Diamonds are worth more when everyone wants one... (DIA, rated SELL)
The market goes up when there are more buyers than sellers. The market goes down when there are more sellers than buyers. The majority of buyers at these levels are short-sellers buying back to cover stock in a meaningless effort to pick the top. Soon, sellers (in the form of smart money) will begin to say this is close enough, let's sell high so we can buy at lower levels. Short-sellers never pick the top, a lack of long-buyers make the top. So why now? Well, let's take a look at the sector which always lead, and will always lead, because without them, money can not be created: banks. More specifically, let's look at how their earnings are being made in 2010 vs. how they were made in 2009. Last year in 2009, record bank earnings were made based on maintaining and not increasing credit provisions for losses (reducing expenses), and true-blue earnings rising through in sales of mortgages first and foremost in the form of record low rates creating a mini-refinance boom. Who was the biggest buyer of these mortgage-backed securities in 2009? The Federal Reserve. What did we just hear? The Fed is done buying MBS. This is why it was a terrific opportunity to buy financials in February-March 2009 in anticipation of this REAL earnings boost delivered by the Fed low rate policy. This year in 2010, bank earnings are no longer reaching higher highs (the key to justifying a higher P/E multiple), and instead are attempting to sustain the same level of earnings. Most importantly, it is how 2010 earnings are being delivered. It is no longer REAL earnings delivered, but technical earnings by (you guessed it) <u> fuzzy math </u> and "innovative" accounting. A great note was provided by Hussman Funds, and I couldn't explain it any better. Below includes the invaluable words from Hussman Funds ( <font> http://www.hussmanfunds.com/wmc/wmc100419.htm </font> ): It is notable that the "favorable" earnings reported by J.P. Morgan and Bank of America in the first quarter were due to reduced provisions for credit losses - charges that are largely discretionary. In the fourth quarter of 2009, J.P. Morgan charged $8.9 billion against earnings to provide for credit losses, but in the first quarter of 2010, it charged $7.0 billion. Thus $1.9 billion of the $3.3 billion in earnings reported by JPM reflected reduced provision for credit losses. Likewise, the main factor driving Bank of America's earnings was a reduction in loss reserves. Indeed, the provision for credit losses was $3.6 billion lower than it was a year ago (when delinquency rates and credit losses were running at a fraction of current levels). The <u> reduced provision for credit losses might be reassuring were it not for the fact that delinquencies, foreclosures, non-performing loans, commercial mortgage strains, and actual charge-offs reported by various sources have been either unchanged or accelerating. </u> Bank of America, for example, reported that 30-day delinquencies on residential mortgages <u> hit a new record of 8.5% in the first quarter </u> (though the surging FHA-insured portion will allow them to pass some of the consequent losses off onto the American public). Moreover, provisions for credit losses are again falling short of net charge-offs, which is what we saw in 2008 before banks got into trouble (see the June 2, 2008 weekly comment: Wall Street Decides to Close Its Ears and Hum ). For example, actual net charge-offs at Bank of America were $10.8 billion during the first quarter of this year (versus $6.9 billion a year ago), exceeding the provision of $9.8 billion that was deducted from earnings in the first quarter. In effect, the Bank reduced its reserve for future losses by about $1 billion, which had the effect of boosting reported earnings accordingly. This accounts for the entire improvement in earnings from the fourth quarter of 2009, and then some. Overall, the current data presents at best a mixed picture of credit conditions. My impression is that investors should not be surprised by a significant second-wave of credit strains. Still, as we've anticipated for months, we have now entered the window where those strains would be expected to begin, so I won't maintain this view if the data don't increasingly support it. Some evidence is consistent with fresh deterioration, but not nearly to the extent that we would consider decisive. Meanwhile, indications of improvement are also extremely thin. It seems unwise for investors to celebrate variations of a few basis points in delinquency rates. It seems equally unwise to celebrate "favorable" bank earnings reports that are exclusively driven by reduced loan loss provisions, particularly when the volume of impaired loans has not declined proportionately. Keep in mind that <u> Enron and Worldcom were able to report outstanding earnings for a while by adjusting the manner by which revenues and expenses were accrued </u> . I suspect that the U.S. banking system has become a similar breeding ground for innovative accounting.