So what, exactly, happened yesterday in the stock market?

Why did the stock market drop so dramatically in the last hour of trading yesterday? Here's the story from Bloomberg:

• "Oct. 21 (Bloomberg) -- U.S. stocks tumbled in the final hour of trading after analyst Dick Bove downgraded Wells Fargo & Co., erasing an earlier rally spurred by better-than-estimated results at Morgan Stanley and Yahoo! Inc. Wells Fargo, the largest U.S. home lender this year, slid 5.1 percent after Bove of Rochdale Securities cut the shares to “sell” and said earnings were boosted by mortgage-servicing fees rather than improving business trends."

Okay... so what?

First off you have to appreciate that Richard Bove is a screaming bull when it comes to the major banks in the United States.

More importantly, he's highly respected. Tim Smalls, head of U.S. trading at Execution LLC in Greenwich, Connecticut had this to say about Bove, "he has a very good following and very long track record of consistency.”

But that's not the best of it. Bove - cheerleader of major bank stock and shill for the likes of Fargo - was on CNBC yesterday morning raving about Wells Fargo.

Then he saw Fargo's numbers.

Faithful readers will recall we thoroughly eviscerated Wells Fargo back in April when the Bank stunned the world by proclaiming it had just finished its most profitable quarter ever. To say we were incredulous is an understatement

And when Bove saw Fargo's most recent report, he (finally) came to a similar conclusion and dramatically switched his assessment of Fargo from "buy" to “sell”; a stunning turnaround from someone who had just that morning been singing the bank's praises.

Bove said the “most disturbing” thing about Fargo’s results is that loan losses seem to be accelerating. Assets no longer collecting interest climbed 28% to $23.5 billion from the second quarter, while the reserve to cover future loan losses grew by $1 billion from the second quarter to $24.5 billion.

What they mean when they say "assets no longer collecting interest", they mean foreclosed homes that no one is paying back anymore. They're UP 28%! And Fargo is has INCREASED the reserve for future losses to $24.5 billion. That represents a potential of almost $50 Billion in loan losses (the size of Canada's record breaking deficit).

The fact of the matter is that the US banking system remains basically insolvent as unemployment soars and the economy worsens. People are walking away from their homes in the United States in record numbers as home prices continue to nosedive.

And what the Wells Fargo numbers tells us is that the loan losses that the major US banks have been hit with are STAGGERING and the problem continues to worsen.

Meanwhile many banks continue to play a sleight-of-hand game by creating a shadow inventory of unreported foreclosed homes. These are homes that are sitting empty because their mortgage holders have walked away but the banks haven't 'officially' foreclosed on them.

They do this in a vain attempt to stem the glut of product hitting the housing market and driving down prices.

These shadow inventories are still incredibly high and hide the full extent of the housing collapse in the United States.

Fargo has only admitted to $23 billion of bad loans. What does that number look like when you include Wells' shadow inventories? We're willing to bet Fargo's reserve of an additional $24.5 billion doesn't even begin to cover it.

The banks recent record profits are a sham because (as pointed out in April) the government has allowed them to use manipulative regulation and accounting standards to play a shell game that allows them to defer taking the losses from the housing bust (mark to market, among others).

It's like they are pretending it never happened.

And as you may recall, the burst in the stock market after quantative easing was announced was propelled by Wells Fargo and their announcement of 'record profits'.

Back in April we said, "the more information that comes out, the more disconcerting the stability of the bank appears. Watch for Fargo stock to drop like a rock when complete financial statements come out. And with it could go investor confidence in the latest market rally."

That reckoning may not fully play itself out yet... but one thing is now very clear; it's coming.

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Prechter: Next Wave Down Will Be Bigger

Robert Prechter is a longtime technical analyst who forecast the 1987 stock market crash and authored a book in 2002 ("Conquer the Crash") in which he warned of the dangers of a U.S. debt bubble and deflationary depression.

In late February, Prechter said "cover your shorts," and predicted a sharp rally that would take the S&P into the 1000 to 1100 range.

With that prediction having come to pass, Prechter is now saying investors should "step aside" from long positions, and speculators should "start looking at the short side."

"The big question is whether the rally is over," Prechter says, suggesting "countertrend moves can be tricky" to predict. But the veteran market watcher is "quite sure the next wave down is going to be larger than what we've already experienced," and take major averages well below their March 2009 lows.

That's right, Prechter is one of those who believes the late 2007- early 2009 market crash was just a warm-up to what Prechter believes will be the bear market's main attraction. In this regard, he says the current cycle will echo past post-bubble periods such as America in the 1930s and England in the 1720s, after the bursting of the South Sea bubble.

