Value-Stock-Plus

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2008-06-20T19:30:00.005+05:30

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This page will NOT

be updated. Please visit the above mentioned site. -- Toughiee
Founder & Editor,
Value-Stock-Plus blog
www.valuestockplus.net
June 20, 2008

The real reason why oil prices are rising

2008-06-04T18:35:00.001+05:30

by M R Venkatesh - rediff.com

By now it is becoming too obvious that the United States is playing the oil game all over again. And this is the desperate gamble of a country whose economy is neck deep in trouble.

Given this scenario, managing prices of oil is central to the US economic architecture. Expectedly, this gamble has been played in a great alliance between the US government, US financial sector and the media.

I have earlier written about:

The impending collapse of the US dollar on account of the inherent weakness in the US economy caused by its structural weakness as reflected in the sub-prime crisis;
The repeated softening of the interest rates in the US that has the potency to kill the US dollar; and
How the fall in the US dollar suits the US corporate sector, especially its omnipotent financial sector.

Naturally, since the past few years, the US financial sector has begun to turn its attention from currency and stock markets to commodity markets. According to The Economist, about $260 billion has been invested into the commodity market -- up nearly 20 times from what it was in 2003.

Coinciding with a weak dollar and this speculative interest of the US financial sector, prices of commodities have soared globally.

And most of these investments are bets placed by hedge and pension funds, always on the lookout for risky but high-yielding investments. What is indeed interesting to note here is that unlike margin requirements for stocks which are as high as 50 per cent in many markets, the margin requirements for commodities is a mere 5-7 per cent.

This implies that with an outlay of a mere $260 billion these speculators would be able to take positions of approximately $5 trillion -- yes, $5 trillion! -- in the futures markets. It is estimated that half of these are bets placed on oil. Readers may note that oil is internationally traded in New York and London and denominated in US dollar only. Naturally, it has been opined by experts that since the advent of oil futures, oil prices are no longer controlled by OPEC (Organization of Petroleum Exporting Countries). Rather, it is now done by Wall Street.

This tectonic shift in the determination of international oil prices from the hands of producers to the hands of speculators is crucial to understanding the oil price rise.

Today's oil prices are believed to be determined by the four Anglo-American financial companies-turned-oil traders, viz., Goldman Sachs, Citigroup, J P Morgan Chase, and Morgan Stanley. It is only they who have any idea about who is entering into oil futures or derivative contracts. It is also they who are placing bets on oil prices and in the process ensuring that the prices of oil futures go up by the day.

But how does the increase in the price of this oil in the futures market determine the prices of oil in the spot markets? Crucially, does speculation in oil influence and determine the prices of oil in the spot markets?

Answering these questions as to whether speculation has supercharged the demand for oil The Economist, in its recent issue, states: 'But that is plain wrong. Such speculators do not own real oil. Every barrel they buy in the futures markets they sell back again before the contract ends. That may raise the price of 'paper barrels,' but not of the black stuff refiners turn into petrol. It is true that high futures prices could lead someone to hoard oil today in the hope of a higher price tomorrow. But inventories are not especially full just now and there are few signs of hoarding.'

On both counts -- that speculation in oil is not pushing up oil prices, as well as on the issue of the build-up of inventories -- the venerable Economist is wrong.

The finding of US Senate Committee in 2006

In June 2006, when the oil price in the futures markets was about $60 a barrel, a Senate Committee in the US probed the role of market speculation in oil and gas prices. The report points out that large purchase of crude oil futures contracts by speculators has, in effect, created additional demand for oil and in the process driven up the future prices of oil.

The report further stated that it was 'difficult to quantify the effect of speculation on prices,' but concluded that 'there is substantial evidence that the large amount of speculation in the current market has significantly increased prices.'

The report further estimated that speculative purchases of oil futures had added as much as $20-25 per barrel to the then prevailing price of $60 per barrel. In today's prices of approximately $130 per barrel, this means that approximately $100 per barrel could be attributed to speculation!

But the report found a serious loophole in the US regulation of oil derivatives trading, which according to experts could allow even a 'herd of elephants to walk to through it.' The report pointed out that US energy futures were traded on regulated exchanges within the US and subjected to extensive oversight by the Commodities Future Trading Commission (CFTC) -- the US regulator for commodity futures market.

In recent years, the report however pointed out to the tremendous growth in the trading of contracts which were traded on unregulated OTC (over-the-counter) electronic markets. Interestingly, the report pointed out that the trading of energy commodities by large firms on OTC electronic exchanges was exempted from CFTC oversight by a provision inserted at the behest of Enron into the Commodity Futures Modernization Act in 2000.

The report concludes that consequential impact on account of lack of market oversight has been 'substantial.'

NYMEX (New York Mercantile Exchange) traders are required to keep records of all trades and report large trades to the CFTC enabling it to gauge the extent of speculation in the markets and to detect, prevent, and prosecute price manipulation. In contrast, however, traders on unregulated OTC electronic exchanges are not required to keep records or file any information with the CFTC as these trades are exempt from its oversight.

Consequently, as there is no monitoring of such trading by the oversight body, the committee believes that it allows speculators to indulge in price manipulation.

Finally, the report concludes that to a certain extent, whether or not any level of speculation is 'excessive' lies entirely in the eye of the beholder. In the absence of data, however, it is impossible to begin the analysis or engage in an informed debate over whether our energy markets are functioning properly or are in the midst of a speculative bubble.

That was two years back. And much water has flown in the Mississippi since then.

The link to the spot markets

Now to answer the second leg of the question: how speculators are able to translate the future prices into spot prices.

The answer to this question is fairly simple. After all, oil price is highly inelastic -- i.e. even a substantial increase in price does not alter the consumption pattern. No wonder, a mere 3-4 per cent annual global growth has translated into more than a 40 per cent annual increase in prices for the past three or four years.

But there is more to it. One may note that the world supply and demand is evenly matched at about 85 million barrels every day. Only if supplies exceed demand by a substantial margin can any downward pressure on oil prices be created. In contrast, if someone with deep pockets picks up even a small quantity of oil, it dramatically alters the delicate global demand-supply gap, creating enormous upward pressure on prices.

What is interesting to note is that the US strategic oil reserves were at approximately 350 million barrels for a decade till 2006. However, for the past year and a half these reserves have doubled to more than 700 million barrels. Naturally, this build-up of strategic oil reserves by the US (of 350 million barrels) is adding enormous pressure on the oil demand and consequently its prices.

Do the oil speculators know of this reserves build-up by the US and are indulging in rampant speculation? Are they acting in tandem with the US government? Worse still, are they bordering on recklessness knowing fully well that if the oil prices fall the US government will be forced to a 'Bears Stearns' on them and bail them out? One is not sure.

But who foots bill at such high prices? At an average price of even $100 per barrel, the entire cost for the purchase of this additional 350 million barrels by the US works out to a mere $35 billion. Needless to emphasise, this can be funded by the US by allowing it currency printing presses to work overtime. After all, it has a currency that is acceptable globally and people worldwide are willing to exchange it for precious oil.

No wonder Goldman Sachs predicts that oil will touch $200 to a barrel shortly, knowing fully well that the US government will back its prediction.

And, in the past three years alone the world has paid an estimated additional $3 trillion for its oil purchases. Oil speculators (and not oil producers) are the biggest beneficiaries of this price increase.

In the process, the US has been able to keep the value of the US dollar afloat -- perhaps at an extra cost of a mere $35 billion to its exchequer!

The global crude oil price rise is complex, sinister and beyond innocent economic theories of demand and supply. It is speculation, geopolitics and much more. Obviously, there is a symbiotic link between the US, the US dollar and the oil prices. And unless this truth is understood and the link broken, oil prices cannot be controlled.

New Blog!

2008-06-01T19:07:00.002+05:30

News Without A Fuse!

A blog which rips apart unwanted news from various websites. Be Smart! Avoid Crap!

How to think like J.P. Morgan?

2008-05-31T15:14:00.003+05:30

A young and pretty lady posted this on a popular forum:

Title: What should I do to marry a rich guy?

I'm going to be honest of what I 'm going to say here. I'm 25 this year. I'm very pretty, have style and good taste. I wish to marry a guy with RM500k annual salary or above. You might say that I'm greedy but an annual salary of RM1M is considered only as middle class in KL. My requirement is not high. Is there anyone in this forum who has an income of RM500k annual salary? Are you all married? I wanted to ask: what should I do to marry rich people like you? Among those I've dated, the richest has a RM250k annual income and it seems that this is my upper limit. If someone is going to move into a high cost residential area in Mont Kiara, RM250k annual income is not enough.

I'm here humbly to ask a few questions: 1) Where do most rich bachelors hang out? 2) Which age group should I target? 3) Why most wives of the riches is only average-looking? I’ve met a few girls who don’t have looks and are not interesting but they are able to marry rich guys. 4) How do you decide who can be your wife and who can only be your girlfriend?

Ms. Pretty

Here's a reply from a fund manager:

Dear Ms. Pretty,

I have read your post with great interest. Guess there are lots of girls out there who have similar questions like yours. Please allow me to analyze your situation as a professional investor. My annual income is more than RM500k, which meets your requirement, so I hope everyone believes that I’m not wasting time here.

From the standpoint of a business person, it is a bad decision to marry you. The answer is very simple, so let me explain. Put the details aside, what you're trying to do is an exchange of "beauty" and "money". Person A provides beauty and Person B pays for it, fair and square. However, there's a deadly problem here, your beauty will fade but my money will not be gone without any good reason. The fact is, my income might increase from year to year but you can’t be prettier year after year. Hence from the viewpoint of economics, I am an appreciative asset and you are a depreciative asset. It’s not just normal depreciation but exponential depreciation. If that is your only asset, your value will be very worrisome 10 years later.

By the terms we use in KLSE, all trading has a position. Dating you is also a “trading position“. If the trade value drops we will sell it as it is not a good idea to keep it for long term. The same goes with the marriage that you wanted. It might be cruel to say this but in order to make a wise decision any assets with great depreciative value will be sold or "leased". Anyone with over RM500k annual income is not a fool; we would only date you and will not marry you. I would advice that you forget about looking for clues to bag a rich guy.

Hope this reply helps. If you are interested in “leasing" services, do contact me.

signed,

J.P. Morgan

Source: The Internet

They're wrong about oil

2008-05-26T15:27:00.001+05:30

by George Soros

Rip up your textbooks, the doubling of oil prices has little to do with China's appetite

Anatole Kaletsky

Just as the credit crunch seemed to be passing, at least in the US, another and much more ominous financial crisis has broken out. The escalation of oil prices, which this week reached a previously unthinkable $130 a barrel (with predictions of $150 and $200 soon to come), threatens to do far more damage to the world economy than the credit crunch.

Instead of just causing a brief recession, the oil and commodity boom threatens a prolonged period of global “stagflation”, the lethal combination of high inflation and economic stagnation last seen in the world economy in the 1970s and early 1980s. This would be a disaster far more momentous than the repossession of a few million homes or collapse of a couple of banks.

Commodity inflation is far more lethal than a credit crunch for two reasons. It prevents central banks in advanced economies from cutting interest rates to keep their economies growing. Even worse, it encourages the governments of developing countries to turn their backs on global markets, resorting instead to price controls, trade restrictions and currency manipulations to protect their citizens from the rising costs of energy and food. For both these reasons, the boom in oil and commodity prices, if it lasts much longer, could reverse the globalisation process that has delivered 20 years of almost uninterrupted growth to America and Europe and rescued billions of people from extreme poverty in China, India, Brazil and many other countries.

That is the bad news. The good news is that the world is not as impotent as is often suggested in the face of this danger, since soaring commodity prices are not the ineluctable outcome of some fateful conjuncture of global economic forces, but rather the product of a typical financial boom-bust cycle, which could be deflated - especially with some help from sensible political action - as quickly as it built up.

The present commodity and oil boom shows all the classic symptoms of a financial bubble, such as Japan in the 1980s, technology stocks in the 1990s and, most recently, housing and mortgages in the US. But surely, you will say, this commodity boom is different? Surely it is driven by profound and lasting changes in global supply and demand: China's insatiable appetite for food and energy, geopolitical conflicts in the Middle East, the peaking of global oil reserves, droughts caused by global warming and so on. All these fundamental points are perfectly valid, but they tell us nothing about whether the oil price will soon jump to $200, stay at $130 or fall back to $60 next month.

To see that these “fundamentals” are all irrelevant, we have merely to ask which of them has changed in the past nine months. The answer is none. The oil markets didn't suddenly discover China's oil demand nine months ago so this cannot explain the doubling of prices since last August. In fact, China's “insatiable” demand growth has decelerated. In 2004 it was consuming an extra 0.9 million barrels a day; in 2007 it was consuming just an extra 0.3 mbd. In the same period global demand growth has slowed from 3.6 mbd to 0.7 mbd. As a result, the increase in global demand growth is now well below last year's increase of 0.8 mbd in non-Opec production, according to Mike Rothman, of ISI, a leading New York consulting group.

Why, then, are commodity prices still rising? The first point to note is that many no longer are. Rice, wheat and pork are 20 to 30 per cent cheaper than they were two months ago, when financial pundits identified Asian and African food riots as the first symptoms of a commodity “super-cycle” that would drive prices much higher. And the price of industrial commodities such as lead, zinc and nickel, supposedly in short supply a year ago, has now dropped by 40 to 60 per cent. In fact, most major commodity indices would already be in a downtrend were it not for the dominance of oil.

But oil is the commodity that really matters and surely the latest jump in prices proves that demand really does exceed supply? Not at all. In the late stages of financial bubbles, it is quite normal for prices to become completely detached from economic fundamentals. House prices in Florida and Spain kept rising even after property developers built far more homes than they could possibly sell. The same thing happened in credit markets: mortgage securities kept rising even while banks created “special purpose vehicles” to acquire vast “inventories” of bonds for which there were no genuine buyers - and dozens of similar examples can be cited from the bubbles in internet stocks and Japan. Similarly, the International Gold Council reported this week that gold demand for commercial uses and investment fell 17 per cent in January, just as the gold price surged through $1,000 for the first time. Now consider the situation today in oil markets: the Gulf, according to Mr Rothman, is crammed with supertankers chartered by oil-producing governments to hold the inventories of oil they are pumping but cannot sell. That physical oil is in excess supply at today's prices does not mean that producers are somehow cheating by storing their oil in tankers or keeping it in the ground. All it suggests is that there are few buyers for physical oil cargoes at today's prices, but there are plenty of buyers for pieces of paper linked to the price of oil next month and next year. This situation is exactly analogous to the bubble in credit markets a year ago, where nobody wanted to buy sub-prime mortgage bonds, but there was plenty of demand for “financial derivatives” that allowed investors to bet on the future value of these bonds.

In short, the standard economic assumption that supply and demand drive prices is only a starting point for understanding financial markets. In boom-bust cycles, the textbook theory is not just slightly inaccurate but totally wrong. This is the main argument made by George Soros in his fascinating book on the credit crunch, The New Paradigm for Financial Markets, launched at an LSE lecture last night. In this book Mr Soros explains how financial bubbles always start with some genuine economic transformation - the invention of the internet, the deregulation of credit or the rise of China as a commodity consumer.

He could have added the Netherlands' emergence as a financial centre triggering Tulipmania or Britain's global dominance as a naval power before the South Sea Bubble of 1720. The trouble is that these initial perceptions of a new paradigm tell us nothing about how far financial prices will adjust in response - will Chinese demand drive oil prices to $50 or $100 or $1,000?

Instead they can create a self-fulfilling momentum of rising prices and an inbuilt bias in the way that investors interpret the world. The resulting misconceptions drive market prices to a “far from equilibrium position” that bears almost no relation to the balance of underlying supply and demand.

The people who tell you that commodity prices today are driven by “economic fundamentals” are the same ones who said that house prices in Britain were rising because of land shortages. The amazing thing is that just months after losing hundreds of billions in the housing and mortgage bubbles, investors and governments around the world have reverted to the discredited fallacy that financial markets always reflect economic reality, instead of the boom-bust cycles and misconceptions that George Soros's book vividly describes.

Additional Reading:

Commodities Prices: Speculation Exposed

Investment Nuggets by Benjamin Graham

2008-05-04T17:45:00.000+05:30

Benjamin Graham, the stock market investor and economist, was the only investing legend who ignored the subjective aspects of equity analysis.

Graham was never interested in meeting managements and knowing what they were capable of doing or not doing. All he saw and studied were hard core numbers -the Balance Sheet. He wanted to buy cheap and under valued assets. Graham had also always stressed the diversification mantra. He professed that investors should buy companies when the current situation is unfavourable, the near-term prospects poor and the low price fully reflects the current pessimism.

Graham advised investors to keep their equity exposure within 75 per cent of their net assets. For the more adventurous investors, a 100 per cent exposure to equity could be considered in case the investor met the following guidelines:

Keep enough cash to take care of 12 months of your family expenses.

Do not panic and sell stocks but actually buy more stocks of solid stable companies as prices continued to slide during the bear markets.

You understand and are able to differentiate between hope and hype.

Below are his few quotable quotes:

“While enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster.”

“The fact that other people agree or disagree with you makes you neither right nor wrong. You will be right if your facts and your reasoning are correct.”

“Confronted with the challenge to distil the secret of sound investment into three words, we venture the motto, Margin of Safety.”

“Many sceptics, it is true, are inclined to dismiss the whole procedure (chart reading) as akin to astrology or necromancy; but the sheer weight of its importance in Wall Street requires that its pretensions be examined with some degree of care.”

“Individuals who cannot master their emotions are ill-suited to profit from the investment process.”

“Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble... to give way to hope, fear and greed.”

“The chief losses to investors come from the purchase of low-quality securities at times of favourable business conditions.”

“The individual investor should act consistently as an investor and not as a speculator. This means…that he should be able to justify every purchase he makes and each price he pays by impersonal, objective reasoning that satisfies him that he is getting more than his money’s worth for his purchase.”

‘Returns dip as motion rises’

2008-05-03T18:22:00.002+05:30

Warren Buffett hasn't got around to writing a book detailing his investment philosophy till date. But, he does outline his investment philosophy in the letters he writes to the shareholders of his company, Berkshire Hathaway, every year. The nuggets of wisdom these letters offer are for investors at large to understand and remember.

In one such letter, for 2005, he wrote, "Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of a genius. But Sir Isaac's talents didn't extend to investing: He lost a bundle in the South Sea Bubble, explaining later, "I can calculate the movement of the stars, but not the madness of men." If he had not been traumatised by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases."

This is a basic law investors forget as markets keep going up. During a bull run, investors tend to look at the returns in the recent past and assume that future returns will be identical. They mistake probability for certainty and pump in more money into the stock market. And when the market falls, there is great pain.

In the letter for 2000, Buffett wrote, "The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money.

After a heady experience of that kind, normally sensible people drift into behaviour akin to that of Cinderella at the ball. They know that overstaying the festivities... will eventually bring on pumpkins and mice.

But they nevertheless hate to miss a single minute of what is one helluva party... During a bull run, stock markets offer astonishing returns in a short period of time as compared to other investments. This helps in attracting more money into the stock market and so the markets keep going up.

But is this really good for potential investors?

Well, Buffett had already answered this in his 1997 letter. "A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves. But now for the final exam:

If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall... Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices."

Hunt for The Bottom!

2008-04-26T23:29:00.001+05:30

Interviews & Videos on CNBC

What happened to India story?

2008-04-07T19:18:00.001+05:30

Unfortunately, the Indian market is one of the worst performers even among emerging markets

by Manas Chakravarty and Mobis Philipose

Most stock markets across the world have bounced back pretty sharply after the panic caused by the Bear Stearns Companies Inc. collapse. The Dow Jones Industrial Average hit a low of 11,650 on 17 March and it’s up 8.2% from there. The MSCI World index is up even more, gaining 8.9% between its closings on 17 March and 4 April.

Many traders believe the measures taken to bail out Bear Stearns and the expansion of the collateral acceptable to the US Federal Reserve to include mortgage-backed securities marked a watershed in the markets. The credit markets have certainly pulled back from the brink. In the US, the spread between mortgage-backed securities and treasurys has narrowed from 200 basis points (bps) on 12 March, before the Bear Stearns bailout, to 170 bps. An index of investment-grade bond spreads, which was 190 bps on 12 March, is down to 111. 30-year fixed mortgage rates have come down from 6.13% to 5.88%. Yields on safe haven two-year treasurys have also dropped. Sure, spreads are still very high, but at least they’re going down.

The improvement in the credit markets sparked a rally on Wall Street and in most other markets. Risk appetite too has bounced back, evident from the fact that the MSCI Emerging Markets index is up 15% since its close on 17 March. While some of that could be on account of the rally in commodities and crude oil, even the MSCI EM Asia index is up 10%, more than the rise in the MSCI World index. As fund flow tracker EPFR Global points out, “Asia ex-Japan Equity Funds enjoyed their best week of the year in early April, absorbing a net $599 million (Rs2,396 crore), as investors found some value in China and continued to commit fresh money to Taiwan in the aftermath of the 22 March presidential election. China and Taiwan Country Funds took in $377 million and $191 million, respectively, while Singapore Country Funds absorbed another $110 million.”

Unfortunately, the Indian market is one of the worst performers even among emerging markets. MSCI India is up a mere 3.4% since 17 March. Indonesia, which is down 1.2% since 17 March, is the other market left out of the rally. Incidentally, both countries have recently seen a spike in inflation.

One reason for the Indian market’s underperformance could be relatively high valuations. That’s also seen from the fact that although the MSCI China index is up since 17 March, the Shanghai Composite index is actually lower since that date. High price-to-earnings markets are not in favour.

Perhaps it’s because the MSCI India index has outperformed the emerging markets index over the last five boom years—its annualized growth rate has been 35.28% compared with 27% for the MSCI EM index and 24.19% for EM Asia. But if we are to pay now for better performance in the past, the question is: wasn’t the outperformance supposed to be a reward for higher growth and for the great India story?

Who should you trust your money with?

2008-03-18T15:00:00.003+05:30

by Vijay L Bhambwani - DNA

It pays to remember some home truths about the market

Over the last couple of days, I heard some mutual fund heads talking on television about the current “compelling valuations” in the stock market and how investors should just buy and sit tight for a couple of months.

But when they were specifically asked what they themselves were buying, there was no clear answer forthcoming. Which brings me to the question, what / who / when should you trust with your money? My answer is simple —- yourself!

It is not that the people voicing their opinion in the public domain are dishonest. They just have to be wrong to make you poorer. They may also (more often than not ) omit to mention a few important facts (the valuations are compelling but I am not buying yet!). When it comes to survival, it is usually to each his own. History has recorded for posterity that humans have eaten their dead kith and kin in wars and other extenuating circumstances to survive.

Why should the markets be any different?

What are the markets anyway? Markets are a collection of all the emotions of the participants put together. Greed, fear, compassion and cruelty included. When it comes to self preservation, even murder is allowed by the courts in certain circumstances. Big-ticket players routinely lead retail players to slaughter houses. Cold bloodedly and calculatively. Books have been written on the subject, talk shows conducted by the dozens but retail players have yet to learn that lesson.

Going further, I have found that Indian markets are a lot more volatile compared with their developed counterparts as the participation has a higher component of emotions in the combination of intelligence and emotions. It should be the other way around, actually, because markets are mathematical, unemotional and unforgiving. Why should you be emotional? Why fight the markets in times of adversity and treat a losing trade as an ego slight?

Factually speaking, we are all susceptible to a feeling of vulnerability during taxing times. We seek someone to hold our hands during trying times and tell us that “all will be well”. We seek strength in numbers - in the fact that we are not alone in our belief of buy & hold. Unfortunately, the markets are readying us for mass murder.

Before you lose any more money in the markets, I suggest reading an excellent book -The Faber Report, by David Faber. The world-renowned CNBC US anchor warns investors against relying too much on voices in the public domain.

Faber has written very boldly —- dates, events and names of analysts, fund managers and managements who have (mis) advised investors in the media and taken contrarian positions in the market to profit from their crooked actions in doublequick time.

He also propagates the idea of upgrading one’s own skills to become self-reliant in the market place —- an idea that I totally agree with. Sometimes, our analysis seems to point towards an unpleasant development emerging in the markets.

Expert / public opinion seems to be pointing towards a reverse case scenario. Who do you trust? The answer is, both. Keep an eye on what is being said but keep doing your own due diligence. Sure, you may go wrong. At least you know you have yourself to blame. But do not form a habit of running away from bad news because it is unpalatable. In financial markets, pain is not in adversity but in the denial of that adversity’s existence.

