TheTrustedAdvisor.com

There’s always two sides to economic news.  It can either be net positive or net negative.  The way these stress tests will be net positive is if we find out that the larger banks don’t have to raise capital.  If we find that the larger commercial banks have to go out and raise tens of billions of dollars, what do you think will happen to our markets?

It’s obviously going to be a negative and the market will most likely turn down off this news.  If we can avoid the situation where the larger banks do not have to raise billions, then we will go higher, because the smaller regional banks aren’t large enough to raise billions by themselves or even collectively as much as might be required by the larger banks.  We can stand to have smaller financial entities in positions to have to raise capital, but if the “too big to fail banks” are found to be undercapitalized, we will go lower.  As long as our larger banks, including bank holding companies, do not have to raise capital, this will be perceived as a positive.

The market is positioned anticipating a minimal amount of capital will need to be raised, but if it gets caught off guard when we find out the news, we’re going lower, and could be until the banks raise their capital.

It’s simple supply and demand.  The money that the banks might have to raise will induce selling in order to create an attractive enough price to get stakeholders in these banks to purchase ownership stakes that replenish the underfunded banks.  I wish I could give a definitive answer, but you’ll get it immediately basically when the methodology and the statements in the stress test results are released.

I can guarantee some will be underfunded, and some will be insolvent.  The real question is whether the larger banks that pose systemic risk to our entire financial system are deemed to be solvent.  On that question, I was asked to calculate capitalization ratios for several of our large banks, and most were sufficiently capitalized.

What it all comes down to is exactly how much money is needed in order to get banks back to solvency.  I happen to think that there will be at least one larger bank, that shall remain nameless, that might have to raise tens of billions.  As long as the supermajority of large commercial banks don’t have to raise capital, the market will rally off the news.

I don’t see any price action that would make me say there have been any leaks as to the results of these stress tests.  I would be ready and vigilant to observe any unusual price action the day before in any particular bank, as it would be an indication of whether that bank was capitalized sufficiently or not.

It is a historic time for the market, having rallied so much off of the lows.  I still hold my S&P target of 1000 by the year end to cap off one of the largest intra-annual swings the market has ever been witness to.

Good luck, and happy trading.