There are many people calling for a bottom to banking stocks, and I must admit, it is a tempting place to play. I never thought Fifth Third would trade so low. Or Keycorp. Royal Bank of Scotland, sorry, I sold you early in 2008; yes, I thought you would fall. When does the excessive leverage finally eliminate the CEO?
Here’s the challenge for investors: on the one hand, you have declining earnings per share in the near term, from losses and capital raises. But when have equity prices fallen enough to discount the future losses?
I am being cautious here. I own no banks.
Here’s another way to think about it — after all of the bad debts are written off, and bad banks eliminated, what kind of earnings stream will be attractive?
I’ll use the homebuilders as an example here — at troughs, they sometimes trade for half of written-down book value, The question becomes the final side of the book value after the writedowns.
I would still be cautious here, but markets are discounting mechanisms — we are getting closer to a bottom in the banks; we are not there yet.
The problem is that its not even possible to speculate on where the bottom is here. We do not know what the banks have on their books. We do not know how level 3 assets values are being modelled. We have some confidence that there will not be a global financial meltdown, with the Fed backstop, but there is no promise that any single bank will not fail. Worse, we might expect that the Fed will allow some high-profile failures.
The perenial bottom calling in banks reminds me of something the chartist Gary Smith wrote at Real Money back a few years ago. I forget the precise details and framing of the question, but when amatuer golfers are asked if they’d be interested in something which would allow them to be guaranteed par, but never again hit a hole in 1, they were not interested. The bragging rights that come from a hole in 1 far out-weigh the value of being a par golfer.
I think this applies in stocks far more often than many investors admit. The bragging rights in calling an absolute top or bottom in whatever is making the current headlines far outweighs the actual value from staying patient and rigorous and catching the middle 50% of a move instead of the first or last 10%.
As for banks and the housing bubble, it took two years before the dot-com survivors were safe to buy. And at the time, you couldn’t give ‘em away. You’d be laughed at for the mere suggestion. When regional banks are derided like utilities as fuddy-duddy investments for seniors looking for dividend income streams, and when the IB’s are universally thought of as incapable of making money for anyone but their executives then it will be time to start looking at financials.
We won’t get a bottom until they just don’t make news anymore. Lehman, Wamu, Citigroup, they are all still making news and headlines.
Banks can’t offload loans anymore, either through whole loan sales or securitization, and they just don’t have the risk monitoring infrastructure to hold them on their books profitably either. Considering that this generation of bank management was all offense and no defense, I believe it will be quite some time before new sources of revenue growth are created. The originate-and-sell model will never be repaired, so until another model takes its place, no bottom will be found in these stocks.