Legend says ostriches bury their heads in sand when confronted by predators. While studies have shown no proof of this, the analogy is pertinent: they just become easy meat. Legend also has it that Red Indians kept their ears to the ground to hear the hoofs of horses carrying in white settlers. Maybe it’s time you started keeping your own ears to the ground rather than relying on “borrowed” ones.

After all, who can protect your wealth better than you yourself?

A tsunami of liquidity

2008-03-06T10:28:00.000+05:30

Source: Mint

We’ve heard a lot about how the credit crunch in the Western financial markets is affecting liquidity. Huge losses have punched a hole in the balance sheets of US and European banks and till such time they are able to repair their net worth, their ability to lend will remain impaired. That has hurt liquidity. But there’s a flip side to the story.

High oil prices have led to windfall gains by oil exporters. That money has to go somewhere. So far, what seems to be happening is that countries in the Persian Gulf region that have their currencies pegged to the dollar, are seeing a big rise in inflation as their central banks mop up dollars and release the local currency into their money markets. Foreign exchange reserves held by these countries are rising.

Moreover, the magnitude of the rise in dollar gains is truly staggering. According to a research note from Morgan Stanley, A Petrodollar Tsunami Warning by Stephen Jen and Charles St-Arnaud, the market value of annual cross-border oil flows is around $2 trillion (Rs80 trillion), evenly split among Gulf Co-Operation Council (GCC), non-GCC and non-Opec oil exporters. While part of the oil receipts—Morgan Stanley’s estimate is 10%—will be invested by these countries within their borders, in infrastructure and the like, the bulk of the windfall will find its way into global financial markets. The note says that about half of it is likely to be invested by sovereign wealth funds, with the rest being direct investments in financial assets. The note ends with the dramatic flourish: “A tsunami is coming.”

At the moment, much of the money is going either into US bonds or, through sovereign wealth funds, into US financial institutions. But with the slowdown in the US and a falling dollar, it makes sense to diversify holdings. Indian markets should benefit, just as Indian engineering firms are already profiting from the boom in West Asia.

Benjamin Graham on Mr. Market

2008-03-05T11:02:00.004+05:30

Common stocks have one important investment characteristic and one important speculative characteristic. Their investment value and average market price tend to increase irregularly but persistently over the decades, as their net worth builds up through the reinvestment of undistributed earnings. However, most of the time common stocks are subject to irrational and excessive price fluctuations in both directions, as the consequence of the ingrained tendency of most people to speculate or gamble.

Risk!

2008-02-25T21:16:00.007+05:30

"A lot of times, the risk of investing is the lowest when the perception of risk is the highest.”

-- Mr. Sandip Sabarwal, CIO, JM Mutual Fund.

Markets: Valuations still not low enough?

2008-02-23T13:58:00.011+05:30

Source: Mint

High valuations seem to be taking a toll on the Indian market.

The Indian market has been one of the worst performers this year, with the Morgan Stanley Capital International (MSCI) India index down 15.9% year to date as on 21 February, while the MSCI Emerging Markets index is down just 7.3%. Moreover, most emerging markets have seen a smart bounce this month, with the result that the MSCI Emerging Markets index is up 6.1% (as on 21 February) compared with a decline of 1.8% in the index for India in February. In fact, India is one of the very few emerging markets that is not in positive territory this month.

What could be the reason? A recent research note from Goldman Sachs Group Inc. says that the Indian market's valuation is still too high and it trades at a 50% premium to the region on the basis of forward price-earnings (PE) multiple.

More significantly, Goldman Sachs believes that "India's pricing implies an expectation of 18% EPS (earnings per share) compound annual growth compared with mid-single digits for most other markets and 13% for China." Interestingly, current consensus estimates are for a re-acceleration of earnings growth of above 20% in fiscal 2010.

The consensus price-earnings multiple for MSCI India is around 19, which makes it important that growth continues to be high. Except for utilities and materials, most other sectors still assume growth higher than their PE multiples. Jeff Hochman, director of Technical Research at Fidelity International, London, has in a recent note argued that India's PE to growth ratio is at 1.39, the same as the world average.

China's is 1.03, Japan's 1.79, but the most overvalued market is the US, which has a PE to growth ratio of 5.12, according to Hochman. Data such as this was behind the now-unloved view that money would flee the distressed credit markets of the West for emerging Asia's more salubrious climes.

Independent research outfit BCA Research Inc. says "there is a mountain of US investable cash sitting on the sidelines, earning an everdwindling rate of interest." When and where will this cash get deployed? While it's unlikely that the markets will go up before light is seen at the end of the credit market tunnel, the cash mountain will ensure that risky assets go up very sharply once the fear ends.

Blame yourself every time a market expert fails you

2008-02-18T13:35:00.001+05:30

The Sensex has fallen by 10.8% since the beginning of this year. Experts who till two months back saw no wrong with the up and away Sensex, and were predicting it will continue to go up, can now be seen on news channels saying “I told you so” on the fall.

Fact is, most of them really don’t know what they are talking about.

As Fred Schwed Jr writes in Where Are the Customers’ Yachts? or A Good Hard Look at Wall Street, “Deep thinking continues to be, as ever, mostly second guessing.” The book was first published in 1940, and remains relevant even today. Schwed writes, “But is it surprising that no one of them is ever quite right? The best explanation is that some of them don’t know what they are talking about; and those who do know, don’t tell all they know, or don’t permit themselves to believe all they know.”

So, why try and predict something that is largely unpredictable? Well, there are several reasons. For one, “It seems that the immature mind has a regrettable tendency to believe as actually true that which it only hopes to be true. In this case, the notion that the financial future is not predictable is just too unpleasant to be given any room at all in the Wall Streeter’s consciousness. But, we expect a child to grow up in time... This, however, is asking too much of the romantic Wall Streeter - and they are all romantics, whether villains or philanthropists. Else, they would have never chosen this business, which is a business of dreams. But the ultimate dream they almost never shed: that there is a secret, meaningful and predictable, in the rise and fall of financial enterprises - that a “close study” of this and that will prove something; that it will tell the initiate when there will be a rally and give the speculator a better than even chance of making a killing,” writes Schwed.

Also, most investors like to know where the stock market is headed to. And this is where the so called “stock market” experts come in, to fulfil an inherent need.

Schwed writes, “For one thing, customers have an unfortunate habit of asking about the financial future. Now, if you do someone the signal honour of asking him a difficult question, you may be assured that you will get a detailed answer. Rarely will it be the most difficult of all answers - “I don’t know.””

And at times, the “cock and bull” story these experts come up with is largely to generate more business for firms they work for. “On the economic side there is no denying that the more financial predictions you make, the more business you do and the more commissions you get. That, we all know, is not the right way to act at all. But I doubt if there are many, or any, Wall Streeters who sit down and say to themselves cool, “Now let’s see. What cock-and-bull story shall I invest and tell them today”... The broker influences the customer with his knowledge of the future, but only after he has convinced himself,” writes Schwed.

The other kind of prediction maker is the chartist or the technical analyst, as they are popularly known these days.

Schwed writes, “He arms himself with a chart (the simplest sort of graph) which depicts the ups and downs in price of the market as whole or of a commodity. This he studies, well away from the news ticker. It is his claim that he can discern in this jagged pattern of behaviour, which reproduces itself, and that certain of the peaks, valleys, and wobbles tell him when it about to do it again.”

A chartist essentially bets on the fact that history will repeat itself. “When the student peers, however closely, at a graph of the Dow-Jones averages, for instance, all he sees for certain is a history of past performances clearly and conveniently depicted. That one can, by examining the line drawn already, make a useful guess on the line not yet drawn, must be predicated on the hypothesis that “history repeats itself.” History does in a vague way repeat itself, but it does it slowly and ponderously, and with an infinite number of surprising variations,” writes Schwed. And this is where the problem lies. History repeats itself too slowly, whereas chartists most times are trying to predict where the markets are headed month on month and at times even for a shorter period. And that is why a lot of them trading on their own money, do go bust.

“It is the popular feeling in Wall Street that chart readers are pretty occult professors, but that somehow most of them are broke. A busted chart reader, however, is never apologetic about his method - he is, if anything, more enthusiastic than the solvent devotee you may run across. If you have the bad taste to ask him how it happens that he is broke, he tells you quite ingenuously that he made the all too human error of not believing his own charts. This naïve thought comforts him; he doesn’t mind so much losing his money, but it would have been more than he could stand to lose his faith in his beloved chart system,” writes Schwed.

A 'Must Read' Article

2008-02-13T19:17:00.005+05:30

The Bespoke Investment Group under their B.I.G. Tips column had a brilliant article out today.

Here's is their text. Please be sure to read all the way through.

A Review of the Headlines:

A recent review of the daily headlines on the front page of the NY Times' business section highlights a relatively downbeat envirornment in the market and the economy. Regarding the consumer, things remain bleak. As the headlines illustrate, Nordstrom's will be put 'to the test', 700 jobs will be cut by Saks and weak sales are causing a 78.7% decline in earnings at Ford and an idling of 16 plants at GM. In the housing sector, as real estate woes worsen, homebuilding activity has plummeted to levels which are the lowest since 1982.

In the credit markets and on Wall Street, junk bonds are at record lows as defaults keep rising. As a result capital levels at banks are at uncomfortably low levels. In an effort to cut costs banks have had to deep-six the dividends and sell off assets to spruce up their books. There has aso been a wave of layoffs among the maor brokers and Citi has had to raise capital at costly terms to win over investors.

Regarding the Fed, while they now see the potential for weakness in the economy, they were late to recognize it. In fact, in the early stages of the credit crisis, instead of responding to the weakness in the economy they put their emphasis on inflation.

However, now that the Fed has recognized the problem, many commentators believe the ailing banking system may be less able to aid in a recovery. To many, the question is not if, instead they are hoping for a 'friendly recession'. Even President Bush has commented that the "United States may be near a recession". With the Fed easing monetary policy, and the ECB maintaining its hawkish stance, markets are worried by the fall of the dollar causing commodities to rally, especially oil rising 6.6% in one day. Rising commodities have stoked inflation fears and nobody wants that blast from the past: Stagflation.

Concerning the market, Microsoft is launching a bold new game plan but the bear market is back. Will it be Gentle Ben or Real Grizzly?

____________________________________________________________________

Sounds like a grim picture doesn't it? However you should know that all the headlines just quoted were from the period between September and November of 1990!!!!!

The S&P 500 bottomed at around 295 in that period before surging to over 415 in early 1992.

Moral: Don't let the press stop you from buying when the news is bad but share prices are fabulous. In a supply and demand market you can only get the best buys when others are desperate to sell.

Source: GuruFocus

Does Everyone Lose in a Crash?

2008-02-11T19:40:00.000+05:30

It’s quite common to hear someone grumbling about how much money they lost on a stock, but did you ever stop to think where that money went?

In contrary to popular opinion, that money is far from lost. In fact, that money was won by a professional trader who profited from the stock’s decline! Sophisticated traders such as these are called the “smart money” because they profit regardless if the market is crashing or booming. The smart money wins most of the money lost by the “dumb money”, or the “average joe” amateur investor. By learning how to trade like the smart money, you can profit tremendously in any type of market. Let’s learn the differences between the two types of traders:

According to the National American Securities Administrators Association, more than 70% of traders will lose nearly all their money! This is solid proof that the majority of traders and investors are dumb money.

What is the Dumb Money Doing Wrong?

First and foremost, the dumb money act as a herd or mob. This group exhibits very little individual decision making. This is exemplified by how the herd follows the financial news so religiously. The financial news is a severe lagging indicator. This is because reporters only report after the fact. It is so silly that people actually think they will gain knowledge that will allow them to have “the edge” in the markets. This isn’t possible because millions of other competing investors are watching the same news! The news is notoriously bullish right before a bear market and bearish right before the market starts soaring.

Another dumb money tactic is to take investment advice from their broker or advisor. Brokers make money from commissions, not from investment performance. They just want their clients to trade frequently to generate more commissions. Additionally, these brokers tell all of their clients the same information, which means you have absolutely no edge over the competition.

The dumb money make investment decisions based on their emotions, rather than solid information. This group will buy stocks based on glamour. For example, in the dot com boom, investors would buy any stock that was a “dot com”, regardless if it had earning or a business plan. The crowd tends to gain a gambling mentality when “playing the market”. They act upon “hunches” and tips, which never work.

This same group consistently buys stocks late into a bull market. The smart money accumulated tech stocks in the early 1990’s, when many investors didn’t even own a computer! By the late 1990’s every investor was buying tech stocks, and this is when the market crashed. Sadly, the markets are set up so that the second the dumb money gets the gist of the game, the rules are changed. This is because the markets are zero-sum, where for every winner there must be a loser.

What is the Smart Money Doing Right?

If the majority of traders and investors lose, then doing the opposite is a winning strategy. This is precisely is how the smart money trade. The smart money wait for a time when the dumb money is most vulnerable to losing. In most cases, this would at the top of a bull market when the dumb money is foolishly raving about how “stocks will never drop” and how “we are in a new economy”. Whenever the majority of investors are euphoric about the market, it is guaranteed to drop! At this point, the smart money liquidates their stock positions and shorts the market, anticipating the coming bear market.

Shorting the market is a process which allows a trader to profit as the market crashes. It is exactly the opposite of buying a stock. As most investors are entering the poorhouse, the people that short in a market crash become extravagantly wealthy. Jesse Livermore shorted stocks and made $100 million in the stock market crash of 1929!

The smart money rarely pay attention to the financial news media because they know that they can’t gain valuable information from something that everyone is watching. Hypothetically speaking, if profitable news media was available, investors would quickly trade upon it, immediately eradicating any competitive advantage. The smart money have their own top secret forecasting systems, however. These systems have rare information that allows the smart money to have an edge over the masses.

The smart money never act upon their emotions for trading decisions. The smart money buy and sell based on what the market and their trading systems are dictating. For example, when the markets have been crashing for a while, stocks become undervalued. This is the best time to buy, as the market will start to rally in the near future. The dumb money is always most fearful at this perfect buying point. This is exactly when the smart money accumulate stocks. If they relied on their emotions, however, it certainly wouldn’t seem like the best time to be buying stocks.

By learning to do the opposite of the crowd, you can become highly prosperous in the financial markets. So next time you hear of someone who lost their shirt in the market, think of the person that profited handsomely!

A View: ‘Dumb’ Money v/s 'Smart' Money

Speculation in stock markets has decreased its effectiveness as market volatilities decline. Thus, it makes speculation less successful. The relatively low returns of hedge funds in the past two years, for example, suggest the diminishing returns for speculative capital. Wave-like market movements have become a new source of speculative profits. A typical example is the current bull market in gold. The market is full of bullish calls and speculation concerning massive buying by Middle Eastern oil money and central banks. When the market inevitably corrects, the smart money, as tends to be the case, will get out first. We are seeing the same dynamic in other markets.

‘Dumb’ money can be characterized as slow money. When a market takes off, it is initially cautious and only jumps in near the top as greed overcomes fear. On the way down, it hopes for a turnaround and pulls out when fear overpowers greed.

‘Smart’ money, by contrast, is essentially characterized by an investment strategy that takes everything with a ‘pinch of salt’ and has ‘stop-loss’ discipline in a downtrend. But, ‘smart’ money can exist only when there is sufficient ‘dumb’ money. As ‘smart’ money keeps taking money away from ‘dumb’ money, the current equilibrium will not be sustainable in the long run; however, quantifying the timeframe for this is problematic: the current global economic status quo may last for two years, five years, or 10 years. It is anybody’s guess. A shock that frightens away the ‘dumb’ money is the most likely candidate to end the current equilibrium. An outbreak of a contagious disease on a global scale, exposure of a massive financial fraud, unrest among the under privileged could upset the applecart.

Source: Site & Value-Stock-Plus Archives

Analysts as entertainers

2008-02-05T14:07:00.000+05:30

“I still wasn’t convinced, until Bob whispered in my ear what I would make in the first year. It was about three times what I was paid at Bell Labs. I stopped protesting so loudly. He then said “And that’s for being right just 51% of the time,” Andy Kessler recounts in his book, Wall Street Meat - My Narrow Escape from the Stock Market Grinder. Kessler was a rank outsider on Wall Street, having come in as a semi-conductor analyst.

Now, what exactly is the role a stock analyst fulfils? At a very basic level, an analyst is supposed to have an opinion on the stock that helps investors make a decision whether to invest in that particular stock. But it is not as simple as that.

“Companies report earnings once a quarter. But stocks trade about 250 days a year. Something has to make them move up or down the other 246 days. Analysts fill that role. They recommend stocks, change recommendations, change earnings estimates, pound the table - whatever it takes for a sales force to go out with a story so someone will trade with the firm and generate commissions,” writes Kessler.

And what does it take to become an analyst on the Wall Street? “Let’s start with the basics. First, there are absolutely no qualifications whatsoever for an analyst job. I’ve always thought that a monkey could do the job, and many do. There are very few analyst training programs, and no obvious way to get a job as an analyst. Most are in the job by accident, as I certainly can attest to.” he writes.

Over time, Kessler was able to form an opinion on analysts in the business. “By watching other analysts in action, I figured out there were three types of analysts. There are: 1) those who know somebody in their industry, 2) those who know their industry and 3) those who don’t know anybody or anything. Lots of analysts had industry contacts - perhaps CEOs who they were buddies with or someone in the CFO’s office who was feeding them information.”

So, how do analysts who really do not know their industry survive? As Kessler writes “Though I was starting to be right on my stocks, I was increasingly convinced it didn’t matter. I looked around the research department, and noticed that very few analysts were right about anything. The job of an analyst has more to do with impressing everyone they come in contact with, and less to do with stocks. At one meeting I had with Fred Kittler, a portfolio manger at JP Morgan, he paused, looked me in the eye and said, “You realise, you are not in the analysis business, you are in the entertainment business.”

Some Quotes on "Prediction"

2008-01-28T19:33:00.000+05:30

"The worst market crisis in 60 years " - George Soros

"We've long felt that the only value of stock forecasters is to make fortune tellers look good. Even now, Charlie and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children." - Warren Buffett

"Forecasts may tell you a great deal about the forecaster, they tell you nothing about the future" - Warren Buffett

"We ignore outlooks and forecasts... we're lousy at it and we admit it... everyone else is lousy too, but most people won't admit it." - Marty Whitman

"Guesses - just so we're clear - are merely expressions of prejudice." - Michael Crichton

"Economists make predictions because they're asked, not because they know." - John K. Galbraith

When are the bulls actually bears?

2008-01-28T17:50:00.000+05:30

by John Authers

Bulls and bears have been duking it out for centuries. There will always be those who think the market is going up and those who expect it to go down.

The current incarnation of that debate, of course, rages over whether the developed world is sliding into a recession. The bulls say such fears have been overdone, creating a buying opportunity. The bears, who are suddenly in the ascendant, point out that if things pan out as badly as they have done at times in history – and the world has gone three decades without a severe recession – then things could get much worse.

As with any interesting debate, both sides have a point. However, there is another dimension to the battle between bulls and bears which does not bring in the economy. Are we in a bull market or a bear market, and how do we know?

Conventional wisdom is that the bursting of the internet bubble ushered in a brief but savage bear market. That ended, depending on which index you look at, either in late 2002, or in 2003. All seem to agree that a new bull market started in earnest once the US and its allies had launched the invasion of Iraq in March, 2003. With the S&P 500, and the MSCI World index last year finally beating the highs they had made in 2000, any argument on this topic appeared to be at an end.

However, there is an intriguing case to be made that we are in fact still lodged in a secular bear market.

That argument has received a big boost from the events of the last six months. And the economy has nothing to do with it.

Stock market cycles are not to be confused either with economic cycles or earnings cycles (although they interact with both in interesting ways).

Instead, the governing theory of Ed Easterling, head of Crestmont Research in Dallas, is that markets follow secular bull and bear cycles. These are determined by peaks and troughs in price/earnings ratios. To avoid confusion with economic and earnings cycles, which markets tend to discount, the key price/earnings (P/E) ratios for this task are cyclically adjusted, taking the multiple of prices to average earnings over the preceding 10 years.

Viewed this way, stock markets look more expensive than if we simply look at the multiple of the latest year’s earnings.

But the argument goes further than that. According to Easterling, a secular bull market is a period of generally rising P/Es that multiply growth in earnings per share, and give investors an above-average return. A secular bear market is the opposite: a period of falling P/Es that offset earnings growth and provide below average returns.

These market cycles are longer than economic cycles, and very much longer than corporate profit cycles. By his estimation, we are now in the fifth secular bear cycle since 1901. This uses the (rather limited) Dow Jones Industrial Average, for which constant historical data is available, but it is unlikely that findings for the more robust S&P 500 would be significantly different.

We may have further to fall in this episode than in earlier bear cycles. Previous bear cycles started in 1901, with a P/E (as cyclically adjusted) of 23; in 1929, with a P/E of 28; in 1937, with a P/E of 19; and in 1966, with a P/E of 21. In all bar one, multiples had fallen by more than half by the time the cycle came to an end.

The current bear cycle began in 2000, with a P/E of 42. So on this analysis, we started this decade at historically irrational valuations. Multiples need to get back at least into the teens before a secular bull market can start (and we are currently at a P/E of about 26).

It is also easy to be tricked by a succession of positive years – at one point there were three “up” years in a row during the 1966-1981 bear market, or by new highs, as happened last year.

There was a similar event in 1972, when the P/E multiple hit 18, and the Dow hit a new high. Volatility was very low – exactly as was the case during the first half of last year – and, as it turned out, the market was primed for a new, savage round of sell-offs.

If there is an external driver for these cycles (beyond investors’ animal spirits), it is inflation. Higher inflation will require investors to demand lower earnings multiples. Japanese-style deflation, where reducing prices put long-lasting downward pressure on profits, also pushes down multiples.

The economy is certainly not unimportant, as a slowdown in activity will make it harder for companies to make profits. But this analysis suggests that the current great preoccuption with the risks of a recession is misplaced – at least from the perspective of investment in stocks.

According to Easterling’s calculations, the average annual return on the Dow during bear cycles was minus 4.2 per cent during the 20th century, while the average during bull cycles was 14.6 per cent. Meanwhile, GDP growth was actually slightly higher during bear cycles (6.9 per cent) than bull cycles (6.3 per cent).

Rather, investors should be more concerned with the debate over inflation. Some fear stagflation, others see a risk of Japan-style deflation, but break-evens in index-linked bond markets suggest the market still broadly believes these risks are under control. That suggests the recent sell-off could be overdone.

Markets should also worry about earnings. The profit cycle is well established, and if corporate profits were to decline this year that would be quite in line with historical experience.

Sell-side analysts’ estimates still imply a strong rebound for earnings by the end of the year.

Finally, there should be a realisation that the bizarre event of this decade is not the recent return of volatility. Rather, it was the recovery that started in 2003.

Possibly due to the flood of cheap money from the Federal Reserve, this arrested the fall in stock prices at a point when multiples had still not got down to the levels normally needed before a strong recovery can start.

Mr. Market and You!

2008-01-22T22:39:00.000+05:30

"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.' This was how Benjamin Graham defined 'investment'. And rightly so! At these times, when the markets are witnessing high levels of volatility, it becomes an ardent need for stockbuyers to understand this difference between a speculative activity and investment. It requires just a misguided step for investor to turn his investment venture into a speculative misadventure.

In this regard, Graham's parable of 'Mr. Market' stands in good stead. This is, probably, one of the best metaphors ever created for explaining how stocks can become mispriced. Through this parable, Graham asks investors to imagine a non-existing person called Mr. Market who is your (investor's) partner in a private business. He appears daily and names a price (stock quotation) at which he would either buy your interest or sell you his. Now, despite the fact that both Mr. Market and you have stable business interests, his quotations are rarely so. At times, he falls so ecstatic that he sees only the favourable factors affecting business. And this is the time he would name a very high buy-sell price because he fears that if he does not quote such a high price, you would buy his interest in the enterprise and rob him of imminent gains.

And then there are times when this very Mr. Market is so depressed that he sees nothing but trouble ahead for both business and the world. These are the occasions when he would name a very low price, as he is terrified that if he does not do so, you would burden him (sell him) with your interest in the business.

Now, Graham says that if you were a prudent investor or a sensible businessman, you would not let Mr. Market's daily communication determine your view of the value of your interest in the enterprise. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But at the rest of the time, you would be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.

What Graham tells investors through this parable of Mr. Market is that they should look at market fluctuations in terms of the Mr. Market example. They should make these fluctuations as their friend rather then their enemy. This means that they should neither give in to temptations that rising markets bring with them nor should they think of doom when the markets are falling incessantly.

