Yielding to the Yield Curve

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You know what's playing havoc with this market, what is secretly undermining hundreds of issues and causing the new-low list to balloon while the new-high list shrinks?

The yield curve. It is just killing the financials. The big banks, diversified and fee-based, can withstand a yield curve that is causing millions of Americans to repay their mortgages and cut their interest charges -- the true effect of a flat curve. But the smaller banks and the savings-and-loans can't make their estimates and are getting sold down with reckless abandon.

Why does this matter? The savings-and-loans figure that the mortgages they make will pay back over years and years and years. They are a vital part of the earnings stream. If debtors all repay their mortgages, which, economically, makes a ton of sense to do, then you get earnings compression. That, in turn, triggers analyst downgrades and selling by institutions, few of which will hold on through a down earnings cycle.

We saw a similar pattern in 1994, the only difference being that the economy was not as strong as it is now, so the situation is not complicated by credit risk. In other words, the same kind of selling is occurring that took place four years ago, even though the solvency of the institutions is not in question.

Nevertheless, the bear market in smaller lenders -- and make no mistake about it, there is a bear market in this group -- shows no sign of abating. If this period is at all like '94, the stocks won't start going up until we've had several quarters of a yield curve with more slope.

You won't get that change in the yield curve until either the

Fed

cuts rates -- I know, don't hold your breath -- or longer rates move higher, making it less likely that we get more repayments. In 1994 I was walking around with just about every newly converted savings-and-loan in my portfolio and I came close to getting my head blown off. Some of them I had to kick out because, quite frankly, I could not take the pain.

But everything I rode through made me a fortune. I find myself in the same boat with my savings-and-loans now. As these companies' stocks go down they get cheaper, not more expensive, I tell myself as I watch my gains turn into losses. These institutions are trading closer to book value and becoming more attractive to others who could use their branch networks and redeploy their cash.

That said, unless the yield curve changes, barring takeovers, no money will be made in this group for now. So it will weigh us down as hundreds of these little institutions get hit for eighths and quarters almost every day.

For me, I keep buying those institutions that could be worth something to someone else, while I stay away from the acquirers. It makes no sense to acquire in this environment until you are sure that you are buying cheaply, and from the looks of things, these stocks want to go lower. So I sock in the good ones and take the pain, knowing the gain will come, as it did, maybe not in 1994, but certainly in 1995.

Earlier today I listened to a couple of excellent portfolio managers talking on "Squawk Box" about their value stocks. Most of them were in the oil and gas business. I guess you could say that my S&L buying is similar to that. It is where value is. Will value be rewarded immediately? Absolutely not. Does value win out in the end? Absolutely.

Random musings

: Was anybody else as impressed as I was with this new guy at

Tandy

(TAN) - Get Report

? I found myself taking notes on "Squawk" and determined, against my better judgment, to go to a nearby

Radio Shack

in the next week or two to see whether the changes this man describes are for real. ... We all know this is a rough time in the market. I am trying my best to keep my diary pieces current. If I tee off on a

Biggs it is because if he has repeatedly called for a bear market, I have to be skeptical. Do you know there was a time when

Michael Metz

from

OpCo

used to go on TV and kill the market with his erudition about how the bear was at our door? I used to get spooked out by him, and I regret that. Literally, he would come on, as cogent as Biggs has been these last few years, and warn and worry. I would sell my

Cisco

(CSCO) - Get Report

or my

Dell

(DELL) - Get Report

. I would then buy it back when it occurred to me that, hey, maybe Metz could be wrong. I don't want to be spooked out. I want to do the rational best thing, even if I agree with Biggs -- which I don't. There may be a better time to sell. There may be things that won't work. What I am trying to keep myself from doing is just reacting.

I do not regard myself as the defender of the bull

. Talk about a no-win job, especially when the market is as choppy and tough as it is. But I do regard myself as someone who must be skeptical of diehard bulls and bears. They both can cost you money.

James J. Cramer is manager of a hedge fund and co-chairman of TheStreet.com.

At time of publication his fund is long Cisco and Dell, although positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column by sending a letter to TheStreet.com at

letters@thestreet.com.