On Wednesday, Citigroup issued a fascinating report, which talked about the "Great Unwind," as markets and economies de-leverage across the globe. Citigroup strategists warned investors that they should avoid companies and countries (like the U.S.) that have grown to rely on too much borrowed money. Specifically, Citigroup predicted that hedge funds, private equity funds and real estate investments would lose market share and that plain old stock investing would likely pick up the slack and become increasingly attractive as investors abandon other asset classes. Echoing S&P's concerns (cited above), Citigroup's strategists warned that the financial-services sector should be avoided because it is still over-leveraged. Citigroup's global equity team made it clear that they were leaning toward emerging market countries, like Brazil, and away from the U.S.
The author of the report, Robert Buckland and his colleagues on Citigroup's global strategy team, wrote in a cover note to clients that "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...But now, any behavior that relies upon continued access to easy money is being dramatically reassessed." Citigroup's global strategy team concluded that "Leveraged banks must lend less, leveraged consumers must consume less, leveraged companies must acquire or invest less, and leveraged speculators must speculate less." Wow! That's a tough but true assessment.
Citigroup's European bank research team pointed out that during the most recent credit crisis - the Long-Term Capital Management hedge fund failure in 1998 -- European banks were leveraged 26 to 1. In the early part of this decade, leverage grew to 32: 1. Now the sector is leveraged 40:1, on average. These strategists stressed that "banks have a long way to go" and concluded by stating that "we would continue to avoid the sector while they are de-leveraging."
Matt King, a Citigroup credit strategist, pointed out that the rate spread between investment-grade corporate bonds and Treasury bonds has jumped in recent months, even though most non-financial companies are not very leveraged. The widening interest rate spread is being caused by leveraged investors (such as hedge funds) having to sell their good quality assets to meet margin calls and requests for more cash or collateral. King stated that "it is the leverage of the investors who hold these bonds that is now being brutally exposed."
The Citigroup report summed up the situation by saying "we are now confronted by a broad bloodbath in the credit markets. 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." Citigroup concluded that "The U.S. shows up as the world's greatest consumer of external capital" and noted that the U.S. "has the most to lose as this capital becomes less freely available."