Coming back to the abovementioned definition of an investment operation, investors need to have a long-term (two to three years) perspective when making their investment decision. Only then would the promised safety of principal and an adequate return accrue to them. Now, the term 'adequate return' typically varies from investor to investor. A high-risk investor would demand a high return from his investment from the extra bit of risk he is taking. On the other hand, a low-risk investor would settle for a relatively lower return. Having said that, in a rising market, expectations tend to be on the higher side without a fundamental premise. Here is where 'Mr. Market' could mislead you. If you believe that 15% per annum is an 'adequate return', then stick to that irrespective of whether it is a bull market or a bear market. Otherwise, you are changing i.e. risk profile is changing, which is not required.

As Graham says, '...in the short term, the market is a 'voting' machine whereon countless individuals register choices that are product partly of reason and partly of emotion. However, in the long-term, the market is a 'weighing' machine on which the value of each issue (business) is recorded by an exact and impersonal mechanism.' Happy investing!

Note: Characters in italics are quotes from Benjamin Graham.

Stock valuations are not about earnings alone

2008-01-21T10:57:00.000+05:30

Listing of subsidiaries, re-rating of peers within a sector and news of private equity deals are among the factors that can transform the valuation picture. by Srividhya Sivakumar - HBL

Healthy growth in corporate earnings, rising institutional interest and ample liquidity have been the main drivers of high stock prices over the past three years. Conventional parameters apart, the recent re-rating of stocks has also been driven by other factors. Companies are valued not just for their core businesses but also for other strengths that have the potential to add value to core operations. Here are a few such triggers investors need to take note of:

Listing of subsidiaries

With the primary market in spate, companies seeking to hive off a new business for subsequent listing stand to receive an attractive valuation for the new business that isn’t captured in the company’s books. The listing of a subsidiary by an existing company has more often than not delivered value to the holding company. Consider Reliance Energy.

Since the filing of the draft prospectus of Reliance Power (early October-07), Reliance Energy has returned about 76 per cent, while the Sensex appreciated by only 10 per cent. Pantaloon Retail, following the announcement of the listing of Future Capital Holding (late September-07), its 78 per cent subsidiary, spurted 40 per cent between the date of announcement and that of the IPO, outpacing the 20-per cent rise in the Sensex.

The price surge in HEG and Rajasthan Spinning and Weaving Mills (RSWM) can be traced to similar factors. Given their rather indifferent valuations, news of the potential listing of Bhilwara Energy, their commonly-held subsidiary, drove their stock prices to new heights.

HEG more than doubled and RSWM appreciated more than 150 per cent in just two months while the Sensex managed a piffling 6 percent rise only!

Going by these trends, investors looking for potential upsides should watch for proposed listings of subsidiaries by companies such as ICICI Bank (planned listing of ICICI Securities and ICICI Ventures), M&M (Club Mahindra) and L&T (L&T Infotech).

Tracking the draft prospectuses of these arms on the SEBI site and looking into the potential valuations of these new companies may help investors time their investments in these stocks. One caveat here is that valuations would hinge on the sector leanings of the subsidiaries concerned.

Peer re-rating

Had you invested in Tata Power three months ago, you would now be sitting on profits of over 70 per cent on the investment, thanks to the high-profile Reliance Power IPO. In the same three-month window, other power stocks such as Torrent Power, JP Hydro, NTPC and CESC have turned in double-digit returns, a rare phenomenon in the sedate power sector. This bout of re-rating was prompted by the Reliance ADAG group’s decision to list Reliance Power.

The spate of new listings in the brokerage/financial space in recent times — Motilal Oswal Financial Services, Religare Enterprises and Edelweiss Capital has had a trickle-down effect on listed brokerage firms, such as India Infoline and Geojit Securities, IL&FS Investment Managers, and so on. The price investors were willing to pay for Motilal’s offer also pegged up the valuations for holding companies with unlisted broking businesses — such as Kotak Mahindra Bank and Indiabulls.

The mega public offer of DLF also had a similar impact on its realty peers. Given that most IPOs today enjoy strong investor appetite, a new listing usually contributes to a fresh discovery of the prices investors are willing to pay for the growth prospects of the business.

In this context, the price action in peer group companies of Emaar MGF (DLF), Oil India (ONGC), Wockhardt Hospitals (Apollo Hospitals and Fortis Healthcare) and Titagarh Wagons (Texmaco), among the many in line for initial offers, bear close watching in the weeks ahead.

Private equity deals

The private equity party in India has just begun; nonetheless, PE deals have altered the price discovery mechanism of our markets. For instance, Eton Park Capital’s acquisition of a 5 per cent stake in Reliance Capital for Rs 500 crore had valued the latter at about 13 per cent of its assets under management. This valuation was quite liberal when compared to the values earlier accorded to Reliance Capital’s asset business and thus drove a re-rating of comparable AMCs, such as Birla Sun Life.

Birla’s AMC business is housed with Aditya Birla Nuvo, the flagship company of this group. The Aditya Birla Nuvo stock gained 30 per cent from the time of this deal.

Similar benchmarking was also used to drive an expansion in price-earnings numbers of several listed broking companies, which attracted private equity deals in good number over the past year or so.

Valuation ‘gaps’ between two firms in a similar business have been swiftly bridged. This underlines the fact that investors are increasingly willing to bet on businesses and stocks if they are available at cheaper valuations in a bull market, rather than try and justify standalone absolute valuations for a business.

Nonetheless, it might not be such a great idea to invest blindly in companies that have attracted PE money. While most such companies have generated profits for shareholders, investors may be better off tracking the company fundamentals before taking the plunge.

For instance, while Nagarjuna Constructions returned about 85 per cent after the Blackstone deal, Gokaldas Exports, despite a similar private equity deal, has delivered only about 7 per cent.

Investment books

Prolonged bull markets, such as the current one, tend to soak up the supply of stock candidates that are available at good “value”. This may explain the trend among market participants to unearth hidden sources of “value” in a company’s asset base or balance-sheet that could add a few rupees to the company’s intrinsic worth.

The market value of investment books of companies (the value of securities/stakes held by the company as a part of its trade or non-trade investments) have been drivers of re-rating for stocks such as Tata Investment Corporation, Ramco Industries, Rallis India, IDFC, and many others. Consider Ramco Industries. The stock price shot up by a whopping 33 per cent in the last one month on discovery of a valuation mismatch; its investment book value per share was higher than the market price.

Arguments on similar lines may partly explain the surge in stock prices of companies such as Tata Investment Corporation, LMW, Dewan Housing and IDFC, to name a few. For instance, in Tata Investment Corporation, the value of its investment book would stand at about Rs 841 per share at current market prices; LMW’s investment book would be valued at about Rs.64 per share.

However, the caveat here is that though the market value of the investment book may be much higher than the book value, it must be capable of value unlocking through a sale of those shares at market price. Companies that do not actively manage their equity portfolios and cross-holdings between group companies may not lend themselves to such unlocking. Moreover, the market value of the investment book too is directly related to the state of the stock market and any meltdown could lead to a swift mark-down in values.

Beware the black swan

More often than not, while such triggers have made stocks outperform the broad market till now, they may not continue to do so. Investors should primarily base their investment decisions on a company’s core business fundamentals.

The Bajaj Auto demerger is a case in point. Contrary to the general market sentiment that demergers are good for shareholders, the stock crashed by about 13 per cent after the terms of the demerger were announced; the stock continues to languish despite a bull market. Investors expecting value discovery for Bajaj’s insurance business were caught off-guard on disclosure of a call option at a nominal price with its insurance partner, Allianz.

This came as an unpleasant surprise to market participants who were pegging up Bajaj’s insurance business at about Rs 600-1000 per share. Such damp-squib occurrences are rare but they prove that investors may be better off going by stock fundamentals for long-term investments.

The "Decoupling Thesis" plunges over the cliff

2008-01-19T15:02:00.000+05:30

Friday’s steep fall took the Sensex down 10.3% from its high of 21,206 points reached on 10 January. The speed of the fall has been unnerving but then, so far, we in India have scarcely been affected by the carnage going on in the world equity markets.

If a bear market is defined traditionally as a 20% drop from a market peak, then global markets are perilously close to it. The MSCI indices of nine markets in the developed world are trading at 15-19% off the levels they were at three months back. That includes Japan, down 17.6%, and Singapore, down 17.4%, (data for three months to 17 January). The MSCI World index is down 14%.

Emerging markets haven’t escaped the sell-off. The MSCI Emerging Markets index is down 13.58%, but if you calculate the index from the peak reached on 31 October last year, it’s lower by 15%. The Far East countries have fared even worse, with the MSCI EM Far East index down 18.5% in the three months to 17 January. In the middle of this bloodbath, the Indian market has so far been the exception, with MSCI India up 3.46% in the three months to 17 January, although Friday’s dive would have sent us into negative territory. Malaysia, up 4.2% over the same period, is the only other Asian market in positive territory. MSCI China has fallen 26%.

Click here for the full article.

'Guru of Wall Street gurus' bets on value investing in India

2008-01-12T12:37:00.000+05:30

by Sanat Vallikappen - DNA Money

Cheap, ugly, obscure and otherwise ignored: these are characteristics in companies that Professor Bruce C Greenwald of the Columbia Business School looks for when he makes an investment decision. Being one of the leading proponents of value investing, a paradigm of investing pioneered by Columbia University's Benjamin Graham and David Dodd in their 1934 text, Security Analysis, it's no surprise that Greenwald likes such companies.

Value investing, as the term suggests, works on the assumptions that the market is inefficient, and involves buying companies whose stock price appears cheap when viewed against its fundamental intrinsic value. For a lay Indian investor, who has been in the middle of a secular bull-run right from April 2003, and who has since seen everything he touches turn to gold, Greenwald may come across as rather conservative.

However, Greenwald feels his strategy would best fit the Indian investor. "When Indians plan for their kids, and their kids' kids, that's very long-term planning. Value investing is about planning for the very long term, maybe 30 years," he says. But will it work in India, where every stock is on overdrive and does not exhibit the characteristics that compel Greenwald to invest. "There is always something, somewhere that will look underpriced, and therefore attractive," says this academic, who has been described by the New York Times as "a guru to Wall Street's gurus."

"It does not work for a company that is doing extremely well, and whose stock price gives you lottery ticket-type of returns," he says. Rather, he says his approach to investing works for companies that have a good management, the industry in which it operates has large entry barriers, has a geographic competitive advantage, captive customers and economies of scale, but whose share price may not have taken any or some of these into account. "An investor like Warren Buffett would like such a company," says Greenwald.

"When you buy a stock, you buy it presuming that it's undervalued. But in the same transaction, there is someone else selling it, thinking it's overvalued. One of you have to be wrong," he says. Again he advocates value investing to be the key to make you be on the right side of the transaction. "Strikingly and disproportionately successful investors have shown this," he says, adding that one of the prominent aspects of value investing is that it does very little by way of forecasting.

Greenwald feels that growth investing, in which investors put money into companies that exhibit above-average growth, even if the share price looks stretched, is riddled with a problem. "A company has to invest to keep growing. It needs to pay the people who pay for that investment. Growth is good only if earnings on the new assets being produced with fresh investments are more than the cost of producing those assets," he says.

For the lay investor, the value approach, which uses all information from the balance sheet and organises information by rank from reliable sources, may be a tough nut to crack because of the lack of access to such information, and their inability to calculate intrinsic value. For Greenwald, it would be enough if professionals (read mutual fund managers) in India adopt this approach, and pass on its benefits to retail investors in their funds.

Some Indian Shares Offer Shelter from Volatility

2008-01-11T20:20:00.000+05:30

By Krishna Pokharel - WSJ

Looking to booming India as a haven from the world's skittish stock markets in 2008? If so, here are three sectors -- and three stocks -- that analysts say are poised to outperform this year: infrastructure, consumer goods and education.

Although India's surging economic growth is projected to slow somewhat this year as the effects of tighter monetary policy are felt, there is widespread confidence here that the expansion will continue even with a slowdown in the U.S. According to a recent report by U.K.-based accounting and consulting firm Grant Thornton International, Indian businesses are the most optimistic among the 34 economies surveyed about the prospects for increased profitability and exports and about the economic outlook in 2008.

India's stock market, steadily on the rise since 2005, therefore still has a lot going for it, analysts say. In the first days of 2008, when the major world markets have been buffeted by fears of a recession in the U.S., the Bombay Stock Exchange's 30-stock Sensitive Index, or Sensex, added 2.6% on top of its 47% jump last year. The index hit a new high Tuesday, closing at 20873.33, and fell yesterday 3.55 points, or 0.02%, to 20869.78 after hitting a record high of 21113.13 in intraday trading.

Among analysts, Lehman Brothers, for example, projects the Indian stock market will grow by 18% to 20% in 2008. Macquarie, too, predicts double-digit percentage gains and has a year-end target of 24000 for the Sensex.

But within the broader market, many analysts see the infrastructure and consumer-goods sectors as set to perform particularly well. Education-related companies could also emerge as hot stock picks, some analysts add.

Infrastructure is seen getting a boost from increased government spending and private investment in power generation, telecommunications, roads, ports and airports. The government late last year projected total infrastructure investment of about $500 billion over the next five years, 2.3 times the total projected to have been invested in the sector in the preceding five years.

Nipun Mehta, director and chief executive of Mumbai-based Unitis Tower Wealth Advisors, is bullish on the infrastructure sector in general and likes Punj Lloyd in particular.

Punj Lloyd is an engineering and construction outfit that builds and designs facilities such as transport systems, nuclear-power plants and pipelines. It is India's second-largest engineering company by sales, after Larsen & Toubro, and has recently entered real-estate development and shipbuilding.

"Punj [Lloyd] has a healthy order-book position and is expected to have consistent profitability over the next few years," Mr. Mehta says.

Mr. Mehta's target price for Punj Lloyd stock in 2008 is 700 rupees (almost $18). Shares closed yesterday at 545.65 rupees, down 2.85 rupees.

Unitis said it doesn't have an investment-banking relationship with Punj Lloyd, but declined to clarify its share-ownership position.

Consumer-goods companies are also expected to perform better in a stock market that may be more volatile this year. Their shares were hit in 2007 by margin squeezes as they cut the prices of their goods, but analysts say that when there are concerns over market volatility, Indian consumer-goods stocks generally give more solid returns than do manufacturing stocks.

A lagging sector last year, consumer-goods stocks have been among the top performers on the Bombay exchange in the early going this year. In 2007, with sector indexes like realty and banks surging by 73% and 60%, respectively, a key consumer-goods index rose by just 19%. This year so far, the consumer-goods sector is up 7.2%.

Tobacco and tobacco-products producer ITC, based in Kolkata, is a favorite of T.S. Harihar of Karvy Stock Broking in Hyderabad. He argues that institutional investors' interest, and buying, will be centered on "defensives" -- stocks that are more stable in periods of volatility, especially consumer goods and pharmaceuticals. This adds up to richer valuations for such companies, Mr. Harihar says.

At the same time, Mr. Harihar believes ITC's stock could get a lift from spinning off businesses such as retail and e-marketing from its core business of cigarettes. The company hasn't disclosed any restructuring plans, however.

"We believe that the brand equity of ITC and the hidden value in its retail and e-Choupal business [an online information and marketing portal for farmers] is yet not captured in its price," says Mr. Harihar. His target price for ITC stock in 2008 is 350 rupees, which would represent a 54% gain from its Wednesday closing price of 227.95 rupees.

Karvy doesn't have an investment-banking relationship with ITC or own the company's shares.

The stock-market wild card could come from an intriguing new sector on the Indian market: education. Some analysts think it is about to take off, with the burgeoning middle class giving priority to better schooling for their children.

Gurgaon-based Educomp Solutions is one of the few listed education companies on the Bombay exchange, and a key pick for Ketan Karani at Kotak Securities in Mumbai. India's young population and rising middle class are willing to pay more for career-enhancing education, which is expected to make the commercial education sector increasingly lucrative.

Because education-as-a-business is now emerging as a key theme in India, Educomp could continue to be a good opportunity to get in early: "It's a niche play right now," Mr. Karani says.

Mr. Karani notes that Educomp is the leader in the sector and was one of the top performers on the Bombay exchange in 2007, with its shares soaring more than five-fold to 4,750.45 rupees. The stock closed at 4,360 rupees yesterday.

Despite Educomp's strong performance last year, Mr. Karani has an 11,000 price target on the company for 2008, up more than double from its current level. He sees the company's stock rising to 20,000 rupees over the next three years.

Kotak doesn't have an investment banking relationship with Educomp, or own its shares.

Source: WSJ

Investor's Checklist: - Seven Mistakes to Avoid

2008-01-05T11:53:00.000+05:30

Don't try to shoot for big gains by finding the next Microsoft. Instead focus on finding solid companies with shares selling at low valuations.
Understanding the market's history can help you avoid repeated pitfalls. If people try to convince you that "it really is different this time," ignore them.
Don't fall into the all-too-frequent trap of assuming that a great product translates into a high-quality company. Before you get swept away by exciting new technology or a nifty product, make sure you you’ve checked out the company's business model.
Don't be afraid to use fear to your advantage. The best time to buy is when everyone else is running away from a given asset class.
Attempting to time the market is a fool's game. There's ample evidence that the market can't be timed.
The best way to reduce your investment risk is to pay careful attention to valuation. Don't make the mistake of hoping that other investors will keep paying higher prices, even if you're buying shares in a great company.
Cash flow is the true measure of a company's financial performance, not reported earnings per share.

In Earning Season, Does Analyst Outlook Work?

2008-01-05T11:35:00.000+05:30

It’s the earnings season again. Brokerages have started sending their December quarter “earnings preview” to clients. These reports will contain the latest estimate of their in-house analysts, complete with forecasts of quarterly earnings per share down to the last paisa and targets for stock price. Yet, in the current bull run, it’s well known that these targets have often had to be revised within a week of the report being published, the sheer speed of the rally catching even the most optimistic unawares. Of course, that hasn’t prevented analysts from going with the flow, bringing out still more glowing reports or finding “embedded value” in the stock. Rare is the analyst who has swam against the tide.

How impartial are analyst recommendations? In a National Bureau of Economic Research (NBER) paper written last year, titled, Do Security Analysts Speak in Two Tongues?, Ulrike Malmendier of the University of California at Berkeley and Devin Shanthikumar of Harvard Business School set out to study why security analysts issue overly positive recommendations.

To the sceptical layman, there seems to be a straightforward answer—analysts are paid to encourage clients to buy stocks, simply because the universe of potential buyers is always larger than the universe of potential sellers. Malmendier and Shanthikumar, not being so cynical, consider two alternative explanations: One, analysts pick favourite stocks and are genuinely overoptimistic; and two, analysts distort recommendations to maximize commissions and underwriting business, particularly if affiliated with an underwriter.

Click here for the full article.

Additional Reading:

Liquidity fears may be overblown

Bought stocks? Do nothing and get rich

2007-12-29T16:44:00.000+05:30

by Arnav Pandya - BS

While investing in stocks or mutual funds, investors use several strategies. Aggressive selling on a downturn, buying on hints of an upward movement and even investing on hot tips from friends are some of them.

However, a very successful approach that a lot of people seldom use is inaction. This method, if effectively used, can cure a lot of financial headaches.

Basically, when you take a call on selling or buying an investment product, you are giving the signal that this product has completed its shelf-life or will add value to your portfolio. Holding an investment for long periods of time indicates that this investment product is good for your portfolio. There are several situations in which you can use this strategy.

Lack of options: There could be time periods when you do not have a worthy option. Any investment decision is based on expectations about the future performance of the asset class. If there are no such products, then it is best to sit tight with the existing investments.

In such a situation, though it may appear that you are not taking any action, the inaction, itself will help you prevent erosion of wealth. For example, if you believe that all the asset classes such as equities, real estate and commodities are overvalued, then not churning your portfolio at this stage may be a great idea.

Cash in hand: Sometimes, you could have an investible surplus but no opportunities. During such times, it might not make great sense to immediately deploy the funds because the present conditions may not help you to earn good returns.

Yes, keeping idle cash is not a great idea. But then, investment products capable of giving good returns should be available as well. If the expectation is that the investment avenue is good but the time is not right to invest, then some waiting helps. This also implies that there are expectations of a possible fall in the value of that asset. A good example of this situation is when an equity investor has cash and is waiting for the market to stabilise before deploying it.

Short-term volatility: As all investment advisors will say, it is always important to be in the equities market for the long-term for good returns. However, it is noticed that investors exit the market in panic or enter when the market has already peaked. It is important that when you are in it for the long-term, you ignore short-term movements.

Obviously, this means having more patience, a firm belief in your choices and not getting ulcers when the market moves against you. This especially applies when you are following a systematic approach towards investment such as a systematic investment plan (SIP) in mutual funds. A tanking market could really unnerve you. But it is best to just quietly and keep investing.

Remember, falling prices of shares mean more units of the fund. And all those units count in the long run. Also, there could be times when you have particular financial goals and disciplined investment is the only way to achieve them. In such a situation, irrespective of the market conditions, you will need to keep on investing. Following a plan is absolutely necessary to achieve your goals. Inaction, in reality, could actually mean affirmative action in such cases.

The writer is a certified financial planner.

How To Select Shares For Your Portfolio?

2007-12-29T15:17:00.001+05:30

by David Opoku

Investors employ a multiplicity of techniques in choosing shares. What is common amongst the various methods is that they don't always work. The suggestions made in this discussion combined with common sense and good judgment should help to hone your stock selection skills.

The first step in the selection process is asking yourself a few questions to help clarify exactly what you want and expect from your investment. It is immensely necessary to endeavour to find out the amount of risk you are prepared to take. Look back, and recall how you felt when you incurred some financial losses. Such memories, with some amount of honesty should help you to find out your level of risk tolerance.

Companies on the stock market are grouped on two main basis: in terms of similarity in size, and on grounds of carrying out the same activities (sector grouping). If your analysis shows you are risk-loving, then your focus should be on smaller companies or growth companies which are generally riskier, with potential for higher returns. If you happen to be the risk averse type or you want a share with minimum maintenance, then you want to consider large organisations, which have a lower tendency to go bust and can also serve as more reliable source of income. Such firms are known as ‘blue chips’. Target shares in industries or sectors that will be positively impacted on my political ventures and economic trends.

After considering the category of companies you want to deal with, you should begin inspecting the dividend yields and P/E ratios of the companies. It is a good idea to be on the look out for companies with reasonably high dividend yields. A P/E ratio between 7 and 10 is very much recommended. Remember that a P/E ratio is only useful when compared to others. Consider companies with P/E ratios that are lower than those of competitors in the same industry, and also lower than the previous years’ figures. The yearly sales and earning per share figures should ideally be increasing over the previous years. It’s a good idea to consider growth companies that have fallen on hard times, but shows signs of future recovery.

You should also decide how long you will be holding the share for. You will thus be on the alert, when it is time to get rid of the share. Higher returns will be earned when a share is held for a minimum of 5 years, with substantial savings in dealing expenses. This, nonetheless, does not mean that duds should not be turfed out before their planned disposal dates. Accordingly, a winner should not be gotten rid of just because it has had a decent run. Tact should be exercised before selling shares and it is good technique to keep an eye on the next share to grab, once the old one is gone.

Do not catch a falling knife. Although it is good practice to buy cheap shares, some shares suffer a free fall in price, and stay cheaper and cheaper with the passage of time. These should be avoided. Also eschew shares recommended by newspapers and tipsheets. The explanation for this is that market makers also read newspapers, and by the time you lay hands on the share, every advantage it has would have been already siphoned out by professional investors, especially, if you’re considering a blue chip. If you want to try your luck in securing a winner you may have to rummage financial statements of companies that have capitalisation less that £100 million. Such companies do not attract professionals, hopeful you can beat the market here.

It is almost impossible to outperform the market extensively. What you want to avoid is losses. A long-term goal of tracking the market, or better still performing slightly better than it is quite realistic and dignified. You should decide to what extent you want to get involved with the management of the share. If you want to be mildly involved, you will be better off investing in mutual funds or investment trusts rather than picking your own shares. Be prepared to buy investment management, when necessary.

Quotes from Warren Buffett

2007-12-26T18:46:00.000+05:30

Year 2007 is drawing to a close & our markets are entering into 5th year of the bull market. So, now is the time to look into retrospect, and have a close look at our investing triumphs & failures. And, what could be better than learning from the Master Stockpicker, Warren Buffett himself.

