The European Impact on Financials and Risk Assets

I wrote back in early October that financials have been an important factor in risk asset performance for the better part of the past four years. The below chart shows that since June, financials are still an important sector to keep an eye on, but that the sector appears to be driven (remarkably well) by the situation in Europe.

Source: Yahoo Finance

It's All About Financials

The chart below compares the absolute return of an investment in the S&P 500 vs. the excess return of an investment in the investment grade financial bond index (as compared to Treasuries) over rolling three-month periods going back 10 years. Note that pre-financial crisis there was a small relationship (even less so the prior decade) with the return streams below showing an r-square from 1988-June 2007 of less than 0.20. Since that time, an investment in the S&P 500 and financial bonds have been remarkably similar in terms of performance with an r-square of 0.56.

Source: Barclays Capital / S&P

Oligopolistic Banking System and Compensation

At this stage, most of us are familiar with the idea that compensation within the financial services industry has grown much faster than compensation outside the system. As can be seen below, this trend has largely gone uninterrupted throughout the crisis.



And while this level of compensation remains exorbitantly high across all of financial services, the lack of competition among the largest banks has caused compensation within the industry to become even more concentrated.

Before specifically detailing those firms, lets go to Wall Street Pit:

The Journal reported that based on its analysis — which includes banking giants J.P. Morgan, Bank of America and Citigroup, securities firms such as Goldman Sachs and Morgan Stanley, and exchange operators CME Group Inc. and NYSE Euronext Inc. — executives, traders and money managers at 38 top financial firms can expect to earn nearly 18% more than they did last year, and slightly more than they did in the record year of 2007.

While 18% seems like a massive jump (it is) from a level that was already too high (in my opinion), it ignores the broader issue of what has resulted from a government (i.e. taxpayer) guarantee on the downside risks of those banks deemed too big to fail... a MASSIVE increase in compensation (the joys of a "too big to fail" title for the select few).

The chart below details the compensation for all of those 38 firms, grouped here by JP Morgan, Morgan Stanley, Goldman Sachs, Bank of America, Citigroup, and "Other" (all others). BUT, slice off Citi and "other" and we can see that the remaining four make up more than 100% of that 18% jump (let it be known that the data below is not an apples to apples comparison - as Felix points out these charts don't account for the fact that JP Morgan and Bank of America have swallowed up smaller counterparts).



That said, my point is that the increase in compensation (and risk) is now concentrated among only these top banks. Bonuses at these "big four" banks are up a whopping 25% since 2007 (all other firms are down 18% since that time) and 40% since 2006 (whereas all other firms are down 2%).



For all the talk and supposed intervention, nothing has changed (actually, with these banks even more "too big too fail", things may actually be worse).

Source: WSJ / BLS

Financials Rocketed, But Is There Any Fuel Left?

The AP reasons:

Financial stocks fueled Wall Street's rally last week. On Monday, they sent the market into reverse.

Hardly a week... since March 6th Financials are up 100%, leading the S&P 500 three-fold.



Sustainable?

Source: Yahoo

The One Recession Proof Area Within Finance

Lobbying paid for by the financial sector continued to grow in 2008 despite the turmoil.



As Boston.com reports, the trend continues:

Major recipients of federal bailout money spent more than $10 million to lobby lawmakers in the first three months of 2009, including arguing against pay limits for corporate executives, according to newly filed disclosure records.

The biggest spenders among major financial firms and automakers included General Motors Corp., which spent nearly $1 million a month on lobbying so far this year, and Citigroup and J.P. Morgan Chase & Co., which together spent more than $2.5 million in their efforts to sway lawmakers and Obama administration officials on a wide range of financial issues.

"Taxpayers are subsidizing a legislative agenda that is inimical to their interests and offensive to what the whole TARP program is about," said William Patterson, executive director of CtW Investment Group, an activist group affiliated with a coalition of labor unions. "It's business as usual with taxpayers picking up the bill."

Source: Open Secrets (idea via Charting the Economy)

What a Difference a Day Makes... Financial Firms Rocket

Bloomberg reports:

Federal Reserve Chairman Ben S. Bernanke rejected the idea that officials plan to use reviews of banks’ balance sheets as a pretext for government takeovers of the nation’s largest lenders.

The Treasury will buy convertible preferred stock in the 19 largest U.S. banks if stress tests determine they need more capital to weather a deeper-than-forecast recession, Bernanke told lawmakers in Washington today. The shares would be converted to common equity stakes only as extraordinary losses materialize, he said.

“I don’t see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalize a bank when it just isn’t necessary,” Bernanke said at the Senate Banking Committee hearing.

And financials roared....



Source: Yahoo