Thursday, March 20, 2008

Citigroup Warns: The "Great Unwind" Has Begun

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Interesting story on CBSMarketwatch.com - sort of parallels my commentary from day 1, about staying away from the anything directly tied to the US for quite a long period of time. It is sort of funny to watch the Street catch up to thesis' 6-12 months later. Now this is just starting to become a popular thing on Wall Street - once it becomes a drumbeat it will probably be time to reverse the trade and in fact go long the subprime US. After all we are just recreating the same conditions of low rates, and easy money that got us into this mess in the first place.

I can only imagine all the research reports on how to take advantage of global famine that should be out by end of 2008 or early 2009 ;)
  • 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."
  • "Leveraged banks must lend less, leveraged consumers must consume less, leveraged companies must acquire or invest less, and leveraged speculators must speculate less."
  • 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. (that's scary) "The banks have a long way to go," the strategists said. "We would continue to avoid the sector while they are de-leveraging."
  • 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.
  • "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."
  • 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."
Now, as always, in oversold conditions - the items written as bearish in this article are the things doing best right now, while the things that should be bought are doing the worst. But as always, in time, this too shall pass. As long as we have the faintest hope for a "2nd half recovery" we'll continue to see these rallies. And then when it's apparent it's not happening... we'll talk about early 2009...then mid 2009 and so on and so forth - the most favorite words on Wall Street right now "everything will be fine in 6 months".

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