Here are some of his best quotes:

If past history was all there was to the game, the richest people would be librarians.
In the business world, the rearview mirror is always clearer than the windshield.
It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently.
It's better to hang out with people better than you. Pick out associates whose behavior is better than yours and you'll drift in that direction.
It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
Let blockheads read what blockheads wrote.
Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.
Of the billionaires I have known, money just brings out the basic traits in them. If they were jerks before they had money, they are simply jerks with a billion dollars.
Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years.
When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.
Why not invest your assets in the companies you really like? As Mae West said, "Too much of a good thing can be wonderful".
Wide diversification is only required when investors do not understand what they are doing.
You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing.
You only have to do a very few things right in your life so long as you don't do too many things wrong.
Your premium brand had better be delivering something special, or it's not going to get the business.
Only when the tide goes out do you discover who's been swimming naked.
Our favorite holding period is forever.
Our favourite holding period is forever.
Price is what you pay. Value is what you get.
Risk comes from not knowing what you're doing.
Risk is a part of God's game, alike for men and nations.
Rule No.1: Never lose money. Rule No.2: Never forget rule No.1
Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.
The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective. The first rule is not to lose. The second rule is not to forget the first rule.
The investor of today does not profit from yesterday's growth.
The only time to buy these is on a day with no "y" in it.
The smarter the journalists are, the better off society is. For to a degree, people read the press to inform themselves-and the better the teacher, the better the student body.
Time is the friend of the wonderful company, the enemy of the mediocre.
Value is what you get.
We believe that according the name 'investors' to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a 'romantic.'
We enjoy the process far more than the proceeds.
We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
When a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.
A public-opinion poll is no substitute for thought.
Chains of habit are too light to be felt until they are too heavy to be broken.
I always knew I was going to be rich. I don't think I ever doubted it for a minute.
I am quite serious when I say that I do not believe there are, on the whole earth besides, so many intensified bores as in these United States. No man can form an adequate idea of the real meaning of the word, without coming here.
I buy expensive suits. They just look cheap on me.
I don't look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.
I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.
If a business does well, the stock eventually follows.

...and here comes my favorite!

There seems to be some perverse human characteristic that likes to make easy things difficult.

Season's Greetings!

2007-12-24T22:07:00.000+05:30

Merry Christmas & Happy New Year!

- Toughiee

Excess returns: All about market timing

2007-12-16T12:33:00.000+05:30

Can market timing generate excess returns? This article argues that excess returns are possible as long as assets price our idiosyncratic behaviour such as loss aversion. A portfolio manager should follow time diversification strategies to capture such idiosyncrasies and follow strict money management rules to control risk.

B. Venkatesh

Asset prices are galloping at a fast pace in the Indian market. Many investors have not participated in the recent uptrend for the fear of a sharp turn in prices. Market timing is, hence, a relevant topic in the current environment.

Professor Javier Estrada’s paper “Black Swans and Market Timing: How not to generate alpha” concludes that “market timing is an entertaining pastime but not a good way to make money.” He argues that if a portfolio manager misses the ten best days in the market, the portfolio annual returns reduce by 3 percentage points.

Likewise, avoiding the ten worst days increases the annual returns by 4 percentage points. As no portfolio manager knows the best and worst days’ ex-ante (before the event), Estrada states that market timing is a wasteful exercise. This article argues that disciplined money managers following time-diversification strategies can generate alpha from market-timing.

Alpha Generation

Alpha is the excess returns that the portfolio generates because of manager skill. Alpha will be 5 percentage points if the portfolio generates 25 per cent when the Nifty moves 20 per cent. Alpha can be generated through market timing or by holding stocks that outperform the market. Some argue that alpha returns will decrease with the proliferation of institutional investors and hedge funds; for more funds will chase alpha-generating assets.

But this argument may not be entirely true. Why? The total available alpha is unknown.

So, even as new funds emerge to harvest alpha, newer sources for alpha generation will evolve. The argument is the same as in the case with oil. As crude oil prices climb, the world is working hard to develop alternative sources of fuel.

Market timing

Generating alpha from market timing involves using technical analysis, which trades on human behaviour.

Take Essar Oil. The stock hit Rs 70 this September and declined to Rs 49. The next time the stock hit Rs 70 in November, it jumped to Rs 250 in 16 days. Why? Experts in behavioural finance have shown that we suffer from loss aversion. That is, we tend to keep losers in our portfolio too long and sell winners too soon. Perhaps, that is what happened with Essar Oil. This stock failed to move past Rs 70 early this January; investors who bought then saw the stock decline to Rs 46. So, the next time the stock moved to Rs 70 in September, most investors sold. The higher supply of shares at Rs 70 pushed the stock price down yet again. Technical analysts would call Rs 70 as the “resistance level”.

After naïve investors offloaded their supplies in September, smart traders gathered critical mass and eventually pushed the stock beyond Rs 70, which now becomes the “break-out” level. A money manager can generate alpha from market timing as long as we all suffer from loss aversion and other idiosyncrasies.

Pareto Principle

Estrada is right. Only a few trading days contribute substantially to portfolio returns. But you know that Pareto Principle holds true in all walks of life. Eighty per cent of your work gets done in 20 per cent of the time that you spend in the office! In the markets, 20 per cent of the stocks in your portfolio contribute nearly 80 per cent of your total returns. Likewise, 20 per cent of the total trading days account for 80 per cent of the positive returns in the market.

Money managers, hence, follow time-diversification to minimise the risk due to loss aversion. Understand that loss-aversion leads to selling winners early and losing the best 10 days in the market. It could also lead to carrying losses and staying in the market during the worst 10 days. Time diversification means that the portfolio manager has exposure across various time horizons. The portfolio will have stocks for the short-term (5 to 30 days), some for the medium-term (30 days to 12 months) and some for the long-term (over 12 months).

This ensures that the manager is engaged in active trading through the year and so does not take profits too soon. Remember, we take profits too soon because we need to see cash flowing into our account at regular intervals. Time diversification also ensures that the portfolio rides through the 20 per cent positive days in any year.

Black swans

Black swans refer to extreme events, such as a market crash. If a money manager does not manage the ten worst days effectively, she is likely to lose all the profits. Professional money managers, hence, follow strict money management methods, such as stop-loss rules to control portfolio risk. The problem is that all managers are not disciplined — they suffer from loss aversion too! And that is when market timing leads to negative alpha.

2007 Stock Market Outlook, Part IV

2007-12-16T12:20:00.000+05:30

"Global Markets Will Weather Worries"

Download

Source: Fisher Investments

Short-term performance is a meaningless metric

2007-12-07T22:44:00.000+05:30

by Arne Alsin

The market is chock-full of short-term performance chasers. These are investors who steer their capital toward investment managers who have generated recent hot performance. By the way, I consider anything less than five years to be short-term.

Short-term performance chasers tend to be emotional and impulsive. When an investment strategy is not working investors get frustrated. Switching to a different strategy (or manager) is seen as a fix. The problem is that short-term performance-chasing leads to underperformance, not outperformance.

For example, at the peak in the Nasdaq in March 2000, investors piled into growth and technology funds because those funds had terrific one-, three-, and five-year track records. Of the 50 most popular mutual funds – measured by the amount of investor inflows for the 12 months ending in March 2000 – 48 underperformed the average fund over the next five years.

How did the most unpopular funds perform? The 50 funds with the largest outflows in the preceding 12 months gained an average of 21 per cent over the next five years against a 1 per cent gain for the average fund.

There are several reasons why this performance-chasing fails to boost returns.

Great performance is not coincident with great management

Performance is a lagging indicator of investment decision-making. More often than not when a money manager makes an exceptionally smart stock purchase, the wisdom of that move is not evident for several months or even a couple of years. Multi-bagger stocks often look quite average, even mediocre, during the first year or two of ownership.

Reversion to the mean

This dynamic – that performance eventually reverts to the average – is an overwhelming force in the market. While it should be a big issue for investors, it is largely ignored. On this I’ll be blunt: some money managers are incompetent. The problem for short-term performance chasers is that incompetent managers can have a run of luck. When the luck turns, investors who buy based on a couple of years of hot performance can get blindsided. Since most managers underperform the market over the long term, investors should view short-term outperformance with suspicion.

Misperception of risk

Short-term performance chasers act based on a flawed understanding of risk. Consider this example: fund manager A pays $60 each for several stocks that he accurately calculates to be worth $100 each. This is a good decision. Shortly thereafter, each stock rises to $100. His rate of return is terrific, at 67 per cent.

Investors react in predictable fashion. They pour money into the fund because fund manager A has produced such a high return. But if the portfolio stays the same, risk has escalated significantly because the assets are no longer held at a big discount to value.

Another manager, fund manager B, also pays $60 each for several stocks that he accurately calculates to be worth $100 each. As with fund manager A, this is a good decision. But, shortly thereafter each stock falls to $45. The fund is down by 25 per cent.

Investors react predictably to a 25 per cent decline and flee fund manager B in droves. The investors have made a mistake. If we assume, like the example above, that the portfolio stays the same, the assets are now very low risk. That is because value now exceeds price by a wider margin that when they were originally purchased. It also follows that investors are fleeing just when their expected return is exceptionally high; eventually the $45 quote for each stock will migrate to the asset value of $100.

Short-term performance has nothing to do with the decision-making skills of fund managers A and B. The managers made equally good decisions. One was lucky because quotes quickly jumped to fair value. The other was unlucky because cheap prices got even cheaper.

Investors see a “cause and effect” in short-term performance

Implicit in the flow of funds into fund manager A and away from fund manager B is that investors think short-term performance is an indicator of skill. In fact, short-term performance is generally a meaningless metric. Consider the Sequoia Fund, a fund that was led by a superb money manager, Bill Ruane, who passed away last year.

For the first four years of the Sequoia Fund (beginning in 1970), Ruane lagged behind the S&P 500 by a big margin – an average of about 8 per cent a year. Did that indicate that this disciple of value investor Ben Graham was lacking in skill? Not at all.

Arne Alsin is a fund manager for Alsin Capital and the Turnaround fund

arne@alsincapital.com

The rational investor looks beyond price

2007-11-25T19:22:00.000+05:30

by Arne Alsin - FT

How do you value a stock? This is the single most important question that an investor has to answer. If you cannot generate an informed estimate of value, you should not be making buy-and-sell decisions.

All rational buyers of assets go through the same exercise. They ask two simple questions: “What does it cost?” and “What is it worth?” If you can look up a stock quote, you can answer the first question. But the answer, by itself, is meaningless.

Let’s assume you like a certain coffee retailer, so you decide to buy the stock. You look up the stock quote and buy at $50 a share. Before you bought, you answered the first question, but the answer is useless in isolation. Is the stock worth $75 a share? Is it worth $25 a share?

To attribute meaning to the $50 quote, a frame of reference is required. This is provided by the answer to the second question: what is it worth? As all sophisticated investors recognise, answering the second question is the nexus around which proper decision-making revolves. If value exceeds price by a wide margin, consider buying. If price exceeds value, consider selling.

If you do not calculate value you are, in effect, a blind investor. These investors base decisions on something other than a comparison of price and value. Because they do not have a frame of reference, they make decisions based on criteria that are almost always irrational.

Many blind investors will buy a stock because it has been increasing in price. They expect that the upward move will continue. Or they sell because the price has been on a steady decline. They fear the slide will continue. In spite of the fact that price information is meaningless by itself, investors ascribe predictive power to price.

This sort of silliness does not occur with other asset classes. If your neighbour offers $15,000 for your car that you know is worth $20,000, you are not going to accept the offer. You certainly would not accept his offer of $12,000 the following week. If he followed up a week later with a $10,000 offer, you would see it as nonsense and summarily reject it.

In the stock market, investors are prone to accept a lower offer for their asset when they don’t understand value. This is particularly true when prices are volatile. When the market gets crazy, investors get crazy.

When the market is in freefall, emotions easily infect decision-making. There is an analytical void when there is no frame of reference and emotions fill that void. Investors think they can divine a pattern to the price action. The result is that, in tumultuous downward markets, they make decisions based on feelings, not facts.

It is not easy valuing stocks. Valuation calculations are difficult because businesses are moving targets. While other assets are relatively static, businesses are constantly changing, requiring frequent adjustment to valuation variables.

The valuation model used by many analysts is based on an estimation of a company’s future cash flows, discounted to present value. There are other methodologies, such as the so-called relative valuation models – that is, a company’s value is forecast on some multiple of (or relative to) book value, earnings or free cash flow.

All stocks are mispriced. There is no such thing as a perfectly priced stock. Some are mispriced by a little, others are mispriced by a lot, but all are mispriced.

No matter which valuation methodology is employed, the idée fixe for rational investors remains the same. It is to measure value and compare that to price.

The fact that price deviates from value, and sometimes by a wide margin, is welcomed by the rational investor. Other investors obsess and worry about price volatility but the rational investor understands that his potential profit rises in concert with volatility.

The difference between the annual high and low for the average stock on the New York Stock Exchange usually approximates 50 per cent. Businesses do not oscillate in value that much. The average publicly traded business increases in value by about 7-8 per cent a year, with the increase being largely linear. That means that price change greatly exceeds value change. For the rational investor, at least, that equals opportunity.

The writer is a portfolio manager for Alsin Capital and the Turnaround Fund. arne@alsincapital.com

'If China did not exist, Sensex wouldn't have traded at this level'

2007-11-17T21:31:00.000+05:30

Global investors are comfortable buying Indian equities at a high price because Chinese equities are priced even higher

by Nesil Staney - Mint

Christopher Wood, managing director and global equity strategist of investment research firm CLSA, expects the Indian economy to grow in the range of 8-10% at least for the next 10 years. Wood said that the Sensex, the benchmark index of the Bombay Stock Exchange (BSE), crossed 20,000 surprisingly fast. He added that the target of 40,000 that he had set for the index back in 2003 could be achieved quicker than what was initially expected.

However, according to Wood, the key to Indian equities is China. Global investors are comfortable buying Indian equities at a high price because Chinese equities are priced even higher. This benchmarking (against Chinese equity valuations) is driving up stock prices in India, Wood said in an interview with Mint. “The valuations in (the) Chinese equity market is forcing investors to re-rate other Asian markets, most importantly India. If China did not exist, the Sensex would not be trading as high as it is today.” Edited excerpts:

What is the short-term view on Indian markets? Will foreign investors continue to buy Indian equities at high prices?

The Sensex crossing 20,000 so early did surprise me. India is an expensive market at present. However, global investors are comfortable buying Indian equities at a high price because Chinese equities are priced much higher. The huge valuations in the Chinese market is forcing a re-rating of all other markets, most importantly India. The target of 40,000 can be achieved much faster. The question, (of) when, is heavily dependent on China. If China did not exist, the Sensex would not be trading at the current level; it could have grown slower. If China goes out of control, Indian market will also shoot up.

Is there a bubble forming in China similar to what happened in Japan in the late 80s?

The Chinese market is an excellent breeding ground for a monster asset bubble. Given the lack of alternative investment opportunities in the country, Chinese equities will continue to rise. If the Chinese authorities continue with incremental tightening, there could be a monster asset bubble in China in less than three years from now.

Do you expect India to tighten policies on capital inflows?

India’s central bank tightening capital inflows is the single largest risk on this market for a foreign investor. The rise in currency is posing a great challenge for the policy-makers. However, the rise in currency is one of the factors that attract foreign investors to India. I think there could be a 5% annualized return on Indian currency.

If the US Federal Reserve continues to cut interest rates, what would be the impact on Asian markets?

The US Fed will no doubt continue to cut interest rates, creating inflation in the country. There is no discipline in their policy. Asian currencies will continue to appreciate against the US dollar. Central banks across Asia will have to fight this. Also, what we are witnessing now is the last stage of the US paper dollar (Federal Reserve Note). It will soon be history. This is not just my opinion; it is the market reality.

What is the outlook on global commodities?

There could be a strong correction in all commodities as the US economy is on a recession. This correction could happen in a short-term. However, I am highly bullish on gold in the long term. In my estimate, gold prices could go up to $3,500 (Rs137,550) per ounce in the long term.

What do you find the most interesting sector in India?

The most attractive stocks are those related to infrastructure, simply because of macro-economic reasons. The huge expansion in India’s infrastructure space will benefit this sector, as seen in the case of other parts of the world. Also, the Indian central bank could cut interest rate sometime next year. A friendly tax cycle would push the fortunes of automobiles and other consumer products. On the other hand, sectors that have huge exposure to the US economy are best avoided.

Imitation is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway

2007-11-17T13:48:00.000+05:30

A new study by two university professors titled "Imitation is the Sincerest Form of Flattery" proves what a lot of savvy investors have known for years: buying the stocks Warren Buffett buys will make you a lot of money.

Abstract:

We analyze the performance of Berkshire Hathaway's equity portfolio and explore potential explanations for its superior performance. Contrary to popular belief we show Berkshire's investment style is best characterized as a large-cap growth. We examine whether Berkshire's investment performance is due to luck and find that beating the market in 28 out of 31 years places it in the 99.99 percentile; however, incorporating the magnitude by which Berkshire beats the market makes the “luck” explanation unlikely even after taking into account ex-post selection bias. After adjusting for risk we find that Berkshire's performance cannot be explained by assuming high risk. From 1976 to 2006 Berkshire's stock portfolio beats the S&P 500 Index by 14.65%, the value-weighted index of all stocks by 10.91%, and the Fama and French characteristic portfolio by 8.56% per year. The market also appears to under-react to the news of a Berkshire stock investment since a hypothetical portfolio that mimics Berkshire's investments created the month after they are publicly disclosed earns positive abnormal returns of 14.26% per year. Overall, the Berkshire Hathaway triumvirates of Warren Buffett, Charles Munger, and Lou Simpson posses' investment skill consistent with a number of recent papers that argue investment skill is more prevalent than earlier papers suggest..

Download the Research Paper

Punting on future gains

2007-11-14T20:31:00.000+05:30

INVESTOR ALERT!

Each bull market is based on its internal logic, one that seeks to explain the seemingly incomprehensible — a vertiginous rise of the markets. So the 1992 bull run had Harshad Mehta’s replacement cost theory. In 2000, Ketan Parekh spoke about the new economy and how it would cast aside the old order. This time, the bull phenomenon has a new logical framework, the esoteric-sounding ‘embedded value.’

This concept has been used to justify a rise in stock prices even as the fundamentals of the Indian corporate sector — operating margins, cash flow — are looking weaker than a year ago. So, is the market missing the woods of the fundamentals for the trees of “hazy” future gains?

Consider SBI, Reliance Industries and Larsen & Toubro. Over the past three months, these companies have seen their stock prices move up by around 50%. The reason for this sudden increase has been associated with the fact that these companies have wholly-owned subsidiaries that will contribute to the cash flows of the company in the near future and thus, need to be valued in the stock price.

A theory for the excesses?

Brokers have given a thumbs-up to the theory that they feel can explain current valuations of the Indian stock market. The theory has been gaining currency for the past two years, but it is only in the past six months that it has been quoted widely to explain the massive rise in certain stocks.

So much so that in August 2007, brokers and analysts believed the Sensex still had an upside of 20% on account of embedded value in certain stocks, which had not been reflected in the stock price. By the beginning of November, the market had moved up by 29% and had exhausted almost all of that value.

That, however, was not the end of the story. According to research reports, more than 20 stocks that are a part of the Sensex still have upsides that are not noticed by the market. Most reports are bullish on large cap stocks like ONGC, Tata Motors and SBI and believe there is still an upside for these stocks in a market that is hovering around 20,000.

Embedded or embattled?

Simply explained, embedded value is the market putting a valuation to earnings that are somewhat visible but may not be completely evaluated as they do not form the main aspect of the company’s business. Broking houses in India are seeing embedded value in many stocks.

Bharti Airtel for its towers, Bajaj Auto for insurance, ITC for hotels and paper — these are some of the companies that have assets or subsidiaries that are not valued in the mainline assets. The earnings are fairly visible to analysts or the markets and some amount of value can be attached to their businesses. The market, though, is now trying to attach embedded value to all companies — whether their earnings are visible or not.

Embedded value is calculated by doing a sum of the parts (SOTP) valuation — the stock price is divided into different businesses to arrive at valuations. While fund managers agree that the SOTP methodology itself is not a problem, the way it has been applied is. This happens when analysts try to value subsidiaries that will take a long time to show cash flows into present values of the stock price.

“The sum of the parts method should be used for understanding valuations as of today and not of the future. It has to do with today’s real numbers... If analysts are using embedded value to calculate values of businesses where earnings are not visible, then this becomes an exercise in fantasy. Embedded value is not about the future, but is about the present and those who are valuing the invisible future in stock prices have not understood this concept,” says Shankar Sharma of First Global.

The runaway value

Take, for example, Reliance. A research report based on August 1 prices stated that Reliance Industries had an upside of 25% when the stock price traded at 1,798. At that point in time, the valuation of the retail business worked out to Rs 80, which was constant for some time.

Much of the change in stock price was taking place due to the increasing value attached to the exploration and production side of the business. In the sum of the parts calculation of the Reliance stock price, the value of exploration and production had gone up by 135% in less than seven months and was at Rs 719 at the end of June 2007.

All broking firms that have brought out reports on embedded value use the SOTP method for companies whose subsidiaries will take a long time to show any business.

In October 2007, another broking house released a report on Reliance Industries where the E&P business was valued at Rs 745 and the retail business at Rs 182. Surprisingly, the retail business had a consensus value of Rs 80 in August 2007, which jumped to Rs 182 in a span of only three months, without any material change in business prospects.

According to the research report, the reason is associated with the fact that Reliance Industries has invested Rs 2,000 crore during the quarter into Reliance Retail and the “loyal customer base” has crossed the 1.5 million-mark. But the link between this and the cash-generation capabilities of the business is at the moment not very clear. After all, it’s cash the market values and not market share.

But Reliance Retail is not alone. State Bank of India is experiencing something similar. Analysts feel the AMC and insurance arm of SBI need to be reflected in the bank’s stock price. Insurance is a business where companies sell products for a long time before they actually start showing cash flows. But analysts feel the trick lies in grabbing the market share as this ensures future profits.

Based on this logic, both ICICI and SBI carry a part value of their insurance and AMC business in their stock price. The market feels the stock price should reflect the values of these businesses which are wholly owned subsidiaries. In August, the SOTP upside associated with SBI was around 44% when the price was at Rs 1,548. Today, the stock is up at Rs 2,237, capturing the SOTP valuations.

For most banks, their insurance subsidiaries are yet to have any impact in terms of profitability. Given the fact that some are gaining market share, it is important to see how relevant these market shares will be in terms of profitability. Tridib Pathak, CIO of Lotus Mutual fund considers embedded value only if the broader certainity of the business and cash flows are visible.

“People tend to go overboard. During the bull market phases, all aspects of the business get considered and during the bear market phase, even the main activity of the company is ignored by the market and stock prices lag behind. It is human behaviour,” he says.

A 'model' explanation

Optimistic research heads and analysts are running their spreadsheets again to rerate businesses. They believe many companies have changed strategies and there is an improvement in business — as a result, there should be a change in their embedded values as well. The trouble is, ‘embedded value’ is a broad concept. In many cases, even the simple revaluation of land gets carried forward in the stock price. Companies like Hindustan Unilever, which have undervalued real estates, are also getting rerated.

Shriram Iyer, head of research at Edelweiss Capital, which has worked on a report on embedded value, says as far as their report was concerned, the stocks achieved the target price mentioned therein. He feels that in a dynamic market, he will have to revisit the report to see if anything has changed for companies to revise their valuations in terms of their sum of total parts of businesses. But he agrees that barring a few exceptions, there may be no point in looking at embedded values or SOTP when the market is hovering at the 20,000-mark.

All this is reminiscent of the way markets had given internet companies large valuations in 2000. Back then, the revenues never materialised and stock prices collapsed. But then, these aren’t like internet companies. “The big problem today is that many companies who are ‘embedded value’ stars have real revenues in other businesses and hence, it is that much harder to disagree with valuation of loss-making subsidiaries,” says the India head of a multi-strategy fund.

Only visible earnings matter

Even if we agree that the business of wholly-owned subsidiaries should be valued into the stock price of the company, the fact remains that in many cases, the cash flows from these subsidiaries are not clear.

For the value of subsidiaries to be reflected in the stock price, the company should have made plans or announced the strategic sale of these assets; or there is an IPO or even demerger of these assets, and the subsidiary has a certainity of business and cash flows. When such things are not in the news, the value of these subsidiaries becomes at most speculative.

“Analyst reports clearly state that the main line businesses are expected to grow at 17-18% this financial year. That is fine. But the valuation of the subsidiaries into the stock prices and their growth rate is humongous.

