I sometimes wonder why a lot of value managers (and some have very impressive track records) seem so keen on investing in financial stocks, often saying that current stock prices represent huge buying opportunities.
Apart from the fact that there is still a lot of uncertainty as to the amount of near-term write-offs linked to the real estate market, there is the possibility of new problems coming from the CDS (Credit Default Swaps) market which has exploded in size over the last 4-5 years as well as the threat from credit cards.
More importantly, these investors seem to implicitly assume that once this crisis is over, industry profits will quickly come back to their pre-crisis level. This seems quite naïve. After all, if the share of financial profits as a percentage of US GDP has exploded over the last few years, it is because of the contribution of the securitization boom and of private equity and hedge funds. Is it really prudent (remember, these are value investors!) to think that this trend will resume given the severity of the current crisis (and given the fact that banks will aggressively compete for deposits, which will bring down margins)? And if not, would it be inept to assume that 'normalized'earnings for a lot of banks might only be half of their recent peak levels, or even lower? And if so, do current valuations still look that attractive?
After the S&L crisis in the early 1990's, some people spoke of a Darwinian environment in which the strong banks would get stronger (which is what happened). In the current environment, it is the 'strong' which seem especially vulnerable and in need of new capital.
This capital increasingly comes from the so-called developing world.
Whereas in a normal environment, their investments might have wounded some people's national pride, they are currently very welcome.
Which brings me to my last point. If you really want to own financial stocks, why not own those of the developing world? In most of these regions, traditional banking (mortgages, car loans, credit cards,etc.) is still a growth business given the increase in living standards. In contrast with their western counterparts, these banks didn't and do not (yet?) need to do a lot of silly and irresponsible things in order to be able to show their shareholders ever-increasing earnings. Banks like UOB in Singapore, Siam Commercial Bank and Bangkok Bank in Thailand or Kookmin Bank in South Korea (to name just a few) therefore seem like much-better long term investments than the likes of Citigroup or UBS.
