Now about that correction

With the Dow Jones Index now down more than 10% from its high, the word “correction” has been bandied about. And so it should be. For some weeks now, we had been watching Citibank (C:NYSE) march down towards US$30, and it was fitting that the Dow crossed into correction territory on the same day that Citi fell below US$30 (US$29.80 in fact).

Now what?

With the Abu Dhabi Fund investing US$7.5 billion for a 4.9% stake in the global financial services giant, Citi has pulled the trigger on one of the three things that CIBC WM U.S. bank analyst Meredith Whitney called for a month ago when she downgraded the stock to a “sector underperformer”:

When we downgraded C shares at the beginning of the month, we stated that it needed raise equity, sell assets, and cut its dividend in order to shore up its capital base. Now that it has raised $7.5 billion in equity, we wait for C to sell assets and cut its dividend.

At the end of 3Q07, C had a precariously low tangible capital ratio at 2.8% and a Tier 1 Ratio of 7.3%. As C has previously announced a $11 billion charge in the fourth quarter, even with this infusion, we still expect these ratios to decline, but now certainly not as low as previously expected.

We continue to believe we are only in the early stages of C’s capital pressures. CDO write-downs are “first inning” issues, but we believe losses associated with C’s high LTV mortgage exposures will mount at an alarming rate over the next several quarters.

I mentioned to a couple of my partners that Citi might be the long term buy once it broke the 30 level, and maybe it is. With the US$ and Dow futures trading higher this morning on the news of the Abu Dhabi lifeline, the correction might be over. And for a day or two we might witness a dead cat bounce. But I doubt it lasts long enough to produce a memorable “Santa Claus Rally”.

A few months ago, I was gently chastized by a couple of Bay Street types for having a defeatist attitude when I said on BNN (see post “BNN interview on global credit crunch“, August 9-07) that “the punters should hide” in light of the mayhem in the credit markets.

Since then, the Dow went from 13,462 to 14,198, and is now resting at 12,743. How’s that for a swing? Lots of money has been made and lost. As with most people in the business, I sort-of took my own advice. While I didn’t buy any stocks during this window, I didn’t liquidate any either (see prior post “No more RIM predictions“, June 28-07). I suppose inaction might count as hiding.

Market timing is so difficult to do, after all. But, with Citi falling to prices not seen since March 1999 and September 2002, it is a bit tempting.

But Ms. Whitney was right to go underweight on the stock at US$38.60, and her call on the capital ratio was bang on, so I think I’ll take her word for it when she says the beating down at Citi isn’t over quite yet.

If you feel the desperate need to buy a bank stock, there’s always the trusty Scotiabank (BNS:TSX). A 14.8% 25-year compounded annual return is nothing to sneeze at, and most analysts believe they have no material exposure to the world of subprime lending.

MRM
(disclosure – we own BNS in our household)