Sometimes the growth rates for the subsidiaries are more than 150%. We understand the main businesses, and have no argument against the valuation of subsidiaries; thus, we accept whatever analysts tell us,” says a fund manager who does not agree with the sum of total part of stock prices or the embedded values in stock prices.

He believes these are concepts used in insurance, and there are people working overtime to apply the theory to stock prices. But Mr Iyer feels this approach to valuing companies is credible as significant value exists in balance sheets which is not near-term earnings accretive. “Some assets need to be valued separately to arrive at a fair price of the stock. It is a valuation tool and needs to be revisited all the time,” he says.

Source: ET

Be cautious at these levels: Rakesh Jhunjhunwala

2007-11-11T15:58:00.000+05:30

Trader and investor Rakesh Jhunjhunwala said the space and speed of the rally has surprised everyone. He is a bit circumspect at these levels because credit conditions in America are not very good and Asian markets are deteriorating at a fast speed.

Excerpts from CNBC-TV18's exclusive interview with Rakesh Jhunjhunwala:

Q: Last year, you were telling everybody that 15% is great and that we should not expect 50% every year. We have done that again. Are you a bit surprised?

A: I would say I am surprised to some extent by at least the gain of the last one-month. The space and speed has surprised all of us.

Q: Do you think we can do an on core, third time lucky with 50% again or is that being too optimistic?

A: It is time to reflect, we have had a rise from 3,000 to 19,000-20,000. I do not think economic conditions in America are very good. Asian markets there are deteriorating at a fast speed. It is an economy, which is drunk on credit. The credit markets are value effected, so I will not be circumspect at these levels.

We have had such a humongous gain from 3,000 to 19,000-20,000. I think markets are going to consolidate around these levels and would feel more comfortable as an investor.

Q: Would you be cautious here or do you see much higher levels even next year on this base?

A: What makes me uncomfortable is the divergence in valuations. You cannot have Infosys making a 52-week low as their earnings have not come down and they are still growing 15-20%. It is one of India’s best performing investments in time to come. You cannot sustain this kind of divergence in valuations, where you keep giving value to momentum, and you lose all value to value. That would be the first sign of an indication, may be it could happen in a week, ten days, or maybe we are in it. May be it could not happen in the next three months and we could go 20% higher, but I think this is the first indication and we have to be very cautious in this market.

Q: When you say you are cautious, are you cautious because of the excesses that have happened? Is it why you are calling for a correction or have you in the medium-term too become circumspect?

A: There are two-three things internationally especially in America where we are facing large uncertainty. We don’t know how this uncertainty will pan out, what value will the dollar lose, and what disorder it can cause to financial markets. I am extremely bearish on US financial markets and think the sub-prime problem is going to be far larger than what people are imagining. There is a paradigm shift in India. The bull market is very much alive. The factors driving this secular bull market are very much alive and kicking, I have no doubt about it. I am hopeful that five years later we are going to be far higher than where we are today. But the fact remains that we at 19,000 are at 19 times 2009 earnings. There is vast divergence in the valuations of the Sensex or Nifty, you have very narrow group of stocks gaining.

Q: Undeservedly are you saying?

A: I will reserve my opinion there. The fact remains that in a true bull market you cannot have quality stocks going to 52-week lows. You can have stocks with no operating income, whose valuations are 100-200 times earnings. The narrowness of the rise, the uncertainty that we are facing, and the speed of the rise, is why I feel the markets need to pause. They need to take a breath and that will give it strength for the long-term rise.

Q: When you speak about a correction, are you speaking about a major sell-off or just about a 10-15% correction? We have seen three of those this year and we are still up 50%.

A: There is a difference between opinion and the empirical evidence of what the screen is telling us. In the last 15-20 days, flows from abroad have considerably slowed down. World markets after the second Fed cut are showing some kind of resistance and weakness. The market is losing breadth and is facing resistance at higher levels. The market should pause and correct, it is more than opinion, as that is what the screen is telling us. We have not had any correction right from 3,000 to 20,000. We have had very severe corrections but they have been related to prices, there has not been any timewise correction. What will really test people’s belief in this market and country will be when the market corrects not so much valuewise but corrects valuewise and timewise. I can’t believe we are going to have a ride from 3,000-40,000-50,000 where investors’ conviction and patience are not going to be tested.

Q: You see this as a likely scenario. Is 16,000 not inconceivable or are you looking at that big a correction?

A: Our last rise was from 14,000 to 20,000, so surely we could carry a 50-60% rise. Things internationally are going to turn far ugly than what people have anticipated. I don’t know valuewise, but timewise we are going in for a good correction. The sheer momentum with which any stock that has some kind of story build around it goes up at unbelievable volumes. I feel the market is ignoring a lot of stocks, these are the first signs of danger. For the whole rise, the market is going to test us timewise and valuewise.

Q: Are you getting the first sense of euphoria creeping into the screen after those 20-25% blowouts that you have seen in the last few weeks?

A: Absolutely, blowing into all kind of stocks. There are some bull and cock story scrips that are seeing tremendous volumes, unbelievable price rises, and nobody wants to talk any sense there. Somebody guesses, spread some story, and advises a buy and investors just go and buy. These are signs, the markets always do that, there is noting surprising about it. But when markets do this, it is time to be alert in my opinion.

Q: Are you surprised that Infosys is hitting a 52-week low while the market hits new highs. Is it a sector write off for you or do you see value there?

A: A bull market does not mean that some stocks just go up and everything else goes down in value. We are in the initial stages of what is going to be a very big, long-term bull market. In the last two-three months, along with international uncertainty we are staring at local elections in the next 6-12 months, which the markets may not like. Don’t forget that the worst mistakes are made in the best of the times.

I don’t agree with this theory that interest rates in America will go down, all problems will be solved, and all assets in the world will inflate. Markets have had a too good and easy this Goldilocks situation. This is a dream run, in the world this has never happened that you reduced interest rates and all ills are over.

You have given USD 2.5 trillion in one-year to people who did not have money to repay. I don’t buy this theory that he will keep reducing interest rates and we will keep buying emerging markets. You can’t take valuations to any level and expect people to keep on buying. Why have flows slowed down in the last two-weeks? Why is China down 5% today? All of Asia and all emerging markets have been weak in the last 10-12 days.

Q: Let me come to another sector which have been one of the pillars of this bull market, telecom. The big pillars like Bharti and even Reliance Communications have started correcting. What do you see for the next one-year for this space, is the best behind them?

A: Some of the dreams of corporate India are now going beyond all reality. Look at the people applying for telecom license, I don’t know what kind of background and qualification they have to go into the telecom business. Someone is doing a broking business and he wants to get into real estate, someone is doing real estate and he wants to get into the telecom business. The way the markets are giving money to public issues, it seems that nobody is even looking at the prospectus or reading it. They are just finding what the prices are in Rajkot and how much is the issue going to be oversubscribed. If you give money Rs 50,000-1 lakh crore or even Rs 10 lakh crore it is not going to be enough because of the way dreams are expanding and the way in which people are getting money, these are all danger signs.

Q: What is your sense on this whole oil and gas space, especially exploration and refining, and the way the market is valuing some of these stocks?

A: I do not apply my mind at all there. There is surely value in oil refining companies. IOC has got a lot of non-refining and non-marketing income. The market doesn’t want the government to decide what income they will have and whether there is very good yield. Never forget in all this momentum that in 1992 the price of Hindustan Lever was Rs 18.20 whereas the index was 4,300, but in 2003 when the index was 2,900 then HLL was Rs 328. As an investor I found that it is not how high my scrip goes, it is at what level it settles after it goes high. If a stock moves from Rs 100 to Rs 1,000 and comes back to Rs 20, then nobody really gains. But if the stock grows from Rs 100 to Rs 1,000 and then does it stop at Rs 600 or Rs 500, I don’t know.

Q: You were speaking about excesses. Have you found some excesses in any of the stocks which we discussed over the last few weeks?

A: I don’t know what is RNRL business, I am confused and didn’t make any effort to find out also.

Q: But RPL tippled and that has a business?

A: It has a market cap of more than Infosys. I can’t say anything beyond that. I am told it has a market cap of more than the entire refining sector.

Q: Some other ideas?

A: In four years, a share of Great Eastern Shipping has appreciated about 25 times. It was Rs 25, when the management bought back six crore shares, they got all those shares in the range of Rs 5-7.

Q: Will you remain cautious for the next few months or a year?

A: We live in uncertain ages and times. Let us see how this will pan out. We will react to it but let us be prepared. We will react to it as it pans out. I don’t know whether the index will stop at 16,000 or if it may have a bottom there, there may be no correction at all. I have some feelings and am going to react to it as the circumstances arise.

As humans and investors we must have the maturity to realize that we can’t earn the wealth without time passing, without it being tested, and without our conviction being tested. Nobody has earned wealth easily and retained it.

I feel we have had it too good and easy to really last. We are going to be tested. In view of the narrowness, rise of uncertainty in the world financial markets, the fact is that we are going to face an election, and the speed at which we have gone up, the only thing I am saying is be alert and cautious and always be there in the market.

Rational Investing and Tricks the Mind Plays

2007-11-11T15:17:00.000+05:30

by Jane Bryant Quinn -Bloomberg

How good an investor are you? If you're like the average Joe or Jane, you think -- for sure -- you're better than most. You remember every one of your winners, in detail. You bury your losers. You never average the two together, which means you have no idea whether you're beating the market or not. If asked how you're doing, however, you'll probably say that you're ahead.

This confident approach to investing does wonders for your self-esteem. Where it leaves your portfolio is another story. We all know we're not supposed to trust our emotions when we buy a stock. What we didn't know is that our investing brain is a traitor, too.

We're hard-wired to kid ourselves. If you doubt it, take a look at ``Your Money and Your Brain,'' a new book by Money magazine writer Jason Zweig. He visited the scientists who study the neural circuits that switch on and off when we invest. It turns out that our brains amount to a hostile environment. To be better investors, we have to work against what our minds want most to do.

Take one of our sturdiest investment beliefs: that with study, we can get good at predicting whether a stock or the general market will rise or fall. To do this, we search for patterns that can tell us what the future holds.

The human brain loves patterns. We see them even where they don't exist. Give us random facts and we'll assemble them into a story. Give us random data -- like the millions of stock quotes flying around -- and we'll arrange them to ``make sense,'' whether they do or not.

Seeing Patterns

You can see this tendency at work in a series of studies done at Dartmouth College. Researchers flashed red or green lights on a screen. The participants had to predict which color would come next. Eighty percent of the flashes were green but the order was random. Over time, the participants learned that green was the most likely call.

Rats and pigeons, fed when they made the right guess, quickly learned to pick green almost all the time.

That's not what human subjects do. We -- the brainiest mammal -- start trying to guess when the next red flash will come. We look for patterns, even when told that the flashes are random. The longer we play the game, the worse we do. Rats outscore us every time. Various iterations of this study have been done since the late 1960s, always with the same results.

Then there's dopamine, the brain chemical that spurs us to act when we sense the possibility of a reward. An unexpected gain -- say, a chat-board tech stock doubling in three months -- sprays dopamine over every available surface. If it happens twice, we're sure the chat board is in the know.

Getting Hooked

Zweig calls this our ``prediction addiction.'' We're addicts for sure. The brain activity in a cocaine user expecting a hit looks almost the same as that of an investor expecting a big score.

The startling thing about pattern seeking is that your brain makes you do it. You can't say no. The response is subconscious and automatic. Because you're unaware of what's going on, the patterns you see seem objectively true rather than neurally driven. Your dopamine turns you into a dope.

We find patterns fast. Two accurate calls will make you expect -- and bet on -- a third. Three is a ``trend.'' Studies show that people seeking new money managers tend to hire a firm after a three-year hot streak and fire one after a three-year cold streak (even though both of these streaks are probably about to change).

Seersucker Investing

The seersucker theory of investing says that, for every seer, there's a sucker. David Leinweber, an expert in quantitative investment, satirized the ``science'' of prediction by sifting through numbers to see how he could have forecast the performance of the U.S. stock market from 1981 through 1993. He combined the total volume of butter produced each year in Bangladesh with the number of sheep in the U.S. and a few other variables, to produce a formula that forecast the past with 99 percent accuracy.

Wall Street is afloat in back-tested formulas meant to forecast prices. The next time you see one, think baaaaa.

You can't quit predicting, but you can quit following your mischievous brain. Handcuff yourself to some form of automatic ``program'' investing. Buy-and-hold. Dollar-cost averaging. Fixed asset allocations (say, 70 percent stocks, 30 percent bonds), rebalancing when your portfolio drifts away from those levels.

Quit checking your stocks all the time. Those random squiggles will start looking like patterns before you can tear yourself away.

Finally, make an effort to find out how well you actually perform. For example, keep track of your stocks on Bloomberg.com's Portfolio Tracker. Average the winners and losers together to see how you've done each year.

While you're at it, keep track of the stocks you sold (something investors rarely do). If the ones you sold do better than the ones you bought, maybe your dopamine is still in charge.

Games hedge funds play

2007-11-03T21:36:00.000+05:30

Source: HT Mint

India has a lot to learn from the double play that hedge funds used in 1998 to attack Hong Kong's economy

Have you heard of the infamous double play that hedge funds used to bring Hong Kong’s economy to its knees in 1998? India, as it tries to understand the games hedge funds play, could learn from that episode.

The Asian economic crisis started in July 1997. Hong Kong had initially done far better than Thailand, South Korea, Indonesia and Malaysia. Till it was attacked using what has come to be called the double play.

Here’s how it went. Hong Kong was committed to a fixed exchange rate against the US dollar through a currency board. By the end of 1997, a group of hedge funds thought that they could make a killing by forcing Hong Kong to devalue its currency. That’s what they had done successfully in many Asian countries in the preceding months.

What they did in Hong Kong was more complicated. In early 1998, the hedge funds built up their armoury by swapping US dollars for Hong Kong dollars. They then shorted the stock market in a sudden coordinated attack, both in the cash and futures segments. They followed it up by shorting the Hong Kong dollar as well.

The Hong Kong Monetary Authority (HKMA) was forced to increase interest rates all the way up to 280% to defend the fixed exchange rate. That brought down the stock market. The short sellers made a killing. Meanwhile, the Hong Kong dollars that the hedge funds had collected in the swap market started earning them usurious rates of interest.

The plunge in share prices led to a capital outflow and further pressure on HKMA to abandon the fixed exchange rate and sharply devalue the currency. That would have given the hedge funds that had shorted the Hong Kong currency another windfall. It was then that HKMA chose an unusual step. Rather than protecting the currency by selling dollars from its reserves, HKMA went in and supported the stock market. It bought $120 billion of shares in two weeks, because that was where the epicentre of the double play lay. (HKMA sold these shares at a huge profit five years later.)

So, why should India bother about an episode of a daring—and brilliant attack—on an Asian central bank 10 years ago?

I am not suggesting here that India will be in any similar danger any time soon. But there are two lessons worth remembering. One, hedge funds often take complicated positions that straddle the share, bond and currency markets. I am not sure that all the loose talk about hedge funds pouring money into India takes this simple fact into account—they may also be speculating in the offshore market for Indian derivatives and currency. The rupee and the stock indices may be part of coordinated trades that we know little about, or even care to know.

Two, the response in Hong Kong, too, was unconventional. HKMA is, like the other institutions in that great mercantile city, a committed bastion of free-market thought. Yet, it had no qualms about abandoning its standard practice and actually buying in the stock market to prop up its currency. The lesson: a central bank may need to use blunt instruments in special times.

In 1999, when the fires that raged across Asia had been doused, Barry Eichengreen and Donald Mathieson wrote a paper for the International Monetary Fund. It was called Hedge Funds: What Do We Really Know? (It is a question that still evades a clear answer.)

Eichengreen and Mathieson identified three main classes of hedge funds. First: the macro funds, which study a country’s economic fundamentals and take large, unhedged positions (going fully long or short) in that country’s markets. Two: the global funds, which pick stocks across the world based on the prospects of individual companies. Three: the relative value funds, which study correlations between the prices of various securities (emerging market bonds and US bonds, for example) and try to profit when prices deviate from their expected relative paths. Long Term Capital Management (LTCM), the hedge fund that was set up by some of the most highly regarded traders and financial economists in the world, was a relative value fund that tried to bet on prices that were off the path estimated by the fund’s statistical models. The story of how LTCM blew up in 1998 has been wonderfully retold in Roger Lowenstein’s book, When Genius Failed.

So, the point is a simple one. Hedge funds make complicated bets, often across countries and markets. They often do it with huge leverage. These funds are part and parcel of the modern financial landscape. They cannot be wished away.

India, too, is attracting billions of dollars of hedge fund money. That’s not a bad thing in itself. But there should be more clarity about what this money is all about. Given this fact, the central bank and the stock market regulator are justified in keeping a close eye on their activities.

Additional Reading:

Hedge Funds: What Do We Really Know? - Source: The International Monetary Fund Research Paper No. 99
This Economic Issue draws on material originally contained in IMF Occasional Paper 166, Hedge Funds and Financial Market Dynamics, by a Staff Team led by Barry Eichengreen and Donald Mathieson with Bankim Chadha, Anne Jansen, Laura Kodres, and Sunil Sharma, and "The Near Collapse and Rescue of Long-Term Capital Management" in Chapter 3 of World Economic Outlook and International Capital Markets: Interim Assessment, December 1998, by Garry Schinasi. Readers may purchase the Occasional Paper ($18; $15 academic rate) and the WEO/ICM Interim Assessment ($36; $25 academic rate; also available on the IMF website).

Bull Story

2007-10-29T17:22:00.000+05:30

Source: BS - by Mudar Patherya

It’s a bull market if you’ve woken up this morning with the feeling: “Thank god, it is Monday!”

It’s a bull market if the analyst takes a deep breath, runs his mind quickly across 1985, 1992, 2000 and says, “But it is different this time.”
It’s a bull market if the MD is talking to you but looking at the CNBC ticker.
It’s a bull market if your son asks you for the meaning of ‘support’ and you confuse him with trend lines and candlesticks.
It’s a bull market if your sense of time evolves from ‘I knew her from the time she was this small’ to ‘It was in those days when Webel-SL was only Rs 5…’
It’s a bull market when your broker says, “Lai liyo baapa, share jowa nahin maley!”
It’s a bull market if you discover a sudden respect for the middle-level accountant of a publicly listed company and suffix his name with a ‘ji’.
It’s a bull market if every analyst advises caution but adds, “However, in the long term we are bullish.”
It’s a bull market if you’re suddenly discovered on the social circuit because you happen to be the husband of the wife who is a niece of the person who was a friend of Rakesh Jhunjhunwala’s father 30 years ago.
It’s a bull market if people call you up to discuss the weather, the pollution, the nation, the Marxists and inevitably end up with, “Kuch khareedne laayak?”
It’s a bull market if everyone is convinced that the country has a great future but will still call you as soon as the market melts three per cent and ask, “Badhoo baraabar, ney?”
It’s a bull market if a Rs 10 crore profit becomes a Rs 15 crore profit quarter-on-quarter and you sneer dismissively, “Kuch ho nahin raha hai!”
It’s a bull market if you disinvest big time but prefer to leave the surplus with the broker saying, “Aaakhir aapko hi toh mujhe dena hai.”
It’s a bull market if you apply the ROI (return on investment) concept to everything your wife says you need at home and grumble: “Yaad hai, if we had not bought the microwave oven but bought Saboo Sodium stock, today you would have been a queen riding an Alto…”
It’s a bull market if you see 25-year-olds trade derivatives arrogantly and come away feeling that you need to read Victor Frankl’s Man’s Search for Meaning all over again.
It’s a bull market if you encounter a new species of professional who only works five days a week from 9.55 to 3.30 and responds to everything with ‘Jalsaa chhey!’
It’s a bull market when housewives discover an undiscovered part of their personalities in the 90 minutes between putting the tadka on the daalm and picking pappu up from school by calling the broker and asking “Tewariji, aaj kya naya hai?”
It’s a bull market when the Opinion Democratisation Index peaks, usually manifested in 23-year-olds dismissing companies with a 10 per cent increase in earnings as ‘dumbs’.
It’s a bull market when you ask why Prism Cement will go to Rs 81 and the answer is ‘Kyonki website pey likha hain’.
It’s a bull market if Enam puts out a research report indicating that the stock could double in a year and you say ‘Bus?’
It’s a bull market when the management is explaining its restructuring, business model and sustainability agenda and the analyst simply wants to know ‘Lekin EPS kya aayega?’
It’s a bull market if the wife starts getting suspicious about an sms every two minutes on your cell phone, sneaks a look when you go to the loo, only to find ‘Buy Nifty futures’.
It’s a bull market when you get a call from someone who you thought was a proud father of an MBA graduate but insists, “Aap mere bete ko aap ke under mein le leejiye, aadmi ban jaayega!”
It’s a bull market when people don’t have more than Rs 223 in their pocket but discuss stake sales and numbers ending six zeroes.
It’s a bull market when you find it difficult to go on a vacation because somewhere deep inside you nurse the feeling that an unattended market might do something stupid behind your back.
It’s a bull market when Nandigram seems a ‘jhanjhat’ and Myanmar monks irrelevant.
It’s a bull market when a company with a turnover of Rs 1300 crore announces an expansion of Rs 16,000 crore, issues a statement, cuts ribbons and is photographed alongside the CM and all the hard work being put in by some outstanding business leaders suddenly looks like poultry raw material.
It’s a bull market when you read the front page of the pink papers and realise how small you are.
It’s a bull market if your daughter mentions ‘Let us take a break’ and your first recall is interrupted hours of trading due to the sun outage.
It’s a bull market when you get irritable on Saturday and Sunday.
It’s a bull market when you read a column like this and say, “What? No tip?” and hiss that your time was bloody wasted.

Chinese Companies are Bigger Than...

2007-10-26T22:22:00.000+05:30

Click on the picture to enlarge

Unpublished Letters by Warren Buffett to Shareholders of Berkshire Hathaway

2007-10-26T20:49:00.000+05:30

I have got hold of two Unpublished Letters by Warren Buffett to Shareholders of Berkshire Hathaway.

Letters are for the Years 1973 & 1976

Click here to download the letters.

Courtesy: Ashish Pandey - Thanks for letting me post the letters!

Please note that the letters are scanned & in pdf format.

Stock markets: A case of tail wagging the dog

2007-10-23T21:20:00.000+05:30

The market is trying to move the economy rather than vice-versa

There is euphoria and a sort of enthusiasm bordering on madness in the stock market. The traditional view is that the stock markets are the barometers of the economy. It is expected that the markets and its indicators in the form of indices are to reflect the future potential of the corporates listed on them and in the process about the future of the economy. If the economy is performing well and is expected to grow at a healthy rate, the markets are expected to reflect that.

Not any more. Globalisation has changed all that. The day trader in Guntur or Kamrup has to worry about subprime foreclosures and yen carry trades. He has to read the lips of the chief of European Central Bank and understand the nuances of the speech given by US treasury chairman. The world has become surreal.

Unfortunately, this globalisation seems to be a one-way street. We are integrated with the global market and influenced by the developments taking place in Alaska or Adelaide, but our markets do not have any influence on the global markets. We do not see news regarding Dow Jones affected by Mumbai meltdown or FTSE impacted by Delhi tantrums.

Hence, this mating dance between our markets and others is extremely dangerous, particularly for the financial illiterates who are large participants in day trading.

In our markets, even though the listed stocks are above 8,000, we find that only around 250 or so are actively traded. Of these, the top 10 securities constitute nearly one-third of the traded value, indicating the level of skewness. In many matured markets, normally no single security has more than one percent of the traded value.

This skewness makes the market illiquid since everybody wants these 10-or-so scrips and when people exit, they also exit from these ten. Our markets are very skewed and shallow and to that extent, the role of the foreign institutional investors becomes important. Though in aggregate terms they constitute a small portion of the market, they play an important role at the margin level.

Institutional investors, particularly FIIs, are in search of better returns on a 24*7*365 basis. The fund manager is paid based on upon his performance and his job is to move funds on a continuous basis. Global funds have to think of geographical allocation and then asset allocation between risky shares and riskless government securities and the portfolio allocation among different shares. The fund manager is accountable only through his profits and he is not emotional about a developing country or a developed country or between European and Asian markets. If parking funds in Antarctica can make gains, he will do so with as much vigour as he would in Wall Street or Dalal Street.

