Analysts – profits on stocks trades all in financial sector

The drummer lifted the brightly colored little container and sprinkled some of the invisible “Eversomuchmoreso” on the apple he held in his hand.

“Consider the prosaic apple – crisp, tangy, almost effervescent. Merely sprinkle some Eversomuchmoreso on it and it becomes eversomuchmoreso crisp, tangy, and, of course, effervescent,” he said with a dramatic flourish. - Mark Twain

New York – Wall Street analysts are skeptical of phenomenal rises in profits of corporate stocks exhibited during the late months of 2010.

They have good reason to be skeptical. The reported gains are all in the financial sector. Though the average earnings yield of S&P 500 securities at 6.4% is above the yield of benchmark U.S. Treasury bonds at 3.5%, the index trading at 15.5 times reported earnings compared to bull market peak variations of 19.7, the news is not really all that good.

Here's why, according to key analysts.

Nonfinancial sector profits in mining, energy, forestry, manufacturing, housing, construction and food commodities all fell substantially during the fourth quarter while, according to Bloomberg Financial News, analysts are arrived at a consensus, predicting rises of 17% average earnings growth in the next 12 months.

How is it to be done? “What's behind the surge in financial sector profits?

"You already know...” wrote Porter Stansberry. Along with propping up the worth of the dollar by buying U.S. Treasury Bonds, the Federal Reserve Board of Governors has lowered interest rates to member banks to nearly nothing.

Companies such as Annaly Capital Management (NLY) borrow money at an extremely low rate such as the 1.8% it paid during the 4th quarter of 2010, then "lend" it through investment in government-guaranteed mortgage securities such as Fannie Mae and Freddie Mac at a 3.65% rate of return, totally insured against any loss.

The net net?

“Annaly earned a 'risk-free' profit of 1.85% on each dollar it touched. Annaly's total portfolio grew to $75 billion – meaning its net interest income was almost $400 million in the fourth quarter alone,” according to Mr. Stansberry.

“Does it seem reasonable that a banking institution with only 114 employees and no branches should earn a risk-free $400 million in one quarter? That implies annual profits of much more than $1 billion. What did it do to earn these profits? Nothing more than pose as a buyer. I say 'pose' because Annaly borrowed nearly all the money it used in these purchases and never assumed any risk whatsoever on the things it 'owned.' Does this make sense? Does it make sense that we, as a society, should trade $1 billion or more for this 'service'?

“I admire the men who built Annaly and run it today. They found a simple – and wildly lucrative – way to take advantage of the absurdity of our banking system. Annaly's roughly $400 million in profits make up a tiny fraction of the $400 billion-plus profit generated by the financial sector last quarter. But they represent perfectly how these dollars were "earned." In almost every case, the money wasn't earned at all – it was simply manufactured by a charade just complex enough to fool the press and the average debtor,” Mr. Stansberry concluded.