Prechter calls the 2000 market peak market a "major trend change" for the market from a very long-term cycle perspective, and the downside is going to continue to be painful well into the next decade. "The extreme overvaluation, the manic buying and bubbles in the late 1990s [and] mid-2000s are for the history books - they're very large," he says. "The bear market is going to have balance that out with some sort of significant retrenchment."

His recent thoughts on video...


Meanwhile in Canada

Canadian personal bankruptcies soared by 54.3% in June according to the Office of the Superintendent of Bankruptcy Canada.

An earlier report released by Toronto Dominion Economics in May suggested that as many as 160,000 people will walk away from their bills in 2009 and 2010 because of high unemployment and debt.

"Unemployment and heightened household debt will drive a substantial increase in consumer insolvencies over the next two years," Craig Alexander, TD's deputy chief economist, said in the report.

Businesses, however, weren't hit as hard as consumers. In June business bankruptcies were up 10.8% year-over-year.

Alexander warned that even if business conditions improve, it may not help the individual bankruptcy situation, as consumers are still carrying a greater debt load and run a greater risk of falling prey to insolvency.

The fact of the matter is that the spectre of rising interest rates remains a massive ticking time bomb for individual Canadians.

If, heaven help us, the market crashes in tandem with a loss of confidence in US debt (triggering spikes in interest rates), the sonic boom against real estate will be profound.

Tick... tick...tick.

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If the rats are fleeing, what does that tell you?

If the rats are fleeing a sinking ship, how wise is it to stay on board?

The R/E shills insist that the market crash is over and that the recovery has begun. The burgeoning stock market is pointed to and the mantra of 'green shoots' is repeated week after week while the Real Estate Associations play the 'buy now or be left behind' card once again.

But is economic recovery really just around the corner?

Not according to captains of industry.

Oh, they still publically say all the right things. "The situation is not as bad as it was, the econonmy is improving, blah, blah, blah." But actions speak louder than words.

With that in mind, let me ask you a question.

If the economy is improving, and the DOW is rocketing back to it's former 14,000 point level, would you dump your stock when the DOW is only at 8,500?

According to a report from Bloomberg, CEOs, directors and senior officers of US companies have been selling their personal shares of their own companies' stock at the fastest pace since credit markets started to seize up two years ago.

Insiders of Standard & Poor’s 500 Index companies were net sellers for 14 straight weeks in data compiled by InsiderScore.com. Since these executives presumably have the best information about their companies’ prospects, what does that tell you?

“If insiders are selling into the rally, that shows they don’t expect their business to be able to support current stock- price levels,” said Joseph Keating, the chief investment officer of Raleigh, North Carolina-based RBC Bank, the unit of Royal Bank of Canada that oversees $33 billion in client assets. “They’re taking advantage of this bounce and selling into it.”

The last time there were more U.S. corporations with executives reducing their holdings than adding to them was during the week ended June 19, 2007, the data show. The next month, two Bear Stearns Cos. hedge funds filed for bankruptcy protection as securities linked to subprime mortgages fell apart, helping trigger almost $1.5 trillion in losses and writedowns at the world’s biggest financial companies and the 57% drop in the S&P 500 from Oct. 9, 2007, to March 9, 2009.

And the weasels are selling again, hmmm.

Talk the market up and then dump your shares on the suckers rushing in.

It's almost a metaphor for real estate sales in Vancouver the past few months, don't you think?

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Tug O' War

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There's nothing like a good 'ole fashion Tug-O-War to get the competitve juices flowing, is there?

Yesterday we profiled Meredith Whitney, a former stock analyst at the investment bank Oppenheimer & Co. Inc, an insider who became one of Wall Street’s first bears when credit markets started to freeze in 2007. Early this week, after government evaluations of their financial health, she said banks are “grossly overvalued” and that "at a core basis, I would not own these stocks. Their business models are not going to come back."

Enter Bill Miller, fund manager of Legg Mason's Value Trust mutual fund. Miller is famous for having beat the Standard & Poor’s 500 Index for a record 15 straight years (before stumbling in 2006) and he proudly proclaims that financial companies are his favorite investment for the rest of the decade.

Now there's bravado for you! And if there is something investors love, it's confidence.

Miller is a self-titled 'value investor', someone who seeks the cheapest companies relative to earnings or assets. Last week he said, “financials have the biggest potential to outperform” and boldly named his favorite picks as San Francisco-based Wells Fargo & Co., Capital One Financial Corp., and New York-based American Express Co.

And faithful readers know how much the Whisperer has been picking on Wells Fargo of late.