It is known that a substantial portion of our market participants are day traders who square off the transactions daily. They can also be called margin players. Individual investors only do this since institutions cannot square off within a day in our system and they should settle transactions on a gross basis in the t+2 format. Actually, we do not know about the aggregate margins provided by individuals to brokers and the financing of these transactions, since currently the relationship is between the exchanges and brokers and exchanges pull the plug -literally - if brokers have not paid the margins or crossed their limits. Substantial portion of these transactions, between the individuals and the brokers are financed by the non-bank financial sector including individual moneylenders.

The markets cannot be talked up or down, as it is popularly believed. If the government tries to artificially push the market by encouraging its financial institutions to buy in the market, then it will be a folly of the highest order since public institutions like banks and LIC will be saddled with papers not worth talking about. Neither the enthusiasm of “experts” regarding the “robustness of our economy reflected in the increasing index” nor the complaint that “the fall in index is manufactured” is justified.

Coupled with this is the enthusiasm of Indian corporates to global money. In the last two years, the appetite of large Indian corporates for external commercial borrowings has been very large. ECBs had shown an additional flow of more than $13 billion last year and interestingly, the top 10 companies, including Reliance Petroleum ($2 billion), Reliance Communications ($1 billion), Tata Steel ($0.8 billion), Reliance Industries ($0.8 billion) and Reliance Energy ($0.8 billion), constitute more than 30% of the ECB approvals/registrations in the later period. This shows that corporates are increasingly looking at external sources due to lower cost and to that extent, developments in the global markets affect their ratings. Also, the major global borrowers have substantial importance in our indices.

We have arrived at an interesting situation in the development of our capital markets, wherein they are significantly influenced by global developments because of the active participation of FIIs — at the same time, big Indian corporates are showing appetite for global borrowings and not for domestic debt due to interest rate arbitrage.

In such a situation, we will find that the stock markets in India are increasingly disconnected from our domestic economy, which is expected to grow at more than 9% in the years to come. Already, there exists a disconnect between the government and the society, and now, this new disconnect between the economy and stock markets. Domestic economy is not moving the market but the tail (markets) is attempting to wag the dog.

As far as the stock exchange index is concerned, it can also move up if the Swiss banker decides to adopt more rigorous procedure in continuing existing accounts under the new ‘know your customer’ rules, further proving the disconnect with domestic economic activities.

vaidya@iimb.ernet.in

Markets are deep-rooted: Rakesh Jhunjhunwala

2007-10-18T22:05:00.000+05:30

Source: Rediff

The bulls of the stock market, including Rakesh Jhunjhunwala, are putting on a brave face, despite a sharp plunge of over 1,000 points in the benchmark Sensex amid turbulent conditions over the past two days.

Commenting on the volatile market conditions and dramatic fall of the Sensex, Jhunjhunwala said: "Nothing has changed" as the Indian market was "deep-rooted."

The country is poised to soon achieve a double-digit economic growth along with an impressive corporate profit growth, which would further drive the bourses, the stock whizkid said.

"I don't have any rocket science but my bullishness stems from my feeling that India's economic growth will be in double digits," he remarked.

"Corporate profits are likely to be up by 18-20 per cent on an average while the present GDP growth of nearly nine per cent will increase to double digits," Jhunjhunwala said. Although the Indian market had a slow growth, it was deep-rooted, he said.

Some other market players said that the sharp plunge in afternoon trade today was mostly due to profit booking at higher levels and the 717-point plunge has now given new entry levels that would be tapped well by investors.

However, this bravado is not being shared by all, especially in the backdrop of the recent proposals to curb investment made through instruments like participatory notes by the hedge funds.

"The proposed measures can have a very significant negative impact near-term on foreign inflows into Indian equities," Citigroup Global Market analyst Ratnesh Kumar said in a new report.

The report by Citigroup's brokerage division said that foreign inflows into India would be negatively impacted in the next 3-6 months if Sebi's proposals on curbing Participatory Notes (PNs) are implemented in the current form.

"There has been a significant rise in the share of P notes in overall FII flows into Indian equities," Kumar said in the report.

P-Notes are mostly unsed by hedge funds, a fast-growing asset class globally in recent years and lack of any new issuance of Offshore Derivative Instruments (ODIs) with underlying derivatives would take away hedging options for exposures in the cash market. This could be a deterrent for new hedge fund inflows, Citigroup said.

Finance Minister P Chidambaram on Wednesday said that the proposals with or without some modifications would be made a regulation.

Local analysts also predicted that trading in the next few days was likely to see selling pressure and market oscillating violently both on speculation about the fate of PNs, an instrument through which hedge funds have significant presence in virtually all the blue-chip companies.

"Today's fall was due to heavy selling by foreign funds. The fall is mainly due to reshuffling, covering of liquid positions and investors taking a long-term call on the market, Premium Investments' S P Tulsian said.

50,000 Sensex in 6 to 7 years: Rakesh Jhunjhunwala

2007-10-18T11:56:00.000+05:30

Source: DNA Money

Rakesh Jhunjhunwala is one of the market’s Big Boys with a portfolio rumoured to be Rs5,000 crore.On the day the stock market crashed, he told DNA Money most Indians don’t recognise the India story, and tried to explain why he remains extremely bullish. On the participatory notes issue There was a day when we had to pledge our gold (to borrow foreign exchange, in 1990). Now we have to restrict foreign capital. Life has come a full circle. Where will Sensex go next? 50,000 in 6-7 years if the current profit growth is sustained.

And GDP growth? India will grow at 10% before 2010?

I have a dinner table bet with TN Ninan, the editor of Business Standard, on this.

What about corporate profitability? Stock valuations are slaves of earnings.

Economic history tells us that earnings grow at 1.25-1.75 times GDP growth. Hence, I see the growth in corporate profitability over the next few years at 17-20%.

Which sectors are hot?

India-centric sectors such as telecom, banking and infrastructure will continue to remain hot. Stay away from IT because the current 30% margins cannot be maintained. Only monopolies can do that.What about real estate? I don't invest in real estate. Real estate prices in fringes of cities will fall because the current prices are unsustainable.

What about household money?

In 1992, 17% of domestic savings went into the stock markets. In 2004, it fell to 1%. And I feel 15% of domestic savings will go into the stock market by 2011. So $45-50 billion of local money is what we are talking about.

Interview with Jason Zweig

2007-10-17T23:04:00.000+05:30

Source: DNA Money

Neuroeconomics is a new science that is taking the investing world by storm, though, until recently, it was confined to the academic circles. Now, through his book, ‘Your Money and Your Brain - How the New Science of Neuroeconomics’ Can Make you Rich, Jason Zweig has tried to take neuroeconomics to the layman. The subject, as Zweig defines it, is “a hybrid of neuroscience, economics and psychology,” which helps us understand “what drives investing behaviour not only on the theoretical or practical level, but as a basic biological function.”

Zweig is a senior writer for the Money magazine and has been a guest columnist for Time and cnn.com. He is also the editor of the revised edition of Benjamin Graham’s ‘The Intelligent Investor’. In an interview to Vivek Kaul, Zweig speaks on Neuroeconomics and his philosophy of investing.

You seem to suggest in your book that investors should not fall for the story behind the stock. What else does one look at, then?

The key is to understand a crucial distinction, first drawn by the great investor Benjamin Graham, who was Warren Buffett’s teacher. Stocks and businesses are not the same thing. Stocks flit around all the time; you can watch them moving up and down on your computer screen all day long. In New York, it’s not unusual for the price of a stock to change at least 10,000 times in a single day of dealing, and I imagine it’s not very different in Mumbai. Stock prices are in constant flux, but business values are not. The underlying value of an ongoing enterprise does not change every day. Something like 99% of all the trading activity in the typical stock is meaningless. The future value of a business has nothing to do with the current price of its stock. What you should do is learn to look past the noisy twitching of stock prices to the enduring value of businesses as living organisms.

Is the business run by honest people who treat outside investors fairly? Does it make products or provide services for which customers are willing to pay higher prices if necessary? Can you understand its financial statements?

These constitute the reality of the business and determine its future value. The “story” behind the stock is almost certainly nothing more than the stampede of thousands of speculators in and out of the shares. Train yourself to ignore them.

“The best financial decisions draw on the dual strengths of your investing brain: intuition and analysis, feeling and thinking,” you write. Isn’t there a dichotomy there?

Yes, there is. But let’s get our terminology straight, and again we can do so by going back to Benjamin Graham. Graham’s formal definition has never been improved upon: “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.” Notice carefully that this is neither an “or” nor an “and/ or” definition; all three components - analysis, safety, and an adequate result - must be present. If any of them is missing, you are not investing. You are speculating. In India, as in the United States, most people who call themselves “investors” are not investors at all. They are speculators. In the short run, particularly while the Indian capital markets are rapidly developing, speculators may be able to earn high returns by rapidly trading stocks without doing thorough analysis. But in the long run, you cannot earn sustainably high returns from mere “gut feelings.” I find it striking that in a society with cultural traditions of great patience and acute analytical ability, so many people trade as if their knickers were afire, scoffing at the long term and analysing nothing but the craziness of the crowd. There is no doubt in my mind that Indians have the potential to lead the world in investment skill. But, so far as I can tell from my faraway vantage point, what most Indians do is not investing. In my own portfolio, I do not invest with the next year in mind, nor even with the next decade in mind. I invest with the next century in mind; that is when my heirs will benefit from my decisions. I do not care what stock prices do this afternoon, or this week, or this month, or this year. I care whether business values are rising. That is what it means to be an investor. You have written about the link between dopamine and the way investors invest.

What’s the link?

Dopamine makes us pursue whatever we think will be rewarding. When we earn more than we expected, that generates a “positive prediction error” - a flood of dopamine that signals to our bodies that something good has happened. After only a few repetitions, the dopamine is released in our brains, not when we earn the actual gain, but when we believe we know that the gain is coming. It is not the reward but the prediction of it that generates pleasure in the brain. I call this the “prediction addiction.” You become addicted to your own belief that you are about to make money. Like any addict, when the reward does not come, you will go into a painful withdrawal.

Why do investors get greedy? Even Isaac Newton lost most of his money in the South Sea Bubble. What does Neuroeconomics have to say on that?

Greed is generated in the same regions of the brain that produce pleasure when we find food or shelter or love. These basic reward circuits are among the oldest systems in the human brain. Geniuses have them, too. Brilliant people are better at generating great ideas than the rest of us, but they are no better at controlling their own emotions than you or I. We get greedy because the anticipation of profits activates the dopamine system in the brain, flooding our neurons with a signal of excitement. Newton was not just one of the smartest men of all time, but was also very well-informed financially; he was the master of the Royal Mint. So he certainly knew better in the “thinking” part of his brain. But his “feeling” brain was swept away with greed. If you do not put policies and procedures in place, in advance, to control your emotions, you will never be able to resist the siren song of the markets when the markets go mad. Common sense and good judgment are vastly more valuable than intelligence.

What makes investors book profits fast, but hold on to their losses?

We do not merely buy stocks and sell them. What we really are buying is pride and prowess, and what we really are selling is pain and shame. Once a stock earns a large gain, you want to lock in the reason for your pride and the proof of your prowess; if you hang on too long, the profit may disappear. But, once a stock produces a big loss, you want to hide the source of your pain and shame. If you sell at the bottom, you will have to admit your error, and that admission will only compound your shame. Whenever humans are ashamed of anything, we cover it up. So we cover our financial losses by pretending they are not there.

So, what is the best way to invest?

My fondest wish for Indian investors is that index-tracking funds will become widely available at very low management fees and dealing costs. If I were an Indian financial entrepreneur, I would study US firms like Vanguard, Barclays Global Investors and Dimensional Fund Advisors to learn how they run their tracking funds so efficiently and fairly. And if I were a young Indian investor, I would embrace low-cost tracking funds and put most of my money there for the very long run. The combination of diversification, simplicity, convenience, and low cost provides an insuperable advantage to the tracking investor. The life of a rising professional is busy enough without having to spend precious time and emotion following every momentary rise and fall of every stock you own. If your money cannot buy you peace of mind, why invest at all?

Does luck have a role in investing?

Luck has a great deal to do with it. Whenever a stock trades, the buyer thinks the seller is making a mistake. The seller thinks the buyer is mistaken. Only one of them can be right. After they both pay their dealing costs and any taxes on the transaction, neither may show any net profit for his pains. In the short run, almost anyone can be right a few times in a row, by luck alone - just as anyone can flip a coin right-side up several times in a row without any coin-flipping skill, whatsoever. Even in the long run, luck can rule the day. It can take years, even decades, to determine whether an investor has genuine and repeatable skill or is just lucky. The danger comes when you believe you are skillful and, in fact, you turn out to be merely lucky. Then you do things out of a belief that every step you take is the right one, and you end up slipping on a banana peel and falling down the stairs.

You talk about the “illusion of control.” Investors tend to be over-optimistic when they are directly involved and have had no negative experience from the over-optimism. How does this affect investing decisions?

It is easy to believe “I did it” when a stock you buy goes up. However, your actions did not cause the price to rise. Ask yourself this: If I had not bought the stock at all, would it not have risen without me? The way to escape the illusion of control is to invest with the aid of a checklist, a series of rules you must always follow before buying or selling any investment. This way, the rules make the decisions for you, and you take your pride out of the picture, enabling you to be more objective. In my book, I outline some rules that may be useful for many people.

Can financial future be foretold?

Some things can be. I am very confident predicting that the Indian stock market will lose a third of its value over the course of a few months. However, I have no idea, whatsoever, when this will happen. I am equally confident predicting that the Indian stock market will rise ten-fold and more over the long term. And I am more confident still in predicting that the true investors who have the courage to buy when the market crashes will make much more money in the long run than the fools who buy only when stocks go up.

Why are investors so addicted to CNBC? Their broadcast gives a feeling the “stock markets are in a crisis all the time.” Does that have an impact on the way investors invest?

Years ago, you could only find out a stock price in tomorrow’s (or sometimes, the next week’s) newspaper. Now you can find out the latest price every few minutes on CNBC or every few seconds online. This is the tragedy of technology - that the tool that should make us wiser, instead makes us act more foolishly than ever before. The human brain is a pattern-recognition machine. The more frequently you look at a series of data, the more often you will see “trends” and patterns that are not really there; they are nothing more than chaos clothed in a costume of regularity, illusions of order in streams of data that are utterly random. After two consecutive stimuli in the same direction, the human brain automatically, involuntarily, and uncontrollably expects a third. We extrapolate repetition out of what actually is randomness. CNBC is addictive because it continuously presents you with the opportunity to perceive what is not actually there: order, predictability, reliable patterns. It grips us the way all great fiction is gripping, with the added irony that very few of us realise that what we are watching is actually fiction.

Most of the investment experts do not really give any usable information. Is not listening to such experts better than taking them seriously?

I would listen very seriously to any financial expert who would provide a comprehensive record of every forecast he has ever made, both good and bad. Many forecasters will tell us about every single one of their successes. However, to the best of my knowledge, there is no financial forecaster alive who has ever provided a complete list of all his predictions, including the failures. There’s a reason for that: Anyone who really knew how to forecast the financial future would be most unlikely to let others in upon his secrets.

Pitfalls primer for irrational investors

2007-10-09T19:00:00.000+05:30

by Arne Alsin

Charlie Munger was asked a few years ago to explain how he achieved his amazing success in the stock market. He thought for a second, and then replied simply: “I’m rational.”

Implicit in Munger’s reply is that other investors are prone to bouts of irrationality. A rational investor, such as Munger, has an edge if other investors make decisions that are subjective, impulsive or emotion-based.

To understand better what it takes to be such an investor, here are three core concepts that every rational investor understands and embraces. If you invest your capital in contravention to any one of these concepts, you are not a rational investor.

The decision-making process focuses on a comparison of price and value

Before making an investment decision, the rational investor requires answers to two simple questions: “What’s it cost?” and “What’s it worth?”

The first question is easy to answer. The second question is difficult to answer, sometimes exceedingly difficult. Regardless, a rational investor will not allocate capital unless both questions can be answered with a reasonable level of confidence.

In other asset classes, the nexus for decision-making always revolves around a comparison of price and an appraisal of value. For example, a rational person is not going to sell a car valued at $20,000 for $10,000. This sort of irrationality does not happen with cars. But it happens every day in the stock market.

Many investors are, in effect, “blind investors” because they make buy and sell decisions without knowing value. You are a blind investor, for example, if you buy the stock of a company because you like its products, or because the company has impressive growth prospects.

These are reasons to become interested in a company. But they are not sufficient reasons to buy the stock. The stock might be overvalued by 50 per cent or more. Without an understanding of both price and value, an investor cannot make an informed, rational investment decision.

The purpose of the stock market is to facilitate liquidity

Many investors misunderstand the purpose of the stock market and this leads to irrational decision-making. Its purpose is to provide a venue for buyers to acquire ownership in publicly traded businesses and for owners (investors as well as companies trying to raise capital) to sell those interests.

The market is amazingly efficient in this regard. There is always a ready bid and there is always a ready offer. It just takes a second or two to acquire or sell a part-ownership interest in a publicly traded business.

But that is as far as it goes. The market tells you price. The market does not tell you value. To ask the market to facilitate the trading of business ownership and, in addition, to value those businesses accurately is asking too much.

When investors see one of their stocks drop by 20 per cent, they get upset because they think they have lost money. But all that has happened, in reality, is that the current offer for their asset has declined by 20 per cent. The value may have not declined at all. It is entirely possible that it has increased.

The owner of a private business does not get upset if he gets a lousy offer for his business. Even if the private business owner actively solicits offers, he does not expect to get a full value offer each and every day. The rational owner of a business, whether it is a private business or a publicly traded business, knows that full value offers occur infrequently.

Price and risk generally move in tandem

Most investors misunderstand risk as it applies to the stock market. Most do not understand that, generally, as price declines, risk declines. If the price quote for a stock worth $100 falls from $80 to $60, the risk of buying or owning that stock has declined in concert with the price.

When value exceeds price, risk declines when value subsequently increases and/or price decreases. And when value exceeds price, risk escalates when value subsequently decreases and/or price increases.

When irrational investors think about risk, they focus only on price. Price is everything to such investors. The fact that they are not carefully comparing price and value creates an analytical void. Emotions usually fill that void.

Higher prices create enthusiasm and an increased interest in buying. Falling prices cause worry, but there is a way for the irrational investor to alleviate the worry: sell everything!

Ironically, irrational investors tend to worry most when they should be worrying the least – when value exceeds price by a wide margin. And they tend to worry least when they should worry the most: when value exceeds price by a narrow margin, or, worse, when prices exceed value.

The writer is a portfolio manager for Alsin Capital and the Turnaround Fund. arne@alsincapital.com

Dip in IT cos' margins inevitable: Rakesh Jhunjhunwala

2007-10-06T17:41:00.000+05:30

Rakesh Jhunjhunwala, Investor and Trader feels that the US subprime crisis has been creating a pressure on IT companies' margins, adding that dip in margins for the IT industry is inevitable.

Rajeev Malik of JP Morgan Chase Bank feels that the overall economy slowdown is going to be less pronounced than what it is for the IT sector.

Both were speaking at a conclave on the 'Subprime Crisis in the US' and its impact on India organised by the CII, Bangalore.

Excerpts from questions asked by Rakesh Jhunjhunwala to Rajeev Malik at the CII Conclave:

Rakesh Jhunjhunwala: There is pressure on margins. If IBM today, in the service industry, is getting 10-11% margins, how long will the Indian Industry do business at 30%? So according to me, the dip in margins is inevitable.

Rajeev Malik: That’s true; but to what extent? You would also integrate that to how long can IT continue purely on employment dimension locally, as opposed to start looking at cheaper alternatives. Philippines is a place that’s increasingly coming into the press, purely in terms of diversification. Now one can say that’s a natural process, but you can’t disagree that it does have an employment impact locally.

Rakesh Jhunjhunwala: My concern is, as an investor, I may now invest in IT stocks but if there is a slowdown in America, what happens to the other sectors of the economy? CII has made a very good report of how vital this software industry is to the Indian economy.

Rajeev Malik: Precisely, which comes back to the point I was making, that there is a cyclical component to your argument. Overall economy slowdown is going to be less pronounced than what it is for the IT sector. This is simply because India is not that opened and IT sector’s exposure to the US is much greater than the exposure of the overall economy. Short answer to all of this is, yes, it is a negative sign.

Rakesh Jhunjhunwala: It would affect the economy?

Rajeev Malik: It would, most certainly. I think the best indication of that would be that in New York, a few days ago, Mr. Chidambaram actually talked about a downside risk on growth; but he was talking more from the rupee appreciation dynamics side. But again, it is coming back to the same issue.

Rakesh Jhunjhunwala: Why are you concerned? The Yen went down from 400 to 120 to the dollar, but they are still exporting…

Rajeev Malik: Yes, they are. But perhaps you are forgetting what that did to Japan!

Rakesh Jhunjhunwala: But that is a boom burst, we don’t have that kind of a boom here…

Rajeev Malik: We have a boom; it may not be that kind!

US economy & housing crisis to worsen: Rakesh Jhunjhunwala

2007-10-05T18:10:00.000+05:30

Rakesh Jhunjhunwala, Investor and Trader, feels that the impact of the subprime crisis will be far worse than expected.

He has said that the Fed rate cut is unlikely to solve the subprime crisis. He feels that the US economy will slowdown and the housing crisis will worsen.

He said that markets may see short-term reactions, but they will decouple from the US. He added that India's long-term bull market remains intact.

He cautioned that the US slowdown will adversely impact the Indian IT sector.

Excerpts from CNBC-TV18’s exclusive interview with Rakesh Jhunjhunwala:

Q: From morning we have heard a variety of views on subprime and what impact it could have on India and emerging markets. What’s your take on it?

A: I think the impact of the subprime crisis is going to be far worse than markets are expecting today. I do not think Fed rate cut can solve the subprime crisis; I do not think that the US housing market is going to bottom for the next 24-30 months. I think the US economy will further slow; anyway at the moment the markets are quite elated with the Fed rate cut. Let’s see what happens.

Q: You been bearish on US saying that the bull-run over there has ended. We saw how this bubble has burst, the whole housing market is gone into a slump, and US stocks are down. What is your take on it?

A: The US market has not slumped; the Dow is nearly at a new high. The markets are perceiving that this problem will be surmounted, just like all other problems.

Q: You expect more Fed cuts to keep fueling the markets going forward?

A: I do not know what kind of Fed cuts will happen, because inflation also has to be looked at. But I do not think the Fed rate cuts can solve this problem.

Q: Our Indian markets, or almost all emerging markets are clued on to what is happening over there (US). Because of that, we are seeing heavy volatility coming into the markets. If you take a look at the past three days also, there has been heavy volatility?

A: I would disagree. About two-two and half years ago, the Sensex first crossed the Dow and today the Sensex is at least 20% higher than the Dow, in numerical terms. So you may have day-to-day reactions, but over a period of time you will decouple.

Q: From a longish point of view, what is your take on the bull run in India?

A: I think the longer-term bull market in India is very much alive.

The factors driving the bull market are alive and kicking and will be present in India for a very long time to come. Having risen from 3,000 to 18,000, we can always be prepared for corrections or some fall. Markets may not even go up for maybe another year. But I do not think the bull market is dead. We had a rise from 3,000 to 18,000 and if we consolidate and do not go up for a year or two, I do not think it’s going to make any difference to the long-term bull market.

Q: Do you think we are going to consolidate from now on and then only progress further?

A: I do not know whether we will consolidate. But even if we were to consolidate and not go up much or go down a little, the longer-term bull market will still be alive.

Q: We heard Chris Wood say in the morning that the Sensex target, the long-term CLSA target, is 40,000. What is your take on that?

A: I can only have some idea of the directions; I have no targets.

Q: You been bearish on Indian IT for quite sometime now. What could happen to the US economy? When we talked to the tech companies, they say fundamentals have not changed, rupee is the only problem. What is your take on that?

A: Fundamentals today might not have changed. But if there is a big slowdown in the US economy, which I personally anticipate, then I think software will also come under pressure.

Earlier, we had all tailwinds for the software industry and in my opinion we have headwinds now. I do not say that software companies are going to go down. Although volume may or may not get affected, margins will be affected and therefore price earnings ratios can be affected.

Q: Midcaps have been very tepid over the past one-month. Is it just like in the middle of the storm? How do you see them bounce back?

A: I disagree. Midcaps are doing exceedingly well. I think 50% of all listed stocks have made new highs. So I do not agree that they have been tepid.

US bull market coming to an end: Rakesh Jhunjhunwala

2007-09-29T12:12:00.000+05:30

Source: Moneycontrol.com

Rakesh Jhunjhunwala, Investor and Trader said that the US housing market is unlikely to bottom in mid-term. He added that US economic growth was unsustainable.

