Early-Warning System Sounds Alarm
Investors in bank, S&L; and insurance stocks seem to be trying to tell us where they think that the economy is going. Better hope that they’re dead wrong.
The financial stocks as a group continue to perform miserably. The New York Stock Exchange index of financial issues closed Thursday at 139.28, down 1.01 points. Year to date, the index has fallen 11%. In contrast, the composite index of all NYSE stocks is down just 5%.
Worse, the financial stocks have been slumping for much longer than many stocks. The financials hit their peaks last October and have been going downhill ever since--a 20% average decline so far.
What ails this group is no secret: Rising bankruptcies and overbuilt real estate markets are causing big loan problems for many banks. Insurance companies, also major real estate investors, have likewise been slammed. S&Ls; have been hit by the debacle in junk bonds, which were key investments for many of them. Meanwhile, interest rates are on the rise again.
That’s the news everybody knows. More important, investors seem to be saying that the worst is yet to come. No amount of good news is capable of producing much of a rally in financials.
Thursday, for example, Glenfed Inc., parent of Glendale Federal Bank, reported operating earnings of 90 cents a share for the first quarter, up 58% from 57 cents a year earlier. The numbers were clearly strong. Yet Glenfed’s shares gained just 87.5 cents to $12.75. This is a stock that reached $26.25 last year.
Citicorp, the nation’s biggest bank, is another stock with almost no friends. It closed Thursday at $23.875, scraping near its 52-week low of $22.375.
Why care if bank and S&L; shareholders are losing their shirts? Because financial stocks historically have been an early-warning system for the stock market overall.
“Sharp declines in financial stocks have at best been accompanied by high-risk periods in the market. And at worst they have ushered in some pretty stinky periods,” said Andrew Addison, a technical market analyst who publishes the Addison Report from Franklin, Mass.
Think of it this way: The economy is only as strong as its financial underpinnings. If the lenders are in trouble, many of their borrowers--companies and individuals--are in trouble, too. The key question now is whether worried financial companies are in the process of forcing a major credit crunch on the economy.
Most analysts aren’t willing to buy that scenario yet. Investors in financial stocks are overreacting, partly because they pushed the shares too high last year, many experts say. Ken Funsten, analyst at Wedbush Morgan Securities in Los Angeles, also suggests that the stocks aren’t being sold now so much as there simply aren’t any new buyers.
But what if the early-warning system is accurate? Steven Einhorn, investment policy chief at Goldman, Sachs & Co. in New York, puts it in this understated way: “If things are as bad as the bank stocks are saying, the rest of the market won’t continue to be as immune as it has been.”
Jacobs Takes a Hit: Jacobs Engineering, the Pasadena-based design and construction firm, saw its stock slammed Wednesday and Thursday. And no one seems to have a good explanation.
The stock tumbled $1.50 on Wednesday, then another $1.625 on Thursday, to close at $21. It traded as low as $19.75 on Thursday.
The two-day loss amounted to 13% of Jacobs’ value. The broad market fell 1.8% in the period.
The only news from Jacobs this week was positive, or so it appears. Jacobs announced Wednesday that earnings in its latest quarter were 31 cents a share, up 41% from a year earlier. Revenue jumped 15% to $219 million.
And Jacobs said its order backlog totaled $1.01 billion, its highest ever. “It was a real straightforward quarter for earnings--nothing strange,” said John Simon, analyst at Seidler Amdec Securities in Los Angeles.
New York-based analysts who follow the stock said they hadn’t heard of anyone in their group issuing a “sell” recommendation.
One explanation for Jacobs’ plunge may simply be profit taking. The stock has had a sensational run, from a low of $11.125 last year. As with other engineering companies, Jacobs is benefiting from a sudden unleashing of pent-up demand for new industrial plants. Likewise, the company does a big business in the cleanup of hazardous waste.
Overall, Jacobs could earn perhaps $1.20 a share this year. So the stock sells for about 18 times earnings--not cheap, but then, you’re paying for healthy earnings growth that looks fairly certain.
So why sell now? This is a thinly traded issue. Thursday, Jacobs’ volume was just 108,000 shares on the New York Stock Exchange. It may be that a few too many individual investors who saw the stock tank on Wednesday tried to get out the door at once on Thursday, to protect their profits.
There’s also the possibility that the dark shadow cast by financial stocks, as noted above, is beginning to widen. The jump in interest rates this week may be causing Jacobs investors to wonder if many proposed plant expansions could be canceled, should the economy slump. Thursday, Irvine-based engineering giant Fluor Corp. also tumbled, off $1 to $41.875.
Nazim Thawerbhoy, Jacobs’ controller, says investors are making the wrong assumption if they think current interest rate trends will affect plant construction. “In our business, companies are planning five years ahead,” he said. He added that he can understand investors’ wanting to sell a bit after a strong run in the stock. But a 13% drop “is no way to take a profit,” he said.
SEC Rule Change: As expected, the Securities and Exchange Commission on Thursday removed some restrictions from the market for so-called private-placement securities--stock or bond issues placed directly by companies with big investors rather than sold publicly.
The SEC voted to allow institutional investors to trade such securities among themselves at any time. Previously, investors who bought private issues had to hold them two years. The SEC also OKd the creation of an electronic network proposed by the National Assn. of Securities Dealers to trade private placement issues.
The idea is to make the market in those securities more liquid--which should attract new investors and ultimately make it easier for more firms to raise capital in the private placement market rather than going through the time and cost of a public securities issue.
The private market won’t be an overnight panacea for smaller firms, but the SEC move will at least offer another route for capital-raising long term. One goal of the changes also is to make it easier for foreign firms to raise money here: The SEC will allow qualified issuers of private securities to avoid the extensive financial disclosure required in a public securities sale.
FINANCIAL STOCKS PLUNGE
While the Dow Jones industrial average is off just 3.5% from its all-time high, the New York Stock Exchange financial stock index has plunged 20% from its autumn peak.
