Identifying a Bottom for Financials

Morgan Stanley is out saying they have consistently argued that the problem for equities originated with the financials and that a sustained improvement in equity prices required, at the least, a stabilization in the performance of the financials. The Firm's negative outlook on financials has been a key reason for its negative outlook on equities overall.

However, a combination of significant Fed action, a steepening in the yield curve, and substantial capital raising help limit downside risk from here. With the BKX index now back at cycle lows, the firm asks at what level they would turn more positive. From here, they believe the downside range for the BKX index is between 60 to 70 points.

A reading of 60 represents MSCO's most bearish case outcome. This would put the BKX index on a 12x P/E multiple on cyclically low earnings generated off a depressed ROE. This is not a level that they believe will be breached. On the other hand, 70 equates to the index trading down to book value. Morgan thinks this is more realistic and is similar to previous periods when valuations have bottomed. This suggests that sub 70 on the BKX index, financials are probably a buy.

Notablecalls: There are some more positive tidbits out there this AM:

• The WSJ is reporting Lehman (LEH) was buying back shares yesterday. Do note there was desk chatter out there saying saying David Einhorn's fund was covering his Lehman short position.
• Kuwait Sovereign Wealth Fund KIA is quoted saying they are looking at investments into the global financial industry. KIA is said to be examining bigger stakes in Citigroup (C) and Merrill (MER) "If there's a good opportunity."
•  Wachovia is upgrading Morgan Stanley (MS) to Outperform this AM.

Comments

[EverydayFinance]

While "results" for the financials may continue to suffer with additional writedowns and surprises, I believe this is mostly built in to the prices and as usual, markets have over-reacted with respect to share valuations. I entered UYG, 2X financial ETF at the bottom in March. I since sold 1/3 stake, but I'm still holding a substantial amount for the recovery. I think if you look out a year, you'll see that financials outperformed. I update the portfolio weekly at Everyday Finance.

[blink0404]

Some financials may outperform, but others are going to tank.

There is still a lot of weakness and fear in this sector, and while the divendends are attractive there are going to be so many mergers, failures, and acqusitions that determining which XLF holding is going to be a winner is difficult. Check out this article is your interested in the sector-- www.greenfaucet.com/fa...... middle of the page.

He suggests you either short XLF or wait... Any one have any other comments?

[Jason T]

I own SKF for clients. A position I started building in May when it was under 100. My thoughts in March when Bear went bust were "who's next?"

LEH come to mind. Over the last 3 years, their asset column went from having $416 billion in assets to $689 billion. Their net tangible equity went from only $13 billion to $20 billion. Granted thet bought back $2 billion in shares each year.

But all that leverage, it seems just way too high. As Warren Buffett has said, there will be more pain in this deleverging process. A bottom we have yet to hit. Probably not unitl 2010 in my opinion, but lots of ups and downs.