Fueling recovery: business and consumer lending on the rise

Credit is the fuel for economic recovery and expansion. We may be seeing the beginning of the next credit expansion, with the nation's largest commercial banks finally increasing their lendings to both businesses and consumers, see this WSJ report.

Signs of a lending rebound in business loans already were evident at some big U.S. banks, and Mr. Dimon cited "fairly broad-based strength across corporate, middle market, even small business." But consumer lending has lagged behind because of unemployment, foreclosures and the reluctance of many Americans to go deeper into debt.

Now, the economy is gaining momentum, as shown by the Commerce Department's report Friday that consumers spent more for the sixth straight month. That means profit-hungry bankers are growing more eager to make new loans, especially to borrowers with strong credit histories.

JP Morgan has just reported a great quarter. More are yet to come from Wells Fargo, Bank of America, and Citi this week.

According to Dick Bove, an influencial bank anaylst, banks are entering a "golden age."

What the bond markets are saying

It's often very important for equity investors to look at what the bond markets are saying.

The long-term yields of US Treasuries have stabilized after the December FOMC meeting. They were creeping up since the Fed indicated its intention to do QE2, and especially after the bi-partisan decision to extend Bush-era tax cuts. US government has no trouble borrowing. The upward sloping yield curve is re-assuring for bank stocks and general equities.

European countries are a different story. The Euro crisis is pretty much still with us. Credit spreads for Greece and Ireland continued to climb in recent weeks. The Greek bond spread is now wider than it was in May, 2010 before it was bailed out by EU and IMF (see Atlanta Fed Financial Highlights). All eyes are now on Portugal as its government are trying to convince investors that they can narrow their budget gaps. The yield on Portuguese 10-year bonds stood at over 7 percent as of last week, according Bloomberg. Can ECB and IMF manage the situation before the crisis spreads to Spain? Investors are not convinced.

In the US, a worrisome development continues to be the muni market and state budget crisis. Illinois is the poster-child of the fiscal mess. The state's bonds have the highest spreads of any state. Illinois's 10-year bond spread has widened in recent weeks to 2.1 percent above the benchmark. A year ago, that spread was less than 1 percent... meanwhile, Bernanke's testimony last week made it clear that the Fed has very limited power to bail out the states.

The bright spot is US corporate bonds. Companies are taking advantage of investors' hunger for yield and the general belief that the corporate sector is healthy and may be poised to deliver the much-needed hiring. Corporations have sold more than $35 billion of investment grade bonds in the first week of 2011, according to the Wall Street Journal, on track to reaching the highest amount sold in the year-opening week since 1995.

Taken together, we agree that it may be wise to invest in US equities, and focus on companies that conduct businesses in states that are relatively healthy and can take advantage of the needs from the emerging markets. Avoid European exposures for now. And be vigilant about systemic risks posed by the Euro crisis and the US state budget crisis.

We do not think China's and India's inflation problem pose such a systemic risk to global financial markets, but it's something to watch out for.

Explosive optimism

This weekend's Barron's has the usually bearish Alan Adelson put up a big warning in "Signs of a Top?"

Market sentiment following the surging December is characterized as "explosive optimism." Indeed, forecasts from Goldman Sach's Jim O'neill's 20% stock market gain and "Year of USA" proclamation, to various market gurus that Barron's has assembled, to the recent low in VIX all seem to agree on a very good year ahead.

Could this be the sign of a temporary market top before the real economies produce sufficient results to support it?

This is probably the most important question to ask heading into the first week of 2011. Perhaps the December surge was really just an amplified "window dressing" and short-covering effect when all the under-performing portfolio managers tried to buy the year's big winners and short sellers ran for the cover. If so, these stocks are over-bought and can see sell offs in January.

As noted by Adelson, one important area to watch is indeed the commodities-related stocks which seem to have not reflected the new policy stand by China trying to reign in inflation and the potential bubble in property markets. China has raised interest rates multiple times and bank reserve requirement multiple times. And RMB has not appreciated much. It seems pretty clear that the easy bank-lending policy of the crisis era is now on reverse.

Yet, from copper, iron ore, to other industrial metals and the companies engaged in their productions, the market continues to assume an ever-expanding appetite out of China. FCX has hit 120/share! Can this continue in the new year? If that reverses, it could be a leading signal for things to follow. For a good anlysis of the copper market, and a fair warning, see this Seeking Alpha article.