Bargain Hunting In Financials (and Energy)

If you were looking for the right time to buy some of your favorite financial stocks, the day may soon be approaching. A cloud of worry hangs over the sector due to the subprime mortgage fallout and many of the top names have been crushed. When was the last time you could have picked up Morgan Stanley at 7.56 times earnings or Lehman Brothers at 7.67 times earnings? In fact only two of the top 25 S&P 500 stocks with the lowest P/E ratios are not in the financial or energy sectors. A full 2/3rds of this list are financial companies, and many of them are officially on sale.

By the way Valero Energy is the largest refiner in the US and is a screaming buy at 7.88 times earnings. It seems some people have caught on to Valero's deep discount and started buying a few days ago on the dip . .

Time to Short the Shanghai Composite?

I'm not a big fan of calling the direction of entire markets, but this one seems like a no-brainer. The Shanghai Composite index is way up from its lows in 2005. It rose from its valley near $1110 back in December of 2005 to its peak over $4330 in May of this year. Over the same time period average weekly trade volume on the exchange increased from 8 billion shares to nearly 55 billion. More and more speculative investors are jumping into the Chinese markets with the hope of making a quick buck.

Meanwhile the index has retreated from its peak and has dipped below virtually all of its moving averages to rest at $3776. Why do I think that the index has very little upside at these levels? Well first and foremost the P/E ratio for the index is 39.82, which is clearly in bubble territory. But, the main reason I believe the Shanghai index is overextended is that the Chinese government has shown its willingness to step in when needed to protect investors from themselves. Just last week the Chinese finance ministry tripled the tax on trading to $0.03. The markets did not take the news well, tumbling 6.5% in the first day of trading after the increase. Since then the market is off another 7% as speculators adjust to the new tax and investors gauge whether that relatively minor change is enough to trip up the bull market. Many probably realize that the finance ministry has more tools in their toolbox to curb speculation and if the market tries to test its highs they will be forced to use them.

Remember it was just a year ago that Shanghai real estate was all the rage. However with a series of tax and administrative measures the government effectively chased speculation out of that market. Unfortunately much of that money has landed in the stock market and the government will in all likelihood be just as diligent in controlling speculation as they were in real estate.

Key thing to notice in the chart below: Yahoo! only tracks volume up to 4 billion. You can see that has been inadequate for quite some time.

Three Great Graphs

I felt that these three great graphs were important to share. Thanks to the guys over at "The Big Picture" for the great information.

1) The first graph relates to historical P/E ratios. In light of recent trends this graph makes the market as a whole look fairly cheap in spite of the strong bull market of the past 4 years.
2) The second graph goes a long way towards explaining why the market still looks cheap. Basically corporate earnings growth has been strong since 2Q2002. The most interesting part of this graph however is the reversal in earnings about half way through the 4Q2006 earnings season. Basically what started as another huge earnings quarter was deflated back down under 10%. While growth hasn't screeched to a halt just yet, the last wave of earnings results left much to be desired.



3) The third graph relates to NYSE Member Firm Margin levels. Basically it tracks how much money is being borrowed to purchase securities. It is useful as a way to track the level of confidence of investors and it is a fairly good barometer of when a market may be overheating. The interesting note here is that margin debt is hitting levels not hit since 1999-2000, but because of strong earnings growth and low P/E 's there may be a lot of room to grow here. It will be interesting to see how high margin levels will get before we see some sort of correction in the market.