Unrealized Losses Loom Large Over U.S. Banks

The FDIC data shows a significant increase in unrealized losses at banks, primarily due to the Fed's interest rate hikes. These losses have reached a peak of $655 billion but have since declined slightly to $512 billion. While interest rate cuts could help mitigate these losses, they may also negatively impact bank profitability. There are concerns about potential risks beyond unrealized losses, such as a recession or financial crisis, which may be influencing the Fed's decision to cut rates.

FDIC Quarterly 2024 Vol 18 No 2

Notes

1. HTM: Stands for Held to Maturity. These securities are purchased with the intent to hold them until maturity. Unrealized gains or losses on HTM securities are not recognized in the income statement.
2. AFS: Stands for Available for Sale. These securities can be sold at any time. Unrealized gains or losses on AFS securities are recognized in other comprehensive income, which is a part of equity.

Proactively Assess Your Bank’s Financial Health with FAU’s Free Tool

If you wish to be proactive and examine your bank's unrealized loss ratio, you can utilize this free tool provided by Florida Atlantic University. Although this screener is not flawless and does not reveal all aspects of a bank's financial well-being, it serves as a valuable starting point.

In the article, the (HTM+AFS) Loss to CET1 Capital column is likely the most important in the context of understanding the impact of unrealized losses on U.S. banks.

Here's why:

• CET1 Capital: This is a key measure of a bank's financial strength and resilience. A higher CET1 ratio indicates a stronger bank.
• (HTM+AFS) Loss to CET1 Capital: This column shows the percentage impact of unrealized losses on the CET1 capital ratio. A higher percentage means that unrealized losses are having a more significant negative impact on the bank's financial health.

By analyzing this column, investors and regulators can assess how vulnerable banks are to potential losses from changes in interest rates. A high percentage suggests that the bank's financial stability could be compromised if interest rates continue to rise or if the bank is forced to sell its securities at a loss.

100 Largest Banks Face Potential Unrealized Losses: Only 20 Riskiest Listed

Market Mayhem: Surviving and Thriving in a Downtrend

Video1.  Markets Are Too Complacent, Creating "A Recipe For Pain (YouTube link)

During his interview with Adam Taggart, Ted Oakley emphasized the potential pitfalls of a bear market.

One thing I find about bear markets that people seem to forget is that they can come on quickly. They don't always have to crash, but they can descend rapidly. You might look up a few months later and realize how much the market has fallen. It's often when people lose their complacency and start to worry that the real pain begins. The biggest problem is that people become complacent when prices are high, and that's a recipe for trouble in the future.

Historical Bear Markets and Corrections

What does history teach us about corrections within bull markets (those that don't escalate into something more severe)? Goldman Sachs provides some insights:[1]

Table 1 presents a historical overview of bear markets and corrections in the S&P 500 since the end of World War II. We identified 14 bear markets and 22 corrections exceeding 10%. On average, bear markets decline by 30% over 13 months and take 22 months to recover to previous levels (in nominal terms). In contrast, the average 'correction' is 13% over 4 months and recovers in just 4 months.

Table 1.  Historical Bear Markets and Corrections in the S&P 500 

Clearly, this is a helpful table. While its findings may seem intuitive to some, I suspect many readers were surprised by the significant difference in recovery times between market corrections and full-blown bear markets. For those worried about near-term market weakness but not convinced of an impending prolonged downturn, this information might offer some reassurance.

Navigating Bear Markets: Strategies and Considerations

It's challenging to maintain short positions, whether you're shorting stocks, ETFs, or bear ETFs. Broker lending rates, dividend payments, and the daily price calculations of bear ETFs can all contribute to difficulties.

A conservative investor can outperform the market simply by holding cash or government bonds. For a more aggressive individual investor, the most cost-effective way to capitalize on a market downturn is to employ a strategy of buying puts and selling calls on SPY, QQQ, IWM, or similar ETFs. Alternatively, they can strategically short large, liquid, and easily borrowable stocks or ETFs after market rebounds.

Mitigating Market Downturns: Strategies from Ted Oakley

Ted Oakley of @Oxbow_Advisors  proposed a 30/30/30/10 portfolio as an alternative to the traditional 60/40 portfolio (Video 1).

• 30% should be in short-term fixed income, not long-term. You'll need to actively trade this portion.
• 30% should be in real assets like commodities and real estate. These won't be the primary growth drivers due to market instability.
• 30% should be in a mix of growth and value stocks.
• 10% should be in cash.

For the categories outside of real assets, you'll need to trade them periodically. You can't simply invest and forget about them like in a 60/40 portfolio.

Their current portfolio reflects this strategy. They have three main accounts:

• Conservative fixed income: This is a very short-term account that rarely requires adjustments.
• High-income account: This account has significant exposure to commodities like gold, miners, fertilizer, and real estate.
• Stock account: They've shifted their stock holdings to include more energy, gold miners, consumer staples, and healthcare. Healthcare is a particularly attractive sector due to demographics and recent price declines.

Overall, they aim to maintain around 50% in treasuries for liquidity. This strategy should help you weather any market storm, though they might experience some declines in a severe bear market.

References

1. Goldman's Latest Warning: 'Some Kind Of Correction Seems A High Probability'
2. Short-Interest: Being Bear Is Back In Vogue

The Crystal Ball of Housing: Demographics and Demand

Housing Demographics with John Burns’ Eric Finnigan (YouTube link)

Eric Finnigan leads demographics research at John Burns Research and Consulting, helping clients in the housing and real estate industries understand demand based on demographic trends. He views demographics as a predictive tool, likening it to a crystal ball for future trends. His interest in demographics began around 2013-2014 while working for a capital allocator firm. He analyzed demographic data to predict shifts in housing preferences, such as Millennials moving from urban areas to more affordable regions. Finnigan has been in the housing market research field since 2007, gaining significant experience during the subprime mortgage crisis. His career has been shaped by a deep dive into demographics and housing economics.

Positive Housing Outlook: Rising Headship Rates

The headship rate, which is the percentage of adults who are heads of households, is a key indicator for understanding demographics and housing demand. A lower headship rate means that fewer adult individuals are living in primary residences.

The rising headship rate suggests a positive outlook for the housing market. It indicates that more adults are forming households, which can lead to increased demand for housing and support economic growth. This trend is likely driven by factors such as a strong job market, rising incomes, and changing demographics.

While the data for the second half of 2024 is still being analyzed, the current trend points towards continued growth in household formation and housing demand. This could have significant implications for the housing market, including increased home prices and rental rates.

Headship Rates in Oregon

In [1], it analyzes household formation trends in Oregon and identifies key factors driving the increase. The aging demographics of Millennials, along with rising headship rates across all age groups, have contributed to the formation of more households. This has led to increased demand for housing in Oregon.

References

1. Household Formation in Oregon