I’ve been doing quite a good job of screening out stocks-are-up-stocks-are-down noise of late, which is a good thing, but allow me a small relapse in response to Jim Surowiecki, who talks today about what happened to Citigroup stock this afternoon.
I want to make an obvious point that for some reason really hit home to me today, which is that people’s decisions to buy and sell stocks, and particularly when they decide to buy and sell, are downright peculiar. Let’s take Citigroup, which was down fourteen per cent on the day (oh, is that all?). It got as high as $14.68, but it traded for most of the day between $13.50 and $14 a share. And during that time, the vast majority of Citigroup shareholders could have sold their shares and gotten a price between $13.50 and $14. (I told you this was obvious.) Yet there were literally millions of shares which were not sold at that price that were instead sold, late in the day, for significantly less. People (or programs) that weren’t interested in selling Citigroup shares at $13.50, later decided that they did want to sell them at $12.75, even though, at the lower price, Citigroup’s valuation was more reasonable, its dividend yield was higher, and its upside reward was obviously greater. Usually, in markets, when prices fall, demand rises. But in the stock market, particularly on days like today, lower prices actually lower demand.
This is all exactly right. But I’m not sure that Jim’s example was a particularly good one, for two reasons.
Firstly, Citigroup, like all banks, is a confidence game. What’s more, its balance sheet is opaque enough that no one really knows for sure whether it’s solvent or not. (The good news is that it’s too big to fail, but that doesn’t protect shareholders, only bondholders.) And so the Citi share price is an important driver of the Citi share price, in that it is a good proxy for the degree of confidence that the market has in the bank.
Citi’s been insolvent before, during the LDC debt crisis; it had the luxury, then, of working out those problems over a period of years without having to mark its bad loans to market. But now, in the wake of multiple bank failures, everybody’s much more jittery, and would have much more confidence in Citigroup if only it started trading at something near its book value of $18.10 per share. (It’s bad enough that book value has fallen so far, from $25.45 a year earlier.)
When a bank trades substantially below book value, it’s a sign that the market doesn’t trust the bank’s marks, or anticipates very large future losses, and possibly some kind of forced liquidation. And as we’ve all seen, the mere anticipation of a forced liquidation, in this market, can be enough to bring one about. Citi is trading in distressed territory, and that means investors are quite rationally liable to exit at any sign of severe market jitters.
And secondly, Citi’s balance sheet hasn’t shrunk much over this crisis, partly because the bank had to take on board its SIVs. In other words, Citi is still more or less the same size, with about $2 trillion of assets, as it was a year ago, when its shares were $20 more expensive.
Today, Citi’s stock price ranged between $12.48 and $14.60 per share — a difference of $2.12, or 17% of the lowest price. That’s a much bigger percentage amount than it is a dollar amount. If Citi, a year ago, had a day when it ranged between $32.48 and $34.60 per share, the dollar amount would have been exactly the same, and the move in market capitalization would have been exactly the same, on a bank of pretty much the same size. But the percentage move in the share price would have been not 17% but 6.5%.
To put it a different way, it’s impossible to value any company the size of Citi to within 75 cents per share. When Citi was trading at over $30, a fall of 75 cents was not such a big deal; today, however, it looks much more important, just because the denominator has come down so far. But the truth is a that a move from $13.50 to $12.75 shouldn’t mean much more than a move from $33.50 to $32.75. A $1 move in the share price corresponds to a change of $5.5 billion in market capitalization, or just one quarter of one percent of Citigroup’s asset base. It’s small, even if in percentage terms it looks big. That’s why leverage is so dangerous.