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A NIM-ble Way to Look at Bank Stocks

If you’re thinking of investing in bank stocks, you should understand  net interest margin, or “NIM” for short. It refers to the dollars of interest income less the dollars of interest expense divided by the average interest earning assets in the period. This is a very important metric for us when we look at the health of the big banks like Bank of America (BAC), JP Morgan (JPM), etc. When a company’s NIM changes, even by a few basis points, it puts a hurting on earnings power.

 

Take Bank of America, for example, who saw its NIM compress 30 basis points quarter-over-quarter. Per Hedgeye’s Managing Director of Financials Josh Steiner:

 

To put this in perspective, the company lost $1.27 billion in quarterly earnings power, or roughly $5 billion in annual earnings power in just one quarter! On a per share after-tax basis, that works out to $0.34 cents in full-year earnings per share. While that may not sound like a lot, Bank of America is only expected to earn $0.55 in 2012 and $0.94 in 2013, so taking a hit of $0.34 in a single quarter is big deal. Remember, that hit is recurring, not one time.”

 

A NIM-ble Way to Look at Bank Stocks  - NIMchart1

 

The above chart represents the six quarters “performance” of NIM for some of the biggest banks out there. It gives you an idea of why banks’ earnings are getting squeezed as NIM compresses; they’re essentially losing out on a big chunk of money every report.

 

On the macro side of things, remember that we’re currently in a low-yield, low-rates environment courtesy of the Federal Reserve. Ever heard of bankers doing 3/6/3? Borrow at 3%, lend at 6%, be on the golf course by 3pm. That doesn’t really work the same way anymore. It’s harder to earn interest in this environment and there’s no longer a 300 basis point spread like there used to be back in the day.

 

What’s the end game to all this?

 

So long as the long end of the curve keeps falling (which it is), and banks remain asset sensitive (which they are), then you should reasonably expect to see NIM come under greater and greater pressure, which, in turn, puts pressure on bank earnings. Bank earnings, NIM – remember to keep your eye on this come Q3. 


INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT

Claims Come Full Circle 

Initial jobless claims were 386k this past week, 36k higher than the prior week's number. There was a 2k upward revision to the prior week's data. The 4-week moving average, meanwhile, fell 1.5k to 376k. On a non-seasonally adjusted basis, claims rose by 11k. The YoY change in the non-seasonally adjusted series moderated to ~7% improvement from a ~8% run rate in the prior week. This last point is the most important. We use the YoY rate of change in non-seasonally claims to gauge the real underlying trend, considering the seasonal adjustment distortions that are taking place. That YoY rate of change has been slowly getting worse over the last few months, decelerating from a 10% YoY improvement to a 7% improvement currently. This suggests a real underlying slowdown, as opposed to the one created by seasonal adjustment distortions. 

 

The Auto Distortions Correct

As a reminder, the distortions over the past three weeks all reflect differences in the timing of auto manufacturing layoffs from recurrent mid-summer plant idling. Last week claims rose 36k, while the two weeks prior to that saw claims fall a combined 36k, so we're back to square one. 

 

Going forward, we still expect distortions in the seasonal adjustment factors to push claims higher from here. By the end of August, these distortions should begin to reverse and the data should start to look better again moving into the Fall months. 

 

INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT - Claims   Auto Distortions SA

 

INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT - Claims   Auto Distortions

 

INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT - Raw

 

INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT - Rolling

 

INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT - NSA

 

INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT - Rolling NSA

 

INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT - S P

 

INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT - Fed

 

INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT - YoY NSA Claims

 

The 2-10 Spread

The 2-10 spread widened 2 bps WoW to 127 bps, as the ten-year treasury yield fell 2.5 bps to 150 bps. That's little comfort though as the curve overall is still exceptionally tight. We've seen plenty of evidence of the effect of this in bank earnings over the past 4 days. Our macro team expects the yield spread to continue to compress.

 

INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT - 2 10

 

INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT - 2 10 QoQ

 

Financial Subsector Performance

The table below shows the stock performance of each Financial subsector over four durations. 

 

INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT - Subsector Performance

 

INITIAL JOBLESS CLAIMS: ROUND TRIP, ONE MONTH AWAY FROM IMPROVEMENT - Companies

 

Joshua Steiner, CFA

 

Robert Belsky

 

Having trouble viewing the charts in this email?  Please click the link at the bottom of the note to view in your browser. 


