November 25, 2008
Greetings,
Crisis du Jour: Citigroup at the Precipice
Financial markets around the world continue in the grip of severe emotional crosscurrents. The crisis of confidence remains palpable. This week the focus is on Citigroup, until recently one of the planet's "premier" super banks, and a monument to its creator, Sandy Weill. Somehow, the description "premier" never quite seemed to fit this conglomeration of disparate financial services companies. Two years ago Citi announced its intention to open 52 new offices in the Boston metropolitan area. Today, quietly closing these locations, Robert Rubin, once Treasury Secretary and now Vice Chairman of Citi's Board and others in command, are busy attempting to salvage what remains. The recapitalization and guarantees just announced are no doubt partially the work of Timothy Geithner, Treasury Secretary-designate, so presumably we are a party to a preview of how the new Administration intends to deal with dislocations such as these. Meanwhile, Sandy Weill will have to figure out how to cover all his charitable pledges around Manhattan, presumably funded with Citigroup stock ($5.95/share today down from $60 eighteen months ago).
The Fumes of Investor Emotion
The contour of today's financial crisis seems to change shape daily. As mentioned recently in one of these e-mails, the main drivers in the U.S. have been hedge fund selling prompted by client withdrawals, tax-loss selling (in which we have been participants for clients also), margin calls (forcing additional hedge fund liquidations), and mutual fund shareholder redemptions. These pressures on the equity markets will no doubt continue through the end of the calendar year and perhaps into early 2009.
Presently, little of this equity market volatility has to do with an objective assessment of the macroeconomic outlook for the next few years. One could argue that at today's price levels, global stock markets fully discount the recession currently underway, and that mired in the emotions of the moment, little attention is being paid by investors to the turnaround which will follow. Recessions tend to cull the economic herd, a painful, disruptive process, but necessary to rebuild the economic base from which a rebound develops. In the relatively mobile, flexible U.S. economy, these adjustments tend to occur with greater facility than elsewhere. A major change is/will be a shift in consumer spending patterns and an increased savings level. A constructive development longer term, nevertheless, this consumer attitude transition for product and service vendors is/will be difficult for most; disastrous for some. A reduction in consumer and business balance sheet leverage will also continue, the ripple effect of which will dampen growth throughout the economy, particularly in the short-run for the financial services sector. Longer term, this should prove a positive base-building development as the turnaround phase of this cycle materializes.
S&P 500 Index Company Earnings for 2009-2010
Investors are long-term holders of securities and tend to be philosophically value-oriented in their security selection approach. Speculators tend to be momentum-chasers, focusing on quarterly corporate earnings reports, attempting to capitalize on surprises perhaps not anticipated by the average investor, and they often get swept along with the herd into "what's hot" following the conventional wisdom of their fellow travelers. Unfortunately, the latter characterization fits the conduct of most hedge fund and professional portfolio managers today. We attempt to stay focused on the long-term, think of ourselves as investors and build client portfolios around asset class sector weightings promising the highest probabilities of success. Remaining fully invested at times like these is often painful, but as we have always stressed, in order to capture the markets' full long-term total return potential, retiring to the sidelines (awaiting "greater certainty") has proven to be a self-defeating approach.
The challenge of the moment for investors is to sift through the economic fundamentals and come up with a reasonable estimate of corporate prospects for the next few years and determine whether current market earnings multiples value those anticipated results rationally. Once today's pervasive emotional fog lifts, longer-term earnings potential will again be a measure by which stock prices will be gauged and volatility will return to more normal levels.
S&P "500" company earnings for 2008 are well understood and fully incorporated into today's stock price levels. Most companies will probably conclude this is the year to "clean up the books" and write off everything that their auditors will allow. This provides a lower earnings per share base for year-over-year comparisons in 2009, the anticipation of which would normally clear the decks for a strong rally early next year. But with many hurdles in the credit markets still to be cleared (e.g., consumer finance company delinquencies, credit card company write-downs, more bank failures), the turnaround in earnings may be delayed into late 2009 possibly early 2010. Again, if the markets revert to some semblance of order and more rational behavior, the prospect of eventual improvement will be discounted well in advance. At the moment, no one has a fix on how this will evolve. Our portfolio realignment programs, in the interim, will continue to focus on tax-loss realization and the substitution of a few new funds which have emerged from our ongoing fund research process.
As always, your thoughts, comments and questions are most welcome. Please contact us via email at tfc@tfcfinancial.com or call us at 617-210-6700.
Sincerely,
James L. Joslin
Chairman & CEO