JPMorgan Chase (JPM): Out of Silver Bullets

Judging by a discussion on CNBC's Fast Money program on Tuesday, it's time to sell JPMorgan Chase (NYSE: JPM).

Joe Terranova, a regular panelist on the show, extolled the virtues of the megabank, but it rang hollow to my ears. After initially observing how the shares are technically challenged because they've slipped below the 100-day moving average, Terranova gushed:

"You have to love a stock where the CEO comes out, and the CEO is so applauded by the investment community, just some of his comments ... [are] able to reverse the decline. It reminds people of the quality balance sheet that JPMorgan has, [and] the quality company that it is. [With] the race to normalize earnings, you have every reason to own JPMorgan." - Joe Terranova, CNBC 12/8/09

Video:   http://www.cnbc.com/id/15840232?video=1353671712&play=1

The CEO in question, of course, is financial superman Jamie Dimon, one of the most popular and worshipped corporate leaders in the market. While Dimon has clearly risen to rock-star status in the eyes of some for effective management of his company during the crisis, I think it's time to take the other side of the trade.

First of all, nothing in finance is always true. The Jamie Dimon effect was bullish 25 points ago when JPMorgan was clawing its way back from the depths of the market crash. But the stock more than tripled from those levels, normalcy has returned to the credit market and Armageddon has been averted. Jamie Dimon's magic wand seems a bit like a life buoy: priceless on a sinking ship, but nothing special when you're back on dry land.

Secondly, there are few incrementally positive steps he can take now that will help the stock. One of the underappreciated things about Dimon is that he's not only Chairman and CEO of JPMorgan. He's also on the board of the New York Federal Reserve Bank. The only problem is he'll step down from that position at the end of the month. Even if he remains influential in the world of banking, his ability to shape policy in ways favorable to his company can only diminish in the New Year. (One must also ask whether Dimon ever have pulled off coups like the Bear Stearns takeover without holding this position at the central bank.)

I am not trying to bash Terranova for liking Dimon. Joe makes plenty of good calls, but there are times when we all look in the rear-view mirror rather than at the road ahead. Many times in my own investing I have clung to something that used to be true -- often remaining insistently bullish despite warning signs on the chart. Every time, my loyalty to yesterday's truth has cost me. Never think you know more than the chart!

JPMorgan: An Ugly Chart

Reasons not to be long:

• Bearish divergence on MACD
• Consolidating below 30-, 50- and 100-day moving averages
• Oct. 14 surge higher represents "blow off top" / "exhaustion gap" and a false breakout.

The fact that Terranova prefaced his comments by noticing bearish technicals, and then proceeded to discuss something that isn't new suggests his take on JPMorgan suffers the same backward-looking tendency.

Furthermore, as much as he likes Dimon, investors can only buy shares in the company he runs, not the man himself. This is especially important because the next step for Dimon could be out the door at 270 Park Ave. and in the door at 1500 Pennsylvania Ave. as the next Treasury Secretary. Given Timothy Geither's mediocre performance so far on the job and Dimon's failure to dismiss the rumors, it's entirely reasonable to expect JPMorgan could have a new captain this time next year. That's especially true if the Republicans score a big win in the mid-term elections and Obama needs to shake up his cabinet. Given that Dimon is considered such an asset to JPMorgan, what happens to the stock if he leaves?

Dimon: Running low on silver bullets?

Even if the left-leaning wunderkind stays on the job, I'm not sure how his magic and political acumen will help the company cope with the real problems facing the entire banking sector in the next year or two. I suspect we're now settling into a prolonged trench warfare of rebuilding a profoundly sick financial industry. Even if JPMorgan is "best in breed," what breed are we talking about? The dodo bird?

The unavoidable truth is that the banking sector is a mess, and will likely remain a no-man's land of broken dreams, credit writedowns and secondary offerings for at least several quarters into the future.

