'The Time to Buy Financials' Is Still Not Now

It is is possible that "is now the time to buy financials?" has been asked on TV every day (literally) for over a year now, and for anyone who views themselves as an investor (as opposed to a trader) the right answer has been no every time.

Throughout all of this I have done very little analysis. I warned about problems long before they manifested themselves in equity prices because of distortions in the yield curve, which did matter; underweighted the sector; and have continued to say that not enough time has passed to make any sort of fundamental case for taking on an equalweight position.

This is easily repeated by anyone in the future. "Hey, the yield curve is inverted, that's gonna be some kind of problem for financials." That seem complex? Of course not.

With each week (or maybe each day) we get news of another set of writedowns, capital raisings and dividend cuts. This past week the market has begun to pay more attention to the regional banks as measured by the Regional Bank ETF (KRE). KRE held up better in the first few months of the year but has done worse over the last two months and diverged lower again in the last few days.

The shift in focus from the money centers to the regionals (if that statement is even accurate) would seem to represent a domino effect. Are there only two dominoes? It would seem unlikely. It makes sense to think the impact on the regionals (fundamentally) will get worse. There have been smaller banks that have failed as a result of all of this, perhaps those were the more aggressive ones, but the crisis will touch even the conservative small banks in one way or another.

The word delevering has popped lately, as in "we're going to see the banks delever." Delevering is an unwinding. It has started but it is not complete. I do not know what the full impact of that will be, and fortunately I don't need to know. Correctly quantifying what happens next is far less important than what your weighting in financials is. If you agreed that this cycle's yield curve inversion would not be different and you underweighted the sector, you already did the work you need to do.

For now, the right thing is to wait.

I would not want to be zero weight, that is also a big bet. Just because it has been correct doesn't make it less of a big bet. One thing is right: Most of the stock price decline has already happened. The Financial Sector SPDR (XLF) is down about 42% from the all time high. The full decline from the top will not exceed 84%. I doubt it will exceed 60% for XLF but obviously certain individual stocks are and will be a different story.

Comments

[G23ROCKS:]

Timing the bottom is a fool's game. It's better to buy strong names in increments over time, selling higher bought shares into strength. As you put it: "One thing is right: Most of the stock price decline has already happened."

2008 Jun 20 11:39 AM

[22thoroughbred:]

I have been long SKF since just under 110, I feel no need to sell out the posn. although I have sold 500 share blocks at every 5 point increment from 115 up, I don't see it hitting 150, but mid-low 140's is a definity possibility.

2008 Jun 20 11:41 AM

[TA:]

BlueDog is 100% right - far better advice than the author

2008 Jun 20 11:56 AM

[rufusmcbufus:]

In Oct. I told the entire market to go suck it by selling everything and going to cash. Just TRY and tell me I'm wrong today.

2008 Jun 20 12:12 PM

[Diyg:]

I'm with you, Rufusmcbufus, but what are you doing to keep your cash dollars from declining in value in our inflationary environment?

2008 Jun 20 12:35 PM

[The Real Ex...:]

The fact is that the financials may not be a buy for many years because this mess is going to take a long time to clean. And during the process shareholders are going to face much more dilution.

You guys might get a laugh if you check the ETFC article posts. There are a lot of fools there betting their life on financials. It's quite funny.

2008 Jun 20 01:01 PM

[rufusmcbufus:]

193395, best I can do is hold cash in a "high yield" savings account around 3% (see bankrate) and HOPE this inflation is based on dumb monetary policy that will soon turn our environment more deflationary through demand destruction. I'm still looking for good ideas for low risk free parking in a trading account.

2008 Jun 20 01:05 PM

[Umm, yeah:]

@ Rufus

Well, if you've been 100% in cash, you missed a nice runup in commodity and energy stocks.

2008 Jun 20 01:08 PM

[rufusmcbufus:]

Yeah, well we can't all play the market perfectly. I did not particpate in that AND I'd say at this point I missed the party. But at least I bailed on the "hold forever because stocks always go up" mindset.And hey, now I can play the short the commodities bubble game.

