Continued from Part 1

On the other hand, it is true that values of the widely followed ABX and CMBX indices have staged impressive recoveries, that not only imply that write downs in the financial sector could be over, but that we even might see some "write ups" of the previously marked down securities. However, it is also becoming increasingly unclear whether these recoveries in the values of credit derivatives are actually meaningful, or are they merely an indication of the continued imbalance in the derivative vs underlying security relationships that triggered a large portion of the last year's "credit mess" to begin with...

Putting it in simple terms- it now seems increasingly likely that some (or many?) of the hedges that Wall Street banks put in place after the sub prime fiasco, might actually end up exaggerating the problems, instead of fixing them in the short term... How bad could the things get? I don't think anyone really knows.

And that's precisely my whole issue with the financial sector valuation today- there is still so little certainty with what "real" balance sheets actually should look like, that investing into almost any investment bank or insurance company today, is almost like walking blind in the mine field- there is a certainly a good chance that one might end up making some outsize returns in the long run by buying into conservatively run "real" banks like JPM and WFC, but on the other hand chances of another "Bear Sterns-like" blow up are nowhere close to being remote either. Add to that- almost inevitably stricter regulatory guidelines from the Fed, massive simultaneous deleveraging, paltry returns from the asset management side of the business, still very nascent recovery in the mergers and acquisition volume around the world and any screams about the "historically low" valuations in the financial sector become quite silly...

"Lemming like" behavior of Wall Street still could, in my mind, trigger another "run-on-the-bank". One would assume that Fed's implied guarantee for the counterparty risk helps to virtually eliminate the chance that the likes of Lehman Brothers would repeat the fate of Bear Sterns. But with their bonuses and paychecks on the line, wallstreeters could become quite irrational in heart bit, and when it becomes a 100% clear that artificial shot in the arm in the form of below inflation interest rates is starting to reverse itself - all the bets are off.

That's exactly why I, personally, believe that staying away from financial sector and investment banks in particular, is still a rational move at this particular point- risk/reward balance is simply not there yet... But once again, my investing strategy is just as much about earning the absolute return, as it is about avoiding risk. Hoping for a speedy recovery in the financial sector at this point is still a pure gamble, so I'll take my chances and stay away...

Stay safe and please free to e-mail me any questions at skepticalcapitalist@gmail.com