Meredith Whitney is bullish on banks

Meredith Whitney, the so-called most powerful woman on Wall Street, moved the markets today with a bullish short term call on the banks. She was particularly bullish on Goldman Sachs. Her earnings estimate for Goldman Sachs, which reports tomorrow, is $4.65 compared to consensus estimates of $3.48. She predicts they will earn $20 for 2009 and more than $22 for 2010.

Goldman Sachs had their highest earnings in 2007 at $24.73. 2006 was at $19.71. In a year where Goldman Sachs is deleveraging, if they can pull off these types of earnings, it will be remarkable.

Naked Capitalism has two videos of Meredith Whitney making these calls.

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Earnings Season

Earnings season is upon us once again.  According to Marketwatch:  "Analysts surveyed by FactSet Research on average expect earnings at S&P 500 companies to be down 35.9% from the year-earlier quarter. Those surveyed by Thomson Financial expect earnings to be down 36.6% from the year earlier." 

In the fourth quarter of 2008, earnings were negative as a whole for the first time for the S&P 500.  On a bottom up basis, analysts are projecting that continuing earnings for Q1 2009 will come in at $13.00 a share up from -$0.11 in Q4 2008.  They are projecting as reported earnings to rebound to $8.75 up sharply from the stunning loss of -$23.16 for Q4.

Analysts missed the impact the recession would have on stocks.  Just 6 months ago, they forecast that Q4 continuing earnings for 2008 would be close to the all time record reached in Q3 lf 2007.  They forecast that Q1 2009 would break the record. 

A year ago, they also forecast a quick recovery from the drop in continuing earnings in Q4 2007.

Analysts are pricing in that the bottom is in for the recession.

Here is an update on Robert Shiller's S&P 500 graph.  Going back to 1881, the average P/E ratio using the trailing 10 years of real earnings has been 16.34. As of today, the current P/E ratio is 14.82.  Using the historical average, stocks are slightly undervalued.  However, the stock market has traded at much lower levels in the past.  In 1982 it reached 6.82 times 10 years earnings.  In the Great Depression it reached 5.56 and it reached 4.78 in 1920.

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Withheld taxes indicate personal income is taking a turn for the worse

The amount of withheld taxes received by the Department of the Treasury for a 12 month period ending October 31, 2008 was 0.65% higher than a year ago after being adjusted for inflation. This is down from September's rate of 1.43%. This is significantly lower than the rate in 2006 and 2007 where 12 month's withheld taxes grew on average by 4.5% a year.

Withheld taxes gives us a day to day glimpse of how personal income is faring well in advance of the official numbers.  So far, withheld taxes in this current downturn is resembling the slowdown during the 2001 recession. Withheld taxes is still currently growing. If the downturn continues, there could be a long ways to go before reaching the bottom. Especially if this turns out to be a stronger recession than the one in 2001.

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Useless Dow Jones Industrial Average Trivia

Yesterday and today the Dow Jones Industrial Average had back to back gains.  The Dow had had a streak of 24 days without having back to back gains.  Before today, the last time the Dow had back to back gains was September 26, 2008 when the Dow closed at 11143.13.  Today the Dow closed at 9325.01 (16.3% lower from 9/26). 

Since October 1928, that has happened 18 times; 11 times since the Great Depression and 7 times during the Great Depression.  It happened 5 times in 1931 alone.  That is pretty dismal considering it could only happen 11 times within one year.  The record is 52 days without back to back gains set in 1931.  The last time it happened before this string was in 1995 and then 1984 before that.

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A look at historical values on S&P 500 Earnings and Home Prices

Throughout the housing bubble, Robert Shiller's book, “Irrational Exuberance”, has served as my compass. In particular, his graph of U.S. home prices adjusted for inflation going back to 1890 was etched in my mind.

In his book, he talked about a home price index that was constructed in Amsterdam with over 300 years of data from 1628 to 1973. He writes “Real home prices did roughly double, but took nearly 350 years to do so…the annual real price increase was only 0.2%.” He released a graph , combining the Amsterdam data with data from Norway and the U.S., in a paper he published later.

Every month I update the S&P Case-Shiller Home Price Index and include what the CME Futures market is pricing in for prices in the near future. Here is a link to my most recent post on the Indexes.

Robert Shiller also had graphs of the S&P 500 going back to 1871. His website at http://www.irrationalexuberance.com/ has spreadsheets that get updated every so often. Here are two of his graphs that I updated with data through today's close.