The Old Wall Way Of Thinking

RIA DAILY PLAYBOOK     

FOR RELEASE ON THURSDAY, JULY 19, 2012

 

 

CLIENT TALKING POINTS

 

CROPPED HEAT

Nearly 20% of the corn crop has been destroyed in the US due to the massive heatwave that has engulfed the Midwest. Forget the policy of devaluing the dollar for now – the lack of QE combined with a massive upward flux in commodity prices is taking place. Corn is wiped out. Wheat isn’t doing well. You need corn to feed cows, pigs, etc. See the chain effects we’re referring to? Expect higher prices at your local grocer soon.

 

BAD BANKS, BAD BANKS

Did you see what Morgan Stanley did? It had a mess of a quarter, slashed 700 jobs, and proved that Old Wall Street is dying. All these banks are running into nothing but trouble. No volume, no market. A bunch of algo guys at the banks are trying to tweak their algos so their algo can front run another algo for a basis point. Sheesh.

 

VOLATILITY SIGNALS

The VIX is headed to 15. The volume is abysmal out there but should the VIX get to 15, we’ll look to short the S&P 500. It’s simple: look at the levels, look at the volume and make the connection. There’s no volume in between our S&P 500 levels, so when we got to 1374, we knew it’d make for a good short. Pay attention out there.

 

 

ASSET ALLOCATION

 

Cash: Up                U.S. Equities: Down

 

Int'l Equities: Down    Commodities: Down

 

Fixed Income: Up        Int'l Currencies: Down

 

 

TOP LONG IDEAS

 

PSS WORLD MEDICAL (PSSI)

The bulk of the bad news is on the table following disappointing F2012. Rebased F2013 estimates far more reasonable, and revenues should be supported by our expectations for rising physician utilization, and in the near-term, a flu season that is shaping up as a considerable tailwind.

                             

TRADE: LONG

TREND: LONG

TAIL: NEUTRAL

 

HCA (HCA)

SS volume accelerated in 1Q12 and employment remains a tailwind to both admissions & mix. We expect acuity to stabilize and births and outpatient utilization to accelerate out of 1Q12, while supply cost management continues as a margin driver and acquisition opportunities remain a source for upside.

 

TRADE: NEUTRAL

TREND: LONG

TAIL: NEUTRAL

 

UNDER ARMOUR (UA)

The company continues to control its own destiny through investments in all the right areas. We think 30%+ top line and EPS growth for 5+ years. One of its failures, however, has been in penetrating markets outside the US. That will happen. But for now, its failure is a competitive advantage in the face of a strengthening dollar. We like it in sympathy with a LULU sell-off.

 

TRADE: LONG

TREND: LONG

TAIL: LONG

 

 

THREE FOR THE ROAD

 

Tweet of the Day: “I couldn’t care less about who’s delivering alpha. Much more concerned with who’s delivering pizza..”-@ilkandcookies

 

Quote of the Day: “Get all the fools on your side and you can be elected to anything.” –Frank Dane

 

Stat of the Day: 700. The amount of additional job cuts taking place by year-end at Morgan Stanley. 


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DRI: DIAL IN DETAILS FOR TODAY'S CALL

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5-10 minutes prior to the 11AM EST start time please dial:

 

(Toll Free) or (Direct)

Conference Code: 429126#

  

Materials: * PLEASE NOTE MATERIALS WILL BE SENT OUT TOMORROW MORNING PRIOR TO THE START OF THE CALL.  

                  

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"IS DARDEN TOO BIG TO PERFORM"

     

"Too Big To Perform" is a turn of phrase that our CEO, Keith McCullough, loves to use to describe the mega-banks that make up the Old Wall.  We think Darden is in danger of falling into that same category within the restaurant space.  While the company generates ample cash flow, the reasons to own this stock, in our view, are increasingly moving away from fundamentals such as market share and toward a blinkered perspective on "hitting numbers" and - of course - that generous yield.  Still, the Street's optimism seems to be based on an Olive Garden turnaround and future growth prospects.  We do not share this view and would caution against owning the stock over the next three years.

 

Our restaurant research team led by Howard Penney will be hosting a conference call on Darden, TOMORROW, Thursday, July 19th at 11am EST.

 

We will address the following topics, among others:

 

  • Management (and executive compensation) is laser-focused on growth. We think that is a problem when the company's two largest brands are struggling to gain any sustained traction with consumers
  • Blind dedication to a "rate of growth" target independent of a changing operating environment can be a fatal mistake. Growth can mask issues, particularly of the transient variety, but the issues at Olive Garden and Red Lobster are long-standing and require significant attention.
  • Inconsistency in the company's rationale behind its top-line strategy at Olive Garden. We are not deducing a clear message from the company regarding its ability to stop the sustained traffic losses at Olive Garden.
  • Massive CapEx demands. The company is facing a prolonged period of investment into its largest chain. Getting this effort started in earnest is taking more time than many were expecting.
  • The margin gap between Darden and some competitors offers clues as to how management could seek to bring about sustainable positive momentum in their largest business.

