>Monday Morning Musings (CITI)

● Financials stage a rally, but for how long? Financial stocks rallied hard on news of better earnings trends in core businesses, along with speculation regarding changes to the uptick rule and possible mark-to-market accounting. Yet, the jury is out regarding the length and sustainability of the recent bounce. Most investors seem ambivalent, with many preferring to avoid the sector until more visibility emerges, especially on the value of illiquid assets.

● Financials market cap has tumbled from 23% to about 9% of the S&P 500. In almost dramatic fashion, the Financials sector has plummeted from its highs by more than tech stocks did after the 2000 peak, plunging roughly 84%. Credit trends have shifted from exceptionally easy terms to severely restrictive as fears continue to be in place with respect to toxic securities, credit card loans, renegotiated mortgages, future business models and equity dilution. Moreover, forward earnings remain under a cloud, given the high probability of lower leverage for many years relative to the past decade.

● No new leadership, but substantial outperformance seems plausible. It is fair to suggest that the Financials sector is unlikely to provide new equity market leadership since past leaders rarely repeat, but a sharp rebound is possible. Indeed, in 2003, technology names popped far more than the overall market recovery, with many stocks that were “priced-for-extinction” in late 2002 experiencing four- or five-fold moves in share prices over the course of a year. This kind of so-called “junk beta” rally could be repeated in the worst performing sector this time around as well.

To see full report: MONDAY MORNING MUSINGS