Financial Stocks Still Shaky Despite Lehman's Rebound

Lehman Brothers appears to have escaped the investor panic that brought down Bear Stearns, but many investment pros say it's too early to jump back into financial stocks.

"I'm just not a buyer in the financials. It's just not time to it yet," says Michael Cohn, of Atlantis Asset Management. "You have to wait for the housing to stabilize, which I think is going to happen this summer."

Kathy Boyle, president of Chapin Hill Advisors, is pointedly bearish on the market, particularly because of the troubles posed by financials.

She expects the market to drop significantly over the summer, with the S&P 500 falling to 1,080, the Dow tumbling below 10,000, and the Nasdaq sinking to 1,530.

As such, she recommends bearish plays, such as Proshares inverse ETFs that benefit from bearish moves in the major indexes. Among them: The UltraShort Financials ProShares .

As a general rule for stocks, Boyle likes defensive issues in the consumer staples category such as Procter & Gamble and Colgate . Conversely, she warns against stocks like fertilizer producer Potash that have dramatic run-ups which will be subject to profit taking during market downturns.

"I honestly still don't think the market has priced in everything that's out there because nobody really understands the complexities of some of these derivatives and some of these swaps," Boyle says. "I think this is a black box and we don't know what's in it."

Still, there are some analysts and portfolio managers who think that now could be a time to find some bargains in bank stocks. That's even in the face of warnings by a Federal Reserve official that the institutions have been plagued by excessive sloppiness and will need to raise cash to compensate for losses.

Lehman itself has rebounded in the past two days, after plunging earlier in the week, amid increasing optimism about the firm. Lehman has taken steps to clean up its balance sheet, slashing its risky debt holdings by as much as 25 percent and raised $8 billion in capital this year to shore up its balance sheet, according to an internal memo obtained by CNBC.

Deutsche Bank reiterated its "buy" rating on Lehman stock. That comes a day after Merrill Lynch upgraded its rating on Lehman to "buy" from "underperform."

"I do like Lehman Brothers historically. I have been an investor. I probably would put some more in there, but I wouldn't make a pick based on one company,"  says Michael Kresh, president of M.D. Kresh Financial Services, who prefers to play the entire sector through mutual funds and ETFs. "Realistically we know some of these players are going to go down." (See the WSJ's Greg Zuckerman warn on financials in the accompanying video)

In addition to Lehman, Kresh believes Merrill Lynch also will make its way through the current financial slump relatively unscathed. He's not as optimistic about Citigroup .

"It's done a very bad job of trying to integrate into a fully diversified financial services empire, and now they're trying to split it back apart,"  he says.

A Change in Thinking

Financial advisers are shifting strategies in the wake of the renewed banking tumult, which also featured news this week that leading bond insurers MBIA and Ambac might lose their treasured triple-A credit ratings, a move seen as crippling to their businesses. Standard & Poor's on Thursday lowered the firms' financial strength to AA.

"I still believe that we're probably going to see one of the monoline insurers go under, and when that happens I don't know what the response is going to be," says Peter Miralles, president of Atlanta Wealth Consultants. "It will be interesting to see the market response over 48 hours once they declare one of them dead."

Miralles looked at Merrill Lynch's move Wednesday to upgrade Lehman with caution and anticipates sideways trading in US stocks until investors can get more confidence in the market. He recommends international markets and ETF plays in gold, which he calls "portfolio insurance."

A leading gold ETF is streetTRACKS Gold Shares which is up 2.5 percent this year.

"I think you're going to have this volatility for quite some time until the market is truly convinced that this is behind us and get a good month or even two with no surprising news," says Charles Massimo, president of CJM Fiscal Management, who also favors international investing. "If you're an investor and all you do is focus on the US market you're going to suffer."

Massimo's firm practices passive investing and he does not recommend specific stock plays. But he believes small-caps and value moves will be the best way to navigate the financials minefield, and recommends index funds as well.

Others are even more cautious.

Atlantis's Cohn says biotechnology and health care appear to be stronger plays now, but the broader market will be subject to the whims of the big financials.

"Right now the market is hostage to Lehman and Citibank," he says. "Just watch Lehman and Citibank and that will tell you exactly what the market is going to be doing."

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