So it is with great interest that we will watch the great Bill Miller and his stock market advice because, make no mistake, it is at stark odds with what the Whisperer has been saying.

Miller’s says his bets hinge on U.S. home prices stabilizing this year and an economy that performs better than projections from the Federal Reserve. Whisperer believes both will do the opposite.

To his credit, in the first three months of 2009, Miller bought about 3.77 million shares of Wells Fargo (who, btw, is the largest U.S. mortgage originator) and almost quadrupled his position in credit-card company Capital One, according to data compiled by Bloomberg and Legg Mason’s Web site. Miller also increased his stake in American Express, the biggest U.S. credit-card company by purchases, by about 22 percent.

With a maasive wave of foreclosures yet to come and a tsunami of credit card write-downs in the offing, what does Miller see that Whisperer does not?

Perhaps a lot.

Miller can currently boast tremendous success with his investments. Since March 31st Wells Fargo has gained 70%, Capital One 96%, and American Express 77%.

But as we saw in yesterday's post when we profiled Whitney, there is significant concern bank stocks will decline because the gains aren’t matched by improvements in their businesses.

“The underlying core earnings power of these banks is negligible,” cited Whitney, who quit Oppenheimer in February to start her own firm, Meredith Whitney Advisory Group LLC in New York. U.S. banks will likely return to “negative earnings” after posting first-quarter profits and the largest companies must sell assets after expanding at an unsustainable pace in the past two decades.

Furthermore home prices are likely to be down 50 percent from peak levels, which makes gains unlikely and a recovery in consumer spending (which accounts for 70 percent of the U.S. economy) may be undermined as banks and card companies slash $2.7 trillion in credit lines by the end of 2010.

It's a classic battle of viewpoints. What makes it so compelling is that the viewpoints are such polar opposites. And the impact from the winner will affect stock markets and real estate worldwide.

We do indeed live in interesting times.

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Email: village_whisperer@live.ca

Insider issues warning about US banks and their stock

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As you already know, Whisperer has been critical of US Banks like Wells Fargo. Their stunning turnarounds in profits have been a large factor in the current market rally that continues to gather steam.

Enter Meredith Whitney, a former analyst at the investment bank Oppenheimer & Co. Inc.

Whitney, who has her own firm now, is renowned for calling out the problems with banks' toxic assets before the issue became widespread. What's her take on the great bill of health given to banks by the recent stress tests?

Whitney thinks Banks are overvalued and the government enabled them to have better first quarter earnings than they should. "At a core basis, I would not own these stocks," she said on CNBC. "Their business models are not going to come back."

Whitney also said that consumer spending is still going to remain slow. "There's a massive retraction in consumer liquidity," said Whitney. "Credit contraction is happening at an accelerated pace. Consumer spending is going to be less than people expect going forward."

Whitney also issued an ominous warning for stock market investors when she said that the rules of trading have changed because of the government's role. "For investors, you invest on what you know to be the rules of the game," said Whitney. "But with the government involved, no rules apply."

Whitney said the changing rules create a big problem for investors going forward. "The biggest danger here is having the retail investor shut out for a period of time because they don't know who to trust on market values."

Day after day more warnings come out about the health of this market rally and how it is not based on solid fundamentals.

The Whisperer encourages you to take heed.

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Email: village_whisperer@live.ca

More on Wells Fargo, yesterday's market rally and an update on a previous post

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Faithful readers know that I have beaten up on Wells Fargo in the past because of it's dramatic financial balance sheet turnaround.

Critics have raised concerns that the stunning improvement in their financial situation has more to do with bookkeeping manoeuvres than the fundamental improvements.

Enter the infamous 'stress tests' of the 19 largest financial firms in the US. These 'tests' are a centerpiece of the Obama administration's plan to stabilize the banks. Some critics have decried the process as weak and ineffective, an artificial attempt to instill confidence in America's financial system.

Regulators have said they will not allow any of the 19 firms to fail because it would be too dangerous for the rest of the financial system. Wells Fargo holds billions of dollars in mortgage, construction and credit card loans.

And based on the results of their 'supposedly sound' quartly balance sheet released last month, Fargo stock has almost doubled in value.

Which make the latest leaked results of the 'stress tests' even more disturbing.

Wells Fargo is one of several banks that regulators will force to hold larger buffers to protect them against possible future losses, according to two people familiar with the matter who spoke on condition of anonymity because of the sensitivity of the process.

Apparently regulators have told Wells Fargo to shore up its finances after the stress tests showed the bank would have trouble surviving a deeper recession.

