Financial Stocks: The Value Trap

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Washington Mutual: RMA in the red zone indicating extreme weakness.

Bernard Baruch once said, “I got rich by taking profits too early.” Yet for generations, traders and investors have ignored his advice, preferring to buy late in the game on the way up or court danger (“Mao Xian” in Mandarin) by rushing into value traps early in a decline.

To quote a popular blogger that rushed into financials in search of value:

August 1, 2007: I had a chance to put together a list of my ten favorite financial sector stocks right here. Once again the market is overly pessimistic about things and that’s forced a number of stocks to levels where they’re deeply undervalued, in some cases stupidly undervalued.

October 29, 2007: I was early rather than late when I bought a ton of financials back in August, and I’m sitting on some pretty large losses now (especially in WM). I thought they were cheap then, and obviously think they’re a lot cheaper now. Bargains can become bigger bargains, alas. I’m not day trading these stocks, I plan to hold them for many years, and I’m not overly worried (though if dividends get slashed that would definitely disturb me). I’m sitting tight.

Indeed, it’s human nature to do this because we perceive prices on a relative basis, relative to what it has been in the recent past. Panic phases in the sentiment cycle make for tradeable “Priced for Armageddon” bottoms while investing tends to work best long after the story has left the front page.

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Citigroup: RMA red for ages.

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Merrill Lynch: RMA red for ages.

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Select Sector SPDR-Financial: RMA red for ages.

The game is even more unforgiving for professionals. While it is one thing to sit and wait for a sector to come back for one’s own account, it is quite another to have clients or subscribers sit on huge paper losses. They don’t like that sort of thing.