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Wells Fargo Earnings and 'Green Shoots'

NEW YORK ( TheStreet) -- Years of weak economic and labor market growth put the term "green shoots" in the dustbin of lame clichés parroted on Wall Street. However, the phrase is now of central importance to the earnings and stock performance of Wells Fargo (WFC - Get Report), the nation's largest mortgage lender and fourth-largest bank by assets.

In 2009, as stock markets hit a financial crisis bottom, so-called "green shoots" of economic growth sprouted in analyst research notes and in the business media to explain a swift recovery in stock prices and particularly those of bank stocks such as Wells Fargo (WFC - Get Report) and JPMorgan (JPM - Get Report).

Green shoots were meant to signify a flowering of economic recovery in the U.S. from the wreckage left by the mortgage meltdown, the collapse of Wall Street and near-death experiences across the global economy. Some such as Nobel laureate Paul Krugman were decidedly skeptical.

As we now know, there has been below-trend gross-domestic-product (GDP) growth in the U.S. that is particularly weak coming out of a deep recession. The fall in the unemployment rate from generational highs, meanwhile, is largely attributable to workers leaving the labor force and not new job creation. In Europe, economic data continues to worsen and emerging market economies are beginning to show weakness.

Google Trends data now shows people are about as likely to search for "bamboo shoots" as "green shoots," Jeffrey Sherman, a DoubleLine Capital portfolio manager, noted on a recent investor call.

While Sherman's point was to highlight how investor misconceptions often carry the day on Wall Street -- for instance the current mania over the Federal Reserve's so-called "tapering" to its bond buying -- it is also worth pointing out terms can be premature or relevant at a later date.

In the case of Wells Fargo's fourteenth straight quarter of earnings growth, green shoots are finally germane to the San Francisco-based lender. In fact, a late arrival of green shoots in data on GDP growth, new business formation, mortgage applications and jobs are the only hope Wells Fargo has of growing its earnings in coming years, as interest rates rise from historic lows.

It is now time to reintroduce the term to investors banking on the notion Wells Fargo's shares can move materially higher from current post-crisis highs.

Green Shoots Are Dead

Sherman, the DoubleLine portfolio manager, highlighted on a July 9 conference call that discussion of green shoots in 2009 conflated a slowing in the worsening of the financial crisis with actual recovery.

Markets were rising and banking sector stocks doubled within a short period of time not because of imminent expectations of financial recovery, but because of clear signs the economy had stopped getting worse.

Such a scenario is called a "second derivative" on Wall Street. Basically, the term is used to state things got less bad today than they did yesterday, or vice versa.

Next time there is a financial crisis, sophisticated investors should focus on such rates-of-change over notions like a "bottom" or "recovery."

For Wells Fargo, much of its highly-touted post-crisis earnings growth can be explained using similar logic.

Without dramatically increasing revenues in recent years, the bank has been able to record a significant rise in profitability as credit quality among the over $1 trillion in loans and securities the bank holds on its balance sheet stopped declining and eventually recovered.
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