What’s Next For Stock Investors?

After a $7.5 billion cash infusion by the sovereign wealth fund of Abu Dhabi into Citigroup, comments by Federal Reserve Vice-Chairman Donald L. Kohn and a more than 500 point two-day run-up by the Dow Jones Industrial Average, investors must be asking, what next. Our response, let’s tackle this question by looking at the headlines noted above that created the catalyst for this move.

Prior to this past Tuesday investors have expressed their concern about the value of many of our largest money center banks, including Citigroup, Bank of America, JP Morgan Chase, as well as our largest brokerage firms, by a stampede of selling which, in turn, sent the share price of those affected down by more than 20%, this during November alone. Those selling were doing so because of the uncertainty regarding the multi-billion dollar negative impact caused by the weakness in the housing market, an ever rising default rate on mortgages as well as home equity loans, and the perception that the malaise in the housing market is spreading into the entire credit market thereby creating a credit crunch and a resulting liquidity crisis. To the rescue, at least for the time being, rode the country of Abu Dhabi in the form of a $7.5 billion cash infusion into Citigroup, from its sovereign wealth fund, a fund created by the monarchy and funded, in great part by their export of oil reserves to the United States as well as other countries. The fund, whose value is estimated to be close to $900 billion, is meant to benefit the monarchy of Abu Dhabi, its ruling family as well as the citizens of this Middle Eastern country. That said, what does this mean to Citigroup? It means that, certainly after a tremendous amount of due diligence, a tremendous amount of “tire-kicking,” an entity decided that Citigroup was worth an investment of $7.5 billion. Some might suggest that although $7.5 billion is not a lot of money, noting that it is “only” 8.3% of the value of this fund, implying that Abu Dhabi could afford to lose their investment. To the contrary, we suggest that Abu Dhabi is investing for the long-term, that they perceive long-term value in Citigroup shares at their current price and, stand ready to infuse more cash, if necessary. Time will tell who will ultimately prove correct in their analysis of Citigroup, the naysayers who suggest that Citigroup, the world’s largest bank still has substantial downside, or, we, at Fagan Associates, that recommend investors dip their toes in the water with a small investment in these shares, recognizing that the shares may not have bottomed, but like the country of Abu Dhabi, stand ready to purchase a little more should the share price still move a bit downward in hopes of much higher shares prices one to five years hence.

Quite briefly, contained within the text of a speech entitled “Financial Markets and Central Banking” and under a section sub-titled “Moral Hazard,” by Vice-Chairman of the Federal Reserve, Donald L. Kohn, was the following statement. “Losses were evident early in this decade in the case of many high-tech stocks, and they are in store for houses purchased at unsustainable prices for mortgages made on the assumption that house prices would rise indefinitely. To be sure, lowering interest rates to keep the economy on an even keel when adverse financial market developments occur will reduce the penalty incurred by some people who exercised poor judgment. But these people are still bearing the costs of their decisions and we should not hold the economy hostage to teach a small segment of the population a lesson.” Simply put, we are not going to penalize the entire country to penalize a precious few. Bottom line, lower interest rates are on the way, perhaps when the Fed next meets on December 11^th (we believe this is the case), in an effort to stimulate a sluggish economy.

This vote of confidence in our financial system, ironically expressed by a sovereign fund of a foreign investor along with “dovish” comments by Vice-President Kohn suggesting lower interest rates are in store, in our opinion, will ultimately result in higher stock prices. Our recommendation, some “backing and filling” after the 500 point jump in the Dow is in order, but investors would be wise to accumulate stocks and/or stock based mutual funds should such weakness occur.

This entry was posted on Sunday, December 2nd, 2007 at 10:00 am and is filed under Columns. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.