The Day Ahead: May Break on Impact

 | Jan 14, 2013 | 8:45 AM EST
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"Let me tell you something you may already know. Nobody hits harder than life. The world will beat you down to your knees, if you let it." -- Rocky Balboa

Today, we'll try and find purpose by way of past investing miscues -- because this week will present a series of significant hurdles to jump if the stock rally is to be maintained, yet nobody seems to give a darn. This is where an investor tends to get hurt.

I also enter the week more bearish I've been for the last two weeks. More specifically, some profits should be yanked from the table as the dumb money flows into stock mutual funds -- a tale so thoughtfully told in the weekend periodicals.

For the following numbers – retail sales, the Empire State Manufacturing Survey and the Philadelphia Federal Reserve Index -- my view is that these releases will mean real-life economic reports meeting equity values.

Retail Sales: This follows a disappointing conclusion to the holiday season, and it comes as consumer discretionary stocks trade to the upside with no upside conviction. A weekend analyst note said consumer spending won't be damaged that much by the expiration of the payroll tax credit. That is pure rubbish. I would believe the predictive forces of Mr. Market before spreadsheet outputs.

Empire State/Philly Fed: I'm concerned about the negative components that have infiltrated the Empire State report. Should the Philly Fed fail to maintain the optimism taken away from the December reading, the exuberant market may become weary of the coming gross domestic product reading for the first quarter, as well as the sustainability of initial 2013 profit guidance -- which I'm thinking could be reasonably optimistic. There are many qualifiers to this expectation, but they collectively converge in this assumption: The real economy is not as strong as the market believes, and that will be evident in the data.

I am not suggesting a complete de-risking maneuver. Earnings season, in my view, has a more-than-50% probability of being better than expected when it comes to both results and guidance. However, be advised that sectors that have led the rally -- such as the financials -- are now susceptible to pullbacks even on positive news due to valuations. Any minor negatives will only add fuel to the fire.

For instance, Wells Fargo (WFC) shares traded lower in response to its earnings beat. I don't think the market's reaction was entirely due to rampant fear on weak net interest margins, compliments of Federal Reserve efforts. For investment banks, as an example, the market may have used Wells' quarter as a hypothetical on what low rates and weakness in trading revenues and continued capital builds could mean for investment-bank earnings.

Breaking It Down

I have identified one item not called net interest margin that could serve as a suppressant to investment-bank earnings, and another overall factor that may dent near-term sentiment. The first, which is earnings-related, constitutes very weak trading revenue -- excluding credit-value and debit-value adjustments. The weakness is due to such reasons as the fiscal cliff, love for fixed income and typical seasonality.

Second on the docket is another quarter of Basel 1 Tier 1 capital builds, which basically indicates the regulation-constrained bank conglomerates are taking measured risk with their capital. My sense is that, in the past six months, financial stocks' robust performance is a function of these firms unwinding capital they'd built up -- by returning it to shareholders in 2013. But the pace of this may flat-out disappoint.

Below is an overview of fourth-quarter sell-side estimates on the top-name investment banks. Observe that expense management continues to be an earnings cushion.  

Bank of America (BAC)

  • Trading revenue: -14% q/q
  • Basel 1 Tier 1 common ratio: 11.6% versus 11.4% q/q
  • Expenses: -5% q/q

Citigroup (C)

  • Trading revenue: -23% q/q
  • Basel 1 Tier 1 common ratio: 13% versus 12.7% q/q
  • Expenses: +7% q/q (includes $1 billion repositioning charge and $500 million or so in litigation costs); flat excluding items

Goldman Sachs (GS)

  • Trading revenue: -10% q/q
  • Basel 1 Tier 1 common ratio: 14% versus 13.7% q/q
  • Expenses: -9% q/q

JP Morgan (JPM)

  • Trading revenue: -14% q/q
  • Basel 1 Tier 1 common ratio: 10.7% versus 10.4% q/q
  • Expenses: -2% q/q

Morgan Stanley (MS)

  • Trading revenue: -21% q/q
  • Basel 1 Tier 1 common ratio: 13.8% versus 13.7% q/q
  • Expenses: -10% q/q

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