Don’t Dive into Financial Stocks Yet

On Monday, Credit Suisse Group (NYSE/CS) cut its price target on insurance and financial services company American International Group, Inc. (NYSE/AIG) to $22.00 from $30.00, based on an expected major loss in the third quarter versus the previous estimate of profits. The housing market remains in turmoil after a 13.2% year-over-year decline in existing home sales. The soft data is worrisome, because it could lead to lower consumer spending, as homeowners face a continued decline in personal home value and assets. This will also impact mortgage and financial companies.

A few weeks back at a speech in a financial conference in Singapore, former IMF chief economist Kenneth Rogoff said that further global financial weakness would surface. He predicted that a large U.S. bank would collapse sometime in the next several months. “The U.S. is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say the worst is to come,” commented Rogoff. His comments, while only an opinion, should be viewed seriously.

We continue to see bearish sentiment and higher risk in the financial sector, which I have been suggesting to avoid over the past months. The reality is that the housing market remains in crisis and the impact on the subprime mortgage and credit markets will continue. Yes, there have been major write-downs of debt relating to credit issues, but I no not believe it is over as of yet.

Financial stocks are currently a dividend play, but be warned that there remains downside financial risk in holding on to financial stocks with exposure to the housing market. And, while dividend yields currently appear to be quite attractive based on the payout, I would be hesitant to accumulate financial stocks given the existing turmoil and uncertainties of further breakdowns on banks.

The reality is that yields have moved significantly higher, because stock prices have declined. In my view, I do not believe this is a valid reason to look seriously at financial stocks. I would wait for clearer signs of strengthening in the mortgage and housing markets before diving in.