, though, that the information was “being furnished, not filed.” That’s legalese for, “If these unofficial projections don’t pan out, don’t blame us.”
‘I Know O.J.’
As “Daily Show” host Jon Stewart noted while mocking cable business news networks, investors shouldn’t blindly accept the word of a CEO talking up his or her own business. “For instance, I know O.J. Simpson,” Stewart said. “He told me that he didn’t kill anybody, and he should know. He was there.”
Citigroup also emphasized pre-provision, pretax earnings. Pandit’s memo, for example, estimated the bank had generated $8.3 billion in such profit.
Provisions are charges banks take against profit to build reserves to absorb loan losses. Some investors say pre-provision profit reflects a bank’s true earnings power.
Maybe this is true in normal times. Today, investors are concerned that the need for more provisions will overwhelm banks. That worry was underscored Monday when American Express Co. reported higher delinquency rates for credit cards in February.
So ignoring provisions in today’s markets is like a bad golfer totaling up his score while excluding mulligans.
Banks weren’t the only ones jawboning markets. Congress pitched in with talk of changes to rules governing short-sales and mark-to-market accounting.
Underlying Cause
Neither goes to the underlying cause of the crisis -- banks making bad loans using too much borrowed money to people buying overvalued homes.
Consider the uptick rule, which Congress last week called on the SEC to reinstate. Until the SEC abolished it in 2007, this rule required investors to wait for a stock’s price to rise before shorting it. A short sale entails an investor selling borrowed stock and hoping to buy it back later for less.
Many investors have clamored for the rule’s revival, saying it prevented shorts from piling onto already falling stocks.
Bringing the uptick rule back may indeed help slow the momentum in a declining market. Yet it won’t change the underlying rationale for going short -- that investors think banks still face hefty losses and don’t believe their books.
It’s also worth remembering that the uptick rule was around when markets nosedived after the tech bubble burst. The Nasdaq Composite Index fell almost 80 percent with the rule in place.
Shameful Give-Away
Likewise, calls to scrap mark-to-market accounting may ultimately undermine, not lift, markets. True, accounting rule makers on Monday proposed a rule change that may give banks a way to avoid recognizing some mark-to-market losses.
Yet even that shameful give-away won’t eliminate mark-to- market accounting or mask balance-sheet weakness.
President Barack Obama kicked this all off with comments two weeks ago that stocks were a buy based on their attractive price- to-earnings ratios.
When presidents start talking about P/E ratios, there’s a good chance we’re seeing a bear-market rally. For something more lasting, investors need real signs the housing market is improving and the increase in unemployment is slowing.
(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: David Reilly at dreilly14@bloomberg.net
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