It appears the entire system is facing major solvency problems. One interesting measure of this comes from the Federal Reserve's "Flow of Funds" report, a quarterly snapshot of everything from insurance companies to charitable foundations. The report provides macro-level data for the entire financial system, and is intended for consumption by economists around the world.

It has big advantage over financial statements from individual companies, which are crafted to satisfy investors and regulators rather than to portray the truth. A few disturbing charts emerge from table L.109 in the last Flow of Funds report, which is also known as the "Z.1":

1)  "Miscellaneous assets" have become increasingly prevalent in the capital structures of our banks, and now exceed $4 trillion. This category leapt by an entire $1 trillion between September 30, 2008, and March 31, 2009, making it by far the fastest-growing item on bank balance sheets.

2)  Excluding these nebulous "miscellaneous assets," the banking system owes more than it's worth:

Bank Asset Mix

Most of these miscellaneous assets recently seem to be real estate accumulated from foreclosures. (The Fed hasn't called me back to explain them.) Of course, all this land and all these houses have completely unclear and unpredictable value. Complicating matters is the fact the prices are dependent on the availability of credit, so the whole thing is like a cat chasing its tail. No one can know how solvent the system really is, which makes a farce of traditional bank metrics.

"'Other assets' across the board are growing," said Chris Whalens of Institutional Risk Analytics said in a recent interview. "It's staring at everyone like everything else today, and no one is doing any homework." (Whalens, it should be noted, considers JPMorgan one of the healthier banks.)

For instance, look at the blue line above, which is the most basic measure of bank solvency: Assets divided by liabilities. Given the fact we know most banks are now are worse off than they were in 1996, the blue line simply should not be soaring higher. The fact it is rising isn't a measure of strength. It means the data is simply incorrect—a bit like when you hit an ice patch and your speedometer shoots up to 90 mph. There's nothing bullish about wrong numbers when you're dealing with highly leveraged entities.

3)      Banks are completely dependent on real estate. I have developed a special way to measure this exposure. On one hand, I recognize banks "traditional assets": Treasury bonds and non-mortgage loans. On the other side, I totaled up miscellaneous assets, mortgages and agency securities, which are all linked to real estate. The result?

(These charts are all through the second quarter. Coincidentally, the latest Z.1 will be released later today.)

Of course, a lot of these assets are agency bonds that are technically backed by real estate, but in reality backed by taxpayers. One has to wonder at a certain point whether Congress won't take action against banks that own these securities. After all, it's not hard to spin the bailouts of Fannie and Freddie as simply another hidden subsidy to the banks holding their debt securities.

As I mentioned in my last column, the banking system is are also being supported by the Fed's low interest rate policies, which are a kind of hidden levy on American savers: Instead of getting taxed on interest you might earn in a savings account, the Fed simply prevents that income from ever occurring. It's another furtive and off-budget way to hand money to the banks. Intellectually, it's the same as when the government doesn't count programs such as food stamps or Medicaid so they can inflate the number of people living below the poverty line.

Finally, things are probably going to get a lot uglier for the Fed, and thus the banks, next year. Political pressure is building on both sides of the aisle to audit the central bank, and Ben Bernanke is facing a much more difficult confirmation than anyone expected. Even if he wins a second term on Dec. 17, his prestige is tarnished and he will probably face growing opposition on Capitol Hill. While that might not sound like a big deal, it could reduce his ability to keep pumping life back into moribund banks. The final danger to the Fed could be the ghost of Mark Pittman, the Bloomberg News reporter who sadly passed away before Thanksgiving. Mark, a former colleague of mine, won a Freedom of Information Act lawsuit against the Fed in August. The ruling was delayed until Jan. 4 pending an appeal. If Bloomberg wins the case, the Fed will be forced to disclose how it spent more than $2 trillion in assistance to the banking system. Regardless of the facts, this will almost certainly produce major headaches for companies in the business.

Given all of these issues, the road ahead for the entire financial sector is packed with landmines. There's simply no reason to own any major bank—especially one as politically connected as JPMorgan.

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