Playing Financials For Another 'Lehman Moment'

Includes: AIG, BAC, C, GS, JPM, MS, WFC
by: Bill Maurer

I said a couple of months ago that I wouldn't talk about the financials again for a while, as I figured that problems in Europe were still present and the sector was going lower. At that point, Bank of America (NYSE:BAC) was at $7 a share, and I said I wouldn't write about it again in a major way until we hit $6 or Goldman Sachs (NYSE:GS) hit $90. Well, both of those are present, and with the news after the bell that S&P downgraded 37 banks, including the ones above as well as Morgan Stanley (NYSE:MS), Wells Fargo, (NYSE:WFC), and JP Morgan (NYSE:JPM), it seems as if I should continue to wait.

And I will. Once Bank of America crosses the $5 mark, investors will no longer be able to buy it on margin. Several big hedge funds hold huge positions in these firms, especially B of A, and it could just get to the point where they say enough is enough. $5 could be that price. I wouldn't be surprised if we saw $4.75 on the day it finally goes through $5, as many will get out. I don't think a reverse split is a good idea either, because it hasn't worked for AIG (NYSE:AIG) or Citigroup (NYSE:C). Despite current expectations for these names to make money this year, estimates have been slashed over and over, which is why the following performance should not be a surprise.

Performance Current 1-month 3-month 2011
Bank of America $5.03 -31.56% -39.98% -62.18%
JP Morgan $28.56 -22.16% -23.45% -31.21%
Citigroup $25.24 -26.09% -19.31% -46.59%
Wells Fargo $24.08 -10.65% -4.82% -21.13%
Morgan Stanley $13.31 -31.07% -22.93% -50.65%
Goldman Sachs $88.81 -23.35% -23.25% -46.78%
AIG $21.13 -19.78% -15.48% -56.23%

The numbers are not good. While some have done better than others, I don't think any Wells Fargo shareholders will be taking solace in the fact that they are down only 21% this year. These seven are down 45% on average. Great for those who are short, but many investors are not.

So why have I decided to focus on financials again? Well, it seems like the problems in Europe are coming to a boil, and we could have that Lehman like moment soon. I hope we do. If the Dow were to fall say 2000 points in the next two weeks, the potential for a huge snapback rally would be tremendous. Everyone laughs at the idea of buying any financial name right now, but think about the following. During the 2008/2009 financial crisis, Citigroup shares fell under $1. They rebounded to over $5. Even down 46% this year, you're still up a tremendous amount if you got in then. Bank of America traded around $2.50 at its lows. It's double that now, and at one point after the crisis was near $20.

The toughest part is trying to time the bottom. With the recent fall, JP Morgan now has a 3.5% dividend yield. That's 54 basis points more than 30-year treasuries currently. If it falls another 12.5%, it will be yielding 4%. You'd have to expect that buyers will be coming into the name as the yield number hits quarter percentage points (4, 4.25, 4.5, etc.). I don't see JP Morgan falling below $20, because at a 5% yield, I think it would create a tremendous value opportunity. While I wouldn't be a buyer yet, I don't think it would be a terrible idea to set some limit orders on the name at logical entry points.

While I don't think Europe is out of the woods yet, I think that US banks have felt too much negative pressure, and I'm patiently waiting for another big collapse. We've seen in the past how huge selling runs have created tremendous buying opportunities, and I think another one is coming. Nobody is going to let the big US banks fail, so even if the government has to buy in again, they will get propped up. Warren Buffett continues to own Bank of America, and even though he's down on his investment at the moment, he made plenty on his Goldman Sachs bet during the last crisis. I wouldn't be surprise if he adds some more financial exposure soon. This could be the opportunity of a lifetime, again. I predict we are going to feel more pain before the rain clears, but if we get another crisis, it will lead to a tremendous buying opportunity.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.