2008 Jun 20 02:26 PM

[huangjin:]

You are right that if a bank has lost $15 billion in market cap, from $20B to $5B, that most of the losses have already happened. But if housing doesn't bottom in 2009, percentage losses for investors may match this year.

2008 Jun 20 02:50 PM

[Wefwef:]

ARM reset period peak only happens in Q1-Q2 2009. The pain will go much further, people maxing out their credit cards etc. The banks will be in turmoil for a long time to come.

2008 Jun 20 03:13 PM

[jerry p:]

Just because a stock fell 50% the past 3 months (100 to 50) does not mean it cannot fall another 50% the next 3 months (50 to 25). Who wants to catch the falling knife when stocks keep dropping? People who bought IMB for a bargain after it dropped from 44 to 14 are now crying as it is at 1.40

2008 Jun 20 06:06 PM

[charlieatus:]

It's a perfect contrarian indicator, time to load financial stocks fully.

2008 Jun 20 07:31 PM

[Jason Rines...:]

You got a good point Jerry P.

2008 Jun 20 11:04 PM

[leh:]

Last time I looked the Nasdaq is still 50%+ off its highs of 2000-2001 during the tech/net/biotech frenzy. That crash eventually led to the real estate/subprime bubble, and now that has popped as well. Who's to say the banking and housing sectors won't follow the same prolonged fate as the Naz--namely a 7-8 year prolonged drubbing (some might call it a healthy correction)?

We may well be in the very early innings here folks. Going countertrend such a wounded, ugly, and non-transparent sector is a fool's game--just ask Bill Miller and all the other geniuses who were early to the party and are now knee deep in red ink. Further unwinding seems very likely, and could go on for several years. Bloomberg just yesterday ran a short piece quoting some of the savviest hedge fund mgrs out there as saying we're merely 1/3 through this mess. I'm staying long natural gas and fertilizers until the charts tell me I'm wrong.

2008 Jun 21 10:01 AM

[Tim Plaehn:]

There are well run regional banks out there with PEs below 5 and yields over 6%. I know earnings may take a hit, but how much and what is the upside on good news? I own some financials and have been adding to the positions over the last few days. Looking for doubles in the stocks over the next year plus dividends.

2008 Jun 21 10:15 AM

[Ex15:26:]

Tim,
Yes, you seem like a thoughtful value investor....
However, buying financials and these regional banks now is tough. You may catch a rally if you get lucky, however you will probably suffer much more just because so many bad stories with other players are still coming out.
Your recommendation of CTBK is a perfect example. It may be a great bank, however if you owned it Monday, you are now 20-30% down from there.
The argument that these stocks are great b/c they pay a great dividend is a tempting one, until they are so impaired that they have to cut that dividend. In the meantime, you've suffered entirely too much carnage and will get further punished when they announce the dividend cut.
I think the financial play will be a great one, I just don't have to call the bottom, I'd rather miss 5% of the longer term 300% or 400% rally over the next several years, to confirm a rally and preserve capital.
I'm not perfect by any stretch of the imagination, just more conservative in watching trends.

2008 Jun 21 11:08 AM

[Stewie:]

I am always shocked when I read these responses. The "it must go back up because it used to be higher" mindset has never been more prevalent and busted more dopey investors than it has in Financials the last three months. Get it through your head the pain won't end until late 2010 and the recovery will be slow and measured. I don't think many of you realize how mismanaged some of these regional banks are. Banks are a haven for palm pressing suck-ups not financial managers, which is why bank run investment portfolios and bank run mutual funds are usually a disaster.

2008 Jun 21 11:15 AM

[E Nuff Sed:]

You got to take advantage of market panics. This is as close to a panic as I have ever seen.

