Wednesday, June 04, 2008

Identifying a Bottom for Financials - Morgan Stanley

Morgan Stanley is out saying they have consistently argued that the problem for equities originated with the financials and that a sustained improvement in equity prices required, at the least, a stabilization in the performance of the financials. Firm's negative outlook on financials has been a key reason for their negative outlook on equities overall.

However, a combination of significant Fed action, a steepening in the yield curve, and substantial capital raising help limit downside risk from here. With the BKX index now back at cycle lows, the firm asks at what level they would turn more positive. From here, they believe the downside range for the BKX index is between 60 to 70 points.

A reading of 60 represents MSCO's most bearish case outcome. This would put the BKX index on a 12x P/E multiple on cyclically low earnings generated off a depressed ROE. This is not a level that they believe will be breached. On the other hand, 70 equates to the index trading down to book value. They think this is more realistic and is similar to previous periods when valuations have bottomed. This suggests that sub 70 on the BKX index, financials are probably a buy.

Notablecalls:

There are some more positive tidbits out there this AM:

- WSJ reporting Lehman (NYSE:LEH) was buying back shares yesterday. Do note there was desk chatter out there saying saying David Einhorn's fund was covering his Lehman short position.

- Kuwait Sovereign Wealth Fund KIA is quoted saying they are looking at investments into global financial industry. KIA is said to be examining bigger stakes in Citi (NYSE:C) and Merrill (NYSE:MER) "If there's a good opportunity"

- Wachovia is upgrading Morgan Stanley (NYSE:MS) to Outperform this AM.

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