Investment Banking Giants

The Dynamic Wealth Report
November 2, 2007

The Fall of the Banking Giants

Banking stocks have started hitting new lows again.  Bank of America (BAC), Citigroup (C), JP Morgan (JPM), Merrill Lynch (MER), and Washington Mutual (WM), just to name a few, have all broken their 52-week lows in the last week.  The chart shown below is the Dow Jones US Banking Index.  As you can see the industry has been in a freefall, dropping more than 20% in the last few months.

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Recently, I have heard from several investors who have been thinking that now is the perfect time to pick up these beaten down stocks.  The reasoning is simple: these are all good companies who will survive the recent market turmoil, their stock prices are at levels not seen in years, and their dividend yields are huge.

Honestly, I like their thinking, but I know their timing is wrong. Don’t try to pick a bottom in this market.

These bank stocks are breaking through new 52-week lows for a very significant reason.  Collectively, the industry earnings announcements from the third quarter was horrible and the write-offs of bad debt were measured in the tens of billions.

The mortgage market turmoil that hit in July and August caused these huge write-offs, and these problems are far from over.  The market is rife with uncertainty, and many believe this is only the tip of the iceberg.  The housing market has yet to find a bottom.  As anecdotal evidence, in the Phoenix area, I am seeing many homeowners lower prices significantly.  In addition, several billion dollars of adjustable rate mortgages are going to reset every month between now and the middle of 2008, according to Forbes.

With these macro factors influencing the banking stocks, I am wondering if the write downs taken last quarter were big enough.  Despite what many people think, these banks just can’t work through the huge multibillion dollar mortgage credit issues in a few short weeks.  In my opinion, it will take at least 9 months to a year for all of the ARMs to reset, for home prices to stabilize, and for banks to identify all of the bad debt they are holding on their books.  I believe other hidden pockets of bad debt will still be found next quarter.

To top it all off, the chant of the shareholders these days seem to be for the heads of management.  Charles Prince CEO of Citibank and Stanley O’Neal CEO of Merrill Lynch both stepped down recently.  It won’t be long before other firms are throwing their CEOs out as well.

The departure of these top executives is an important event to consider. When new management arrives they like to start with a clean slate.  This means cleaning out junior management, and taking other financial write-offs.  New management has one shot to blame it on the “other guy” they are going to write off everything they can.  It happens all the time, and I’ve seen it over and over again.

Citibank, who already wrote off $6.5 billion, just announced that they will write off between $8 billion and $11 billion in the fourth quarter . . . can the other banks be far behind?  Don't pull the trigger on these stocks just yet.

•  Gold (New high of over $800)

Gold prices marched higher, crossing $800 for the first time in decades.  Concerns over inflation and a declining US dollar are driving demand.

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