What happened to the outstanding quarterly results that had Wells Fargo on an excellent financial footing?

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In the Markets yesterday...

Yesterday, at about 11:05am, the Canadian Business News Network declared that different conditions were driving the market upward for the day. The BNN host stated that "gains appear to be driven by investors who are jumping into the market for fear of missing out on the rally".

Hmmm...

'Green shoots' that are nothing more than signs the economy is doing less worse, instead of getting better & impulse stock buying because investors fear they are missing out on the rally.

Perhaps you recall yesterday's post about the three stages of a bear market trap?

Don't look now, but I think the canary in that cage over there is dead.
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Update Post

You will recall that on Saturday April 25, 2009 I made the following post titled "Deja Vu - all over again". On that day the phrase that pays was 'corporate-style subprime loans'.

I cautioned that the next big financial disaster looming on the horizon in the United States was commerical mortgages structured just like the subprime housing loans.

Today the Miami Hearld published a story sounding a warning over this exact issue. Quoting the article, "Thousands of commercial mortgages valued at hundreds of billions of dollars are approaching a renewal date. By some estimates, two out of every three will no longer meet the original loan conditions and won't be able to refinance. And with prices for commercial properties expected to plunge, a vicious cycle may unfold much as it has in the nation's housing market.

A commercial mortgage meltdown is likely to prolong the nation's economic recovery. The falling prices in commercial real estate will lead to additional bank losses at a time when banks are sapped by home mortgage defaults and soaring credit card defaults. This could lead to future additional taxpayer assistance for the banks."

Hmmm... make that TWO dead canary's in that cage.

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Email: village_whisperer@live.ca

Riddle me this...

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Spend some time last week ruminating with one of this blog's faithful readers about the stock market soaring on word that the US Bank 'Wells Fargo' had projected a surprising $3 Billion first quarter profit.

Howard Atkins, chief financial officer for Wells Fargo, said in the release, "Business momentum in the quarter reflected strength in our traditional banking businesses, strong capital markets activities, and exceptionally strong mortgage banking results — $100 billion in mortgage originations, with a 41 percent increase in the unclosed application pipeline to $100 billion at quarter end, an indication of strong second quarter mortgage originations.”

Uh-huh.

Market investors seized on the news. And since so many pundits have identified the stabalizing of US Banks as a key condition of restoring prosperity to the North American economy; the news was significant.

But you can colour me a skeptic.

Aforementioned faithful reader had a chuckle over my pensive reaction. But it seems my doubt may not have been completely misplaced.

I came across a report today on Housing Wire that suggests that as much as nearly one-third of the bank’s first quarter earnings may be nothing more than an accounting maneuver.

Apparently the jump in earnings pertains to FAS 160, an accounting rule first announced in 2007 that became effective on January 1, 2009. The rule addresses accounting for minority interests, and mandates that the ownership interests in subsidiaries held by parties other than the parent corporation be clearly identified and presented as equity for the purpose of consolidated reports.

The effect of the new accounting rule allows certain liabilities to ‘jump over’ to the asset book as non-cash transactions via paid-in capital, thereby rolling directly into earnings and boosting reported equity.

In the case of Wells Fargo, the bank found itself with up to $824m it could use this quarter as an accounting gain to earnings.

Now... even if HousingWire’s Teri Buhl is correct... that still leaves more than $2 billion in profit. But even that remaining profit margin may not survive scrutiny.

Further investigation has lead critics to query the status of a large number of bad loans at Wachovia, the diversified, wholly owned financial services subsidiary that Wells Fargo recently acquired. What happened to them?

In it's announced earnings, Wells Fargo gave no details on delinquency trends or Wachovia’s credit losses.

Now there is rampant speculation that the timing of the merger has obscured these losses through purchase accounting adjustments.

So while this anomaly is being investigated investors are being cautioned to remember that what Wells Fargo has released is merely a quarterly statement. Quarterly statements are not audited (only annual reports undergo a full audit).

And what is the significance of all of this?

Well... under normal circumstances such accounting games within corporate PR announcements raise nary an eyebrow with the general public.

But in these tenuous times, the stock market received a huge boost on the Wells Fargo first quarter profit announcement. And the announcement has played a crucial part in bolstering the confidence of the public in the governments efforts to resusictate the economy.

These are times of strained public confidence and trust in both Wall Street and the Banking Community. I suspect that if this so called 'profit' turns out to be an accounting slight-of-hand, there may be a severe public counter-reaction.

And that counter-reaction could trigger another round of significant losses on Wall Street.

We will watch with great interest as this unfolds.

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Email: village_whisperer@live.ca