Hands Off Financial Stocks

A 75-basis-point cut in the Fed Funds rate to 2.25% by the Federal Reserve on Tuesday along with some decent earnings from several financial institutions helped to drive robust buying in the markets. Yet the fiasco that is occurring at The Bear Stearns Companies, Inc. (NYSE/BSC) remains a concern that the credit crunch may get worse.

The Fed’s move is positive, but again I’m not sure it will be enough to turn around the ailing U.S. economy and softening consumer spending. The reality is that a recession could happen later this year due partly to the fallout in the housing market, which is continuing with no signs of bottoming, negatively impacting asset wealth.

The federal government is doing its best to turn around the housing slump. On Wednesday, the government announced that it would give access to billions of dollars at Fannie Mae and Freddie Mac to help with the refinancing of mortgages that are vulnerable to default due to the rising level of foreclosures across the country.

At this juncture, we continue to view the situation in the financial services sector as trouble, because many of the bellwether financial stocks remain down 50% from their 52-week highs. The downward slide in stock values clearly demonstrates the market risk. This is true even in stocks that some would view as long-term buy and hold stocks, although this is clearly not the case in reality. The financial stocks are now dividend plays paying good dividend yields, but the downside risk remains high.

As we move forward, we expect to hear of more impacts driven by the fragile state of the subprime market and increased credit concerns in the banking system. Clearly, the credit and housing market is not improving and could get worse. The key is to wait out the credit crunch and see how things unfold before jumping back into financial stocks, especially those with a high exposure to mortgages.