We’re Not Out of the Woods Yet

The last several sessions saw some calm and cautious optimism return to the stock markets after news that JP Morgan Chase & Co. (NYSE/JPM) had increased its bid for The Bear Stearns Companies, Inc. (NYSE/BSC) to $10.00 a share from the previous $2.00 a share. The revised bid was excellent for many speculators that acquired the shares of Bear Stearns after the collapse believing that a higher bid was in the works.

Trading on Tuesday morning in Bear Stearns was at over $11.00 a share. This suggests that investors believe the $10.00 bid may be too low and expect another higher bid either from JP Morgan or another investment bank or private equity firm willing to try to turn things around. At a market capitalization of about $1.53 billion, Bear Stearns is well down from its value in 2007. However, keep in mind that the company has extreme exposure to negative credit.

In a recent interview with CNBC’s “Squawk Box,” RBC Capital Markets’ regional bank analyst, Gerard Cassidy, suggested that investors should underweigh banks at this time given the continued credit issues.

Our view is to try to wait out the current turmoil and watch for things to improve in the banking sector before jumping back in. The inherent sector risk remains high and makes investments in banks vulnerable to above average downside risk.

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Some good news emerged on Monday after the National Association of Realtors reported a 2.9% rise in existing home sales in February — the first increase since July 2007. On Tuesday, data from the Standard & Poor’s/Case-Shiller index pointed to an 11.4% year-over-year drop in the price of U.S. homes in January.

The reality is that the fragile condition of the housing market and U.S. economy will continue to make stocks vulnerable to downside moves, although the DOW has survived several declines below 12,000 followed by positive rebounds shortly thereafter. We view this as positive, but there is no guarantee that another decline below 12,000 will not occur. Hold tight and remain prudent in your trading and investing strategy.