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US & Chinese banks - part 1, the barometer for a global stock market recovery
Investors betting on the fact that stock markets are now bottoming out, are in for a cold splash in the face. Global share market performance may look bad, but there could be more pain to come. David Whittall, Bennelong SGI Portfolio manager, discusses.
Finance is by far the largest sector in the global stock market. The top 950 financial companies alone account for more than 17% ($US3.8 trillion) of global stock market capitalisation. In terms of regions, the dominance clearly lies with China and the US. And within this sector, the largest industry group is banks, accounting for 53% of the global finance sector.
As a consequence, the health of US and Chinese banks is one of the most direct barometers of the global economy and global stock markets.
Part 1 - Imbalances in the US labour and housing markets
On the eve of WWII, about 6% of all goods producing workers were construction workers, with the remainder largely involved in manufacturing.
Starting in the early 1990s, however, the US economy entered a period in which more and more manufacturing jobs moved to China and an increasing number of US blue collar workers entered the construction sector.
By 2007, more than a third of all goods producing workers in America were building homes and other structures. But the housing boom is well and truly over; as a consequence, there is an excess of around 4.1 to 4.9 million construction workers in the US.
In January, the US economy had an unemployment rate of 7.6%. If four million construction workers are added to this, total unemployment would reach 10.2%.
But that is only the beginning.
Within the US economy, residential structures is the single largest private fixed asset class, by far, accounting for $US17.8 trillion of the $US33.4 trillion in US fixed assets (as at 2007).
Not surprisingly, the largest lending activity of US banks is mortgage lending for residential real estate, followed by non‐residential real estate.
In December 2008, US unemployment had reached 7.5%; residential delinquencies were 6.85% and commercial delinquencies were 5.3%. One month later, unemployment had soared to 8%, with data suggesting it will exceed 11%.
The jump from 8-12% would mean an additional 8% of mortgage holders will lose their jobs. As the personal savings rate in the US is just bumping off zero, the newly unemployed mortgage holder will most probably become a delinquent loan holder.
Regional banks in the US have some $US1.7 trillion in loans outstanding; the largest pool of these is mortgages followed by commercial loans. Loan losses of 4% on this $US1.7 trillion pool would equal $US64 billion.
In practice, default rates have been skewed higher by banks' exposure to sub-prime, neg-am and Alt-A loans.
As unemployment takes hold, our assumptions need to be consistently updated. An anticipated 8% loss on the $US1.7 trillion loan book would wipe out $US136 billion - nearly 60% of the equity of the top 92 regional banks we follow.
Part 2, ‘Two sides of the one bubble', will explore the impact on China.
This editorial is based on the March 2009 white paper ‘US and Chinese Banks - the Barometer for a Global Stock Market Recovery', written by the Bennelong SGI global equities team.
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