According to Jhunjhunwala the bull market in the US had signs of excesses. He said that he believes that the US bull market is coming to an end. Jhunjhunwala forsees a big slowdown for techs if the US markets slow down.

He added that interest rates and commodity prices will also come down.

Excerpts from Rakesh Jhunjhunwala's speech at Capital Markets Seminar:

It is difficult to believe that the largest holder of the US treasury bonds is China. To me, I think it is geo-politically very sensitive issue and if I were to be the President of America I would redeem them the next day. They have forgotten where Hindi-Chini bhai-bhai led (Indians) to.

Having said that, the US economy was the engine of economic growth worldwide. It was an unsustainable methodology of growth, where you borrow, borrow,borrow and consume, consume, consume. Also we had a 25-year bull market in America and all bull markets, regardless of regulators, always produce excesses. Excesses are not products of loose regulations but more products of bull markets because then markets make people lose their sense and they become absolutely greedy.

I personally believe that the US housing market is not going to bottom in the next 36 months; because you built 21 million houses in 2 years as against 16 million every year. So you build one million extra and at least out of those 16 million normal ones, 40% of the houses in the last two years have been sold to subprime and allied alternatives.

In Miami, you have a building boom amongst the housing bust. So I think the world is underestimating the consequences of this subprime or the meltdown of the US housing. There was a vicious cycle in America where you gave money to people on credit to people who could not afford USD 50,000 - you gave them half million dollars; not based on their ability to pay, but on the value of their capital assets. They primarily drove the buying of houses in the last 24 months.

On interest rates:

It is not the question of interest rates. No one in his right sense now is going to give loans to sub-prime mortgages again. The resets are just starting.

So I foresee a few things.

One, the problem in the housing market problem is going to get worse because there will be a lot of foreclosures. Two, there is lot of housing under construction which cannot be stopped immediately. And third, people say there is full employment in America. But housing is 70% of America’s GDP and that itself would lead to a slowdown in America.

This slowdown in the housing industry is going to lead to a slowdown in the US economy. This again, would mean lower wages and lower employment, which could result in greater housing loan repayments defaults.

I read an economist saying that Europe has had faster increases in housing prices than America. There is a very large subprime market even in Britain. So I think this will continue to transfer itself even to Europe.

I believe there have been great excesses in the US bull market. That bull market, in my opinion, is coming to an end and the real excesses will be exposed only after the bull market is over.

Though at the moment we are all very happy and feeling that this is something like long-term capital management or the Russian debt crisis, where the Fed reduces interest rates and all problems go away. I do not believe that because credit is not only available on cost; it is also a question of risk appetite to borrow and risk appetite to lend.

So I think that credit is no longer going to be available in America or if it is, it is going to be available in a measured manner. There is going to be a slowdown in America.

There are various opinions that if US interest rates comes down money will flow into emerging markets. Let us put the impact in two parts – one, how they will affect economic activity and how they will affect asset prices.

On India:

As far as India is concerned, I personally foresee a big slowdown for the software industry. I do not think that if America slows down; more work will come to us. I think if America slows down, more work could come 36 months later. I think 25%-30% IT budgets are discretionary and there will be big cuts in IT budgets.

As far as other Indian exports are concerned, I do not think they are going to be affected very substantially. As far as commodity prices go, I think they will come down. Interest rates also will be down, which is good for India.

US is a very dynamic economy; it has great self-correcting measures. This recession in America depends on factors like whether it is going to be orderly, or create a lot of disequilibrium etc. If it is an orderly one, I think Indian markets will be not be affected to a very large extent. But if it is a huge disequilibrium, then things are going to be quite unpredictable.

Just don't ignore subprime

2007-09-27T12:42:00.000+05:30

by Parag Parikh, Narayan Ramachandran and Rakesh Jhunjhunwala

Source: ET

Even as fears of the US recession cast a cloud over Indian skies, stock markets across the world are waiting to see how adjustable rate mortgage (ARM) repricing would pan out in the US towards the end of this month. The key question in investors’ mind is whether a resetting of interest rates would trigger another bout of subprime contagion and volatility in world markets?

Though most experts in the Indian market believe all aspects pertaining to the US subprime credit defaults have been factored in, there is still some amount of apprehension in the market.

ARM is a borrowing facility with an interest rate that is linked to an economic index. The interest rate and the borrower’s payments are periodically adjusted to the changes in the index. There are pre-determined rate caps to limit the lender from overcharging the borrower.

According to experts, the biggest risk and opportunity happens to be the extent of slowdown in the US. If there is a severe slowdown in the US, then bets are off across all markets, including India. If there is a mild slowdown, where the slack is transferred from housing to capital spending, and to a lesser extent, net exports from the US, growth assets like India will do exceedingly well in the context of an US slowdown. If the US GDP growth slips from around 3.50% to 2.50%, emerging markets including India will do well.

"I think the real economy in the US is in serious trouble. The Fed’s decision to cut lending rates highlights that fact. So, the ARM reprising on September 30 could continue to brew constraints in the real economy. But a big equity market contagion due to subprime is pretty much discounted," said Narayan Ramachandran.

Though the Indian market is trying hard to distance itself from the US subprime market, there is a feeling that there is something worrisome that is lurking in the background.

"Though I am not an expert on this, subprime damage to the US economy is going to be far larger than what we are expecting. The US might go into much deeper recession," said Rakesh Jhunjhunwala.

Echoing Mr Jhunjhunwala’s concern, Nilesh Shah says, "The subprime is $1.2 trillion, and the size of the US is roughly $13 trillion. Subprime is more or less 10% of the total US housing market. Out of the US GDP, housing loan is $11 trillion or approximately 8% of the GDP."

Mr Shah adds, "I am not an expert on the US economy. But I know that today we have smoke in our house because there is fire in American homes. If they don’t put out their fire, we will have more fire. If there is furthermore fire, we will choke and probably become subconscious and their homes will be burnt down. The Fed has taken the first step to bring the extinguisher out. The general feeling is that they will be able to contain it."

Though, no one in the market is sure as to how India would be impacted, there is a feeling that subprime and the US recessionary fears would not muffle Indian market in the long term. Many feel that the long term impact of subprime would be beneficial for India, as people would realise that RBI has curtailed chances of subprime credit defaults in the country.

“I don’t think subprime is a huge problem. It is bound to impact Indian markets only in the short-term,” said Vallabh Bhanshali. Reiterating this, Mr Jhunjhunwala said: “India would only be impacted in the short term. I think, subprime scare will also lead to a fall in commodity prices and interest rates worldwide.”

Another thought process evolving in world markets is the substitution of key markets with the dramatically changing commodities market. Over the past few years, commodities have been changing the world dramatically. Wealth is there with people having ‘commodity tradables’ like oil. Growth is seen everywhere in the commodity spectrum and the cycle has seen unprecedented growth, investment experts say.

ET - ROUNDTABLE

Will the next bubble be in emerging markets?

2007-09-22T13:03:00.000+05:30

There is a school of thought which says that the markets have been having one long serial bubble for decades

by Manas Chakravarty

Now that the great housing bubble in the US is bursting, attention has already shifted to where the next bubble will be. A large number of stock market strategists believe that it will be in emerging markets.

Why should we have another bubble? That’s an easy one—with the US Federal Reserve cutting rates by 50 basis points on Tuesday, Ben Bernanke has sent a powerful signal that he is willing to inject liquidity into the markets, brushing aside arguments that those who had lent imprudently should be left to stew in their own juice and that helping them out would create moral hazard, which would encourage further irresponsible risk-taking.

It’s a clear admission that the notion that markets have to go through periodic purges to get rid of their excesses is a non-starter in an age when financial markets are so large that they’re the tail that wags the economy dog.

There’s a school of thought which says that the markets have been having one long serial bubble for decades. It all started with the oil price rise of the 1970s, with the Gulf oil producers accumulating vast surpluses, most of which were funnelled to US banks. That led to a big rise in money supply in the US, setting the stage for a heady bout of lending by mortgage companies, which culminated in the Savings & Loan disaster of the 1980s.

Also at the same time, oil surpluses were lent by the banks to governments in Latin America. Later on in the 1980s, when interest rates rose and the dollar appreciated, these loans turned bad and led these countries into a debt trap.

The 1980s are often spoken of as a “lost decade” in terms of development for Latin America. In the US, the rise in interest rates led to the bust in the savings and loan associations and the biggest rescue operation by the US government in history. That was when, worried by the continuous rise in the value of the dollar and the loss of competitiveness to Japan, the US forced the Plaza Accord down Japan’s throat, forcing it to let the yen appreciate. That led to a fall in the value of the dollar, capital repatriation to Japan and a lowering of interest rates there to rock bottom to keep exports going. It created the mother of all bubbles in Japan, with the Nikkei going up to a stratospheric 39,000 and real estate values going through the roof.

But all bubbles have a nasty habit of popping, and when the Japanese bubble burst, it sent the country into a prolonged depression from which it is yet to recover.

After the bust in Japan, the Asian tigers became the next bubble, with capital flowing like water to these emerging markets. When that huge bubble burst during the Asian crisis, the money hotfooted back to the US, where the tech bubble was waiting to happen.

We all know how that ended and how Alan Greenspan’s rate cuts set the stage for the housing bubble in the US and, in keeping with the spirit of globalization, led to the first truly global bubble.

Coming back to the present, there are two arguments why emerging markets will be the next bubble. One of them, long supported by Michael Hartnett, global emerging markets equity strategist for Merrill Lynch, is that the rate cuts will lead to additional liquidity which will flow into emerging markets with their fast-growing economies.

Their argument is the familiar one of the current credit crisis being 1998 in reverse: while Fed easing in 1998, when there were massive credit problems in Asia, led to a flood of liquidity flowing into largely US tech stocks, this time the credit crunch is in the US and so the money will go to emerging markets.

The other, related view is the one advocated by research firm CLSA’s Russell Napier, who writes: “A new world order is emerging, where Asia and probably Europe lead global economic growth. The future increasingly looks like one where foreign private capital will seek non-US dollar exposure, forcing foreign central bankers to step up support for the US dollar and domestic liquidity creation. Such a seismic shift in global financial markets augurs the birth of a new world order.” In other words, the weak dollar will force central banks to intervene in the foreign exchange markets to mop up dollars and that will release a flood of liquidity into their markets, creating a bubble.

Where’s the catch?

The catch is that the US economy must avoid a recession. Says Hartnett: “Financial crises followed by recession have resulted in bear markets (e.g., US/S&L 1990, Japan/land bubble 1990, US/tech collapse 2000). In contrast, financial crises not followed by recession have resulted in great buying opportunities (e.g., 1987 crash, Mexico 1995, Russia/LTCM 1998). We believe the latter will prove the case this time around for emerging markets.”

But won’t the US slowdown affect other economies as well? It will, but it’s all a question of relative performance. And a country like India, not very dependent on export demand, should do well.

What about the fact that the price-earnings multiples of markets such as China and India are already very high? It’s in the nature of bubbles and manias to forget about valuations. Remember the valuations of tech stocks at the height of the so-called “New Economy” bubble? If Merrill Lynch and CLSA are right, the blowout phase of the bubble could be just beginning.

Additional Reading

Want to know what Rakesh Jhunjhunwala is buying next?

2007-09-17T12:33:00.000+05:30

Source: ET - 16th September, 2007

It is 12.30 pm at RaRe Enterprises, Nariman Bhavan. There are five monitors showing more red than blue. The market is facing a blood bath. The Sensex is falling. In the thick of the action, Rakesh Jhunjhunwala turns from these screens, he is unruffled.

There is a massacre happening as investors lose wealth but Mr Jhunjhunwala looks at you almost bored and says “lets not discuss the markets”. The biggest investor in India is chewing paan as he loses wealth on his screens. He lights a cigarette. He loosens his white shirt. He has not worn a tie for the last five years.

“I know I am losing wealth but should I let this bother me? I don’t think so. I would be crazy to look at my wealth like this. I believe that India stands on strong fundamental grounds and over a period things are only positive. But please do not interpret this as Rakesh Jhunjunwalla is saying that the Sensex is going to touch 40000. Some day it may touch. But who knows when?”

For a man who purchased Tata Tea for Rs 5000 when he was only fifteen years old, Rakesh Jhunjhunwala has a total networth of ap-proximately Rs 6000 crore along with his wife Rekha Jhunjhunwala. The exact value of the portfolio is something he doesn’t like to talk about.

He doesn’t have any rules for his science of investing. But his ap-proach is fundamental and takes a long-term view thus he is also re-ferred as the Warren Buffet of India. Jhunjhunwala has never met Warren Buffet but admires and even follows his style of investment.

“Don’t insult the great man by comparing me to him. I am young and I’m constantly learning. There is so much to learn from others.” He pauses and refuses a phone call from a big corporate house in India. “But at the end of the day I want to be only Rakesh Jhunjhunwala and nobody else”, he says.

Retail investors, analysts and fund managers always want to know what he is buying. Everybody wants to be a part of Rakesh’s stocks. He knows that. He leans back and looks at you and tells you that he is not an advisor or a fund manager.

He and his wife came into the limelight with Crisil Limited. At the end of April 2005 he was holding 14.26% of the company, accounting for Rs 70 crore. In the same year the couple made Rs 27 crore after they sold out to the S&P open offer at Rs 775 per share. Today his in-vestment in Crisil is worth more than 200 crore and the holding accounts for 7.63% of the entire company. In all the companies that he has invested, it is this investment that has given him his famed mo-ments.

In India, bull runs have been associated with certain individuals. In the nineties it was Harshad Mehta and in early 2000 it was Ketan Parekh. But Jhunjhunwala does not like to be associated with any booms. He believes that the market is above individuals. Individuals can be associated to excesses in the markets, but not to the phase of the markets itself, he believes. It is like if the market is at a P/E multiple of 20, an individual might just make investors believe that the P/E should be 22. He thinks that individuals who believe that they are bigger than the markets do not last for a long time.

“The market is rational. An individual can never be smarter than the market”, he says and his phone rings. Someone wants to sell him a credit card or personal loans. He politely refuses and drags on his cigarette.

“The market is about greed and fear. Sometimes there is too much greed and sometimes there is too much fear. It has a lot to do with the psychology of the market. You have to sometimes read the market like you read an individual”, he adds.

But Mr Jhunjhunwala has not taken any courses in psychology or behaviorial finance to understand the psychology of the market. He has always believed that psychology cannot be learnt in classrooms. He has learnt his lessons in finance by practicing them and never believed in borrowed wisdom. He has liked his experience first hand. “I have experienced the markets from its core. You know I was there during the day of the bomb blasts when it happened. I have seen ups and downs so my understanding of the market is from being in there”.

That is probably why international fund managers like to spend time with him to understand the Indian equity market. He meets at-least two international fund managers a week. Probably that is where he markets or tries to sell the India story to the global equity fund managers. He doesn’t like it when he is referred in this context.

“How can you sell the Indian equity to the global fund manager? Is it an FMCG product like toothpaste or a shampoo? These fund managers are here because they believe in the fundamentals of the country. Not because a Rakesh Jhunjhunwala wants them to buy Indian equity”. He gets slightly excited.

Incidentally, foreign investors are selling Indian equity as global markets are facing a liquidity crisis. Those who have purchased the India story are jittery. Highly leveraged funds that invest into global markets based on borrowed money are facing the heat. They have purchased assets that they are not able to value. They don’t even un-derstand the nature of these assets.

As the ground beneath their feet starts to shake, Rakesh Jhunjhunwala sits firm. He was in Lonavala watching movies when the crisis was very severe. He is patient and knows that this shall also pass. The red on the screen will turn to blue. The market will once again be the winner. Mr Jhunjhunwala will remember this. His greatest fear - he might fall prey to his own philosophy. The market will remain above all individuals.

At a time when the market is going through volatility and an uncertain phase, Jhunjhunwala has no advice for the investors. “I don’t advice anybody. I don’t manage anybody’s money. I manage my wife’s money because I don’t have a choice.” He smiles and stubs his cigarette

Has de-coupling happened?

2007-09-11T11:08:00.000+05:30

Source: Business Standard

Stock prices come tumbling down in the US, Europe and Asia, but Indian stock prices continue to climb, and the key indices are not far from their all-time highs. The financial and economic news gets from bad to worse in the United States, and the dreaded ‘R’ word (for recession) has begun to get used as the housing market tanks and employment numbers fall for the first time in four years. But Indian markets continue to bounce along, recovering by some 10 per cent from the trough it hit last month. Is it possible that the de-coupling thesis — which says that the Indian market will strike out on a different course from those in the west — is turning out to be true? If so, it would be a striking development, for until now the accepted wisdom was that the foreign institutional investors (FIIs) dictated, through their conduct, the direction of Indian stock prices. If they were investing, Indian prices went up; if they were selling, the prices fell. That no longer seems to be the case; or more correctly, the same institutional investors who are selling in other markets may be buying here. If true, that would mean, among other things, that as part of the “flight to safety”, global investors with a long-term outlook are looking for safe harbour in Indian bourses.

If these optimistic hypotheses are what explain current stock price trends in India, the underlying explanation can only be that the markets are responding to the strengths of the Indian economy. For one thing, the currency risk that is a standard element in emerging market assessments, is not the same any more as the rupee notches up gains against the dollar. But the more important reason is that the Indian growth story has so far been unaffected by the turmoil in global markets and its fall-out. The first-quarter GDP growth numbers have been flattering, industrial growth has maintained its tempo, and companies continue to do well. Exports have decelerated, but agricultural growth will be helped by the good monsoon. Such slowdown as has occurred so far has been on account of domestic factors, mainly the Reserve Bank’s response to the signs of overheating early in the year. Indeed, the onset of the sub-prime crisis in the US has helped India get rid of its problem of plenty, namely a flood of dollars that was adding to domestic money supply and making monetary policy difficult. Indeed, if the Federal Reserve in the US were to cut interest rates next week, as is widely expected, the RBI could do the same here — something that would have been unthinkable three months ago.

Of course, the current economic tempo cannot continue indefinitely; the July industrial production numbers are due this week and will give some pointers, as will the second-quarter corporate sales and profit numbers that will come early next month. But most analysts assume that even if there were to be a slowing of the current tempo, GDP growth in the year as a whole is unlikely to drop below 8.5 per cent — which would be very good going in a rocky global environment. What investors may not have fully recognised, though, is the full impact on corporate bottom line. For the moment, what seems to be true is that the hedge funds that have faced liquidity pressures overseas have been selling their Indian holdings, while long-term players among the FIIs have been busy picking up stocks. If this trend continues, the FII presence in the Indian market will have acquired a healthier hue as the role of the hedge funds gets diluted.

Radhakrishnan Damani: The Return of Mr White & White

2007-09-09T12:08:00.000+05:30

Source: ET

March 2007: Investors were jettisoning Tata Steel shares on worries the company may end up with too much debt to finance its acquisition of Corus Steel. The stock was down nearly 20% from its high of Rs 519 touched on January 29, two days before Tata Steel won a long bidding war for Corus.

Intently studying the stock from his trading screen, on the 9th floor of Dalamal House in Nariman Point, was 54-year old ‘White & White’ (one of the many names this legendary investor is known by on Dalal Street). He sensed too much pessimism.

He had been steadily gathering shares of the steel behemoth in small lots over the past month. He was convinced it was time to take the plunge. Mr White & White ordered his dealers to double up their purchases. His voice was calm as ever, though this was his first big bet since his return to the stock market in early 2007 after a six-year hiatus.

Soon, data showed Tata Steel’s cost of debt for the Corus acquisition would be lower than market fears. The fortunes turned and the stock touched a new high of Rs 622. Radha Kishan ‘RK’ Damani, stock market icon, had hit it off again, like an old hunter returned to the jungle. The reclusive investor, always dressed in white and white (hence the nickname), had seen an opportunity in the chaos and make a killing.

Successful speculation is just one facet of Mr Damani, who shuns publicity despite his formidable reputation. He had actually earned his name as one of India’s finest value investors and built his fortune by identifying winners among multinational company stocks during the late 80s and early 90s.

His modest appearance can be deceptive. Mr Damani’s net worth is an elusive figure, but some market players put the number at Rs 5,000 crore. His holdings are spread across a range of companies from 3M India to Samtel India, and he typically holds less than 1% stake.

Old-timers still remember his big-bang victories on the bourses, but Mr Damani quit the markets suddenly in 2001 to dabble in India’s nascent organised retail industry. Over the next five years, he built the D’Mart chain and gained respect as an entrepreneur.

But one day in February this year, just when folks had begun to forget his influence over the stock markets, Mr Damani resurfaced. The question now in everybody’s mind is whether he will regain his old touch. To answer that question, one must probe the man and his investing style.

The man with the Midas touch

Mr Damani started his career as a trader in ball bearings, far from the battlefield of bulls and bears. Following his father’s death, he shut shop and joined his brother’s stock broking business, inherited from their father. Just 32 and lacking knowledge of market dynamics, Mr Damani’s only asset was his keenness to learn.

“He was not a value investor to begin with; he began his career in the stock market as a speculator,” says a Damani watcher. Mr Damani was quick to realise speculation was the not the best way to grow capital. Inspired by the legendary value investor Chandrakant Sampat, he started playing for the long term.

Often, his strategy was simple. When he bet on Indian Shaving Products (now Gillette), his reasoning was, “People will shave no matter what.” It took Mr Damani some time to gain a foothold, and several of his initial bets flopped. But he steadfastly refused to follow the herd, and concentrated on evolving trading strategies of his own.

Gradually, he began getting his calls right, and within the next couple of years he had joined the ranks of the big boys on Dalal Street. “Few players possess the kind of patience he does. But when he is convinced about any stock, he would buy his desired quantity in one sweep. And if he felt that a stock had run its course, he would dump his holdings at one go,” says an associate.

Also noted was his promptness in cutting losses. “Unlike many other players, ego would never get in the way of his booking losses,” says the associate. Mr Damani himself once said, “Cutting your losses is like performing a surgery on one arm with the other; painful, but it has to be done, otherwise the arm may have to be amputated.”

Mr Damani likes to keep a low profile. “He is not very articulate and does not communicate much, but he is a great listener. He patiently hears out everybody and never scoffs at any idea. It is a different matter that at the end of it all, he would back his judgement and instinct,” says the associate.

All along, Mr Damani made some great calls both on the long and short sides of the market. Yet, many players viewed him as a bear rather than a bull. “In India, anybody who is skilled at short selling is frowned upon, the general perception being that short sellers destroy value,” says a close friend of Mr Damani.

His limited circle of friends is said to include Dalal Street’s latest cult figure Rakesh Jhunjhunwala. Often, the market believed they hunted as a pair. Even if one of them was active at a counter, broking circles would say the duo was in it.

A string of successes notwithstanding, it was the epic battle of 1992, in which he emerged victorious, that would mark Mr Damani as a stock market legend. It was the battle with the Big Bull, Harshad Mehta.

Reining in the Big Bull

The flashy Harshad Mehta shot into prominence thanks to a daring rally that lasted the better part of 1991, only to eventually fizzle out in April 1992. Mr Damani, on his part, was bullish on the market only till February 1992. Even as the Big Bull was pumping up the shares, Mr Damani began to go short.

He reasoned blue chips had already run up a lot and fundamentals no longer justified the rally. What Mr Damani had not bargained for was the seemingly limitless supply of funds to Harshad Mehta. The market kept rising, but rather than cutting his losses, Mr Damani rode on his conviction and doubled up his short positions. “The market took off vertically between February to April, and RK was trapped badly,” recalls a veteran broker. “His losses were huge, and if the rally continued for a few more weeks, he may even have had to shut shop.”

But then, it emerged that Harshad had been siphoning off funds from the banking system and using them to buy stocks. When the scam got exposed, the market went into a tailspin. Mr Damani not only regained the lost ground, but walked away with a tidy profit.

Harshad Mehta was to lock horns with Mr Damani once more in 1998, but this time with fatal consequences for the Big Bull. Harshad now focused on three stocks, BPL, Videocon Industries and Sterlite. The prices of these shares touched dizzy levels even as the broader market fell. It was as though Harshad’s picks were defying gravity.

All the time, Mr Damani was biding his time on the sidelines. A disciple of the old school of investing, his assessment was that the stock price had run far beyond fundamentals. At the time he thought was right, he started building short positions.

Prices continued to climb and he had to square off some initial positions at a loss. But soon, signals came that the Big Bull was having trouble financing his positions. And Mr Damani moved in for the kill. He simply doubled his short positions, under the weight of which, the market caved in.

