Archive for November, 2008
Is the Recent Stock Rebound Sustainable?
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Stocks have staged an impressive 5 day rally going into Thanksgiving. Financial stocks, led by Citigroup, have rallied off their lows. As I wrote in my last post, Citi was simply too big too fail and was massively bailed out by the US government. Before addressing the overall rally, let’s talk about the Citi situation.
Just 2 months ago, Citi was buying Wachovia, one of the largest banks in the world. Just a week ago, Vikram Pandit, Citi’s CEO, was assuring investors of his banks’ financial health. All of sudden, they need a massive bailout, which could put US taxpayers on the hook for as much as $250 billion. Of course, this is on top of the $25 billion Citi received under the TARP plan. As I have been stating repeatedly, the problem is leverage. When you decide to leverage your balance sheet at 20, 30 or 40 to 1, it doesn’t take much in asset deterioration in order to wipe out all your equity. Look at it this way: If you have a margin account and buy twice as much stock as you could under a cash basis (in other words, an investor with $1 million buying $2 million worth of stock), your stocks must decline by 50% in order to be totally wiped out. If you are leveraged at 20/1, even a 5% decline would wipe you out. At 40/1 (think Lehman), it would only take a 2.5% decline in order to completely wipe out your equity. Of course, this did not happen overnight, which begs the question of where the regulators were when this was all going on. Citigroup’s assets are still being hurt by the decline in their CDO mortgage paper, as well credit card defaults. It doesn’t help that their investment banking revenues (as what has happened with much of Wall Street) have plunged. I believe that eventually Citi will be forced to sell off at least some of their assets in order to preserve the others.
Getting back to the market, I have real doubt whether this rally is sustainable over the longer term. Companies as well as individuals have (belatedly) started to hoard cash. Real estate prices continue to decline as the credit crisis continues. Corporate earnings are still weak, with forward projections showing little cause for optimism. Here is a link from Yahoo finance: Link
On the other hand, Carl Icahn recently bought another 6.8 million shares of Yahoo, so at least one institutional investor sees value here.
As a final thought, please keep your thoughts and prayers directed toward the tragedy in India.
Will Citigroup Swim With the Fishes?
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There is a story in The Godfather (by Mario Puzo) where they deliver a fish wrapped in a mans’ vest, The implication is that he now “sleeps with the fishes” i.e. at the bottom of the sea. Is this the end of Citi? I am firmly convinced that Citi cannot possibly survive in its’ current form. (see my article on October 5 ): Understanding The Downfall of Bear Stearns
Citigroups’ balance sheet woes have sent their stock down below $4 per share. The stock was over 50 a year ago. The bank is heavily leveraged. I heard from reliable information that many institutions were looking to transfer their funds out of the bank on Friday. Such a run, which led to Wachovia’s desperate sale to Wells Fargo, could put Citi in deep jeopardy. The problem is that unlike Wachovia, Citi is considered too big to fail. However, they may also be too big to be taken over, especially given the severe decline in financial stocks. According to Charlie Gasparino from CNBC, the government is desperately trying to find a solution. He believes they Citi will not get an AIG-type bailout.
I do not believe that Citi will be allowed to fail. A chapter 11 by Citi could lead to a domino effect which might threaten the destruction of our entire financial system. I think that the Fed will find a buyer, possibly a foreign entity, who will take them over with government guarantees. I believe that Citi will not survive this weak in its’ current form. Either they will merge with another financial institution, or the government will arrange a major bailout package. We shall see.
The market rallied almost 500 points on Friday. Many commentators were crediting this to the naming of Timothy Geithner as head of the Federal Reserve. I doubt this was the real reason. I think the market rose due to a combination of the oversold condition and that it was option expiration day for November. Anyone know the last time the market rose 2 days in a row? Well, you have to go back around 2 months to September 24-26. During those 2 days, the Dow rose from 10,825 to 11,143. The next trading day the market fell almost 800 points, and we havn’t seen these levels since. Even with last Friday’s gain, the Dow closed just above 8000. Although I hope I’m wrong, I think there’s an excellent chance the market will resume its’ decline tomorrow.
The Equity Markets Continue to Plunge
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Yesterday, the S &P declined another 6.7%. It is now trading at an 11 year low. NASDAQ is down an incredible 13.2% for the week and 23.5% for the month of November. Of course, this is on top of a horrendous September and October. The financial stocks are dropping like rocks. Here are some numbers (and this is just over the last 4 days!)
Stock Close Nov 14 Close Nov 20
Citicorp 9.52 4.71
General Electric 16.02 12.84
Morgan Stanley 12.03 9.20
Bank of America 16.42 11.25
JP Morgan 34.47 23.38
Citicorp may be forced to seek a merger candidate due to a sharp slide in their share price. The auto makers are not getting a bailout right now. Unemployment is soaring. Consumer spending has ground to a halt. What you are seeing is a tremendous deleveraging of our entire financial system.
Here is an excellent article from Forbes by Nouriel Roubini: Link
Today’s opening looks higher, but where we close is anyone’s guess.
