Tuesday, March 10, 2009

The Citigroup "Rally"

The performance of the stock market today, March 10, 2009, I believe, provides us with a clear indication of what is predominantly on the minds of investors. The major concern of investors is the value of the assets that are carried by companies on their books, and especially on the asset values on the balance sheets of financial institutions.

I say this because Citigroup has been the “poster child” of what most investors feel is wrong with the financial markets and the economy. The perception is that Citigroup is so weighed down by assets that are not performing and that must be written down that there is little or no hope for its survival outside of a full takeover by the United States government.

Focus has been so strongly focused on the “asset problem” that other institutions, like Bank of America and JP Morgan Chase & Co., have also been affected with concerns about the value of their assets. As a consequence, the stock price of these and other financial institutions have declined drastically due to the uncertainty as to whether or not they are solvent.

The stock market took off right from the opening bell this morning. The cause—a memo written by Vikram Pandit, the chief executive officer of Citigroup, to employees of his organization indicating that Citigroup had been profitable for the first two months of 2009 and was likely to turn a profit for the first quarter of the year. If this happens it will be a sharp turnaround in performance for the company, a move to the black after five consecutive quarterly losses.

There was no indication about any special write-offs or credit losses, but the memo gave hope to the idea that Citigroup, even after such write-downs, would post a profit for the first quarter.

The hope that was forthcoming, I believe, is the hope that Citigroup will now be operationally in the black going forward and that this kind of performance would give them the time and cushion to continue to work off bad assets and take more modest charge-offs against profits in the future.

The hope is certainly not that Citigroup is “out-of-the-woods.” That would be too much to hope for. To me, what is captured in the market response is that Citi may still have time and not be forced into some precipitous governmental takeover action.

Now, let me say that this was just one day and just one piece of action released by someone that needs, in the worst way, to give some sort of encouragement to his troops. Tomorrow is another day and there will be more information and more market maneuvering in the future. But, it was a day in which there was a possibility for hope—no matter have small that hope might be.

The problem had been that investors had perceived asset values declining with no bottom to be seen. And, there was no one or no event in sight that might put a stop to this decline.

This is why I believe that the financial markets have not been giving President Obama and his team “good grades” on their efforts to craft an economic policy and a bank rescue bill. The economic recovery plan was proposed and passed by Congress, yet there was no “bounce” in the market due to this program. So far, any bank rescue bill talked about or outlined has been deemed a dud.

It is this latter failure that the financial markets have been reacting to. To the financial markets the concern over asset values has dominated everything else. The recovery plan does not address this issue and so does not provide any confidence to investors over possible bankruptcies and takeovers related to institutions that are insolvent due to the bad assets on their books. Expenditures on infrastructure and education and health care and so on are one thing, but a stimulus package like the one that passed Congress cannot prevent a collapse of the financial system as the value of assets plummet and are recognized.

And, so the memo relating to the two-month performance of Citigroup hit the market and gave investors some encouragement that there might be some possibility that the problem related to asset values maybe…just maybe…could be worked out. And this attitude spread to other companies and other areas in the stock market.

We see that the stock of Bank of America Corp. rose 28 percent, the stock of JPMorgan Chase & Co. rose 23 percent, and the stocks of PNC Financial Services and Morgan Stanley increased by double digit numbers. Of especial interest is that the stock of GE rose by 20 percent reflecting the spillover of the positive attitude given to the banks was also given to GE and the concern over the fate of GE Capital.

Again, all of these companies have seen the price of their stocks decline in the past six months or so because of the concern over the value of their assets.

As mentioned, stocks rose from the opening bell, seemingly responding to the contents of the Pandit memo. But, the market responded to other news that they interpreted in a positive manner.

Fed Chairman Ben Bernanke gave a speech that reinforced the “good news” coming out of Citigroup. In this speech, Bernanke discussed the need for moving onto a new regulatory system. The part of his statement that market participants focused upon was Bernanke’s claim that the accounting rules that govern how companies value their assets needed to be changed. The Fed Chairman was careful to say that he did not believe that the mark-to-market accounting rules should be changed. Still he did talk about how asset values should be treated and investors reacted to this in a positive way. Again, the focus of the market was on asset values and little else.

There was one other bit of news that the financial markets reacted to in a positive way and that was the comment of Barney Frank about the “up-tick” rule. This statement, although important in itself, was only a side-show in the movement of the stock market today. Its just that when the good news is poring in, look out!

The important take away about the performance of the stock market today is that the major focus of the investment community is on the value of the assets on the balance sheets of banks and other organizations in this country. This message should be read loud and clear by the Obama administration. Spending plans are fine, but the recovery of the country depends very heavily on what is done about the value of the assets on the books of banks and other organizations and how losses in value are going to be worked off.

This is important too because of what is on coming in the future. It seems as if the credit problem is going to accelerate as the defaults rise on credit card debt, as interest rates need to be reset on Alt-A and option payment mortgages over the next 18 months or so, and the looming bust in the commercial real estate market. The asset value issue is not going to go away soon.

So, we got a rise in the stock market. We may get several more in the next week or so. I don’t believe anyone can predict the movement in the stock market over the coming six months. There are still too many uncertainties. And, even if the stock market were to rise over the next six months, my bet is that the asset valuation problem is still going to be with us. And, in all likelihood it will still be with us next year at this time.

1 comment:

Kim Merriman said...

Is it coincidence that the upswing coincided with some exceptionally good weather on the east coast? It may sound frivolous, but our state of mind is influenced by our broader context. Investors get some good news, enjoy some nice weather, and next thing you know we are ready see the market in a more positive light...