I have been selling resources/ materials and buying financial s since January when I noticed value guys like Pzena, Whitman etc loading up on Financials. My losses since January are well into the six figures. I am starting to sweat but am prepared to wait it out a few years.

I really cannot see names like AIG, AXP, Citi, Barclays, LLoyds etc going out of business. Seems to be a panic.

One of biggest success was buying P&G in 2000 when it got chopped more than 50% in a matter of weeks, due to a panic because they missed earnings. I re-mortgaged my house to buy the stock. It took 2.5 years - but the stock came back and after 8 years I am sitting on gains of over 300%+.

2008 Jun 21 01:00 PM

[Stewie:]

"You got to take advantage of market panics. This is as close to a panic as I have ever seen."

What market panic are you talking about ? Look to FITB as an example, they slashed their dividend 66% and cut their earnings guidance by 50% plus. So how is the stock halving in price a panic ? It looks pretty damned efficient to me. Just face the fact you bought into the small rally in financials in late January when you should have realized the macro situation would only worsen.

2008 Jun 21 06:21 PM

[E.D. Hart:]

"I really cannot see names like AIG, AXP, Citi, Barclays, LLoyds etc going out of business. Seems to be a panic."

There is no panic, just a long grinding decline. The consensus bet is to buy finacials now. The contrary bet is to short them. Citi may not go out of business, but so what. Does that mean it wont be dead money for two years, maybe three? No, I sold all my financials in February, and wont buy more until the housing and debt crisis are somewhat turning around.

Its true you pay a steep price for a cheery consensus, but it is also true that you shouldn't catch falling knives and that you should take what the market gives you.

The market right now is giving a loud and clear warning that the financials are in serious trouble, and it is based on a collapse of trillions of dollars in asset prices--the US housing market lost 2.7 trillion dollars, and the collapse of debt has been even more serious.

History shows that it takes a long time to resolve debt collapse, and housing collpases. It will take 5 years or more to resolve. Maybe 10 years. Want to play that trend?

2008 Jun 21 10:20 PM

[schooly d:]

I operate on the assumption that what has been true of value stocks/distressed companies in the past will be true of financials in the present. In the short term there will be more pain, more so than in the broader market. In the longer term the majority of financial companies will continue to underperform the broader market and several will probably disappear altogether. But a few will have been unfairly penalized or will turn things around masterfully and these few will reward investors handsomely. I'm not smart or knowledgeable enough to identify in advance the favored few, so I just invest in passive value indexes (RPV, EFV) that t present happen to have a high representation of financials. I won't hit the jackpot, but I won't go broke either and I expect to do ok.

2008 Jun 22 11:24 AM

[Stewie:]

This is part of the problem, value stocks and distressed companies are not one in the same. Value stocks are overlooked situations where the street has underestimated the the earnings and growth potential. Distressed companies are crappy situations where the street had overestimated earnings and growth. They are almost polar opposites.

2008 Jun 22 06:37 PM

[The Real Ex...:]

leh you are 100% right.

YYZ, those without VERY VERY DEEP Pockets should never buy into a panic. Whatyou fail to realize is that we have had dozens of panics over the past years and we are just getting started. So if you plan to buy the "panic" I hope you will have enough to buy all pf the rest opf the panics that will happen over the next few years. Just make it easy on yourself and buy oil and gold. Don't be a fool. Stay out of the financials...now and far into the future. It will take many years for them to get back on track. WAIT AND SEE.

2008 Jun 23 04:50 AM

[The Real Ex...:]

Stewie, you are 100% right. So many people cannot disguish between the two. Only the very best investors should ever even consider messing with distressed securities. Did no one learn anything from the Internet collapse????

2008 Jun 23 04:51 AM

[blink0404:]

Hey Roger Nusbaum fans,

Here's a link to an Roger Nusbuam interview with Chip Hanlon on greenfaucet.
www.greenfaucet.com/no...

They discuss the market and why Nusbaum thinks there could more downside for stocks to come.

2008 Jul 02 03:59 PM