By the way, oil was off the boil by US$3.28. It’s still well above US$90, though. Gold was punished as investors took the rally in Citibank (NYSE:C) as an ‘all clear’ signal to get back in the equity waters. And what about yesterday’s big move? What does it mean?
To recap: Abu Dhabi’s sovereign wealth fund (SWF) the Abu Dhabi Investment Authority (ADIA) loans Citibank US$7.5 billion to shore up Citi’s capital. Citi pays 11% and the units are convertible to equity at a strike…er…a price of US$31.83 to US$32.74. ADIA gets a 10% premium on the previous day’s close of US$29.79.
Joy ensues on Wall Street as a corner is emphatically turned. We are now on the road to…where exactly?
Asian markets, including right here in Australia, all reversed course and rallied smartly yesterday on the news that America’s largest bank would be given a lifeline by one the Middle East’s most prosperous SWFs. But was ADIA’s move a sign of confidence in the American economy and America’s largest bank. Or was it just a good trade with a worthwhile probability of an excellent return?
Unless we’re mistaken, the deal is effectively an in-the-money call option on Citi that doesn’t expire for two years, with a yield to make a junk bond jealous. The Wall Street Journal reports that, “In exchange for its investment, ADIA will receive convertible stock in Citigroup yielding 11% annually. The shares are required to be converted into common stock at a conversion price of between US$31.83 and US$37.24 a share over a period of time between March 2010 and September 2011.”
Let’s review. The SWF gets rid of depreciating dollars and trades them for a yield higher than what Brazilian and Mexican sovereign debt currently offer…combined. AND it gets equity, about a 4.5% stake in what is perceived as a pillar of the American financial community?
What could possibly go wrong? Worst case, Citi needs more capital and must go hat in hand to other SWFs or generous billionaires (paging Warren Buffett). The stock could halve again. Citi’s liabilities, once opaque, could turn out to be utterly unmanageable.
Or US$30 was roughly the bottom for the stock. The credit worm has turned and all is now well in stock market. That’s the story Wall Street went for today. Still, we’re not sure we’d be a buyer of the largest bank in the US even on these terms at this price. Would you? How much more capital will it need?
The whole situation of a Middle Eastern SWF bailing out an American financial stock also shows what an awkward position you’re in if you own a lot of US dollars these days. You’re hard pressed to get rid of billions of petro-dollars in an efficient way, even if you’re trying to. You have to take bigger and bigger risks.
It also shows, in our humble opinion, what a sham diversification is these days as a portfolio strategy or possibility. Diversify into what?
All asset classes moved up in perfect harmony during the credit boom. Now, with a bear market in credit, they are all moving down, though not at the same time nor in the same orderly fashion. But everything is correlated…and headed in the same direction (down). Except maybe gold, which has decoupled and should be negatively correlated, the occasional sell-offs notwithstanding.
Here’s a question. Among financial assets, what goes up when you have a bear market in credit? Answer in the form of a question, please.
What are tangible assets than cannot be produced from a printing press?
The oil producers might consider that the best way to preserve the value of their oil is…to keep it in oil. Certainly producing faster only depletes it more quickly. Or, you could turn it into a capital asset (trade, tourism) that produces some future income stream. For now, though, the oil keeps flowing, and so do the dollars.
We ended yesterday working out a “deus ex machina,” some miraculous way the Federal Reserve can forestall the resetting of all those ARMs next year and prevent a crisis even worse that what we have now, which is pretty bad.
Here is a new possibility we didn’t consider until the Citi news broke. The SWFs re-capitalise the financial sector in exchange for equity. The Fed isn’t needed in any active way for this kind of bailout. It simply has to facilitate a transfer in the ownership of American financial assets to foreign governments. Maybe these new shareholders will demand better risk taking from management than the old shareholders.
The end of the credit bubble is different than the end of the tech bubble, where stocks merely fell. This time, something more serious is going on. It’s also a lot different than the Japanese buying nice paintings and commercial real estate in America while their own real estate market collapsed. We wonder if the end result will be any different for the average punter.
Markets and Money