Last week was the fifth week in a row of positive markets in both Canada and the United States. Many investors thought the rally would fizzle out after the first day of the shortened week, however, it was carried along by the momentum of strong gains in the financial and oil sectors. On Thursday, the rally hats were definitely on when Wells Fargo -- the fourth largest bank in the United States -- reported record profits for the first quarter of 2009. The unexpected profit report sent the overall market up more than three per cent in the United States, and approximately 2.4 per cent in Canada.
Surprisingly, the part of Wells Fargo’s business that really drove bottom line profits was its mortgage business. Right now loans are cheap and mortgage applications are on the rise thanks to U.S. government initiatives and lower interest rates. After Wells Fargo reported twice the profits that analysts had expected, this week looks to be quite interesting as most major U.S. banks will report their first quarter numbers as well. If some of the other large lenders such as Bank of America and Citigroup can also report better than expected profits, this may provide the financial sector and the overall markets with the spark that is needed for the “bull run” to last a lot longer.
Most of the major U.S. banks have said that both January and February were great performing months. Citigroup even went so far as saying that the first quarter was shaping up to be its best quarter since 2007. Thus it will be interesting to see how the numbers look.
One of the reasons for the resurgence in profits is the Federal Reserve allowing banks to borrow from them at extremely low interest rates. These banks then turn a very nice profit by lending this money out to the consumer at a much higher rate, making room for very nice profits.
The financial sector's improved performance is also due in part to a couple of major points of contention that are being discussed: market to market accounting and the "uptick rule." It looks like the rules pertaining to how one valuates an asset which is on the books of a company but has no value today based on current market conditions will be changed. This should be advantageous to the banks because they will not have to write down many more assets which have deeply hurt their profitability. In addition, the uptick rule may be reinstated in some form in the coming months. This rule prevents short sellers from continuing to short a particular stock (most short sellers were selling financial stocks short) until there is an uptick in the stock's price, removing the ability for traders to excessively beat up on a company’s shares. The market, in anticipation of these rule changes, has helped move banks stocks higher over the last few weeks.
As I have stated many times in previous articles, the banks are the key to economic recovery. The government here in Canada and in the U.S. have spent billions of dollars to make sure that the financial system recovers to lead us out of this recession. North American banks are too big and too important to their respective countries to be allowed to fail. This is a powerful statement that should give investors in this sector peace of mind that these companies will continue to do business for years to come, and thus their shares should move higher over time. In the face of rising unemployment, the market continues to rise because more people are regaining confidence in the North American banking system. The bank’s upcoming first quarter reports should continue to build on that confidence.
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Allan Small is an Investment Advisor with Dundee Securities Corporation, a DundeeWealth Inc. Company. This is not an official publication of Dundee Securities and the author is not a Dundee Securities analyst. The views expressed are those of the author alone, and are not necessarily those of Dundee Securities or Metro Canada.