Rally In Financial Stocks - Economic Reality & Market Illusion

We are a bit perplexed by what would seem like “irrational exuberance” in the markets today (Monday) - in particular, the financial stocks. We are all but too aware of the nuance between “reality” of the economy and the “illusions” that the market clings to from time to time.

As there are always three sides to any story, this is our view:

March pending-home sales up 3.2% month-over-month, better that the 0.4-0.6% expected. With the moratorium on foreclosures lifted last month, our impression is that increase in pending home sales is more a function of financial institutions pushing its inventory of Other Real Estate Owned properties off its books.

We do not think the $8,000 tax “deferment” is the end-all-be-all to getting first-time buyers to step up to the plate. We think it is more of a function of investors, both foreign and domestic, being willing to take a chance. We would also point out that while recent home prices increased nationally a bit, could this be more of a function of the deterioration in the economy resulting in McMansions going into foreclosure?

March construction spending rose 0.3% month-over-month — better than the 0.9% decline in February but below the 1.0-1.5% expected. There needs to be more clarity with what is and is not included. Our discussions with small developers in the Chicagoland area yielded that financial institutions were willing to extend credit to developers (depending on what percentage of the project was completed) to finish the project. We do not think that there is a market improvement in the economy, but it makes simple economic sense that a building that may go into foreclosure is easier to sell if it is completed.

Where the devil is that darn “stress test”? The whispers are that we will hear the pronouncement this Thursday. Why the delay? Clearly a number of the financial institutions in question vehemently disagree with the findings per closed-door meeting. We were made aware of Citigroup’s (C) and Bank of America’s (BAC) need for capital last week. Wells Fargo’s (WFC) halo appears a little tarnished; it was revealed today that it will also need additional capital.

It is extremely counterintuitive that companies that will in all likelihood need to dilute their shareholder base and their respective stock price should be afforded the type of price appreciation experienced over the past month or so.

By raising capital, it does not necessary mean a translation into loan growth, considering that many of these institutions have downsized their mortgage operations over the past 2 years. We suspect these institutions will be purchasing their loan growth, through independent mortgage brokers or directly from Fannie Mae (FNM) or Freddie Mac (FRE).

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