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Déjà vu All Over Again: Financial Sector Profit Soars




The financial sector will be providing the real story during this earning season. Last quarter's results, have shown a remarkable swing back to profitability. And I expect we'll see more of that.

financial sector profitability compared to non-financial Apr 2010
Source: Chart of the Day

The disadvantage of the above chart is that the scale is arithmetic so the earlier data isn't visible. As well, what really matters is how well the fiancial sector was performing in comparison to other companies. With that in mind, here is an even longer term chart, courtesy of Gluskin Sheff, showing the relative profitability of the financial sector:
financial sector profit Apr 2010

The swing back into profitability is unprecedented, taking financial sector corporate profits up 240% year over year:

financial sector earnings growth Apr 2010

Rydex Traders
The Philadelphia Bank Index (BKX) has been on a tear, catching up and then keeping up with the S&P 500 index. Not surprisingly, the Rydex traders have re-discovered this sector and pushed a relatively high amount of capital into the Rydex Financial sector fund. From a contrarian point of view this is means trouble since usually these traders have an almost perfect track record for jumping on trends at the wrong time.

Bullish Percent Index
The bullish percent Index for the S&P financial sector is surprisingly low at 67%. This suggests that the rally pushing up the BKX is not very broad based. At least not enough to bring the BP index up to previous highs of +90% as it did in January 2004, January 2006, January 2007 and September 2009. When we see almost all of the sector giving a point and figure buy signal, the sector usually tops. But that isn't the case now.

Mirage
But profitability hasn't come about as a consequence of the normal economic activity that you would think of, for example, lending. As we looked at earlier, bankers are sitting on a gargantuan level of excess reserves, basically playing the yield difference between two government rates: the Federal Reserve and US Treasury bonds. They borrow from the Federal Reserve at near zero rates and lend to the US government for a profit.

In the previous cycle the profits were a mirage perpetrated by fraud masquerading as greed. In this cycle they are a mirage because the banks are just riding a very steep yield curve.

So in essence the bank bailout was not a one time event when the US population handed over more than a trillion dollars to a select club of financial companies. It is very much ongoing behind the scenes with vast sums being transferred every day allowing the financial sector to recapitalize its balance sheet. And to get geared up for the next financial crisis (Crisis Harder).

There is something very very wrong with this. And the US has still not really addressed any of the root causes with proper legislation or changes to how banks conduct business. The Democrats are working on a bill but the banking lobby is working just as hard, if not more, to cut it to ribbons. At least for now, it seems the GOP doesn't have the votes to block it. We should see something tangible within a week or two.

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8 Responses to “Déjà vu All Over Again: Financial Sector Profit Soars”  

  1. 1 Brad Miller

    Imagine that! A casino with no chance of losing making money.
    Will wonders never cease?

  2. 2 Ak

    Hey B,
    Where do you get your rydex data from?
    Thanks!

  3. 3 PEJ

    (Un)fortunately, the financials profits are not realized, and the losses are not marked to market. Did the financials raise their dividends back to the 2006 or 2007 levels? Or offer any of the stupid things they were doing at that time like stock-buy-back programs? To me, it's all accounting fraud.

  4. 4 Babak

    Ak, the Rydex data is available from Rydex's site.

  5. 5 Wes

    Babak said this about the financial sector:

    "From a contrarian point of view this is means trouble since usually these traders have an almost perfect track record for jumping on trends at the wrong time."

    Nice call, Babak

  6. 6 Jordan

    I received a newsletter email from a regional bank that is traded on the Nasdaq which is up over 200% YTD that said that their losses are becoming less and less each quarter. Their stock increased the next day. Interesting how a bank can lose money and their stock value can increase.

  7. 7 jannice

    they are cooking their books to funnel money into their own pockets and leave the gov't with fully depreciated bailout assets. when tax time comes they will cook again to make themselves tax-exempt.

  8. 8 Cal

    With level 3 - mark to whatever you want on commercial portfolios the banks would all be bankrupt if proper accounting were used.. its all a house of cards..Good report on the Fed Bond spread that the banks are using...very true and not seen a lot.

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