Avoiding Financial Stocks Even As Credit Ice Shows Cracks

While it is far too early to declare a thaw in the frozen credit markets, we are seeing some significant cracks in the ice. The yield on the 3-month T-bill is now up to 1.04% from 0.93% yesterday. During the worst of the crisis, this yield actually went negative briefly, and spent days below 10 basis points. Yields like these are the financial equivalent of the banks stuffing cash into mattresses.

I would like to see this get up over the Fed Funds target rate of 1.50% at the very least before we can declare victory,  but the movement is very much in the right direction. Similarly, the TED spread, or the difference between the 3 month T-bill and what banks will lend to each other for 3 months has narrowed to 2.72% from 3.04% yesterday. While this is higher than it got to at the time of the Bear Stearns implosion (and thus still indicates very significant stress in the credit markets), it is very much moving in the right direction. Two weeks ago it was above 4.50%. Under normal circumstances the spread is under 0.50%.

The spread between the rates charged for 1 month commercial paper of the very strongest companies, and just plain normal companies, or the A2P2 spread is now at 4.18%, down from 4.38% on Friday and a recent high of over 4.60%.

These developments make me cautiously optimistic that the huge and unprecedented moves made by the Fed are having some effect. The freeze has already done significant damage to the real economy, and that damage will not be quickly undone. It seems like the storm is abating, and it will soon be time to go out and gawk at the damage.

I would still avoid the Financials and the Consumer Discretionary firms. I simply do not have the stomach to speculate in names like National City (NCC), Zions Bancorp (ZION), Morgan Stanley (MS), General Motors (GM), Harley Davidson (HOG) or Macy’s (M).

However, this is not the time to flee to 100% cash either. Look at companies where the business will not be greatly affected by a severe economic slowdown, which have strong balance sheets and big dividends. Firms like Pfizer (PFE), Bristol Myers (BMY), Conoco (COP) and Verizon (VZ) look like solid investments at current levels.

More aggressive investors should also be interested in the oil service and drilling firms like Halliburton (HAL), Baker Hughes (BHI), Transocean (RIG) and National Oilwell Varco (NOV).

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