This Market's Not Yet Ripe for Bottom Fishing

So many are asking: Is it time to start buying the beaten-down bank stocks? The Dow Jones Wilshire Banking index is down approx 20% YTD. Some bank stocks are trading at or near book value. One can easily say drooling valuations. On top of that we had a nice rally last week. Even the Abu Dhabi sovereign government fund came in with an investment in Citi (C) similar to Prince Alaweed in the early 1990s banking crisis. So why not join the fun and make some money? However, is one's memory really short enough to forget the September market rally, which was not sustained?

No one has a crystal ball, and anything can happen. In past crises, as well in many bear markets (which we are not in yet), issues are not - as one hopes - resolved within a matter of weeks. In 1989, Japan’s stock market was at 39,000; today, in 2007, it is running at between 15,000 and 16,000. The true money is made when there are capitulations and the proverbial blood on the street. When Prince Alaweed came in to purchase Citigroup, he purchased shares at half of book value. The recent Abu Dhabi purchase was not anywhere near those valuations. The next issue seems to be: How does one value the types of paper these institutions are still holding? One needs to take into account that very little of this paper has been written off. One needs to ask: What has changed?

Hedge-fund group Citadel might have called some kind of a bottom with its purchase last week of a $3 billion portfolio of asset-backed securities from E*Trade Financial (ETFC) for just a little more than 25 cents on the dollar. However, if one is to consider this a bottom, a very major problem still exists. Many firms that own these assets are still carrying them at much higher valuations and have not yet written them down. What will happen to the shares of these companies when they eventually write down this paper?

David Einhorn from Greenlight alluded to this in one of his writings. It is similar to homeowners who have not lowered the prices of their houses even though the market has changed dramatically. They still have not sold their houses either. Possibly, in the short term, one can witness a bounce in share prices of the financials, as nothing ever goes straight up or down. We simply might be witnessing a dead cat bounce. What surprises are on the horizon? Banks from Norway to Japan are the latest victims of the carnage. I find it very hard to see that we are at a bottom, with tremendous valuations that value investors drool for. What truly has changed? If you plan on bottom fishing, make sure you bring a change of clothes in case you get soaked.