Thoughts on Economy and Bear Market after Goldman’s 1Q 2009 Earnings Report

Last week, Wells Fargo surprised the market with positive earnings results that exceeded consensus estimates. Goldman Sachs, after the close of today’s trading (13-April-2009), has done no less as it also handily beat the consensus estimates.FASB changes in mark-to-market rules give traditional lenders like Wells Fargo a lot of latitude with assumptions for asset values. Goldman Sachs, on the other hand, is a reformed investment banker deprived of its lethal powers of leverage, but still has some of the best and smartest prop traders on the street. $7.15bn of the quarter’s $9.43bn revenues were derived from proprietary trading and investments. Shareholders entitled to receive their $0.35 per share dividend will make no qualms about this. To capitalize on its success, it also separately announced a $5bn common equity offering to raise capital which will likely be allocated to pay off TARP funding.

How could things have gone from so bad to so good in a heartbeat? Is this just another “smoke and mirrors” ruse by Wall Street? Truth cannot hide from the passage of time. This whole mess started with housing and many believe that it will end with housing. If so, here are few things to consider:

  1. Although the home-building industry initiated much needed consolidation with the announced merger between Pulte Homes (PHM) and Centex (CTX)last week, publicly traded home-builders account for only 25%-30% of the market for new home construction.
  2. Foreclosures continue to climb and are projected to increase (see currentforeclosures.com). The current unemployment rate is reported @ 8.5%,  but a jump to 10% to 11% unemployment rate is bound to negatively impact the number of foreclosures.
  3. Construction and Development loans, as reported by Richard Suttmeier (Chief Market Strategist @ ValuEngine Institutional Research), stand at $590bn (for community and regional banks), are down 6.2% year or year, and are rapidly becoming toxic assets.

What I really find myself asking in the midst of all this hoopla about “recovery” is when will we begin to see meaningful and positive reversals in the employment trends? GDP is projected to be positive for the 2nd half of 2009, but if absent is the creation of new jobs, then I suspect we may be witnessing unsustainable trends in the rebound of financials and the broad equity markets.

Again, I do not dispute that unemployment is a lagging indicator. However, should it fail to improve significantly over the next 6 months, then many economists may consider naming it the “dragging indicator” because there can be no sustainable recovery in a 70% consumer based economy without a recovery in sustainable jobs.

Globally, export dependent economies also suffer from a weaker U.S. consumer driven economy. It is no coincidence that the last U.S. trade deficit report showed a negative $26bn contraction due mainly to a drop in non-oil imports instead of the usual culprit of high energy prices. Some predict that emerging markets will consume more, but these very markets also lack a developed consumer credit infrastructure to facilitate such spending habits and have yet to experience a complete cultural/social values paradigm shift to lead to this. It is all a process and it all takes time.

Besides all the above, the rising equity index prices accompanied by declining volume tell me that not everyone, especially institutions, is buying what Wall Street is selling. Therefore, I still regard this as a bear market rally and recommend that investors and traders treat it accordingly. Judging from the quarterly earnings results of Goldman, it looks like this is exactly what they are doing, i.e. favoring short-term profitable tactics over long-term strategic investment commitments.


Originally published at Hillbent.com and reproduced here with the author’s permission.