Buying Into Financials: The Good News And Bad
Quarterly reports next week from Citi, JP Morgan, Washington Mutual , Wells Fargo, Comerica , Merrill Lynch, PNC .
There are plenty looking to go long after the reports are out, based on valuation. For example, Citi and Wells Fargo are trading in the bottom 10 percent of their historical valuation (i.e., more than 90 percent of the time the stocks have traded at higher valuations), according to Bernstein.
The bears argue that this is the classic "value trap," i.e. buying into stocks just because they are cheap. There's good news and bad news here.
The good news:
--Many on the Street feel that we are working through the subprime/collateralized debt obligation (CDO) mess.
According to Deutsche Bank, during the fourth quarter, 11 of the 16 largest banks have preannounced earnings with approx. $24 billion. in new charges. That could go to $40 billion before the quarter is over.
It's widely believed that Merrill and Citi will announce additional write-downs when they report next week, but to a great extent this is already priced into the stocks. How far? We don't know, but Deutsche Bank estimated that exposures of brokers to CDOs have been reduced 55 percent to 65 percent from initial balances, and that banks will get in that range next week.
Of course, all this could change if something else happens, like a bankruptcy from a bond insurer. Still, that is a lot of write-downs, and give some support to the idea that this could be a "kitchen-sink quarter" for CDO exposure.
The bad news:
--It's likely loan losses will be accelerating, and it's unlikely this will be the "kitchen-sink quarter" for this problem. We're talking more losses from consumers, as well as the construction area. We've already heard comments to this effect from National City ,Capital One , American Express . This is clearly the next big headwind that financial will have to face, and it is not at all clear that the market has priced in this potential leg down.
To some extent, these losses may be offset against future gains. Bulls are already arguing that Visa's IPO (expected Q1) will create significant pre-tax gains for major stakeholders like Citi ,JP Morgan ,BofA , and Wells Fargo that could be used to offset losses.
How is the global market holding up?
We will hear from our parent, General Electric , as well as Intel and IBM . The Street’s interest here is about the global marketplace; much of the bull argument is based on the U.S. contagion not spreading to a great extent abroad. There is evidence of slowdown in the UK (retailer Marks and Spencer reported horrible numbers this week); what does the rest of the world look like?
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