 

 

Please reply to this email with any questions.

 

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst



Bringing the Heat

“Midway upon the journey of our life,
I found myself within a forest dark,
For the straight foreward pathway had been lost."

-Dante Aligihieri, “The Inferno”

 

Keith is out in California this week meeting with some of our subscribers, so instead of getting up at 2am Eastern time he handed me the baton on the Early Look this morning.  As I was riding the train into New York last night, an article in The New Yorker prompted the theme for this note: heat. (By the way, yes I know hockey players from Alberta aren’t supposed to read The New Yorker, but just indulge me this once.)

 

Whether you are a believer in global warming, or not, this has been one heck of a hot summer.  The temperature hasn’t necessarily created an inferno, like in Dante’s namesake poem, but, yes, it has been quite hot.  In fact, for the month of June the average temperature in the United States was 71.2 degrees Fahrenheit.  This is two degrees higher than the average for the 20th century.  In aggregate, the average June temperature made the last 12 months the hottest year since record keeping began in 1895.

 

Not surprising, especially for those amateur psychologists amongst us, the upshot of the heat wave is that according to a University of Texas poll more than 70% of Americans now believe in climate change.  This is up from 52% in the winter of 2011 when we had record snows.  If you didn’t know whether the average person reacts to their most proximate stimuli, now you know.

 

The downside to Mother Nature bringing the proverbial heat is that much of the more agriculturally oriented parts of this country are experiencing droughts.  According to the National Atmospheric and Oceanic Administration, the country is under the most severe drought since 1955.  Currently, 55% of the contiguous United States is in a moderate-to-severe drought. 

 

So, inferno? Indeed.

 

The upshot of a drought is that it provides a bullish backdrop for commodity prices.  Former Hedgeye intern Brennan Turner recently retired from professional hockey and now operates a brokerage business for farmers in Western Canada.  As part of his business he writes a morning note to farmers.  In his note from a couple of days ago, he commented that for Canadian farms, because of the drought in the United States, this year could be like three years in one for both yields and revenues.  As they say, there is always a bull market somewhere. 

 

The more pressing question for most of us, though, is whether the bull market that has been occurring in U.S. equities over the last week plus is sustainable.  Our view, not to mince words, is no.  In fact, yesterday between meetings Keith ducked into a Starbucks and shorted the SP500 in the Virtual Portfolio. So, we are official time stamped on our bearish view.

 

The first thing that concerns us is volatility.  As is highlighted in the Chart of the Day, every time that volatility has approached the 15-ish level on the VIX over the past three years, the market has put in an intermediate term top.  Volatility is a great proxy for investor sentiment and currently the VIX is at 16.2.  Complacency, just like heat, is officially here my friends.

 

The second factor that we are concerned about is earnings.  Wall Street analysts are quite good at engineering earnings “beats”.  This quarter is clearly no exception since as of yesterday 73% of companies in the SP500 had “beat” earnings for the quarter.   Even if the market is excited by this, those of us who are quantitative in nature should not be surprised.

 

Coming in the Q2 2012 top down earnings estimates for the SP500 were projecting a -2.1% year-over-year decline in earnings.  How’s that for the soft bigotry of low expectations?  So sure, companies are beating very low expectations, but more concerning for the equity market is future earnings estimates.  Currently, earnings growth for Q1 and Q2 of 2013 is expected to be 14%.  Yah, I don’t think so.  Both a lack of real earnings growth and declining future earnings are not a positive catalyst for equities.

 

Finally, one of our last major worries is Europe.  Just as the Eurocrats finally go on their lengthy summer vacations, the European sovereign debt markets have again taken a turn for the worse.  Overnight, the Spaniards held an auction for 2-5-7 year bonds and bond buyers didn’t exactly bringing the buying heat.  To be precise, bid-to-cover was an abysmal 1.9x versus 4.3x just over a month earlier on June 7th.   Meanwhile the yield on the Spanish 10-year bond is once again back above the 7% handle.

 

Not to put wood on my bearish inferno this morning, but for those of you who are interested in stock specific ideas our Restaurant research team, led by Howard Penney, is hosting a conference call on Darden Restaurants this morning.  I won’t give away their punch line, but the title of the call is: “Is Darden Too Big Too Perform?” I think you get the drift.  If you are institutional investor and interested in listening in, ping .

 

Our immediate-term support and resistance risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Germany’s DAX, and the SP500 are now $1, $101.29-106.98, $82.88-83.93, $1.21-1.23, 6, and 1, respectively.

 

Good luck out there today,

 

Daryl G. Jones

Director of Research

 

Bringing the Heat - Chart of the Day

 

Bringing the Heat - Virtual Portfolio


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