Peabody changes his tune on banks

By Dan Wilchins

NEW YORK (Reuters) - Charles Peabody, an independent analyst who has been bearish on financial stocks for three years, says investors should selectively buy shares of banks such as Citigroup Inc (C.N) and Wachovia Corp WB.N, saying they are attractively valued.

Bank shares could rise 35 to 45 percent on average from their first-quarter lows, amid signs the housing market might be bottoming out, Peabody said in an interview.

Bank shares generally perform well early in an economic recovery, which means buying them can make sense when the economy is bottoming out, he said. Investors looking for a payoff should have a 12-month time horizon, he added.

"I don't think this thing has a V-shaped turn," Peabody said.

He is upgrading individual banks over time, he added.

Peabody expects Citigroup to earn $3.00 per share in 2009, which means the bank is trading around 8.5 times the 2009 forecast. But as the bank's outlook improves, that ratio should rise closer to about 10 times, Peabody said.

Generally, it makes sense to buy bank stocks on dips, particularly when their price-to-earnings ratios are single- digit or their shares are close to book value, Peabody said.

The economy does not look strong now, but there are signs it is bottoming out, Peabody said. Indicators such as housing starts, permits, residential spending are at levels that typically reflect troughs.

And the government is taking steps to bail out the economy. The Federal Reserve is lowering interest rates, Congress seems likely to soon pass legislation to help the housing market and accounting watchdogs are easing rules on marking assets. Peabody also expects the Treasury Department to take steps to prop up the dollar.

"Our feeling is, we're in the trough of the recession right now, but these measures should pull us out of the recession by mid-year," Peabody said.

Peabody is a partner at independent research firm Portales Partners in New York. He was one of the few Wall Street analysts to recognize the extent of potential problems in the financial sector prior to 2007.

INVESTMENT BANKS NOT AS STRONG

The outlook for capital markets on the other hand is not good, which is why investment banks are likely not as good an investment now, Peabody said.

"The capital markets are broken and volume activity in that business is going to be anemic," Peabody said.

Not all analysts agree with Peabody.