Are the Financials Now Seeing the Bottom?

Some interesting moves by a number of banks, namely Wachovia (WB), Wells Fargo (WFC), and Bank of America (BAC) that has some major investors and market watchers now wondering whether these stocks look oversold, at which point if they are, that would signal the start of the bottom in the financials.

This is the time smart investors have been searching for, the pinpoint of light at the end of this black tunnel, the end of the national nervous breakdown in the banking sector, the time in which investors start to pile in to these stocks.

Some of these shares have recently traded at what it costs to buy a gallon of gas or milk or two New York City subway rides, a severe downdraft that could position them for a snap back rally. As Tobin Smith, founder of ChangeWave Research says, there is "more bad news ahead for banks from purely recession-based loan problems--but at these values, you should be buying the dips, not selling the pops. You'll thank me in two years with 100% gains."

Smith adds though that the markets "should retest the July 15th bottom, but if it's not the bottom, we have more than a recession-lite on our hands."

Yes, we know the storyline, that U.S. banks may need to raise another $65 bn of additional capital to cope with mounting losses from a global credit crisis that will not peak until 2009, Goldman Sachs analysts said last month, on top of the $120 bn already raised.

However, stocks in the S&P 500 financial sector recently ticked surprisingly higher on average, and just turned in their best six day performance, with the sector standing tight in the middle of its 50-day moving average, according to data from Birinyi Associates. I don't think these moves were juiced by a short covering rally, I think there's more at play here.

To be sure, we could be talking about a bear market rally in the financials. Just as I'm not one who likes to think about the end of the world, I'm not of the mindset that Wall Street really is looking for what some perfervid, febrile minds in the media say they are searching for, a capitulation event.

This kind of Holy Grail thinking has too many satirical points of entry that even Monty Python could not handle, a Hallelujah sing to Jesus moment when the markets redeem themselves and the bulls immediately, next day, send the markets rocketing north faster than Halley's comet.

This kind of thinking is impenetrable nonsense of the highest order. We're in a long slog, there will be washouts in individual sectors, and then the market will slowly climb back. The key is to figure out when to get in at the bottom of the U curve. There have been some encouraging signs.

First, watch the action at Wachovia (WB).

Yes historic losses, massive job cuts and a battle axe taken to its dividend. But its new chief executive, former Treasury undersecretary Robert Steel, recently spent $16 mn buying one million shares in the bank. Despite massive charges from the ill-gotten purchase of Golden West bank, Wachovia also announced it is well capitalized, meaning it doesn't need to raise any more equity capital (though it could unload assets).

To be sure, that might be a lot of baloney, and it will raise capital down the road. Also the bank could continue to be hamstrung by future writedowns from the credit crisis and government investigations into alleged fraud in the auction-rate securities market. But Steel is on the stick cleaning out the stables, positioning Wachovia for a breakout. Turnaround in the shares by the end of the year? Stay tuned.

Wells Fargo is also saying it won't need additional capital, SunTrust (STI) and Washington Mutual (WM) also have announced they do not need new capital. Also saying the same is Bank of America (BAC), despite the colossal, potted balance sheet it just bought in the form of Countrywide Financial (CFC) and the fact that Morgan Stanley recently cut its outlook on BofA and said it will need to raise $12 bn in capital to digest Countrywide. However, BofA just announced a sizable $3.75 bn stock buyback. BofA and Suntrust also say they will not cut their dividends--for now.

To be sure, this is no time to be fatally naïve, given the too rosy comments from Merrill Lynch's (MER) chief exec John Thain earlier this year, that the beleaguered brokerage did not need to raise capital. When it did, as it was faced with mounting losses, and in a backbreaking move unloaded its stake in Bloomberg, the Wall Street information powerhouse.

This is no time to be covering up with a multitude of spins if you are running a financial firm.

But check out the action in the iShares Dow Jones U.S. Financial Services ETF (IYG). Last Thursday, it raced higher, after JPMorgan Chase (JPM) reported second-quarter profits of $2 bn, more than half the year ago figure but still beating expectations. Yes managing expectations is a mugs' game on Wall Street, but being a thoughtful bull, I'll take it. Same held true for Wells Fargo (WFC), when it recently disclosed respectable second-quarter earnings beating estimates.

On both banks' news, the stock market closed higher in the triple digits, kicking off a sweet mini-bull run in the financials we haven't seen in a while.

Maybe this thinking is of a piece with holding onto a Styrofoam floatie during a typhoon, but what's true is the markets and the economy have endured crises after crises and both will resurface from this financial nuclear winter.

The problem is, as one of my favorite stock market and economics experts, Donald Luskin, has pointed out (his website "The Conspiracy to Keep You Poor and Stupid" is a brilliant, laugh out loud howler of a must-read, http://poorandstupid.com/chronicle.asp ), is how these concerns make money down the road, given that the giddy subprime days are over, when Wall Street spat out its drunken daisy chain of cut and paste, mortgage-backed securitization jobs now sitting as landfill in portfolios from here to the Arctic Circle and beyond.

That, and whether Wall Street has humbly learned its lesson (doubtful), is for another day. What's clear is that this daisy chain of kryptonite has vaporized the profits it earned during the housing bubble, "Wall Street's Great and Giddy and Bubbly and Crazy Freelance Experiment to Provide America 100% Homeownership." Wall Street, too, will find its way out of the mess.

No one knows when housing and the financials will bottom, but stabilize and bottom they will, as Luskin says.

So the world will go on, the earth will continue to rotate on its axis, solar flares will continue to heat the earth and the more unhinged in the green crowd will continue to blame wobbly patterns in El Nino and global warming on the First Lady's smoking.

The way to play it is to buy the KBW ETF (KBE), which tracks the performance of the banking, broker/dealer-asset management, insurance and mortgage finance sectors within the financial services industry.

Recently trading at $34, it's cheap at 13 times earnings. Top names include Wells Fargo, (WF), JPMorgan Chase (JPM) and Bank of America (BAC). It's also got old reliables like Northern Trust (NTRS), PNC Financial Services (PNC) and State Street (STT).