Going back to 1881, the average P/E ratio using the trailing 10 years of real earnings has been 16.34. As of today, the current P/E ratio is 16.98. Whether or not the stock market is fairly valued right now is in great debate (as shown by the huge gyrations of the stock market in recent weeks). It really depends on what you think will happen to earnings and how severe the slowdown will become. Here is a graph showing the earnings for the S&P 500 going back 20 years.

The analysts have been caught off guard by the severity of the credit crunch. Back in April, analysts thought that 2008 Q2 earnings would be higher than the peak in 2007 Q3. Here is a graph from my April 2008 post. 2008 Q1 and Q2 earnings were substantially lower than forecasted. For the last year, analysts have constantly been surprised by earnings and have consistently overestimated earnings for the last 12 months. Last week's plunge was in part due to the fact the market was realizing that there will be a slowdown in earnings due to the credit crunch. The million dollar question is how much and how long the slowdown will be.

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Withheld taxes post weak growth; further slide is likely

The amount of withheld taxes received by the Department of the Treasury for a 12 month period ending September 30, 2008 was 1.41% higher than a year ago after being adjusted for inflation. This is up from August's rate of 0.76%. This is significantly lower than the rate in 2006 and 2007 where 12 month's withheld taxes grew on average by 4.5% a year.

So far, withheld taxes in this current downturn is resembling the slowdown during the 2001 recession.  Withheld taxes is still currently growing.  If the downturn continues, there could be a long ways to go before reaching the bottom.  Especially if this turns out to be a stronger recession than the one in 2001.

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Growth in withheld taxes is slowing down dramatically

The amount of withheld taxes received by the Department of the Treasury for a 12 month period ending August 29, 2008 was 0.73% higher than a year ago after being adjusted for inflation. This is down from July's rate of 1.66%.  This is a dramatic decline from 2006 and 2007 where 12 month's withheld taxes grew on average by 4.5% a year. 

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Growth in Withheld Taxes slows in July

The amount of withheld taxes received by the Department of the Treasury for a 12 month period ending July 31, 2008 was 1.71% higher than a year ago after being adjusted for inflation. This is down from June's rate of 2.27%.

Through the last cycle, the year over year growth rate of withheld taxes closely mirrored the stock market. The real growth rate turned negative just as the recession ended. It wasn't until the end of 2002 and the beginning of 2003 that the growth rate bottomed and started to improve. The stock market also started growing at the same time. Currently real withheld taxes is growing year over year, but the trend is downward.

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Withheld Taxes show income still growing but at a slow rate.

The amount of withheld taxes received by the Department of the Treasury for a 12 month period ending June 2008 was 2.39% higher than a year ago after being adjusted for inflation. This is up slightly from May's rate of 2.20%. Through the last cycle, the year over year growth rate of withheld taxes closely mirrored the stock market. The real growth rate turned negative just as the recession ended. It wasn't until the end of 2002 and the beginning of 2003 that the growth rate bottomed and started to improve. The stock market also started growing at the same time. Currently real withheld taxes is growing year over year, but the trend is downward.

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Withheld Taxes Show Income is Declining

The amount of withheld taxes received by the Department of the Treasury for the last 12 months through May 2008 was 2.27% higher than a year ago after being adjusted for inflation. 12 month's withheld taxes ending in May 2008 is now off 0.63% from the peak reached in December 2007.

While withheld taxes are declining slightly, they have not reached the magnitude that occurred during the 2001 recession when withheld taxes declined over 5% year over year. Withheld taxes gives us a real time peak at what is happening to income. It is consistent with the recent spate of economic data suggesting that we are flirting with recession but are not feeling the effects of a full-blown recession.

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Withheld taxes show that personal income is still declining

Withheld taxes show that personal income is still declining. One year's withheld taxes through April declined 0.21% from March after being adjusted for inflation. Withheld taxes peaked in December 2007 and have declined 0.91% since then. Before adjustments for inflation, Withheld taxes has grown 2.31% for the first four months of the year compared to a year ago. Core CPI has averaged 2.37%. This is also not accounting for growth on a per capita basis. The U.S. has averaged 1.01% population growth over the last 10 years. Real growth less than 1% would still be negative on a per capita basis.

Withheld taxes gives a real time peak at income. Income is declining consistent with the manner it declined at the beginning of the last recession.

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Ambac posts loss of $1.7 billion; market cap is at $351.65 million

Ambac Financial, the second biggest bond insurer behind MBIA, reported first-quarter net losses of $1.7 billion or $11.69 a share. Analysts had expected a loss of $1.51 a share. Ambac insures bonds worth more than half a trillion dollars and yet has a market cap of only $351.65 million after today’s close.

Some of their losses are coming from suspect deals. Per the Wall Street Journal:

Ambac has hired legal and forensic experts to examine 17 of its financial guarantee transactions covering residential mortgage-backed securities as performance deteriorates.

