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Without New Jobs, the Landscape Is Totally Different

Excellent post by Sham Gad from RealMoney. I had to link this one. I truly believe every word he says.

The longer this rally persists, the more confident market participants will become. In fact, the self-reinforcing bias can fuel a rally for a lot longer than fundamentals warrant. That’s why I penned a piece in June advising readers that despite the 40% rally up to that point, it wasn’t a good idea to be a hero and go short the market. And just two weeks ago, despite the 60% rally at that point, I made some consideration as to why this rally could continue.

The fact that I have been right thus far is partially due to luck. I didn’t write those pieces because I’m a hopeless bull, but rather because this market is being supported by fiscal and monetary forces never before seen in the U.S. And add in the human emotional factor — the longer the market goes up, the more folks on the sidelines want to get in immediately after any pullback — and you have a recipe for big, big upside. But eventually we’ll have to deal with a big, big headwind — unemployment.

The stock markets are built on cycles. The greatest rallies in market histories have occurred after the most dramatic declines. The opposite is also true: After the 20-year bull market that launched in 1982, we had a disastrous pullback in 2000 followed by several years of unchecked upside that lead to 2008.

So while I am on record as still saying that you are brave soul if you think shorting the market might be the prudent thing to do, I am also on record as saying that I get more and more concerned as this rally continues without the creation of jobs.

The two words that frighten me most right now are “jobless recovery,” but that’s exactly where we are going. Even the positive forecasts I read don’t suggest the unemployment rate will be lower next year or even the year after. The International Monetary Fund is forecasting global GDP growth of 3.1% next year, no doubt led by China’s 7%-10% growth.

While I applaud the efforts our government is pursuing, job creation needs to be at the top of list — even above health care. According to the Bureau of Labor Statistics, since the recession officially began in December 2007, the number of unemployed has doubled to 15.1 million from 7.6 million. That makes the reported unemployment rate 9.8%. However, the oft-ignored U-16 figure, which includes folks who have stopped looking for work and part-timers seeking full-time employment is now over 16%.

The staggering job loss numbers alone are frightening enough. But what really concerns me is that these jobs may be lost forever. Most of the job losses, unsurprisingly, are coming in areas like construction, manufacturing and retail — those industries have been hit hardest, and as consumers continue to eliminate many forms of discretionary purchases, these sectors are likely to remain depressed for some time.

And as these businesses learn to cope with a reduced workforce, the likelihood of all those jobs coming back diminishes greatly. And while these workers remain idle, they are not being trained with new skills that may be required over time. The result is permanent job loss, and the effects are devastating — consumers continue to operate in fear mode, saving every penny, which is bad for businesses everywhere.

We can get out of this recession and on our way to a lasting recovery if the government succeeds at gradually substituting its consumption and spending for private consumption and spending. This transition won’t happen right away, but job creation is the best tool for tipping the scales. Instead of simply flooding the market with stimulus dollars — many of which seem to be going nowhere — the government might consider using those funds to incentivize private business to hire more workers.

Private businesses do the best job of maximizing efficiency. If they are induced to hire more people, that’s more people who are learning new skills, more people paying taxes, and get this — more people with health insurance.

I certainly don’t have all the answers, but the longer this recovery continues without a strong signal that jobs are being created, the more you can expect an economic future that the folks at Pimco dub “the new normal” — an environment characterized by a permanent reduction in corporate profit growth, rising unemployment, fewer investments and more reliance on government aid.

Such a scenario would be terrible for the market and would essentially negate the long-term investment thesis of a lot of excellent businesses. I would no longer want to own excellent companies like FreightCar America , TravelCenters or Mueller Water , knowing that while they all represent long-term bargains, their catalysts will have been weakened under such a scenario.

Instead investors would have to accept a future of reduced market returns with quality names like Wal-Mart and Johnson & Johnson being the best places to put capital to work.

Keep an eye on the employment numbers — sustained weakness in the labor space will have far-reaching effects implications for many otherwise quality investments.

1,000 Banks Will Fail In Next Two Years

Paul Miller, Managing Director and head of financial institutions research at FBR Capital Markets, is well known in the investment community for providing in-depth, fundamental analysis and investment recommendations on thrifts and mortgage finance companies….

