This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
TheStreet Open House

Financials Will Lead the Bear Market

This column was originally published on RealMoney on March 15 at 4:01 p.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here .



I have made my call for a bear market for stocks, led by real estate problems, which will end with the U.S. economy in recession. Today I will review the progression of these calls and drill into the risk/reward for a few major regional banks.

In my Jan. 4 column , I wrote that I expected the housing slowdown to continue, mortgage foreclosures to rise significantly and that bulls were making risky bets on community and regional banks.

I also profiled seven regional banks, six of which have been big losers, highlighted by Fremont General (FMT), down 58.9%, and IndyMac (NDE), down 35.9%. The lone winner, Compass Bank (CBSS) is up 12.7% because of a takeover offer from Banco Bilbao Vizcaya.

In my last homebuilders update , the Philadelphia Housing Sector Index (HGX) tested a downtrend going back to the July 2005 highs. This week it declined 14.7% to test its 200-day simple moving average at 219.21, holding the last two days to provide some short-term stability.

Philadelphia Housing Sector Index (HGX)
Source: Reuters

My call last month for the Dow transports to test my quarterly pivot at 4693 finally happened on Wednesday. The Nasdaq has yet to fall as low as its quarterly support at 2272, but it sure seems like weaker-than-expected data is trumping inflation, as woes in the real estate markets are in the headlines.

The FDIC Quarterly Banking Profile for the 2006 fourth quarter was released on Feb. 22, and in my opinion, showed that banks were burning the candle at both ends, as assets were slower to come in, while outflows in the form of residential construction loans continued to rise and were up 25.6% year over year.

Here is a summary of the concerning trends I see in the FDIC data:

FDIC data of the 8,681 insured institutions is showing deterioration of growth in total assets, a shift to a decline in reserves for losses and a huge swing to negative growth for net operating income.

  • Total assets rose to $11.9 trillion, but growth is decelerating.
  • Reserve for loses has declined to $77.6 billion.
  • Net operating income peaked at a record high at the end of the second quarter of 2006, but the sequential growth is stumbling and declined 11.6% in the second half to $33.3 billion.

  • Source: FDIC data

    The amounts of residential construction and development loans and commercial loans continue to grow on the balance sheets of our nation's banks.

  • Residential construction loans now total $565 billion, up 25.6% year over year. If we take that $565 billion and divide that by $220,000 per house, we get 2.5 million new homes vs. the recent annualized new-home sales rate of less tha 1 million.
  • Commercial construction loans topped $900 billion for the first time. If the economy is slowing and community developments are put on hold, the needs for new office space and malls are in question.

  • Source: FDIC data

    Problem balance sheet items are on the rise.

  • "Other real estate" category is up 48.4% year over year. This is where loan collateral such as land gets hidden.
  • Loans and leases that are 30 to 89 days past due posted a 14.3% sequential rise and a 22.6% year-over-year increase.
  • Noncurrent loans and leases rose 8.0% sequentially and 13.6% year over year.

  • Source: FDIC data

    On Tuesday, the PHLX/KBW Bank Sector Index (BKX) broke below its 200-day simple moving average at 113.01. Today I will profile a few of the 21 components of this index. As the chart shows, BKX is trying to test its 200-day SMA at 113.05 today.

    PHLX / KBW Bank Sector Index (BKX)
    Source: Reuters

    Bank of America (BAC) is rated a buy as recent weakness has the stock below its fair value at $52.81. BAC began the year overvalued with declining technical momentum. Its $54.21 Feb. 15 high was just below my annual and semiannual risky levels at $54.24 and $56.13. This indicates risk to my quarterly value level at $49.00, which was tested at the March 14 $48.36 low.

    Trading the stock between a value level and its fair value is fine if you have the discipline, but long-term investors should avoid the risk. As the table shows, BAC has 10% of all assets among the 8,681 FDIC insured institutions and the largest exposure to residential construction and development loans at $21.6 billion, or 3.8% of the total in the banking system.

    Bank of America (BAC) Q1-2006 Q2-2006 Q3-2006 Q4-2006 Q2/Q1 Q3/Q2 Q4/Q3
    Assets $1,104,944,125 $1,160,260,442 $1,185,580,956 $1,196,123,794 5.00% 2.20% 0.90%
    Residential Construction $20,697,011 $20,957,819 $21,120,787 $21,562,188 1.30% 0.80% 2.10%

    Commerce Bank (CBH) is rated a hold and is overvalued vs. its fair value at $29.73. The stock traded as low as $30.45 on Jan. 17, but failed at its $35.09 200-day simple moving average on Feb. 23. The table shows rising sequential exposure to residential construction loans on slowing asset gathering. This is a ticking time bomb! Investors should thus consider reducing this position with the shares trading around my monthly pivot at $33.10.

