Another Selloff Among Financials Makes Some Stocks Look Cheap

Inflation worries resume but early third-quarter indications appear reassuring.
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If the equity market is jittery, to use the pundits'

mot du jour

, then the bank-stock sector is an inconsolable and

Prozac

-immune bundle of nerves.

And, despite solid-looking fundamentals, financial stocks probably will remain in that wobbly state through next week, when more key economic numbers and third-quarter earnings are released, according to analysts and investors.

The

KBW Bank Index

, which tracks the shares of 24 large banks, was down 4% Friday afternoon. Among the institutions worst hit were

Chase

(CMB)

, off 5.7%,

J.P. Morgan

(JPM) - Get Report

, down 4.5%, and

KeyCorp

(KEY) - Get Report

, down 4.5%. The index is down nearly 25% since its 1999 high, posted in April.

Friday's bank selloff had two immediate causes.

In a speech Thursday to the

Office of the Comptroller of the Currency

,

Fed

Chairman

Alan Greenspan

made skeptical-sounding remarks about equity prices, and questioned some of the assumptions on which banks are basing their credit risk assessments.

Then Friday morning, a closely tracked inflation number came in much higher than expected, sparking fears of further rate hikes, which can be guaranteed to wreak havoc among bank stocks.

With steep declines like these, and banks now looking cheap to many investors, it may be tempting to see Friday's action as a final, furious selling wave that marks a bottom for the sector.

But the nadir may still be a while off, say market mavens.

On Tuesday, the

Consumer Price Index

is scheduled to be released. A CPI number that suggests inflation isn't a threat, of course, would help, says David Berry, an analyst at

Keefe Bruyette & Woods

. But he adds: "With the market so on edge, it will take more than one number to calm people down."

Also, several large banks, including

Bank of America

(BAC) - Get Report

, Chase and

Citigroup

(C) - Get Report

, are reporting third-quarter earnings next week. Expect further turbulence if these three, or any other well-known names, report low-quality or lower-than-expected earnings, says Berry, whose firm has done no recent underwriting for Chase, Citigroup or Bank of America.

Bank of America, reporting Monday, will be a particularly important event, since its stock has been under pressure, in part by credit-quality fears.

The big question for investors is whether bank-stock prices have already fallen to levels where they are anticipating more negative events. If they have, then it may make sense to start buying.

While he thinks the market overreacted Friday morning, Bill Rubin, a manager at

Keefe Managers

, a New York-based hedge fund, says he wouldn't be surprised by more volatility. That said, he thinks Chase, which his fund already holds, looked particularly attractive Friday.

Overall, Rubin thinks that fundamentals are still very good in the financial sector, pointing to robust early third-quarter results as evidence.

Using data from 33 banks that have already reported third-quarter numbers, Keefe Bruyette & Woods has come up with some reassuring-looking statistics for bank investors. Despite the fact that rates have risen this year, the banks posted loan growth of 10% in the third quarter from year-ago levels. Operating revenue is ahead 10%. And net charge-offs as percentage of loans, an indicator of credit quality, have edged up 0.25 percentage point.

Chuck Bath, manager of the

(NWFAX) - Get Report

Nationwide fund, says some banks' stocks are so cheap that they're already pricing in a possible rise in the 30-year Treasury bond yield to 6.5%, from Friday's 6.28%.

He likes credit-card provider

MBNA

(KRB)

, down 1 3/16, or 5.29%, Friday.

Bank One

, which issued a profit

warning in August that has helped wipe over 40% of its stock price since then, also looks good, says Bath. At Friday's price of 32 5/8, Bank One trades at 9.1 times 1999 earnings forecast by

First Call/Thomson Financial

and has a dividend yield of over 5%.

"Hey, Bank One is nearly yielding more than the long bond," says Bath, whose fund holds MBNA and Bank One.