Market Commentary From Navin R. Johnson

There are a couple of ways you can take this post. One is that I am a jerk (I have family that will agree with you) and the other is to understand how important it is to call BS on what you are hearing and look at things in their simplest light. Put differently, big picture things are often what they appear to be.

For the past few years I have been a broken record on several points and nothing has changed fundamentally in a big picture sense with any of them. That the fundies haven't changed isn't the best way to articulate the point.

The banks first flashed a warning years and years ago by virtue of their weighting in the S&P 500; more that 20% is a flashing yellow light. Then the yield curve inverted which makes lending less profitable which lead to the perceived need by the banks to take more risk for the same return. This dynamic, referred to in some circles as a Minsky Moment, played a large role in the financial crisis.

By financial crisis I mean the worst one in 80 years.

At the same time Europe was having a financial crisis of its own and it too was really bad. If you've been following all along then you've been reading how bad this is, same as many people have and there has been no reason to think things have improved any. Quite the opposite, Europe appears to be much worse.

One argument in favor of buying banks has been that they are attractively priced in relation to their book value. This argument has been made up, down and all around including Barron's a couple times. Um the real estate market is nowhere near getting better so how can the book values be thought of as being correct? This question has been asked by some people but not enough. From the simplest view possible banks lend money for real estate, they have loans outstanding for real estate and the real estate market is still going down (slower than before) so how can book values be correct? You don't need a degree in forensic accounting to come up with this question.

Banks from the US and Europe have offered a couple of good trades along the way, no doubt, but the fundamentals have stunk all the way along and they still stink. I don't know how the pundits miss this but they do. Just stay away.

I've also prattled on about municipal bonds. The states are collectively up a creek even with tax revenues generally higher this year than last. There are deficit and underfunding issues galore which is a new phenomenon on this kind of scale. This makes the risk in the muni bond space different than it has been in the past--on this scale. This is not a Meredith Whitney proclamation of failures just a very obvious recognition that the fundamental dynamics in this space are not normal and this is manifested in intermarket yield spreads that are not normal. Where bonds are concerned I would prefer normal over abnormal.

Now it is possible that the downgrade will in turn have a direct impact on the muni market along the lines of states can't have a better rating than the country.

The above process of looking at things simplistically and going with the obvious conclusion can also apply right now to other European equities besides the banks, Japan and probably a few other things. This is obviously an Occam's Razor argument and while I do not know why some many people had to bet on BAC and Citigroup earlier this year there is no way that the simple viewpoint could leave anyone surprised that the worst crisis in 80 years still has a long way to go for the banks.

Can there be any doubt now that some huge portion of the doubling off the 2009 low was aided by the desperate measures taken by the Fed, Treasury and the Administration? The take away is to be skeptical anytime someone makes an extreme justification about why some apparently broken segment of the market is in fact not broken. Think about the parade of people who never saw the crisis coming (based on their public comments anyway). Now the downgrade doesn't matter. Really?