Wednesday, December 13, 2006
Is the Treasury "Bid" a Flight to Safety?
If it is (which is the camp we are in), one would need to be considerably more cautious about financial stocks as we head into earnings season. The disconnect is that spreads on financial bonds are still historically thin, a seemingly serious conflict with the weakening economy scenario. How will the stocks (and bank paper) respond with the slightest sign of weakness in credit quality. It's hard not to think a fairly quick reversal of the gains from the last few months/year in both bank and finance stocks as well as the widening of debt spreads even if Treasury rates continue to be bid. The level of conviction one must have to continue to stay long finance stocks and bonds (beyond benchmarks) needs to be high. Absent a view that a rather short term relative value play (versus non finance stock or bonds) is driving the strategy, one would be hard pressed to find "value" in these securities beyond a few quarters. We would expect insurance paper, and p/c stocks do be equally vulnerable to developments on the economic front as well as adjustments to earnings expectations as we move into 2007. You are not being paid to hold them. At least with some financial stocks, reasonable dividend yields offer a cushion, though an exit strategy ought to be in the thought processes on any rallies. The discrepancy between the performance of C and JPM, relative to BAC and WFC suggests some money is being taken off the table on the two stocks with larger gains over the last few quarters/years, especially if you take away the J Dimon premium, now being built in.