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Citibank, the GPS and uncharted territory for investors

Investment strategies that worked in past recessions won’t work today, this U.S. advisory says, so make sure you take the safest route.

It’s a marvel of modern technology. You can’t possibly get lost with it.

You don’t have to rustle around in the glove compartment searching for the right map. You never have to ask for directions.

We’re talking about the global positioning system (GPS), of course. Once you learn how to use it, you’re golden.

Well, mostly. The program may not always calculate the fastest or most efficient route to your destination. And some new or little-used roads may not be programmed in at all.

“As a result,” says Mr. Bob Carlson, “sometimes I find myself driving on a road while the GPS shows me to be on undeveloped land.”

And that’s exactly where many investors find themselves these days, he says in the latest issue of Bob Carlson’s Retirement Watch. In uncharted territory.

One point cannot be made too often, in this analyst’s view. “Numerous times since July 2007 investors who followed the strategies that worked so well since 1982 have suffered major losses.”

Mr. Carlson explains why we are not in a normal cycle, what has to be done to put things right, and what investors must keep their eyes on.

He starts out with that punching bag of American recessions, Citibank.

The ghost of Citibank

The ghost of Citibank keeps coming back to haunt investors, says Mr. Carlson.

“In the bear market of 1991, Citibank was on the ropes — it usually is when the economy is declining,” he comments. Rumour piled on rumour.

The bank would go under. Or the government would step in to save it. A few investors bought the stock at its lows. Then, as if in a fantasy (the Arabian Nights?), a Saudi Arabian prince came to the rescue with a sizeable investment.

“In the ensuing bull market, those investors made about 10 times their money in less than 10 years.”

Citibank is now the consumer banking arm of Citigroup, which is right back on the ropes, on cue. But the game’s not the same.

Not on the same road

The lesson many investors drew from the Citibank crisis of a decade and a half ago is “to buy companies in crisis and hang on for big returns,” says Mr. Carlson. Many are following that route again.

But we’re not on the same road, no matter what the GPS says. “We are in a different environment now,” insists the editor.

In 1991, we had a brief recession in the midst of a long-term boom. Today we are in a major de-leveraging, deflationary cycle. “In a normal cycle, when interest rates decline, businesses and consumers respond by borrowing, spending and investing,” explains the editor.

“Today, there is little borrowing and spending. Because of the differences, those who tried to repeat the Citibank experience lost money.”

This is not to say that there is no hope, Mr. Carlson writes. Mortgage rates have fallen a little. Commodity prices are below their highs, which is good for manufacturers and consumers. The commercial paper market is starting to function and corporations are able to sell bonds.

Too much debt

But it’s just a start, warns the editor. “These changes are not yet enough to restore growth or even stop the slide.”

Washington does not seem to understand the real problem. “They give money to banks and expect bankers to lend, hoping that will revive the economy.” But consumers and businesses have finally decided they have too much debt. They don’t want to borrow.

So asset prices continue to decline. Real estate prices are still the key, since they are backed by so much debt and represent so much of the net worth of Americans. The more they decline, the more people flee debt.

So, consumers spend less and businesses cut jobs.

And this vicious circle comes back to the banks, which have three reasons not to lend money.

History misleads us again

The first problem the banks have is that their own balance sheets are in such bad shape. They are trying to stay solvent, never mind grow.

There are also fewer qualified borrowers out there. Good credit risks are harder to find. Which leads to reason number three, which is the simple fact that there are fewer loan applications.

The upshot of this is that the de-levergaging cycle — the desperate attempt to wipe away debt — is more powerful than the liquidity injections from Congress. The stimulus legislation, in Mr. Carlson’s view, simply does not address the problem of too much debt and falling asset prices.

So what’s an investor to do? Preserve capital, states the editor firmly. Some investors see an enticing opportunity in tax-exempt bonds, investment trade corporate bonds and high yield bonds. They are trading at historic discounts to other assets.

But history may be misleading us again, says the editor. In today’s climate, those discounts may be more of a trap than an opportunity.

“The sovereign wealth funds of foreign countries no longer will invest in U.S. financial services companies, because they invested early in the crisis. They have lost a few billion dollars on those investments.”

So don’t go charging after cheap investments just because they’re cheap, hoping for a big payday down the road, this editor cautions. Until money starts circulating again, drive conservatively until you’re back in well-charted territory.