Citi’s $1.11 million autocallable barrier notes on industrial ETF may not deliver expected growth

By Emma Trincal

New York, July 10 – Citigroup Global Markets Holdings Inc.’s $1.11 million of 0% autocallable barrier securities due Jan. 5, 2026 linked to the Industrial Select Sector SPDR ETF are structured to enhance returns with no limited upside at maturity. But such growth opportunity is unlikely to benefit investors given the choice of underlying sector and an overvalued equity market, advisers said.

The notes will be called automatically at a premium of 5% if the closing level of the ETF is greater than or equal to its initial level on Jan. 2, 2024, according to a 424B2 filing with the Securities and Exchange Commission.

If the ETF gains, the payout will be par plus 155% of the ETF return.

Investors will receive par if the ETF declines but ends at or above its 75% final barrier, and they will lose 1% for every 1% that the ETF declines if it finishes below the final barrier.

Don’t fight it

“I’m not bullish on this sector. If I had to pick a sector, industrials would not be my first choice,” said Scott Cramer, president of Cramer & Rauchegger.

“It’s a tough place to get gains.”

Inflation is still not at the Federal Reserve’s 2% target, which suggests more rate cuts ahead.

“When you’re betting on the industrial sector of the S&P, you’re betting on economic growth. But the Fed doesn’t want growth. You’re fighting the Fed. I don’t think it’s a good bet at this time,” he said.

The terms of the deal “are not bad,” he added.

“The barrier is generous. The leverage with no cap, attractive. But the ETF may be lower in two years.”

Better sector plays

Another issue with the industrial select sector ETF was its valuation.

The fund closed at $107.32 a share on the trade date. The entry price is at about the same level as the fund’s high of January 2022. In addition, the share price of the ETF has jumped nearly 30% since its low of September.

“I can see other sectors where you could find better value and more growth potential,” he said.

“Energy for instance would be a better pick. Energy makes the world go round. Demand is not going away. And the energy sector is undervalued.”

The same could not be said about the industrial sector.

“Those stocks are overvalued, and they would be very vulnerable in a recession,” he said.

Speed bump

The call date in six months triggering a 5% premium, or 10% per year, was not the optimal outcome.

“5% is not exciting. But that’s what they have to do to give you the no cap leverage at maturity. They don’t want to be caught having to pay 1.55x the return. They had to make this scenario less probable.

“And yet, the payout at maturity is what makes the note interesting. You may be buying it for the upside, which you may not get,” he said.

In conclusion, Cramer’s main criticism was the choice of the underlier.

“The terms are fair. But I wouldn’t do it on this sector,” he said.

Two years to soar

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, pointed to the “stretched” valuation of the underlying fund.

“This is interesting,” he said.

“But industrials are overvalued. That said, the market as a whole is overvalued at this point.”

Both the call and leveraged payout at maturity were reasonable scenarios.

“The call is attractive. You get your 5% in six months. The uncapped leveraged return, if there is no call, is attractive as well. But the problem is whether you can fully benefit from it.”

The absence of a call in six months means a negative return at that time, he noted.

“Then the question is: you have two years to generate a good enough return in order to take advantage of the uncapped leverage. But since we’re starting from an overvalued level, at today’s valuations, what’s the return potential two-and-a-half years from now?

Low probabilities

“If we have a pullback in six months, you’ll skip the call and then you’re going to need a lot of growth to make the leverage work. With the looming risk of a recession, it’s not very realistic.

“The note is based on a lot of assumptions that are unlikely to happen. The market is already approaching its all-time high. Valuations are already stretched. How much more upside can you expect?”

The S&P 500 index hit an all-time high on Jan. 4, 2022 at 4,818.62. It closed on Monday at 4,409.53, or only 8.6% off the peak.

While the uncapped and leveraged upside at maturity suggested that the note could deliver growth, the current market cycle with its rich valuations made growth unlikely, he concluded.

“You have to be well above today’s level in two-and-a-half years. I don’t think the odds are in your favor,” he said.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the agent.

The notes settled on July 6.

The Cusip number is 17291RLK6.

The fee is 0.5%.

© 2015 Prospect News.
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