NEW YORK ( TheStreet) -- Citigroup ( C) has sounded a word of warning on valuations in the global financial sector, suggesting investors reduce their exposure to the group as a whole and make more select investments instead. >>>Five Reasons to Steer Clear of Bank Stocks As part of a general strategy call on global equities, the firm cut its view of the financials to neutral from overweight, calling the group the "problem child" of the current market cycle. Citigroup expects that overall, because of their plus-60% rally from the bear-market lows set a year ago and the pattern illustrated by historical trends, global equities are entering a period where appreciation will be slow and arduous. "Past experience suggests the initial price surge is now over and that global equity markets will grind higher over the next 24 months," the firm told clients in a research note issued late Wednesday. Of the financials specifically, Citigroup said that: "Outperformance tends to fade one year after the market bottom," for a cycle's "problem child," which it explains as the group whose highs and lows lead the overall market down in a bear market and back up in a recovery. "Those investors who took a brave top-down view and moved Overweight financials as they called the 2009 market surge should now be reducing exposure and moving back towards a more stock-picking approach within the sector," the note states. "
D espite all the dilution and fears about further regulation, the financial sector has rebounded as much as we would expect given how far it fell in the bear market." Shares of the financials were lower on Thursday with the KBW Bank index ( BKX) slipping nearly 2% in recent trades. The index includes 24 U.S. banks, including Citigroup, Bank of America ( BAC), JPMorgan Chase ( JPM), Wells Fargo ( WFC). Shares of the other large financials, such as Goldman Sachs ( GS) and Morgan Stanley ( MS) were falling somewhat on Thursday.
Citigroup's concern about valuations for the banks echoes a move earlier this week when BMO Capital Markets downgraded the sector to market perform from outperform primarily for that reason. "In our view, the rally in the bank stocks now reflects the improvement in leading indicators on both credit quality and the economy," the firm said. "For the bank group to move higher, we would need to see some follow-through on the credit quality improvement and a stronger economic recovery to get closer to 'fully' normalized earnings."
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BMO Capital sees uncertainty about the housing market as the major near-term risk to the banks returning to fully normalized earnings. "We are concerned that there could be another downturn in home prices as government stimulus is pulled back and with a prolonged jobless recovery," it stated in the note. "We believe that weaker housing trends could delay the economic recovery." But the firm continues to recommend U.S. Bancorp ( USB), Fifth Third ( FITB), PrivateBancorp ( PVTB) and BOK Financial ( BOKF). -- Written by Laurie Kulikowski in New York.