Gauging the outlook for pure mortgage lenders like Countrywide (CFC) is a tough game and one that I am choosing not to play. The company is predicting that the third quarter was the trough and profits will return in Q4 and 2008, but nobody really knows for sure. Delinquency rates are still rising at CFC, standing at 7.1% as of September 30th, up from 5.7% three months before.

Until there are signs of stability and that stability hangs around for a while, I'm not going to bottom fish in mortgage-related companies like pure lenders or mortgage insurers. Honestly, those stocks are down so much, trading far below even recently slashed book values, that I think eventually there will be plenty of upside without even needing to time the bottom of the cycle.

Until then, I continue to like the bigger diversified banks with fat dividend yields. With these stocks yielding more than treasury bonds, I think you can justify buying low and being patient, knowing that calling a bottom is essentially impossible. I would, however, start making a list of the kinds of stocks you might want to target when things start to rebound. You won't be able to time a purchase perfectly, but there is no way that most of the home builders, mortgage insurers, and big lenders won't survive and be consistently profitable when the markets get back to some sort of more typical environment.

There will be money to be made, but I'm not comfortable jumping into pure plays just yet. Hopefully by sometime in 2008 things will stabilize and we'll have a better idea of what "normal" conditions look like. At that point, making bets will be much more prudent.

Full Disclosure: No position in Countrywide at the time of writing