Irrational Exuberance?

I must once again highlight the point of this blog. It is to try to distill my thoughts on happenings in the financial markets in order to gain a greater understanding. Right now, it seems that hot money may be flowing from commodities (read oil) into financial stocks. Granted, the financials were well overdue for a rally, having fallen pretty much daily for the last few months. Right now there is no point arguing with the bulls. They are in full control of this sector and will be for a while, although I feel the overall trend is still down.

I would never argue that I know more than the analysts or that I alone am aware of the intrinsic value of the banking stocks. That would be downright arrogant of me, but there is one aspect of this rally which leads me to believe that it is not based on fundamentals. Have a look at the monoline insurers. For those who are unaware of what these firms do, they essentially sell insurance to the purchasers of all types of debt. Up until a few months ago, these firms all had AAA ratings and the debt they insured was given the same rating (as the insurers would pay the purchaser of the insurance for any degradation in the value of the debt). Unfortunately the monolines got involved in insuring subprime mortgages backed securities) for premiums that were way too low (as they, as well as many others involved with these instruments did not fully understand them). As the defaults on subprime assets rose, the insurers faced increasing payments to the buyers of their insurance. Overinvolvement in subprime assets has essentially spelled the end for Ambac (ABK) and MBIA (MBI).

With regionals taking larger than expected writedowns in their prime mortgages, and Amex saying that the current crisis is affecting even those with good credit, reasonable logic concludes that it is worse than expected for the monoline insurers. However, they are rallying to highs not seen in a month, with MBIA up 18% and ABK up 11% today alone, building on previous gains. This prime example of irrational exuberance is what indicates to me that this rally, for most financial stocks will be relatively short-lived.

I will admit that I do like JPMorgan and potentially Banc of America on the back of their strong earnings. But would only buy them on the weakness that I anticipate will follow this rally.