During its first quarter earnings conference call Wednesday, David Wallis, Ambac's chief risk officer, said the company is examining transactions that have performed much worse than expected.

Wallis suggested that one prime candidate for legal scrutiny is a deal with Bear Stearns Co. it closed in April 2007. Another is a transaction with First Franklin.

Ambac originally projected that losses on the underlying collateral of the Bear Stearn's transaction would be between 10% and 12%, but now expects losses at 81.8% of underlying collateral, a transaction that has seen an unexpectedly "rapid escalation of losses," and represents an outsized percentage of the insurer's expected credit impairment, Mr. Wallis said.

Some of the factors the company will examine include loan-level document review and a review of legal documents "focusing on representations and warranties," Wallis said. "Hypotheses are being built which involve fraudulent activity in various guises."

Here is a chart from Ambac's presentation showing the losses incurred. Highlighted in yellow are the Bear Stearns and First Franklin Deals.



Mortgage delenquencies have not yet peaked and are still accelerating. The financial crisis is like an iceburg. We can see some of the losses, but the bigger question is how much future losses are lurking beneath the surface.

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Market is pricing in a quick recovery

The stock market is shrugging off massive writedowns by banks and brokerage firms. In the beginning of this month when UBS wrote off $19 billion in bad debt, the stock market had a strong rally. The stock market is pricing in that the worst is over. Here is a chart of the S&P 500’s earnings over the last 20 years. Earnings peaked in Q3 2007 and fell sharply as banks and brokerages took a lot of mark-downs. Over 20% of the S&P 500 companies have reported already. Earnings have been on average better than last quarter. The majority of banks and brokerages have already reported for this quarter, so it looks like Q1 2008 will rebound from the lows reached last quarter. In fact, according to the earnings estimates, the market is pricing in that Q2 2008 will be higher than the highs reached in Q3 2007. The market is then estimating that earnings will then regain their old form and continue accelerating higher at a rapid pace.This would be a very fast recovery. After the recession in 1990, it took 4 years for the market to surpass the highs reached before the recession. After the recession in 2001, it took the market 3.5 years to surpass the highs.

I think it is too early to call a bottom in the financial crisis. Housing prices are declining at an accelerating pace. Delinquencies and Foreclosures are also surging.

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Withheld Taxes Stablizes in March

Last week I discussed Withheld Taxes and Matt Trivisonno’s real time daily charts. Marketwatch has an article on TrimTabs, an investment research firm, and their analysis of Withheld Taxes.

Let's start with the bad news: Not only is the economy in a recession, according to TrimTabs, it has been in one for six months now. The only reason that this isn't more widely recognized is that it takes months, if not years, for the government to officially confirm that a recession has started.

Now the good economic news from TrimTabs: There is a distinct possibility that the economy has already emerged from the recession, or is about to. TrimTabs bases this relatively cheerful assessment on an analysis of daily income tax withholdings from the U.S. Treasury. According to Madeline Schnapp, director of macroeconomic research at TrimTabs, withholdings during March were 4.1% higher than one year ago.

Adjusted for inflation, 12 months taxes withheld through March 2008 was virtually unchanged declining 0.026% from February 2008; year over year 12 months taxes withheld is up 3.41% adjusted for inflation. After dropping sharply in January 2008, taxes withheld has stabilized in the last two months. However, there have been similar rebounds before when the overall trend was down during the last recession.

Although my chart for taxes withheld only goes back to 1999, it is possible to get an idea of what it looked like by looking at income taxes filed with the IRS. Income usually declines significantly during recessions (just like it did during the 2001 recession). The current decline has been very small so far.

This current possible recession is being led by the housing and credit crisis. All the housing indicators are still getting worse: mortgage delinquencies and foreclosures (are still accelerating), housing prices (going down at a faster pace), housing demand (sales are still dropping fast), credit crisis hasn’t been resolved (lending is tight and large writeoffs are ongoing). I believe it is premature to call the end of a recession. Furthermore, I think it is still premature to say one has definitively started.

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Withheld Income and Employment Taxes: A Real Time Insight into Income

The Department of the Treasury reports daily the amount of Withheld Income and Employment Taxes. This gives us insight into income in real time. Matt Trivisonno updates the data daily on his blog. Here is his post discussing the info. Here is his daily chart.

