| The Great Unwind has begun, Citigroup warns |
[Mar. 20th, 2008|10:42 am] |
Avoid leveraged companies, countries and consumers, bank's strategists say
By Alistair Barr, MarketWatch
SAN FRANCISCO (MarketWatch) -- The Great Unwind has begun, Citigroup Inc. strategists warned on Wednesday.
As markets and economies de-leverage across the globe, investors should avoid companies and countries that have grown to rely too much on borrowed money, they said.
That means favoring public-equity markets over hedge funds, private-equity and real estate, while leaning toward emerging market countries and away from developed nations like the U.S., the bank's global equity strategy team advised.
Within equity markets, the financial-services should be avoided because it's still over-leveraged, while other companies have stronger balance sheets, the strategists said.
"Steady growth, low inflation and rock-bottom interest rates encouraged economic and financial participants across the world economy to gear up over the past few years," Robert Buckland and his colleagues on Citi's global strategy team wrote in a note to clients. "Easy money encouraged many to buy a bigger house, a bigger car or a bigger speculative position."
"But now, any behavior that relied upon continued access to easy money is being dramatically reassessed," they added. "Leveraged banks must lend less, leveraged consumers must consume less, leveraged companies must acquire or invest less, and leveraged speculators must speculate less."
Financial-services companies are the most vulnerable to this reduction of borrowed money across the globe, they said.
During the last credit crisis in 1998, European banks were leveraged 26 to 1. In the early part of this decade, leverage grew to 32 to 1. Now the sector is geared 40 to 1 on average, according to Citi's European bank research team.
"The banks have a long way to go," the strategists said. "We would continue to avoid the sector while they are de-leveraging."
Other companies are in much better shape, having rebuilt cash from strong earnings since 2003. Emerging market companies have developed particularly strong balance sheets, having learnt hard lessons from the Asian financial crisis a decade ago.
However, even though some companies may not have much debt themselves, they may be exposed to over-leveraged customers or highly leveraged investors, Citigroup warned.
Automakers, home builders and electronics retailers benefited as customers borrowed money cheaply in recent years to buy cars, houses and flat-screen TVs. That attractive financing is now being withdrawn.
"There will be plenty of companies that have strong balance sheets, so may not be most immediately vulnerable to the credit crunch," Citi said. "But they may find that their leveraged customers are vulnerable."
The difference, or spread, between interest rates on investment-grade corporate bonds and Treasury bonds has jumped in recent months, even though most companies aren't very leveraged.
This widening may be caused by leveraged investors such as hedge funds having to sell good quality assets to meet margin calls, or requests for more cash or collateral.
"It is the leverage of the investors who hold these bonds that is now being brutally exposed," Matt King, a Citigroup credit strategist, said.
"We are now confronted by a broad bloodbath in the credit markets," Citigroup said. " The most leveraged paper is falling in value because it is leveraged, and now the least leveraged paper is also falling in value because it is owned by leveraged investors."
Investors should also avoid hedge funds themselves, along with private equity, Citi added. Both types of investment rely at least partly on borrowed money to generate returns.
"Private equity returns have been especially strong. Without leverage it will be much harder to meet excessive investor expectations [most surveys suggest 20% annual returns are expected from the asset class]," Citi warned. "Similarly, many hedge funds have generated healthy uncorrelated returns by adopting cautious underlying strategies, but applying significant leverage. Again, that looks unsustainable in the current environment."
Leveraged economies, like the U.S., should also be avoided, in favor of emerging market countries, which have reduced borrowing, the bank advised.
With less capital sloshing around the world, and the dollar falling, the U.S. may have to compete more to finance its deficits.
"The U.S. shows up as the world's greatest consumer of external capital," Citi noted. So it "has the most to lose as this capital becomes less freely available."
Alistair Barr is a reporter for MarketWatch in San Francisco.
(Citigroup is already in trouble and this article, although honest, is just shooting themselves in the foot.) |
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| Comments: |
I heard a seminar recently on this - on an international basis, investors remain quite positive.
How can investors remain positive when the Carlyle group, the king of hedge funds, and Bear Stearns, the 5th largest trading bank in the US, have just gone bust in the last week?
Of the economic articals I'm reading a few months back they were comparing the present situation to recessions in the 70s and 80s. A few weeks ago it was WWII and now more articals are comparing it to the depression.
It is in fact very similar to the depression. Although that was kicked off by a devastating drop in the stock markets the real problem behind the great depression was an agricultural estate bubble bursting (similar to the housing bubble burst now) and a massive amount of public debt through HP (now its credit cards and loans taken out against the value of the house).
There is the decoupling theory which says that other world markets will not be dragged down by whats happening in the US but this is just wishfull thinking and watching how the markets have been reacting over the last 8 months unfounded.
Although Chinese and Indian consumer spending are on the rise they are not yet in any way comparable to consumer spending in the USA which is the powerhouse behind the US and ultimatly the world economy. As house prices there fall, people lose jobs and then homes through reposession, and the price of basic commodities like oil and food go up (oil 74% in the last year and most food stuffs up 100%)Then consumer spending is going to be cut drasticly.
It's largely restricted to banks at the moment though, at least that's the feeling here. Returns on diversified companies that aren't highly leveraged are good and in Oz, unemployment is at a 33 year low. I do think a lot of it is just surface sheen; credit card spending is still big so that makes it look as if people have money but more and more people are putting basic needs (groceries, utilities) on their credit cards and eventually that has to blow up.
I dont realy know about the Ozzy situation.
In Britain they are as loaded up in debt as the Yanks with a similar housing bubble. I guess the problems will begin there about 6 months behind trouble in the US.
In Holland, as far as I know, there is no housing bubble. We have just come out of a resession here and the banks are very tight on mortgages and loans.
The other problem with the US is the devaluation of the dollar which means peoples wages dont buy as much and their pensions are not worth as much when they cash them in.
Interest rates are going up and I believe will continue to do so but I meant to add that I think Oz is in a fairly unique situation in that, while obviously global markets are going to have an impact it's probably cushioned to an extent due to our somewhat isolated location and the fact that we have stronger ties with the Asian markets due to proximity.
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