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Commentary Topic from greenfaucet

The Stress Pre-Tests

As I said on Reuters Monday morning, this week's saga of stakeholder battles over auto companies Chrysler and GM (NYSE: GM) would set the stage for banks next week. The Treasury-Fed brain-trust has done a clever job so far of leaking enough Stress Test information to test the waters of investor opinion and find out what will spook the markets most. Like the FED being quoted a few days ago that they told both Citigroup (NYSE: C) and Bank of America (NYSE: BAC) to raise more capital. And publishing some of the details of the methodology last Friday--parameters for GDP, unemployment, and housing prices--was a good way to give investors something to chew on for a week so as not to be surprised on that front.

But, the furor between Chrysler bondholders and the Obama administration was probably considered "too hot" and not the best environment to release bank test results with already-controversial testing methods and plenty of potential to spook investors regardless of their long-term implications. So, now we have to wait until May 7th, which still may be too soon with all the issues that we already know will be hot-buttons:

Does it makes sense to publicize the complex results and potentially hurt banks further?

What if the parameters for "more adverse" recession scenarios aren't considered "stressful" enough?

If clear plans for capital-backing are not laid out in advance by Treasury, will the banks that are deemed to need it most get what equity they have left destroyed by merciless selling? (How close was Citi to a Lehman scenario recently?)

Who decides which equity ratios are most critical and what levels necessitate more capital?

Who takes the worst "haircuts" if debt is restructured in asset-liability swaps?

Will/should preferred shareholders be converted to common equity?

I'm just a trader, not a financial analyst. So I'm sure there's probably a few important issues I left out in the list above. The simple way I see it, perception is 9/10ths of reality here. This has been setting up for a classic "buy the rumor, sell the fact" situation because large holders of bank stocks--institutional investors who have watched their shares of Citigroup, Bank of America, Wells Fargo (NYSE: WFC), Goldman Sachs (NYSE: G), Morgan Stanley (NYSE: MS), JPMorgan (NYSE: JPM), State Street, and a handful of troubled regional banks recover--are still "banking on hope" that the worst is over for these names. Since no one, not even the best bank analysts, will fully understand the test results on the day of release, the 19 stocks (and then some) will get sold until the dust settles.

In preparation for what we originally thought would be fireworks on Monday, investors were busy stocking up on puts this week in Wells Fargo, SunTrust (NYSE: STI), and the KBW Regional Banking ETF (NYSE: KRE). And not surprisingly with the S&P still holding on to gains from a 30% rally off the lows in March, we saw large put buying in some ETF's that represent consumer stocks. The SPDR Consumer Discretionary ETF (NYSE: XLY) saw heavy put buying across various strikes in June on 3 days this week. It is currently sitting right on its 200-day moving average at $23 after making a nice double-bottom at $16 in November and March. The SPDR Retail ETF (NYSE: XRT) has been even stronger in this rally, not even nearing its November low at $15 and now, at $27.50, is over 15% above its 200-day moving average. The XRT saw put buyers in the June 24 and 28 strikes yesterday.

What might be prompting this institutional buying of puts? Well, if your near-term outlook for the broad market is weakness, you buy puts on indexes. And picking indexes that have run the farthest might give you the most bang for your buck. The XRT is a prime candidate given its recent run. How many stocks, let alone indexes or ETFs are 15% above their 200-day moving averages? An additional catalyst here might be that a potential global pandemic causes reactions by governments that encourage more and more people to stay home from school and work and this could impact retail consumption in Q2.

Just hitting the tape... the FED is expanding the TALF to include other assets such as mortgage-backed securities. More efforts to get credit flowing--and soften the blows of the Stress Tests.

Kevin Cook, ONN.tv