Investors should resist the temptation to time the bottom in global financial stocks based on their perceived undervaluation, said Merrill Lynch chief investment strategist Richard Bernstein, who views "bottom fishing" of financial stocks as risky.
"We continue to suggest underweighting financial stocks because of the myriad of risks facing the sector. This applies to financials in a global context, not simply to U.S. financials," Bernstein wrote in "The RIC Report."
Merrill's U.S. as well as global quantitative strategy groups view financials as significant "value traps" -- stocks that appear to be undervalued, but have no visible catalysts to keep them from becoming even more undervalued.
European and U.S. insurance companies, however, remain the preferred industry within the overall sector, Bernstein said.
The analyst noted that investors appear to have considered only credit conditions and have largely ignored the coming slowdown in global growth.
Investors are just starting to realize that the deflation of this credit bubble is not simply a "US subprime problem," Bernstein said.
"Indeed, they are just beginning to see a tightening of global credit markets. The cost of capital is rising around the world, and financial markets are beginning to react to that fact," he said.
Bernstein, however, said a contrarian view suggests that investors should start considering how financial companies will eventually grow once the sector goes through what promises to be a considerable consolidation and balance-sheet repair process.
"The sources of growth for tomorrow's financial companies are likely to differ from those of today. The challenge for the long-term investor is to identify the catalysts for that future growth," he added.
(Reporting by Tenzin Pema in Bangalore; Editing by Anil D'Silva)