Is the Recent Stock Rebound Sustainable?
Nov 28, 2008
Posted by Jody Eisenman | Filed under Uncategorized
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.
November 29th, 2008 at 3:16 am
Judging from a time series of ^DJI, it looks like we have 1 or two more economic tumbles before the thing takes off again.
In panics past, there were generally 2 or 3 mini-rallies (and subsequently troughs) before the market took off again. This rally is #2. What’s more, recent recessions have lasted 8-11 months. If you count our recession as starting some 8 months ago, then this is the rally; however, most economists believe that this is going to be a long and deep recession. Historically, long recessions have lasted more than a year. I would say that we’re due for 2 more troughs.
November 30th, 2008 at 5:18 pm
Could be. The economic data is not very encouraging.
December 10th, 2008 at 6:22 pm
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