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Five Things You Need to Know: Dawn of the Dead


It's thrilling to see the Financials rising up from the dead.


Kevin Depew's Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Dawn of the Dead

My desk is on fire. Not metaphorically, but literally. The weird thing is I was actually following the instructions for once when I hit this slight snag:

Zombie Cocktail

1 oz. apricot brandy
1 oz. light rum
1 oz. Jamaican rum
1 oz lime juice
2 dashes grenadine
orange juice
1 oz. Bacardi 151 rum

The next part is what caused this horrible conflagration: I read the words "Mix light" and so I did. That was clearly a mistake. Looking at the recipe now... by firelight... I can see the error of my ways. In my haste, I apparently didn't give the author time to finish: "Mix light.... (turn page) and dark rum and brandy in a cocktail shaker and add lime juice and grenadine." Now that changes everything.

The point I am trying to make is not this, but its importance cannot be overemphasized: YOU CANNOT RELY ON RECIPE WRITERS THESE DAYS TO USE PROPER SYNTAX AND PUNCTUATION.

No, the point I am trying to make is that we are plunging headfirst into the dawn of the dead, which just happens to be why I was trying on the zombie cocktail for size. Different eras call for different instruments. This is the era of the zombie, of reanimation, of raised spirits. Consequently, we will need large quantities of both rum and fire, the most potent implements we have to deal with this new era.

On the one hand, the thrill of reanimating the dead is matched only by the release found in acting on the bizarre Freudian urge to clone sheep. The difference is that sheep cloning has the pretense of being a forward-thinking act of good will in the name of science and human advancement, while reanimating the dead and giving them some semblance of life - albeit a mute and willess one - is almost always carried out for some dark and evil purpose.

It is thrilling to see the Financials rising up from the dead. But, we need to know what kind of rally we can expect from these zombie stocks, and more important, what happens after that rally? These are reasonable questions.

2. They Live!

Take a look at the TOPIX Japan Banks Index.

In the early 1990s, shortly after forming a peak that was nearly identical to the recent PHLX Bank Index (BKX), the TOPIX Banks Index fell from a high of 1477 down to 554 on a closing basis, a 38.2% retracement of the bull market move.


What happened after that retracement level was reached? The TOPIX Banks Index proceeded to rally nearly 80% over the course of the next 14 months.

Now, let's take a look at the PHLX Bank Index.


A similar rally over the next 14 months would take us to the low 80s on the BKX.Seems impossible to believe but we're already in the low 60s this morning.

3. The Rest of the Story

Of course, the rest of the story is that after the TOPIX Banks Index rallied nearly 80% from 554 back to 962, over the course of the next 10 years it collapsed to 124.

Remember this: zombies feed on the living, gnawing through flesh and bone for no useful purpose other than to sustain their own rotting existence and increase their legion. (See today's Number 5: The Next 20% for more.)

4. Capitulation?

Yesterday had the feel of capitulation. And, the number of technical indicators pointing in that direction continue to stack up. We've looked at the NYSE High-Low Index here before: heading into this week it was at levels last seen at the 1998 Long-Term Capital Management low. It's now at levels last seen in 1990.

Chart courtesy Investor's Intelligence:
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Now, the NYSE High-Low Index is calculated daily at the close. But before we get too excited about this being THE capitulation point, let's take a look at the longer-term Weekly NYSE High-Low Index, also courtesy of Investor's Intelligence:


Longer-term, we are nowhere close on a weekly basis to where this index bottomed in the 1990 period. We are now due for an intense and vicious rally, but we still have lower to go before everything is said and done.

5. The Next 20%

No, I don't mean the next 20% in the stock market. But if we're looking for reasons why the societal shift in risk appetites and consumption will be so broad and encompassing over the next decade, we need look no further than this Bloomberg piece on the housing market:

New 20% Down Payment Makes Savers From U.S. Spenders

"The U.S. housing crisis may accomplish what years of parental hectoring couldn't: Turn Americans from spenders into savers."

Some interesting datapoints from the article:

  • Lenders will issue 53%fewer purchase mortgages this year than in 2006
  • Mortgage lenders are increasingly requiring 20% down for a home.
  • The average household, which puts away less than 1% of after- tax pay, will have to save 10% for 10 years to buy a home.

Eventually we will reach the point of recognition where we realize that easy access to credit is finished for this cycle. Oh, it will return one day. But that one day will not likely arrive in the next few years, no matter what happens with Fannie Mae (FNM) and Freddie Mac (FRE).

That is really the reasons the rally in Financials is much like reanimating the dead. Their business models have been predicated on using lots of leverage to take advantage of borrowers eager to put money in motion. Now, that velocity of money is slowing in a secular shift. Banks will struggle to reconfigure their business models to return to profitability, but if you consider what moves are available you will quickly see that those moves - raising fees, etc. - ironically only further slow the velocity of money by increasing consumer costs.

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No positions in stocks mentioned.

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