Friday, June 6, 2008

Reasons To Sell Financials Now

Now that the Fed has cut rates and looks like they are going to be pausing through the summer the conditions seems right to sell financials.  The sector has recovered recently as the solvency of many firms has been confirmed.  Also, many firms have been able to secure additional capital.  While confidence in the sector may have risen recently with the stock prices of firms in the sector, this does not mean that all is well in the sector.

The conditions seem right to go contrarian and short financials.  These firms are going to raise more capital as the recession worsens and losses related to the U.S. mortgage crisis grow.  The sector is also likely to see more dividend cuts and lower returns as a result of deleveraging.  Morgan Stanley analysts Betsy Graseck, Cheryl Pate and Justin Kwong came out with a similiar assessment of the sector in a research note on Monday.  The analysts also said that the credit markets problem are leading to a situation that is worse than the recessionary environment of 1990 and 1991.

Given the continued disarray in the credit market and the other headwinds faced by the sector, like a U.S. recession and deteriorating consumer credit performance, the recent rise in financial stocks may be premature.  Financial stocks in the S&P 500 are up more than 15% since their lows in mid-March when Bear Stearns got saved.  The difficulties in the credit markets are not even half over and fixing these markets will take even longer.  There are still lots of risks to financial firms.  The prince believes that credit deterioration will accelerate and banks will dilute earnings by raising more equity capital.  With all the aforementioned risks to the downside The Prince thinks it makes sense to short financials.  As the Prince has written earlier, an easy way to sell short financials is by buying SKF.

Disclosure: The Prince owns no positions long or short in financial firms or related ETFs composed of financial firms.

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