Sell Into the Financials Rally - Morgan Stanley

Morgan Stanley advised clients on Monday to sell into the rally in financial stocks. Morgan analysts Betsy Graseck, Cheryl Pate and Justin Kwong anticipate further dividend cuts, increased dilutive equity offerings and the continued deterioration in the credit markets.

The comment which was perhaps the most revealing of all: Morgan analysts suggested that we are only in the “3rd inning” of difficulties in the credit markets. This makes Morgan Stanley one of the first - and one of the only - banking institutions that has come out with an extremely negative outlook on the financial markets. The vast majority of financial institutions have recently declared that “the worst is over;” leading to a rally in financial stocks. Indeed, financials in the S&P 500 are trading up more than 15% from the March 17th fall of Bear Stearns.

Have conditions really improved that dramatically since that fateful Monday? That’s a simple sounding question with a complex set of answers. The credit markets have improved, in terms of increased liquidity, with the Fed opening up the discount window for investment banks. However, the real economy, which has had only a minimal impact on the financial markets thus far, is deteriorating rapidly. Home prices are continuing to decline, costs of living are continuing to increase (look at the price of oil and food for examples), and the job market is reeling. The real economy will come back around and hit the financial institutions far harder than the freeze in the credit markets did. The Fed put out one fire, but threw gasoline on the other - through massive inflation - and we have not even begun to witness the effects this will have on our economy.

I am encouraged by Morgan Stanley seeing through the false rally. Their belief that we are in the 3rd inning is probably very close to the truth. We have seen roughly 8 months of deterioration, making the 9th inning scheduled to start in late 2009. I think that might be a bit optimistic, but far more in-line with reality than the “experts” who control the financial media would have you believe.

If you subscribe to the belief that we are in the 3rd inning, then you might want to consider purchasing shares in SKF, an inverse exchange traded fund that goes up 2% for every 1% financial stocks go down.

Disclosure: The author of this article holds no positions in any of the companies mentioned.

Comments

[Voice of Re...:]

If analysts were half as smart as they would have us believe, how come they never agree on anything when they all crunch the same numbers?

What use do I have for ALL analysts? The same use I have for used toilet paper. None. Just flush both and good riddance!

2008 Apr 28 07:16 PM

[karchad:]

Hmmm, so according to the geniuses of Morgan Stanley, when the financials were 100% above this level, I was supposed to buy. Now that financials are 50% down, I should sell. Just brilliant. No wonder investors' returns are so poor compared to the indices. No wonder the word is ANAL-ysts... Long-term, buying the financials is a steal at this moment. Laugh at me now, and then let's compare returns in 5 years (and if you're viewpoint is less than 5 years, you and I are talking apples vs. oranges). Maybe Morgan Stanley analysts are the new contrary indicator, right up there with the front-page of Time Magazine.

2008 Apr 28 09:39 PM

[Ryan:]

No, CNBC is the ultimate contrarian indicator. The Morgan Stanley analysts, along with Warren Buffett have this one right.

In 5 years, bank and Ibank earnings will be nothing like their earnings up until mid 2007. If we look 5 years down the line, they might be slightly undervalued at todays levels, but 1 year down the line, they're overvalued. That's what Morgan Stanley is saying. I commend them for recognizing that the bottom has not been seen yet. Everyone else is just pumping.

If you're honestly looking 5 years out, you are truly a wise investor. However, I think there are better plays out there for long-term investment. For example, agriculture, like ADM, and established biotechs like Genzyme, Novartis, etc...

2008 Apr 28 10:06 PM

[Bo Peng:]

The height of this sucker's rally, IMO, is WM and UBS. WM virtually eliminated dividend, diluted existing shares by over 50%, had a massive write-down. And the end is nowhere in sight with their substantially sub-par (which is already very low) subprime and alt-A holdings performance so far. Guess what happened? The stock has gone up.

UBS -- 30% dilution, massive write-down, fights over future directions going public. Stock goes up.

I understand the sucker's thinking -- private equities and Uncle Ben's safety net et al. I just think TPG paid a very expensive price at $8.25 for WM, which will not be rescued because

1. their depository base is relatively small, and
2. they're not nearly as weaved in to the counterparty risk web as BSC, so that their demise will not cause a significant systemic shock. They hold most of their originations.

2008 Apr 28 10:38 PM

[Jason Tillberg:]

I just bought SKF and FXP today. Small amounts.

I think we've got downside right around the corner. CNBC has been ridiculously happy and bullish lately. They laughed at Steve Frenkel when he suggested we could have a 2000 point drop in the Dow starting within this week. He was guest just last Friday. He had suggested back on January 18th that the Dow would likely go to 11,600 and then bounce about 800 points and then head lower. He was nearly right on. So, I heed that guys warning this time.

I think Ben cuts rate 25 bp .. housing is in need of major help still.

2008 Apr 28 10:43 PM

[fatcat:]

hope you guys are right..been buying put on financials for 2 months,got one double,losing on everything else! Really need cof to go in the tank but it defies all logic,up 3 today.leh is another broke piece of crap..

2008 Apr 29 12:47 AM

[fxtrader07:]

@katchad: that will be a very long time you'll have to wait. The financials were a value trap in late 2007 and they are still a value trap in 04/2008. Alt-A downgrades have just started - but certainly not one single bank has started to write down one single dollar of these. And the problem here is, that unlike the AAA-tranches from subprime, Alt-A are much less collateralized. so if the mortgage loand goes into default, losses are eating into the Alt-A tranches much, much faster than in the case of subprime RMBS. So subprime have a higher probability to get hit, but have more cushion. Alt-A get hit later and not so often. But when they get hit, boy, is there real blood flowing out! Moody#s recenty downgraded a chunk of Alt-A. Many AAA-tranches there went to junk overnight!
so good luck with the financials- some are value, i agree, but to figure out which, is very hard to do at this point. chances are, you will hold a,lot of stocks with more dilution, huge addiotional writedowns and significantly impaired earnings power for manyx, many years to come.
doesn't sound that sexy to me...sometimes, there is a real reason for a 50% drop in stock prices. and sometimes, 50% are not enough at all to properly reflect the deteriorating fundamentals

2008 Apr 29 04:21 AM

[Ryan Freund:]

Thanks for the comments, everyone. Great discussion!

2008 Apr 29 10:08 AM

[vaduz:]

i agree to this pessimistic view - lets hope the fed will help enough or better: be able to do so despite the inflation problem..............

2008 Apr 29 12:36 PM

[Jason Hamlin:]

Article recommending buying SKF and SRS on technical set up...

www.goldstockbull.com/.../

2008 Apr 29 07:44 PM

[Jason Tillberg:]

Looking back on articles like this makes me smile. I commented above too saying I was buying SKF and FXP. I bought more throughout May and still own for clients.

This was indeed perfect article and some very wise comments.

2008 Jun 24 02:00 PM