TWST: Are there any good stories out there?

Mr. Miller: In my coverage list, I don’t have any. But you have to really pick out small – some of the small, good community banks that have done very well. There is one that’s out there that I do not cover, it’s called First Niagara (FNFG), and it has been able to pick up some of the branches that PNC had to divest in the Nat City (NCC) deal. It’s in upper New York; they were very conservative, had a lot of capital on the sidelines and they raised capital for growth. And that’s the type of company that you want to look at – companies that are raising capital not to shore up their balance sheets but to take advantage of dislocations. It’s just one example. I think the Northeast area is the area that you can dig around to find some nice gems.

TWST: Is that because there are more community banks in that area than in other parts of the country?

Mr. Miller: Not necessarily. Every region has their unique flavor. The Northeast had its share of mergers, but the Midwest has unit banking, which created a ton of banks in Illinois and some other Midwestern states. And so you might say you have too many banks sitting out there – too many small banks that can’t overcome these crises. Illinois didn’t have a big run-up in its housing market, but yet it’s leading – one of the leading states – in bank failures because so many of its banks are just not big enough to overcome the crisis. I think every region is unique. There are 8,000 banks out there, of which probably close to a 1,000 will fail over the next couple of years. But I would think mostly the big failures have already taken place. On an asset side, it’s definitely going to be smaller but the numbers will be mind-boggling. Still, it really won’t mean a lot, if that makes sense.

TWST: To have all those small banks fail?

Mr. Miller: It’s not going to be as devastating as you think because the asset size will not be that big. You’re not going to have any more WaMus, which really caused a lot of panic in the system when they took place.

TWST: On the list you’re following, do you rate anything as a “sell” currently?

Mr. Miller: We have a few “sells,” more than I would like to have. We think Wells Fargo is very rich at these levels. We believe that their credit losses are coming slower in the late cycle, but they have not recognized the losses like some of these other companies have. So we are very concerned about Wells Fargo’s valuation, with it trading at three times book. It’s one of the highest-valued stocks that we have on our coverage list.

TWST: Are there any other stocks or any developing stories you are following that are worth noting?

Mr. Miller: Yes, the big issue that we are watching right now has to do with another foreclosure wave and the impact it will have. The foreclosure moratoriums really shut down foreclosures for six months, from last year up to March 31 of this year. Now that the foreclosure moratorium has been lifted, it takes about six months to take possession of a home and get it ready for sale. And so you are going see at the end of the year a hidden inventory start to come out putting what we think could be significant pressure on home prices. If so it would put another leg down on home prices. Now what we don’t know – which we hope, because nobody wishes for negative news on a constant basis – is that there is enough demand out there to buy up this excess inventory sitting on the banks’ balance sheets on foreclosed properties. If there is not, you could see some more downward home pricing pressure, which could have a self-fulfilling impact on people exiting the market, which would then see more pricing pressure on the downside than you really want to see in the market.

Bank takeovers worsened the financial crisis by making firms that were already too big even bigger, said Nouriel Roubini, the New York University professor who predicted the financial crisis.

“The institutions are insolvent,” Roubini said in a Bloomberg Radio interview. “You have to take them over and you have to split them up into three or four national banks, rather than having a humongous monster that is too big to fail.”

JPMorgan Chase & Co. agreed to buy Bear Stearns Cos. in March 2008, with help from the Federal Reserve, while Bank of America Corp. purchased Merrill Lynch & Co. Wells Fargo & Co. took control of Wachovia Corp. and PNC Financial Services Group Inc. got National City Corp.

Banks around the world have reported $1.29 trillion in credit losses tied to the housing market collapse since 2007. The deficits, which spurred the first simultaneous recessions in the U.S., Europe and Japan since World War II, pushed the American government to pledge $12.8 trillion to stabilize the banking system and revive economic growth. That figure amounts to $42,105 for every man, woman and child in the country.

The Standard & Poor’s 500 Index, which tumbled 38 percent in 2008, has rallied 22 percent after sinking to a 12-year low on March 9. Roubini said in a Bloomberg interview that day that the S&P 500 is likely to drop to 600 or lower this year as the global recession intensifies.