    Commerce Bank (CBH) Q1-2006 Q2-2006 Q3-2006 Q4-2006 Q2/Q1 Q3/Q2 Q4/Q3
    Assets $36,958,645 $39,530,521 $39,453,557 $41,169,973 7.00% -0.20% 4.40%
    Residential Construction $784,488 $955,515 $981,677 $1,067,942 21.80% 2.70% 8.80%

    Wachovia (WB) is rated a hold and is below its fair value at $58.29. Since the Feb. 22 FDIC data release, it has declined 9.2%, from $58.80 to yesterday's $53.39 low. $58.16 was my semiannual risky level and my quarterly value level is $54.24. Note the deceleration of sequential asset growth and the acceleration of exposure to residential construction loans.

    Wachovia (WB) Q1-2006 Q2-2006 Q3-2006 Q4-2006 Q2/Q1 Q3/Q2 Q4/Q3
    Assets $496,566,000 $504,270,000 $517,174,000 $518,123,000 1.60% 2.60% 0.20%
    Residential Construction $18,129,000 $19,242,000 $20,148,000 $20,755,000 6.10% 4.70% 3.00%

    Wells Fargo (WFC) is rated a hold and is below its fair value at $35.70. My $33.66 annual pivot was the barrier on Jan. 25, and Wednesday's $33.01 low tested my $33.15 annual value level. Traders can consider trading this range, but investors should observe that WFC is draining assets while increasing exposure to residential construction loans.

    Wells Fargo (WFC) Q1-2006 Q2-2006 Q3-2006 Q4-2006 Q2/Q1 Q3/Q2 Q4/Q3
    Assets $415,802,000 $415,859,000 $400,807,000 $398,671,000 0.00% -3.60% -0.50%
    Residential Construction $14,235,000 $14,712,000 $15,333,000 $15,869,000 3.40% 4.20% 3.50%

    Washington Mutual (WM) is rated a hold and is just below its fair value at $40.90. WM ended 2006 with a high of $46.38 and declined 16.5% to $38.73 on March 14. The stock is below my monthly and annual pivots at $41.59 and $42.03, which should limit the upside. WM is also shedding assets while increasing its exposure to residential construction loans.

    Washington Mutual (WM) Q1-2006 Q2-2006 Q3-2006 Q4-2006 Q2/Q1 Q3/Q2 Q4/Q3
    Assets $347,416,019 $351,148,192 $347,571,788 $345,294,612 1.10% -1.00% -0.70%
    Residential Construction $2,989,344 $3,055,858 $3,186,161 $3,446,862 2.20% 4.30% 8.20%

    At time of publication, Suttmeier had no positions in any of the stocks mentioned in this column.

    Richard Suttmeier is the chief market strategist for RightSide.com, where he writes the Small Stocks and Sector Report. Early in his career, he became the first long bond trader for Bache and later began the government bond department at LF Rothschild. Suttmeier went on to form Global Market Consultants as an independent third-party research provider, producing reports covering the U.S. capital markets. He has also been the U.S. Treasury strategist for Smith Barney and chief financial strategist for William R. Hough. Suttmeier holds a bachelor's degree from the Georgia Institute of Technology and a master's degree from Polytechnic University. He appreciates your feedback; click here to email him.

    Select the service that is right for you!

    COMPARE ALL SERVICES
    Action Alerts PLUS
    Try it NOW

    Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

    Product Features:
    • $2.5+ million portfolio
    • Large-cap and dividend focus
    • Intraday trade alerts from Cramer
    • Weekly roundups
    TheStreet Quant Ratings
    Try it NOW
    Only $49.95/yr

    Access the tool that DOMINATES the Russell 2000 and the S&P 500.

    Product Features:
    • Buy, hold, or sell recommendations for over 4,300 stocks
    • Unlimited research reports on your favorite stocks
    • A custom stock screener
    • Upgrade/downgrade alerts
    Stocks Under $10
    Try it NOW

    David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

    Product Features:
    • Model portfolio
    • Stocks trading below $10
    • Intraday trade alerts
    • Weekly roundups
    Dividend Stock Advisor
    Try it NOW

    Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

    Product Features:
    • Diversified model portfolio of dividend stocks
    • Alerts when market news affect the portfolio
    • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
    Real Money Pro
    Try it NOW

    All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

    Product Features:
    • Real Money + Doug Kass Plus 15 more Wall Street Pros
    • Intraday commentary & news
    • Ultra-actionable trading ideas
    Options Profits
    Try it NOW

    Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

    Product Features:
    • 100+ monthly options trading ideas
    • Actionable options commentary & news
    • Real-time trading community
    • Options TV
    To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
    Submit an article to us!
    DOW 17,172.68 -107.06 -0.62%
    S&P 500 1,994.29 -16.11 -0.80%
    NASDAQ 4,527.6890 -52.10 -1.14%

    Brokerage Partners

    Rates from Bankrate.com

    • Mortgage
    • Credit Cards
    • Auto

    Free Newsletters from TheStreet

    My Subscriptions:

    After the Bell

    Before the Bell

    Booyah! Newsletter

    Midday Bell

    TheStreet Top 10 Stories

    Winners & Losers

    Register for Newsletters
    Top Rated Stocks Top Rated Funds Top Rated ETFs