Pzena: For Value Investors, Now's the Time to Buy Financials

The following is an excerpt from Pzena Investment Management's (PZN) Fourth Quarter Newsletter Commentary:

Today, the world seems to have completely adopted the China/India growth story, believing it means a permanent shortage of commodities. At the same time, the subprime crisis is thought to have undermined the world’s financial system. This has led to record valuation spreads between commodities and financials, as you can see in the figure below. In fact, the spread in valuations is wider now than at any time in the past 55 years. In our experience, the extreme views driving this spread are a perfect example of momentum “group think,” which rarely turns out to be correct, and we believe present us with an extraordinary value opportunity in financial stocks...

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Currently, the distinction seems to be very clear. Financial stocks are suffering from the fear that each month will bring news of additional writeoffs. But the fear is disproportionate to the likely reality. After all, Citigroup (C) wrote down $8-11 billion in 2007, but saw its market cap drop by some $129 billion. Once it’s clear what the true damage is, history tells us the underperformance should begin to reverse.

Economic data increasingly indicates we’re entering a recession now. Housing, job, and manufacturing numbers are off, and although GDP grew well in 2007, investors seem to be expecting a recession: they’re in fear mode and failing to pay attention to valuations. If history is any guide, when those recession fears are realized, investors will focus on the impending recovery and value should outperform.