The Outlook for Financials Failure

I don't actually know how long "Is now the time to buy financials?" has been part and parcel of every interview.

While I have been underweight for ages, and still am, there is one aspect to this whole meltdown that we need to keep in mind - an aspect that could be relevant especially if one-year or two-year performance does not matter:

Of the larger financial companies, will there be any that fail as a result of the entire event still unwinding? (I believe Bear Stearns market cap topped out in the $20 billion range, and if that is correct, I would not say it was that large.)

Obviously some folks think there will be failures, and with history as a guide, there might be one or two, which would not be a lot. Point being, most of them will survive.

As far as large cap, domestic banks go, I cast my lot with Bank Of America (BAC) a long time ago but I seriously doubt that Citigroup (C) is going to fail. The next 10 points might be down for all I know, but at some point $21.22 (Thursday's closing price) is going to look like a steal of a price.

If one- or two-year performance does not matter, then a 50% drop from here on its way to $100 at some point in the future (not a prediction of any sort) would not mean anything. While I am not predicting any price for Citi, I will point out that after being left for dead in the early 1990s the stock went up 3000% in about ten years. So the idea that some distressed bank stock could be a five-bagger sometime between now and the next financial crisis may not be ludicrous.

Further, any stock with a high yield that can maintain that dividend would add dramatically to the compounding effect of buying the right distressed stock.

To be clear, I am not yet increasing my weight in the sector. The environment is not healthy, but of course it will get healthy again, and just as financials have lagged badly recently, they will outperform at some point. Today's post is not a prediction of when it will happen, just a little reminder of the cyclical nature of this sort of thing.

Comments

[jsc173:]

The big ones won't fail, but they won't succeed, either?

What does that mean?

For me, it means it will be another 3-5 years for them to be able to get beyond the effects of their current problems and completely redefine themselves (which they must do to survive).

2008 Jun 06 04:34 PM

[wes mantooth:]

The banks won't recover from this hangover for years. I'm sticking with high quality insurers for the long term. Some of them are currently quite cheap. I just bought some MKL today in fact.

2008 Jun 06 05:55 PM

[Alex Filonov:]

Goldman Sachs is not a bank, but it's priced like one. I'm seriously thinking of buying it.

2008 Jun 06 06:25 PM

[TA:]

Always nice to read a rare objective opinion on things

Thanks to the author

2008 Jun 06 08:22 PM

[Roger Nusbaum:]

Wes Mantooth? Great moniker, I'm in stitches.

2008 Jun 06 10:28 PM

[wes mantooth:]

Thanks Roger, I enjoy your articles.

2008 Jun 07 06:07 AM

[Norman Lepo...:]

Good article.

2008 Jun 07 09:17 AM

[Jared:]

Can we get a clarification here on what you mean by "casting your lot with Bank of America"? You don't seriously think BAC will be the large cap bank that rolls over, do you?

2008 Jun 07 09:24 AM

[Emerald:]

For those inclined to take a small yet risky position, it will be the international franchises that make the most money 3-5 years from now. Therefore, Citi is a better bet than BAC. Deleveraging is a current problem, but it will end and you have the Bernanke put as a floor.

2008 Jun 07 01:35 PM

[bearfund:]

It's hard for banks to raise capital when most of what they offer is yield but the yields, fat as they are relative to other stocks, are below the rate of price inflation while real interest rates remain negative, suggesting strong inflation for years to come. The market is asking itself why it should invest in bank stocks when it could have oil instead. Yesterday, at least, the answer was pretty clear.

Paradoxically, if the Fed raised rates to 7%, I'd like the banks a lot better: the weakest would fail quickly and the strong would be available cheaply, becoming attractive homes for capital as their much-reduced dividends would nevertheless exceed the rate of price inflation for years to come, with capital appreciation on the cards when short-term rates later ease. Right now it's just an unattractive and overpriced muddle in which, as you seem to be saying, no one fails but no one succeeds either. Oil it is, then.

2008 Jun 07 02:07 PM

[Roger Nusbaum:]

Jared, BAC is the one domestic financial stock I have owned for several years. Everything else for financials has been foreign banks.

2008 Jun 07 02:26 PM

[DevKumar:]

Here is how we can fix this country...

1. Start Oil exploration in Alaska immediately . This will reduce the pressure on oil. Believe me environmentalist's say will not be able survive beyond 10 years when China takes over most of the property in this country.
2. Come out of Iraq immediately and tell them to continuously supply free oil for USA as IRAQ needs to pay for the cost of the war.
3. Open up immigration for those people willing to invest in USA housing stock - can have different ranges for different regions.
This will immediately put some life in housing market.
4. No tax upto $100,000 in income for next 5 years if a couple produces a kid.
5. Open up nuclear plants , run as semi govt entities on a non-profit basis, as many as we need to give cheapest supply of electricity to US people. Build new railway lines, trams if needed across the country to run everything of electricity .
6. Increase patent protection for drugs from 20 years to 40 years to give incentive to drug companies so that they can reduce the price of drugs by half. This will give them enough time to come up with new drugs as well.
7. Build govt sponsored education institutions to mass produce doctors, surgeons and dentists to bring down the cost of health care or open up easy immigration for medical professionals. These newly immigrated medical professionals will need to work for cheap and for atleast 5 years in govt owned hospitals.

2008 Jun 07 03:00 PM

[yea ok:]

New USA. Thanks for all your communist ideas. Perhaps one day we can be like haiti

2008 Jun 07 08:17 PM

[twistedstee...:]

Perhaps New USA should move to Europe or another country if America is so screwed up. America may be having problems, but this is by no means a recession.

One of the greatest strengths of our economy is the American Capitalist. More government regulation of the healthcare industry may be necessary, but anyone who has ever been to a military hospital can tell you the difference. You get what you pay for.

2008 Jun 09 12:15 AM