For more than a year now, the financial sector has taken a beating and financial exchange traded funds (ETFs) have since been bruised and battered.

However, such stocks as Wachovia Corp. (WB), have been selling at 51% of book value for the past few weeks. Many investors may begin to salivate at these numbers, but although financial stocks look cheap, it may be too early to bank on them.

Jason Zweig for the Wall Street Journal looks at certain theories of Benjamin Graham, which would encourage investors to hold out on investing during the current market environment. He quotes Graham as saying, “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”

As an investor, it is emphasized to distinguish between a sound investment and speculation before money is put toward any financial instrument.

By safety of principal, Graham means protection against loss under normal or reasonably likely market conditions. In our current economic state, one cannot pretend to be protected against loss while real estate is still crumbling, being that it is the foundation for most financial stocks.

When evaluating whether or not to jump back into financials, a look at how financial institutions are investing may answer the question as to whether or not it is time to get back on board. The heads of financial companies lack the confidence and/or cash to buy their own shares. When these banks and institutions don’t know what their own assets are worth, there really isn’t any way for outsiders to value a stock without speculation. If the heads of financial companies won’t buy, why should you?

Although it might not be the right time to ride the financials wave quite yet, this sector will have the greatest turnaround once the market rights itself. Up until the market corrects itself, it is essential not to over speculate. It is a much better strategy to wait until positive trends are evident rather than predicting turnarounds. Use the 200-day moving average to spot trends, and save yourself from potential losses that often come from trying to make predictions.

Some ETFs that may be affected by a turnaround include:

  • iShares Dow Jones US Financial Sector (IYF), down 21.4% year-to-date
  • Vanguard Financials ETF (VFH), down 21.1% year-to-date
  • Financial Select Sector SPDR (XLF), down 23.3% year-to-date

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.