Are US Financials a Buy?

U.S. banking stocks came under renewed selling pressure on Monday, after uninspiring earnings from Citigroup and Wells Fargo further doused sentiment in a sector that has taken a severe beating in recent months.

Citigroup Building
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Citigroup Building

Even as financial shares on Wall Street have slumped as much as 40 percent in the past year, the investment community remains divided about whether it is now a buy or still a sell for the lenders.

In the negative camp is Alec Young, chief global equity strategist with U.S.-based S&P Capital IQ, who has an "underweight" on the sector, citing weak loan growth, margin compression and regulatory unknowns.

"The thing is with a credit crunch, we learned this with Lehman, things can get a lot worse, and these falling knives can be really treacherous. So we continue to err on the side of caution with financials, even though it is a crowded trade, we admit," he said.

But fund manager Bill Smead disagrees, saying the sell-off in the shares of U.S. banks this year is exactly the reason to be buying into the sector. The CEO & CIO of Seattle-based Smead Capital Management - who likes and owns shares of Wells Fargo and Berkshire - believes U.S. financial stocks are now "deeply undervalued", based on price-to-book ratios and price to normalized earnings.

"The second thing is... we feel like we're getting close to the end of that down-swing because the people that are overweight financials are paying a very, very stiff price for it right now," he said, adding that while financial stocks could still see some pain, investors with a medium to long term horizon could do well.

"If you have a three-to-five year timeframe, and you're buying the Wells Fargos of the world here, at maybe six times normalized earnings, in three years you're going to feel great, even though you might have been sick to your stomach for the next couple of months," Smead noted.

For Young, the greatest risk for the financial sector is the Europe debt crisis, and advises investors to steer clear unless there is a "clear way" out of Europe.

"The biggest reason that we're still scared of the banks is Europe," Young said. "That still far from being resolved, despite these short-covering rallies that we see from time-to-time.”

“If that situation gets worse, the amount of pain that can be inflicted on you if you own the large money-centered banks, anywhere in the world, not just in Europe, but in Asia, or the U.S., it's just tremendous," he warned.