Have any of your stocks recently tumbled below $5 a share? If you own Citigroup (NYSE: C) stock, then you know that it is among the former blue chips like General Motors Corp. (NYSE: GM) and Ford Motor Co. (NYSE: F) that have breached that $5 limit. They currently trade at $3.88, $2.84, and $1.45 a share respectively. And there's a good chance that if that company has breached $5 a share -- it will drop further.
How so? It turns out that under some circumstances, big institutional investors such as pension funds, endowments, and asset managers must sell a stock when it drops below $5. I have not been able to find out exactly why, however it's likely that these institutional investors owe their shareholders a fiduciary duty to act prudently to protect their investments.
So if there is not enough trouble as a stock approaches $5, institutional selling will make things worse -- and represents an obvious profit opportunity for short sellers. If a stock is dropping fast below $10, for example, a short seller can borrow the stock and sell it short -- which puts further downward pressure on the shares. If it then tumbles below $5, that represents a quick doubling if the short seller can buy back the shares and repay the loan as institutional investors dump the stock.
In the case of Citi, the trouble can be heightened by the rising cost of insuring debt. For example, Citi's insurance premium -- in the form of Credit Default Swap (CDS) rate -- has risen 19% since yesterday from 3.95% to 4.70%. This could force Citi to come up with collateral to keep insuring the bonds. If it lacks the cash, it might not make it through the weekend.
And the institutional selling that started when it breached $5 yesterday is contributing to the downdraft.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He owns Citigroup stock and has no financial interest in the other securities mentioned.
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Reader Comments (Page 1 of 1)
11-21-2008 @ 3:29PM
BHarrison said...
The GREED that is killing our economy is that there are so many people "gaming" the markets without regard to the end result . . . they are slaughtering the cows that produce the "milk and cream"; and compulsively destroying their own markets. It's the same as the FIs fraudulently using pyramid and Ponzi schemes to maximize their markets with almsot worthless stocks until the "House of Cards" collapsed.
Just as we as a nation "gave away our manufacturing base", we have bankrupted our resources, and we are now destroying our economic base which will block our recovery efforts.
The "programmed selling" of stocks falling below $5.00 a share, and the accompanying short selling is a guaranteed equation for destroying these corporations. But if the corporate assets, other than their own stock values, is good, then why can't these corporations still survive if they are dealing in worthwhile products (the profits on other stocks in the case of FIs).
It appears that the only things of value will come out at greatly discounted "fire sales" of these corporations' bankruptcy sales. Now that they don't have the small investors to plunder, they are destroying their own markets . . . perhaps they can then become used car salesmen during a depression; they deserve that. (It's like trying to keep a crack addict away from crack.)