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Don't Buy Into the Financials Rally

The big rally in financial stocks is, in my opinion, a mirage. The financials have been helped by short-covering which will fizzle fast. The other issue affecting financial stocks is a decision recently made by the government which will impact every investor, but it's not getting enough attention. Last week, the SEC decided to limit short selling practices to protect Fannie Mae (FNM) and Freddie Mac (FRE). Normally, the SEC wouldn't dream of influencing the markets, but since Uncle Sam may have to foot the bill to shore up these mortgage giants, the SEC decided to step in. Their action also protects 17 other financial companies like powerhouses Merrill Lynch (MER) and Morgan Stanley (MS).

The SEC also announced plans to crack down on people who may be spreading rumors to manipulate stock prices. Apparently, the rumormongers are the latest scapegoats politicians are pinning the blame on. They better move fast before the public starts blaming the government for the credit mess! Already, dozens of hedge funds have received requests to turn over e-mails to regulators as they probe the collapse of Bear Stearns and a near-collapse of Lehman Brothers (LEH).

All this was good news, which buoyed financials last week. Then, right on cue, Wells Fargo (WFC) released better-than-expected earnings and boosted its dividend by 10%, fueling a 33% one-day rise in that stock. Then, on Friday, Citigroup (C) announced good news. By good news, I mean that their massive loss wasn't as massive as Wall Street had expected. So on the surface, things were looking up for financials.

However, the banking industry still faces rising loan losses and declining revenues. As a former banking regulator, I strongly urge you to run away from most U.S.-based financial stocks. These stocks are not out of the woods yet. The vast majority of financial stocks continue to receive a D or F grade in my PortfolioGrader Pro stock rating tool.

Other recent e-letter issues:
11.20.08: Automakers Left Empty-Handed
11.13.08: Four Tips for Buying Stocks in Bad Times
11.06.08: The Bull Market for Fundamentals
10.30.08: Why You Should Be Buying Right Now
10.23.08: How to Invest in a Volatile Market