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How to Trade the Bailout: Buy Only the Best in Banks

Published: Wednesday, 24 Sep 2008 | 1:47 PM ET

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By: Jeff Cox,
Special to CNBC.com

In whatever form it takes, the government rescue plan for the nation's financial system should provide an entry point for investors looking to buy bank stocks again.

New York Stock Exchange
Richard Drew / AP

While concern remains over what happens once the short-selling ban expires, most market pros are looking at the federal intervention as an important step in getting banks liquidity, and thus helping them lend again.

With that lynchpin in place for the nation's economy, investment advisers are hopeful that can free up much of the cash waiting on the sidelines for a chance to go to work.

"By many metrics stocks are priced as low as they have been for 25 years," says Peter J. Tanous, president and director of Lynx Investment Advisory of Washington, D.C. "If you still believe in the future of this country, it is very possible that in five years from now you will be able to look back and say, 'Wow, what a buying opportunity.' "

But Tanous, who says he has never seen "more nervousness on the part of otherwise sophisticated investors" in his 40 years of doing business, doesn't advocate going in and grabbing individual bank stocks at will.

He instead remains cautious, advising clients to look for broad-based exchange-traded funds that provide wide exposure to the sector, while buying only the top of the line in terms of individual companies.

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In particular, he calls Bank of America [BAC Loading... () ] "extraordinarily undervalued" while figuring that a play in a financial ETF such as the SPDR Financial [XLF Loading... () ] would make sense.

Tanous also believes bigger names Goldman Sachs [GS Loading... () ] and Morgan Stanley [MS Loading... () ] are worth a look, but says investors may want to wait a bit until it becomes clearer how the former broker-banks will operate as holding companies.

"They're transforming themselves into a different type of institution and I think it may be prudent to wait six months to see how this plays out," he says. "Bank holding companies attract a huge amount of capital. The bad news is they will no longer be able to leverage that capital like they did in the past."

Indeed, the sentiment for financials seems to be a green light but with a touch of yellow.

(Will the bailout work? Jeremy Siegel, of the Wharton School of Business, provides analysis in the video at left.)

"We think fairly strongly that pretty much anything they do on the bailout side has the tendency to tamp down the panic in the financial areas and the financial institutions for investments," says Diane de Vries Ashley, managing partner at Zenith Capital Partners. "As a result, we're making the suggestion that people look much more closely at getting their toe back into that water, or perhaps putting two or three more toes than they had in before."

Like Tanous, de Vries Ashley advocates grabbing ETFs to invest in financials "rather than a single bet unless you were truly enamored or convinced about a particular stock."

"The inclination would be in as broad-based an ETF as you can get right now, with a tendency to look at a value bias and look at entities that still will likely pay some level of dividends, which have some stability," she says.

Even Buffett is Cautious

While it's difficult to characterize an investor who has just plunked $5 billion into a company--Goldman Sachs--as guarded that's the way Warren Buffett sees himself at this point.

WALL STREET IN CRISIS - A CNBC SPECIAL REPORT

He told CNBC that he sees Goldman as the best-run of the big Wall Street bankers, but he's hardly endorsing the entire sector.

"I'm not buying a cross-section of banking institutions," Buffett said. "I certainly have confidence in Goldman, and you could say it's a vote of confidence in Congress to do the right thing."

To be sure, not everyone is buying the notion that the congressional bailout is going to make everything all right again.

For Investors

Banks After Lehman: Winners and Losers

"I have been at this since 1972 and I’ve never seen anything like this," Dennis Gartman, publisher of the Gartman Letter, said on CNBC. "I’m cutting down the size of my portfolio and I’ve even wired money out of my account so I couldn’t get larger."

Gartman, in fact, recommends selling the SPDR Trust [SPY Loading... () ], which corresponds directly to moves in the S&P 500 index, as well as the UltraShort S&P 500 ProShares [SDS Loading... () ], which rewards investors double for downward moves in the S&P financials.

Yet he's also holding Goldman as well as Chicago Mercantile Exchange Holdings [CME Loading... () ], which operates two self-regulatory futures exchanges.