Don't Flee to the Citi for Safety

Countless market pundits are calling for a shift out of small-caps and into big-caps on the premise that they will hold up better during the expected economic weakness ahead. I believe many large-caps are just as risky as small-caps and have minimal upside potential over the next 12 to 18 months.

A prime example is Citigroup (C - commentary - Cramer's Take), which reported second-quarter earnings Monday morning. While it trades at just 11 times expected 2006 earnings, with a 4.2% dividend yield, I believe the stock is a value trap. Citigroup's consumer business is floundering and is unlikely to show any improvement in a weakening global economy. At the same time, the company has become overly dependent on the strong investment-banking cycle for growth.

The earnings report paints an ugly picture. Excluding the "corporate/other" category, revenue grew 10%, a respectable number for a company of Citigroup's size. However, 77% of that growth came from Citigroup's investment-banking business, which accounted for only 30% of revenue.

Citigroup's colossal consumer business, which contributed 56% of revenue, grew only 5% worldwide. Even though the U.S. economy is relatively strong, Citigroup's U.S. consumer business only grew 1% in the quarter. Rising interest rates combined with sky-high energy prices and rising inflation are almost certain to take a toll on the U.S. economy, particularly on the consumer. Therefore, I have to imagine that Citigroup's slowly growing U.S. consumer business would likely retract in a weakening economy.

At the same time, Citigroup's investment-banking business would be equally vulnerable to economic weakness, eliminating the company's only serious growth driver. I have become extremely cautious on the investment-banking sector, selling the lone brokerage stock in the Breakout Stocks portfolio this morning.

A solid global economy driven by low interest rates and rising emerging-market economies has created a perfect storm for investment banks. But with rates across the world going up, I'm very cautious on how long the group's run can continue, especially in M&A, a red-hot area that analysts are almost universally bullish on.

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In keeping with TSC's editorial policy, Michael Comeau doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Comeau is a research analyst at TheStreet.com. In this role he performs stock analysis for TheStreet.com Breakout Stocks, and is also a regular contributor to RealMoney.com. Prior to his arrival at TSC in June 2004, Comeau worked as a Consultant to Toyota Motor North America, performing in-depth research on automotive industry issues, primarily in the areas of alternative engine technologies, competitive analysis and macroeconomics. His primary market interests include consumer technology, specialty retail, and small-caps. Comeau received a bachelor's degree in Finance from Brooklyn College, and has completed Level 1 of the CFA program.. He appreciates your feedback; click here to send him an email.