J.P. Morgan's equities team has said financial stocks will help lead the market higher this year. Today, they held a call on the financial group and say they are still overweight, and they expect it to be one of the better performing sectors.
In a note, they concede their call was "challenged" early in the year when developments were worse than expected, but their basic call is still intact, because of improvements in the credit markets and a "trough like" price-to-book for the group.
I listened to part of a conference call with those analysts, and they had plenty of interesting things to say, particularly as major banks and other financials are expected to report profits starting next week.
(JPMorgan Chase and Wells Fargo report Wednesday; Merrill Lynch reports Thursday; Citigroup reports Friday)
They said among the encouraging signs for the group is the rally in credit default swaps, particularly for the financials. They also say with Fed funds at 2.25 percent and headline inflation of around 4 percent, there is a "negative real fed funds" rate.
In this type of environment, investors are penalized for holding cash and are encouraged to build leverage. Historically, it has proven to be favorable for financial stocks.
But Vivek Juneja, who follows large-cap banks, said he still sees trouble coming for that group.
"We're cautious on the large-cap banks, as we we see fundamentals worsening and spreading beyond housing," said Juneja.
He said home equity is a "well-telegraphed" problem area -- but he expects to see higher losses in other areas, such as credit cards.
"We're not out of the woods yet. The credit crunch isn't over, either," he added. "Lending standards are much tougher."
Juneja said he expects the news around the bank group to remain volatile -- but he is seeing buying interest now. "With every turn the Fed makes, people think this is the bottom. There will be a time to buy, but we are cautious right now because we are concerned the recession could be protracted," he said.
Steve Alexopoulos, who follows mid-cap banks, says he believes it's time to buy in...slowly. But once the trend for the group turns positive, it will be very quick.
"I don't think it is going to be possible to find a bottom here," he said. "I think the big flag that's going to be waved is a very big move in the group."
Alexopoulos said he is hearing from investors that they are not yet buying the mid-caps, but they are starting to look for possibilities.
Small-cap bank analyst John Pancari also says its not time to overweight because there is more downside risk, but JPMorgan notes that small-cap banks and the exchanges are the financial stocks with the lowest overall risk exposure. Duration of the recession is one risk for the small-cap group, he said.
The analysts' top longs are PrivateBancorp , Texas Capital Group , Och Ziff , IntercontinentalExchange , MF Global , Goldman Sachs , Fannie Mae , Freddie Mac and Assured Guaranty .
The top financial stocks to "avoid" are TCF Financial , Whitney Holding , Eaton Vance and Chimera Investment .
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