I was able to compile complete monthly data going back to 1998. The chart on the right shows the amount of the Withheld Taxes for the past 12 months updated on a monthly basis starting January 1999 (January 1999 reflects data from February 1998 through January 1999). Withheld Taxes rose at a fast pace from 1998 and started to slow at the end of 2000. The S&P 500 started to decline around the same time that income growth started to decline. Withheld Taxes didn’t start to rise until mid 2004 well past the official end of the 2001 recession. However the rapid decline started to slow at the end of 2002. The S&P 500 bottomed out around the same time. Withheld Taxes is once again declining. Incomes tend to decline during recessions.

This second chart is a monthly version of Matt Trivisonno’s daily chart. It shows the year over year change of the Withheld Taxes for the past 12 months updated on a monthly basis. This shows how the S&P 500 is forward looking. When Withheld Taxes are starting to slow the S&P 500 declines even before the growth rate goes negative. Conversely the stock market rebounds as the decline rate starts to improve even before it turns positive.

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Stock Market rebounds again after large Gap Down

The SPY (tracks the S&P 500) opened down 2.345% today. Counting today, since 1994, the SPY has gapped down more than 2.25% 17 times. It has closed higher than it opened 16 times with an average gain of 2.89%. Today SPY continued the trend closing 1.37% higher.

I discussed this trend in this earlier post. Here is the updated spreadsheet.



Here is a look back at the days with largest gap downs with intraday charts going back to 1998.

9/17/1998: The stock market was affected by the Russian/Emerging Market Crisis. Russia defaulted on their government bonds in August and September. Long Term Capital Management (LTCM) was unraveling due to related highly leveraged trades. LTCM was bailed out by the Fed on 9/24/1998.



9/21/1998: Russian/Ererging Market/LTCM Crisis.



10/8/1998: LTCM used up $1.9 billion of $3.6 billion injected into the fund the prior week with the Fed bailout. Another hedge fund, Tiger Management, lost $2 billion on October 7 because of the Yen Currency bets.



1/13/1999: Brazil scraps their currency support and lets their currency float resulting in currency devaluation.



03/13/2000: The Nikkei closed down 560 points (2.8%) as Japanese Q4 GDP was down 1.4 from the previous quarter. S&P Futures were down 27 points before open and Nasdaq futures were at a lock-limit down of 82.



04/27/2000: Nikkei closed down 115 points (0.6%); Korean Kospi fell 21 points (3%). U.S. Q1 Employment Cost Index rose 1.4% leading to fears that the Fed would get more aggressive in trying to cool down the economy. S&P futures were 34 points lower and the Nasdaq futures were at a lock limit down of 110 points before open.



03/14/2001: DAX was down 2.5%, FTSE was down 1.65% over concerns about a slowdown spreading due to hawkish ECB. Fitch downgraded 19 Japanese Banks. S&P and Nasdq futures were both trading lock-limit down before open.



09/17/2001: U.S. stock markets reopen after being closed since the 9/11 attack. The Nikkei closed down 5%. U.S. Equity futures were not trading prior to open.



9/21/2001: Nikkei closed down 2.35%; Hang Seng down 4.1%; Dax was down 6.38%, FTSE down 5.46%. S&P Futures were down 38 points and Nasdaq futures were down 48 points before open.



6/26/2002: Nikkei closed down 4.0%; Hang Seng down 2.4%; Dax was down 4.7%, FTSE down 3.1%. S&P futures were down 27 points and Nasdaq futures were down 44 points over WCOM accounting fraud concerns.



07/24/2002: Nikkei closed down 2.6%; Hang Seng down 3.3%; Dax was down 4.2%, FTSE down 3.0%. S&P futures were down 19.2 points and Nasdaq futures were down 18.5 points on weakness overseas and a follow-through of the previous day’s declines of 4.5% for the Nasdaq and 2.7% for the S&P.



1/22/2008: Nikkei closed down 5.7%; Hang Seng down 8.7%; Dax was down 0.9%, FTSE was up 0.2%. S&P futures were down 60.8 points and Nasdaq futures were down 83.8 points. There was a global equity selloff while the U.S. market was closed for MLK day. Fed cuts rates by .75% ahead of its scheduled meeting on 1/30/08.



1/23/2008: Nikkei closed up 2.0%; Hang Seng was up 10.7%; Dax was down 2.0%, FTSE was down 1.0%. S&P futures were down 39.6 points and Nasdaq futures were down 69.4 as ECB says that keeping inflation in check is top priority. Apple issues a disappointing outlook.



3/17/2008: Nikkei closed down 3.7%; Hang Seng down 5.2%; Dax was down3.5%, FTSE was down 2.3%. S&P futures were down 28.4 points and Nasdaq futures were down 46.2 points on news that Bear Stearns was being acquired for $2 a share by JP Morgan Chase. The Fed cuts the discount rate by .25% over the weekend.

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