It's one of the hot Wall Street debates. Do you or don't you hop on the bandwagon and buy one of those bloodied, but rebounding financial stocks?
Let's look at the banks. At first glance, with 70 banks having failed this year, more failures on the way and some estimates calling for another $400 to $800 billion of writedowns from bum loans, banking shares -- many of which have skyrocketed from their recent lows -- hardly seem appetizing at current levels.
That's also the thinking of a prominent New York hedge fund manager who requested anonymity and is short 6 different financial stocks (a bet they will go down in price), primarily banks. His view: "I may be early, but even with the government handouts, these guys are not out of the woods," he says. "No investor really knows or understands the extent of the toxic assets on their books, guaranteed there are more bad loans to come, and I see plenty of disappointing earnings ahead over the next few quarters."
Unfortunately, he put his money where his mouth is. He's losing money, he admits, on 5 of the 6 stocks, but he's sticking to his guns. "It hasn't been easy; The way things are going," he quipped, "I may soon have to go the blood bank."
Such a trip for a blood infusion is understandable since shorting the financials these days is practically equivalent to playing Russian Roulette. Some glowing examples of this risk are seen in the blistering performances of such well known financial names as Bank of America, Citigroup, JPMorgan Chase and Morgan Stanley. The shares of these companies have shot up anywhere from about 240% to 570% from their recent lows.
"You've got to be out of your mind to short these stocks now," says money manager Arnold Silver of Los Angeles-based A. Silver Associates. "Sure they're up a lot, but they've got momentum, and if the economy continues to show more signs of improvement, many of the financials could go a lot higher because they're still way down from their highs."
He may be right, but many Wall Street pros disagree, as evident from the sizable short positions in many financials. For example, in the 4 financial stocks mentioned above, latest figures show short interest ranging from 40 million shares to 92.6 million shares
Charles Biderman, CEO of West Coast liquidity tracker TrimTabs Research, partially owned by Goldman Sachs, disagrees. Painting an ominous banking picture, he contends that, "If banks marked to market the value of their loans and stopped accruing interest on their non-performing loans, most major banks would have no capital left," he says.
He notes, too, that a big chunk of all mortgages -- notably 11% of home mortgages and an estimated 20% of commercial mortgages -- are not current. Banks he points out, are not admitting these loans are in peril.
Arguing that the recently rally in the financials made no sense, he's advising clients to short an exchange traded fund, whose trading symbol is XLF and which tracks the performance of Standard & Poor's financial sector index.
Fred Dickson, the chief investment strategist of D.A. Davidson, a regional Northwestern brokerage biggie out of Great Falls, Mt., also strikes a negative stance on the financials. "I would be leery of them," he tells me, "Not only have they had a huge run, I would also be concerned about derivative problems and more credit risks."
Morgan Stanley, on the other hand, thinks the banking bears are way off base. Analyst Betsy Grasbeck believes the bear case risk for the banking universe has significantly diminished for 3 reasons. First, stabilizing jobless claims increase her conviction that growth in consumer non-performing loans will peak sooner than later. Secondly, she sees more liquid credit wholesale credit markets and greater competition among banks lowering corporate borrowing costs over the next several quarters, reducing commercial NPLs. Third, improving bank earnings should help accelerate corporate repair.
Yet another plus, Grasbeck estimates that stock buybacks -- which reduce the number of shares and hike per-share earnings -- could become material starting in 2011.
In conjunction with its sunny view, Morgan Stanly recently fired off highly favorable research commentary to clients in which it pitched the shares of 2 of the country's banking goliaths--Bank of America and Citigroup. It projects respective capital gains for the duo of 70% and 37.5% over the next 12 months. It figures B of A, currently trading at about $17.40, can reach $30. And Citigroup, now at $4.04, is seen climbing to $5.50.
A cautionary note from Grasbasck: The likelihood of continued economic turbulence as the economy emerges from a recession, which suggests the prospects of considerably more volatility for financial shares. Or, as Silver sees it, still more shocks for bank stocks.
Write Dan Dorfman at Dandordan@aol.com.