Who's Buying Financials?

What adjective would you use to describe someone who kept on buying bank stocks even as they fell and fell and fell? I'm not sure if there's a word in English for "someone who doesn't learn from his mistakes", but while many would probably alight on "foolish", or its cognates, David Dreman would beg to differ:

David Dreman, founder of Dreman Value Management LLC in Jersey City, New Jersey, said investors showed courage by pouring more money into bank funds as financial shares plummeted. His firm oversees $15 billion and had almost 29 percent of the assets of its large-company funds in financial shares as of March 31, its most recent public disclosure.

Ah yes, there you go. Courageous. Someone should give these chaps a medal -- especially since they're not getting any of the more conventional rewards from investment.

Bill Miller, of course, is the classic value investor who reckons that if a stock is a good value at $34, it must be really good value at $8. But financial stocks don't really work like that, because thanks to the power of leverage a relatively small change in asset values can bring their net worth down below zero, wiping out their equity entirely.

It seems that the general public doesn't get it either:

Exchange-traded funds linked to baskets of financial shares raised $8.67 billion during the first seven months of the year, the most of 94 investment categories tracked by research and investment firm Birinyi Associates Inc...
Financial shares in the S&P 500 are this year's worst performers just as they were in 2007.

From a retail-invetor perspective I can see the appeal of bank stocks. As I explained at some length back in February, most Americans have real and understandable difficulty getting their heads around the world of bank finances, where deposits are liabilities and loans are products.

Remember too that the investing public last paid attention to stocks back during the dot-com boom, when the companies hitting the headline were all equity and no debt. Market cap was enterprise value; if a company went to zero that meant it was worthless, not that it would simply be taken over by its creditors. The new math -- the one which applies to highly-leveraged companies like Citigroup and Fannie Mae and Bear Stearns and MBIA -- is much more complicated and fraught, and frankly most individual investors aren't remotely qualified to try and place a value on these things. But they don't try; they just look at the amount the stocks have fallen and reckon that they must be cheap at some point. Which is exactly the kind of thinking which led to declarations that Citigroup was a bargain at $36 a share. (It's now half that.)

If you think the risks in the financial industry are overdone and that it's due for a bounce, go out and buy some subordinated debt. At least that way you get a moral-hazard bailout play if things do go wrong, and you still get a lot of upside if things go right. Buying a falling stock is selling volatility, and that's really not something you want to do in the present environment.

Oh, and one other thing: a real reporter's medal to Bloomberg's Elizabeth Stanton, who didn't stop at the obvious conclusions when she saw all the inflows into financial ETFs. Yes, lots of people are buying those funds right now, but it's not always for the reasons you might imagine:

Some investors are putting money into bank funds to hedge short positions on financial stocks, not to bet on a rally, said Dodd Kittsley, San Francisco-based senior investment strategist at Barclays Global Investors, which manages 163 ETFs that trade in the U.S.
Short interest in financial companies rose in June to 4.6 percent of shares outstanding, the highest on record, Deutsche Bank AG data show. Traders pared bets against banks and brokerages and investors pulled money from ETFs in July as the stocks advanced, data compiled by Birinyi and Bloomberg show.

I like that: it explains a lot of the numbers without having to resort to investor stupidity, and it's pretty obvious once you think about it, which I didn't before I read it. Thanks, Elizabeth, for some real insight here.