Weak Housing Is Spoiling Party for Financial Stocks

Wall Street is worried that continued weakness in housing will crash the party for bank stocks, which have staged a surprising upturn following a better-than-expected start to earnings season.

AP

New housing data Thursday showed that sales of existing homes dropped again in June and prices fell in nearly every region, indicating that tight credit and a moribund economy continue to weigh on the market. More numbers are due Friday that will measure the sales of new homes.

With analysts believing that both the stocks and the economy cannot recover until real estate regains its moorings, Wall Street saw its two-week rally come to an abrupt halt as banks shaved the dramatic gains they realized since last week.

The selloff put doubt on a belief that even if the broader market hasn't shown a capitulation, financials at least have bottomed.

"Clearly it's a symbiotic relationship," says Mike Larson, an analyst with Money and Markets. "Before you are going to see a real lasting turn in financials and an end in the deterioration in credit quality, you're going to have to see the underlying housing market solidify. That's just not happening."

One of the reasons home-buying is down is because banks are hesitant to lend, which in turn is due to relatively weak balance sheets. At the same time, mortgage rates have jumped and are nearing the July 2006 peak of 6.8 percent that was the highest in four years.

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Foreclosures also add to the gloom surrounding the industry and now comprise more than one-third of all housing sales.

It all adds up to an overall pessimism that experts think only time can heal, despite the bevy of governmental measures that have been thrown at the problem over the past year.

"The only thing that can fix the underlying imbalance between supply and demand is lower prices, less construction and really the passage of time," Larson adds. "It's a slow, drawn-out process."

Where Does That Leave Banks?

Because banks rely so much on mortgages for their business, they feel a housing slump especially acutely. Washington Mutual ,  a leading mortgage lender in the US, has been especially hard-hit.

The company this week reported a stunning $3 billion loss and said it was holding more than $8 billion to cover deteriorating mortgages. A brief rally at the beginning of the week fell apart and the stock dropped as much as 20 percent in Thursday trading.

Other financial stocks tumbled as well, with Wachovia also giving back some of its uptick for the week.

"Citibank and Bank of America are not on credit watch anymore because they recorded earnings that were not completely disastrous," says Michael Cohn, of Atlantis Asset Management. "Washington Mutual is something that bears watching here. It's going to be a proxy for what's going on with the financials."

Cohn believes financials capitulated last week at least in terms of preferred stock, though he says the immediate future remains uncertain.

"We could have made a bottom in financials. That's not to say that any great things are going to happen to them after this rally," he says. "It's way too premature to find a bottom in this (real estate) market."

Cohn watches two ETFs in financials: the iShares US Preferred Stock Index and PowerShares Preferred , both of which tumbled last Tuesday and Wednesday amid concern about the status of Fannie Mae and Freddie Mac and other sector issues. They have since rebounded.

But Larson watches the Financial Select Sector SPDR , which he said is now charting its fourth alleged bottom in the banks that he says is unlikely to hold up.

"How many V's have we seen?" he said, referencing the direction of the stock pattern after interest rate cuts and other news of the last year that supposedly signaled the end of the worst for financials.

A recovery, he says, "is going to be something where there will be lots of fits and starts. The best advice to investors is you've got to be careful because this is about the fourth time that Wall Street said buy the financials. They're 0 for 3 so far, with the fourth to be determined."

No Place to be But Down

It may be that in the current climate of fear, at least as far as housing is concerned, that a change in market psychology also will be needed before the industry can recover.

"In my mind I just can't see how those numbers could have been anything but bad just judging by how everybody in this country felt about the conditions in the economy and the conditions in housing," says Dennis J. Barba, managing partner of the Oxford Group of Raymond James & Associates. "I don't think you can draw conclusions by these numbers because the general public was in such a state of fear in the spring and early summer."

Yet Barba also sees some value in preferred shares of the big banks, though he says he hasn't bought anything yet, based on their relatively strong showing in earnings.

"I'm of the opinion that you have to get through third-quarter earnings in the financials to see what else is potentially out there," he says. "We're going to have a real good idea of which banks are in trouble."

By then real estate also may be ready to recover, according to some in the industry who see prices in many markets hitting reasonable levels and a bit of a change in mood among the homebuying public.

"In the last even three to four weeks we've seen more people call us to get preapproved for loans, putting their toe back in the water to see what kinds of loans are available, what are rates," Michael Menatian, president of Sanborn Mortgage, said on CNBC. "You won't see it in the statistics yet but I think it's going to start happening."

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