A lot has happened in the financial markets since April when I predicted the subprime mortgage market to explode. I was correct that the effects would ripple through the stock market, but incorrect about the exposure of some leading banks. Lehman Brothers and Bear Stearns exposure to the subprime mortgage market is greater than I had anticipated, creating a deeper decline in these stocks. These stocks are currently trading at less than 10x 2007 and 2008 earnings which would normally be considered cheap. Unfortunately earnings estimates are declining which does not bode well for their stock prices. In addition liquidity in the financial markets is drying up rapidly which will ultimately create much lower earnings for these companies.
I currently recommend one underweight the investment banking sector due to declining earning estimates, declining financial liquidity, and the major unknowns regarding the effect of the subprime market, debt unable to be sold for hedge fund buyouts, and potentially declining investment banking deal flow.
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