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Broken Bank Stocks a Canary in the Stock Market Coal Mine?

Stock-Markets / Banking Stocks Aug 20, 2010 - 08:36 AM GMT

By: Mike_Larson

Stock-Markets

Best Financial Markets Analysis ArticleIf there’s one sector of the stock market that trades like death warmed over, it’s the financials. Bank stocks simply can’t get out of their way these days.

Take the KBW Bank Index (BKX) of 24 leading U.S. banks. You can see in this chart that it plunged in April and May, and it hasn’t been able to get off the mat since. In fact, just this week, it’s collapsing to fresh, multi-month lows.


chart1 Broken Bank Stocks a Canary in the Market Coal Mine?

Why should you care?

Because the banks are a canary in the coal mine for the broader stock market! The BKX topped out in February 2007 … foretelling the collapse in the Dow and S&P 500 that began several months later. And I believe we’re going to see something similar happen again.

So what’s eating the banks? Plenty!

Falling Loan Demand and Mounting Loan Losses Hammering the Banks!

Let’s start with the home mortgage market …

Housing starts are stagnating in the 550,000 range, while building permits just slumped to a 15-month low. The National Association of Home Builders’ confidence index dropped to 13 in August, a 17-month low. And the Mortgage Bankers Association’s purchase loan index is hovering around the worst levels since 1997.

That pretty much means the home mortgage business is dead in the water.

Meanwhile, commercial real estate loans are a lead anchor around the industry’s neck …

Commercial lenders are getting stuck with distressed properties at an alarming rate.
Commercial lenders are getting stuck with distressed properties at an alarming rate.

Charge offs of souring commercial real estate loans surged 155 percent in the first quarter, according to the FDIC. A stunning 17 percent of construction and development loans were noncurrent at large banks, more than double the level a year earlier.

What about commercial and industrial loans, the bread and butter business loans that banks make? There’s just no demand! Companies simply don’t want to borrow.

The just-released Senior Loan Officer Opinion Survey from the Federal Reserve showed that demand for C&I loans shrank at small banks for a record 16th quarter in a row! Demand has dropped at medium- and large-sized banks in every quarter but two over the past four years.

And then there’s consumer credit: Credit cards, auto loans, and the like. It shrank 1.5 percent in the second quarter, bringing the cumulative decline to 6.5 percent since late 2008. Credit card debt alone has plunged to the lowest level in almost five years!

Slumping demand and souring loans have caused hundreds of bank failures over the past couple of years. And the problem is just getting worse …

The FDIC now has 775 “problem” institutions on its watch list. That’s more than double the 305 institutions the FDIC was closely watching a year earlier. Those banks have a whopping $431 billion in assets combined.

Margin Shrinkage Making a Bad Banking Problem Even Worse

Then there’s the issue of collapsing net interest margins, or “NIMs.” Banks make a sizable chunk of their income by borrowing at lower, short-term interest rates and lending or investing at higher, long-term interest rates.

When the spread between short and long rates is wide and rising, it’s like manna from heaven. Banks can coin money. But when it’s narrow and falling, it’s the kiss of death. The profit margin on each dollar lent or invested can collapse.

One rough spread gauge I monitor is the difference in yield between the 2-year Treasury Note and the 10-year Treasury Note.

And as you can see in the chart below, that spread has plunged from 291 basis points in February to just 210 basis points now. That’s the lowest in more than a year. It’s going to put serious margin pressure on a sector that’s already getting hammered by rising losses and shrinking demand.

chart2 Broken Bank Stocks a Canary in the Market Coal Mine?

My advice?

Get the heck out of any financial stocks you may own! And get out of other sectors vulnerable to a renewed financial and real estate slump, including REITs.

Or if you’re interested in going on the offense, consider taking a look at some of the recommendations and ideas in my latest report … The Ultimate Survival Guide for the Double-Dip Recession of 2010-2012.

It’s chock full of investments, advice and tips for surviving a renewed downturn in the stock market driven in part by a deteriorating financial sector.

Until next time,

Mike

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