Panic set in. The prices of the three chosen stocks plunged 60%. Some brokers say exchange authorities even tried to bring together Mr Damani and Harshad for a compromise but the talks failed. “It would be wrong to say that RK’s call was motivated by a desire for revenge,” says a market watcher who once worked with Mr Damani.

“It was all about the price... He would have short sold those stocks irrespective of whoever had a bullish view on them,” he says.

When Mr Damani came to know that some small shareholders were left with positions they could not exit, he covered up a part of short positions by buying shares from these investors at a negotiated price. This was not the first time he had done such a thing. In the early 90s, Mr Damani had accumulated a pile of ACC shares.

When a payment crisis loomed, Mr Damani responded to a request from authorities and offloaded a part of his holding at a discount. He was among those probed by regulators for suspected price hammering, but was eventually given a clean chit.

Towards the fag end of 1998, the overall market sentiment began to improve. Before long, the market was in the grip of a bull run led by technology stocks, which would peak out in February 2000. RK continued to trade, but those close to him say he had already begun scaling down the number and size of his bets.

Was he preparing for a self-imposed exile from the market beginning somewhere in 2001 for the next few years? Friends say he was always passionate about retailing, but were there other factors also that influenced Mr Damani to retreat from Dalal Street?

After the stock market crash of 2001, bear operators were once again under the regulatory scanner, the allegation being that they had colluded to hammer stock prices. Needless to say, Mr Damani also figured on the list of suspects. “Like any other operator, RK made most of his money being on the long side of the market,” says a broker who knows Mr Damani for long.

“He had a finger on the pulse of the market and would not hesitate to sell short if the situation called for it. Unfortunately, his short (selling) calls attracted more attention than some of his long (buying) calls,” he says.

Some players say that Mr Damani found himself a bit out of depth during the technology boom of 1999-2000. He stuck to the classic rules of trading, short selling shares that he felt were over valued and going long on the under valued ones.

But stocks from the sectors that he had an sound understanding of, cement, automobile, steel, were out of favour. Technology was the buzzword at the bourse, and irrespective of whether those companies were making money or not, investors were falling over each other to buy into them.

And Ketan Parekh had now taken over the as the reigning Big Bull, and carved out a reputation for himself as a champion of new economy stocks. Mr Damani’s old school strategies did not work well for him in this period.

The comeback

If anyone had not noticed, Mr Damani’s right calls on Tata Steel and State bank of India made them aware of his return to the stock market this year. But this time, it has been a mixed bag of hits and misses, those close to him say. “Over the last one month, he has been as successful or unsuccessful as other players in his league,” says a Damani watcher.

It may be premature to judge the old fox when the markets have not shown a clear trend. India, like other equity markets around the world, has been volatile over the last month as a result of the crisis involving sub-prime loans in the US. It is anybody’s guess how things will go from here.

The market has also undergone a sea change during Mr Damani’s absence. The number of participants, stocks and liquidity have risen manifold. If there is greater transparency, there is also more volatility to contend with. Admirers or critics, everyone is impatient to know whether and how Mr Damani is going to pull it off this time.

BSE Sensex Fair Value Estimates

2007-09-05T17:22:00.000+05:30

Click on the image to enlarge

Why active investing doesn’t work

2007-09-03T19:30:00.000+05:30

Peter Bernstein writes,

“It is a paradox, but nevertheless true that stock prices are so hard to predict because stock prices are themselves predictions of the future.”

“But a respect for evidence compels me to incline towards the hypothesis that most portfolio decision makers should go out of business - take up plumbing, teach Greek, or help produce the annual GNP by services as corporate executives (sic). Even if this advice to drop dead is good advice, it obviously is not counsel that will be eagerly followed. Few people will commit suicide without a push.” —Paul Samuelson

Stay away from fund managers who believe in active investing, or so Samuelson, the first winner of the Nobel Prize in Economics, seems to be suggesting in that quote, perhaps favouring investment in index funds. And what makes him do that?

Peter L Bernstein may have an answer. “In 2004, Burton Malkiel of Princeton, and author of A Random Walk Down Wall Street, studied all mutual funds in existence since 1970 - a total of 139 funds surviving over more than thirty years. He found that seventy six of the funds underperformed the market by more than one percentage point a year; only four funds outperformed by more than two percentage points a year.

Malkiel reports that more than 80 percent of the actively managed large capitalisation funds covered in the Lipper Analytical Services failed to match the returns of S&P 500 over periods of longer than ten years ending in 2003. Malkiel also points out that “there’s almost no persistence in excess performance……In decade after decade, the top funds in one period are often the bottom funds in the next… There’s no way to tell in advance which funds will outperform,”” Bernstein writes in Capital Ideas Evolving.

To cut a long story short, there is very little evidence that active investing works. Even if a fund manager has delivered better returns than the market, over a period of time, how does an investor identify him in advance? “If identification of superior managers becomes a simple matter for investors in general, those mangers will be buried under an avalanche of new money to a point where they will no longer be able to pursue the investment strategies that delivered the superior performance. There is a tipping point somewhere for every manager, regardless of skill and style,” writes Bernstein.

“The long history of mutual funds shows that superior performance, even in the short run, tends to attract new assets that swell the size of the portfolio under management. As assets under management increase, the costs of trading tend to follow suit, and the edge of the active manager begins to diminish.”

The primary reason why fund managers find it difficult to beat the returns of the market is that stock prices are so tough to predict. The other reason that makes active management of money difficult, is volatility. “Volatility - a fancy word for what happens when we are taken by surprise - is a vivid indicator of how ignorant of the future we are and how emotionally we respond when the future arrives and fails to conform to our expectations,” writes Bernstein.

Bernstein takes the help of Robert Shiller to take the point forward. “As Shiller interprets it, volatility means people are changing their minds about the future almost from moment to moment. And why? New information arrives that is different from what they had been expecting.

But, there is no need to believe that the new information is necessarily correct information or readily understandable information, or even the kind of information people should be heeding. In Shiller’s opinion, the so-called information on which investors base their decisions is a jumble of many factors that go beyond the cold facts of the economic fundamentals or the latest corporate earnings reports.”

“To Shiller, excess volatility implies “that changes occur for no fundamental reason at all.” The swings in stock prices seem to reflect investors’ attention to many factors other than the present value of future stream of dividend payments: fads and fashions, fears and hopes, rumor and restlessness, recent stock price performance, or old saws about how in the long run everything comes out rosy in the stock market”, writes Bernstein.

And since the herd likes to think in a similar way the asset pricing decisions are almost always wrong.

As Bernstein writes

“ When many investors are using the same kind of rules of thumb and arrive at similar kinds of beliefs about the future, asset prices are almost always wrong in the sense that the return investors anticipate is chronically too high or too low relative to the risks involved.”

In the world of active investment, almost everyone is trying to throw darts in the dark. “When you know only a little, and you know you know only a little, it is tempting to believe others may know more, especially when markets are moving strongly in one direction or another”, writes Bernstein.

Given this, luck starts playing a very important part.

As Bernstein writes,

“As a matter of luck, any portfolio manager can end up beating the market in short periods of time. Luck puts other managers below the market for short periods of time.”

Hence, very few active managers like Warren Buffett, Bill Miller and Peter Lynch have been able to beat the markets, year-on-year, over a long period.

Random Musings

2007-09-03T18:03:00.000+05:30

Open season
Should investors press the sell button when open offers come at a premium to prevailing share prices? A ready reckoner
Investment should not dance to market tunes
When the bears dare to eat into the capital, hold on to your investments till the bulls return to recoup these capital losses.
The Indian investor gets savvier
Domestic investors are showing greater maturity in the face of global turmoil as they keep faith in the market. The confidence stems from the fact that India’s growth is shielded from global upheavals.
PE on prowl
The Board of Directors of Nagarjuna Construction Company has accorded its in-principle approval for issue of two crore shares and 91 lakh convertible warrants, aggregating to Rs 615 crore to the US-based private equity giant Blackstone
When stocks get ‘re-’ or ‘de-rated’
Just as a re-rating can inflate returns from stocks of high-growth companies, a de-rating coupled with slowing earnings growth can be a double whammy for investors.

Weekend Reading

2007-08-31T19:31:00.000+05:30

Value Investors Only Care About Bear Markets
A value-oriented investment approach in the style of Graham and Buffett does not focus on bull market performance. In fact, by definition, true value investing always focuses on weathering the bear market storms and coming out relatively unscathed.
Most overpriced real estate markets

They're culture-rich and scenically stunning. But invest in a home in any of these 10 cities and your balance sheet might take a beating.
Stocks of brokerages catch investors’ fancy
Betting on new product offerings, spread of online broking
Worst seems to be over, for the time being: Raamdeo Agarwal
Raamdeo Agarwal of Motilal Oswal feels that we have seen the worst of the correction and the worst seems to be over, at least for the time being. He adds that there has been an improvement in both the factors that led to the markets' dismal performance.
Stockmarkets: Beauty Or The Beast
Debates surrounding which stockmarket index is better do not include a discussion about their quality
Prepare for an awesome autumn
Those blinded by the summer correction into believing bad times and a bear market are ahead will miss this autumn's rally. Don't be among them. The correction could last a bit longer - and many do a W-like-bottom, bringing a whole additional roller-coaster ride before the rally. But there is a good up-move coming.

India growth story to continue, despite odds: Rakesh Jhunjhunwala

2007-08-30T17:42:00.000+05:30

Super broker Rakesh Jhunjhunwala sounded optimistic while talking about the Indian market weighed against its US counterpart at a recent meeting organised by Shailesh J Mehta School of Management, IIT, Bombay. While analysing the Indian market weighed against its US counterpart, Jhunjhunwala quoted the former US Federal Reserve Chairman Alan Greenspan: "History has not dealt kindly with the aftermath of protracted periods of low-risk premiums." The super broker feels the going will get tough for the Indian markets for the next few months. This is sad, he said as India has all the ingredients that markets value.

Click here for the full story.

Growth versus value stocks

2007-08-27T21:14:00.000+05:30

When the markets are making new highs every day, solid large-cap value stocks are nobody's favourite

Source: HT Mint

by Manas Chakravarty and Mobis Philipose

Periods of market turbulence lead to a flight to quality, or a flight to value.

When the markets are making new highs every day, solid large-cap value stocks are nobody’s favourite, as everybody is busy chasing growth stocks. It’s only when investors start having doubts about growth that attention shifts back to value investing.

Investors have for long been divided into two camps—those who believe in growth stocks, in the belief that their superior earnings growth justifies the price, and those who believe in hunting for under-priced stocks that offer value.

Growth investors believe in buying stocks with above-average earnings growth, no matter what the price. Value investors look exclusively for “bargains”, or stocks that are trading at a discount to their usual valuation.

Of course, the growth versus value debate is also a caricature—most investors opt for a mix of growth and value stocks. But many funds have sprung up to take advantage of the distinction between these two investing styles.

Which of them have done better during the recent sell-off?

MSCI Barra has a set of indices that distinguish between growth and value stocks and they show that while the world growth index has fallen 1.09% in August (till the 24th), the index of world value stocks is down 0.59%. That’s exactly as expected, since investors flock to value stocks during sell-offs. The MSCI US value index is up 2.33% this month, while the growth index is up 0.89%.

Emerging markets, however, are a sub-set of the growth stock universe, which is why both the emerging market growth stocks as well as the value stocks have been hammered. The EM growth stocks in the MSCI Barra universe are down 6.59% this month, while EM value stocks are down 6.53%. So the sell-off hasn’t spared EM value stocks. Year to date, emerging market value stocks are up 14.9%, compared with EM growth stocks being up 13%. The MSCI India value index is down 9.4% this month, while the India growth index is lower by 10.02%—only a marginal difference.

Proponents of value investing claim that value stocks do better over the longer term. That appears to be true for the US, where the MSCI Value index has given annualized returns of 4.82% over the last ten years, while the growth index has grown 4.10%.

But in India, value stocks have scored over growth stocks this year, over a one-year period, over the last two years and over the last five years. That’s surprising, because India is supposed to be a growth story. It’s only over a 10-year period that the MSCI India growth index has delivered higher annualized returns than the value index.

Random Readings

2007-08-27T17:50:00.000+05:30

The hitchhiker's guide to mega bucks
Egrets fly from one bank of a river to the other, in search of prey. But sometimes, even they opt for a free ride across the riverbed, sitting on the back of a submerged hippo. Wildlife enthusiasts may be familiar with this scene. However, the phenomenon of ‘riding on the hippo’s back’ need not be limited only to the nature’s galleria. After all, who doesn’t want to generate some gains from the hard work of others…?
The magic potion revealed
Banking, capital goods, media and fertiliser stocks will do well in future, while IT, auto and real estate sectors may see a slowdown.
Don't worry, look at the brighter side
As the dark clouds of the US sub-prime crisis and yen carry trade gather over the horizon, the silver lining will come from select emerging markets like India.
Home Safe Home
Stocks may plunge because of the crisis in global markets and political moves back home. But the India growth story is still tenable and promises gains for the patient investor.
Ignorance is not bliss
The discounted cash flow is not an effective valuation tool for commodity (capital-intensive) industries.
Indian markets have outperform EMs: HSBC
Read HSBC Global Research's report on how Indian markets have performed against other EM benchmarks in the current correction, in contrast to previous episodes.

Random Tidbits

2007-08-27T10:01:00.000+05:30

Huff, Puff The House Is Down
Subprime mortgages crash, then the global markets fall. There's a cautionary tale in it.
15000 Penny Punters
Small investors with wily strategies brave the vagaries of the stockmarket
Making sense of Sensex moves
Sensational headlines such as “Sensex in free fall”, “Bloodbath on D-Street” and “Market faces mayhem” would have surely stirred up a storm in your teacup as you read the morning newspaper in recent weeks
Taking stock after the correction
In the sweeping correction that has caused global stock markets to tumble like nine-pins, the BSE Sensex has shed 9-10 per cent off its peak value. Stocks in sectors such as telecom, steel and construction have plummeted 15-30 per cent the past
Time to get into secular high-growth stocks’
Set aside funds to buy telecom, engineering as these sectors have great potential and are not related to politics in the longer term.
‘16,000 looks difficult for Sensex this year’
With political troubles within the country and global uncertainties, investors are naturally reluctant to buy. But better value may emerge in the next couple of months.
Store of value
Markets seem to be on their way down. The analyst community is still guessing the next day’s index move. Gap down opening are leaving the traders clueless and volatility is the order of the day. Newspapers are agog with the description of the market plunge. However, there are stray incidences where the stocks have bucked the trend.
The IPO game
The Indian initial public offering (IPO) market is under the microscope again with the recent re-pricing of the South-based real estate major Puravankara Projects IPO. The initial price band of Rs 500-525 had to be scaled down to a much lesser range of Rs 400-450. The re-pricing has pointed towards three important facts.
Getting real with real estate
It is estimated that in the last 12 months, 23 real estate companies have raised a whopping $4.4 billion through IPOs, FPOs, GDRs and other avenues. And with reports that few more companies are going to hit the markets, the magnitude of real estate’s share in the already exceeding liquidity, is increasing exponentially. Also, it seems that investors’s exposure to real estate IPOs have been increasing like never before.
Who's the real villain? CDOs or sub-prime mart?
If I could be born again, and I had a head for big numbers, I'd like to be an investment banker in New York. Look at what I would do for a living. First, I would play in the collateralised debt obligation market. What this is, is not relevant, except to understand that CDOs are a more important cause of the financial crisis sweeping the western world than the infamous sub-prime mortgage market in the US.
Long & Short Term Capital Gains Issues
Calculating tax is a rather difficult exercise for individuals. More so, when it comes to mutual funds. This is because there are several calculations required for this purpose before arriving at the appropriate figure. Also, there is a need to do some segregation to remove any confusion. Here are some calculations where we use the basic tax rate on these investments excluding education cess for better understanding.

Investment Nuggets by Benjamin Graham

2007-08-26T21:45:00.002+05:30

Benjamin Graham, also known as the “Father of Value Investing” and the “Dean of Wall Street”, was a pioneer in driving home to investors the importance of crunching numbers. He popularised the examination of pri ce-to-earnings (P/E) ratios, debt-to-equity ratios, dividend records, net current assets, book values, and earnings growth. Conservative in his financial teachings, he introduced the concept of looking at share investment as buying a share in a business, rather than stand-alone investment. He also devised Mr Market, the concept of the stock market as a schizophrenic entity. His investment tenets have been both followed and modified, not only by Buffett, but other legendary and successful investors like Walter Schloss of WJS Partners, Tom Knapp and Ed Anderson of Tweedy Browne Partners and Bill Ruane’s Sequoia Fund.

“The individual investor should act consistently as an investor and not as a speculator. This means..... that he should be able to justify every purchase he makes and each price he pays by impersonal, objective reasoning that sati sfies him that he is getting more than his money’s worth for his purchase.”

“An investment operation is one which, upon thorough analysis promises safety of principal and adequate return. Operations not meeting these requirements are speculative.”“Most of the time common stocks are subject to irra tional and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble... to give way to hope, fear and greed.”

“You are neither right nor wrong because the crowd disagrees with you. You are right (or wrong) because your data and reasoning are right (or wrong).”

“The one principle that applies to nearly all these so-called ‘technical approaches’ is that one should buy because a stock or the market has gone up and one should sell because it has declined. This is the exact opposite of sound business sense everywhere else, and it is most unlikely that it can lead to lasting success in Wall Street. In our own stock market experience and observation, extending over 50 years, we have not known a single person who has consistently or lastingly made money by thus ‘following the market’. “We do not hesitate to declare that this approach is as fallacious as it is popular.”

“While enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster.”

“Stocks will fluctuate substantially in value. For a true investor, the only significant meaning of price fluctuations is that they offer ... an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.”

“To have a true investment, there must be a true margin of safety. And a true margin of safety is one that can be demonstrated by figures, by persuasive reasoning, and by reference to a body of actual experience.”

“Strangely enough we shall suggest as one of our chief requirements... that our readers limit themselves to issues selling not far above their tangible-asset value.”

A Growing Subprime Web

2007-08-26T14:31:00.000+05:30

Click on image to enlarge

Source: BusinessWeek

Random Gleanings

2007-08-25T14:43:00.000+05:30

The Subprime Lending Saga

2007-08-20T18:26:00.001+05:30

Selected writings from around the world.

How a Panicky Day Led the Fed to Act - WSJ
Freezing of Credit Drives Sudden Shift; Shoving to Make Trades
Lessons of Past May Offer Clues To Market's Fate - WSJ
In Asia, It's a World of Extremes - WSJ
China's Insular Markets Defy Slump in Shares; Other Trends Pose Worry
Asian Traders Brace For More Instability; Feng Shui Consultations - WSJ
Crises Counsel - Fortune

Will the subprime lending meltdown and credit crunch send us into a financial free fall? We asked the sharpest minds in business to share their reactions to the downturn, and their insights on the road ahead.

Leaders speak on market meltdown

2007-08-20T17:32:00.000+05:30

Crisis Counsel

Will the subprime lending meltdown and credit crunch send us into a financial free fall? We asked the sharpest minds in business to share their reactions to the downturn, and their insights on the road ahead.

The following is the selected writings of various investment leaders on current crisis covered by Fortune

An entire article is avaialble here.

Marking to myth by Warren Buffett

Chairman and CEO, Berkshire Hathaway

Many institutions that publicly report precise market values for their holdings or CDOs and CMOs are in truth reporting fiction. They are marking to model rather than marking to market. The recent meltdown in much of the debt market, moreover, has transformed this process into marking to myth.

Because many of these institutions are highly leveraged, the difference between "model" and "market" could deliver a huge whack to shareholders' equity. Indeed, for a few institutions, the difference in valuations is the difference between what purports to be robust health and insolvency. For these institutions, pinning down market values would not be difficult: They should simply sell 5% of all the large positions they hold. That kind of sale would establish a true value, though one still higher, no doubt, than would be realized for 100% of an oversized and illiquid holding.

In one way, I'm sympathetic to the institutional reluctance to face the music. I'd give a lot to mark my weight to "model" rather than to "market."

Watch for buying opportunities by Bill Miller

Chairman and chief investment officer, Legg MasonCapital Management

These sorts of things are what's known to the academics as "endogenous to the system"--that is to say, they're normal. They happen usually every three to five years. So we had a freezing up of the market for corporate credit in the summer of '02. We had an equity bubble just before that. In '98 we had Long-Term Capital. In '94 we had a mortgage collapse like we're having right now. In 1990 we had an S&L collapse. In '87 we had a stock market collapse. These things flow through the system, and they're part of the system. I saw one quant quoted over the weekend saying, "Stuff that's not supposed to happen once in 10,000 years happened three days in a row in August." Well, I would think that you would learn in Quant 101 that the market is not what's known as normally distributed. I'm not sure where he was when all these things happened every three or five years. I think these quant models are structurally flawed and tend to exacerbate this stuff.

But these events represent opportunities. When markets get locked up like this, it's virtually always the case that you'll have opportunities if you have liquidity. Instead of worrying how bad it's going to get, I think people should be thinking about where the opportunities might be.

The NYSE financial index is probably the best barometer of what's to come. The financials tend to be a very good indicator of where the market's going. They tend to lead the market because they're the lubrication for the economy. So I think the financial index will tell you if this thing is over, and so far it's telling you it's not over. It's still falling. But just as financials lead on the downside, they will lead on the upside

The most dangerous words on Wall Street by Wilbur Ross

Chairman and CEO, WL Ross & Co

I recently overheard two men arguing about who was better off. One boasted about his new car, the other about a plasma TV and so on, until one proclaimed, "I am better off because I owe more than you are worth." The second man conceded defeat. This anecdote summarizes the mortgage bubble. Americans spent more than they earned in 2005 and 2006 and borrowed the difference. The federal government did the same. Everyone secretly feared this was unsound but wanted immediate gratification, so there was applause for talking heads who said global liquidity would make these borrowings safe. Alan Greenspan went so far as to suggest that people take out adjustable-rate mortgages.

Liquidity, however, is not about physical cash; it is mainly a psychological state. Subprime problems have consumed only trivial amounts of global cash but already have burst bubbles by shocking lenders. Clever financial engineering effectively had convinced lenders to ignore risk, and not just in subprime. A major hedge fund participated in a loan to one of our companies, but sent no one to a due diligence meeting. So I called the senior partner to thank him and tell him about the non- attendance. He responded, "I know. For a $10 million commitment, it wasn't worth going to a meeting."

When subprime issues first surfaced this spring, many major institutions said they had none, but recent quarterly write-offs show they did. They weren't lying; they just didn't know what they had. Their embarrassment has brought risk control back into vogue. It was always silly to lend to weak credits at discounted interest rates, and without documenting income and balance sheets and without appraisals. No amount of model building should have enabled Wall Street to take $100 of such paper and alchemize it into securities sold for $103. Models inherently assume a future similar to the past and therefore they fail when multiple standard deviations occur. Subprime models also did not capture ever more lax credit standards nor that real estate might suffer severe and protracted price declines, again proving that the two most dangerous words in Wall Street vocabulary are "financial engineering."

Now that we have identified the cause of the disease, how severe and how contagious is it? The present $200 billion of delinquencies will grow to $400 billion or $500 billion next year because $570 billion more low, teaser-rate mortgages will reset to market and consume more than 50% of the borrowers' income. Therefore most of the loans will be foreclosed or restructured. Probably 1.5 million to two million families will lose their homes. Meanwhile, few lenders will put mortgages on the foreclosed houses, so the prices will plummet. Despite these tragedies, total losses will probably be less than 1% of household wealth and only 2% to 3% of one year's GDP, so this is not Armageddon. However, even prime jumbo mortgages will be more expensive and more difficult to obtain.

Similar excesses occurred in corporate debt markets. Leveraged buyouts were financed with few or no restrictive covenants and with some borrowers able to "toggle," or issue more bonds to pay interest in lieu of cash. The debt-to-cash-flow ratio hit record highs, and more than 60% of junk bonds issued are rated B or lower. Only 13% of high-yield issuance proceeds was for capital expenditures for expansion--87% went for sponsor dividends, stock buybacks, LBOs, or refinancings, none of which inherently advance credit worthiness. And this exotic lending paid only 2.5% to 3.0% more interest than Treasury bonds' 5.5%. Therefore investors received only 8% or 8.5% interest on bonds that had a 25% probability of defaulting, the same ignoring of risk as in subprime.

The cause was also the same. Wall Street made $100 of these credits into tranches of securities that sold for $102 or more. Again we had securitization pseudo-alchemy creating fool's gold. The weakest 5% or so of a $2 trillion universe of leveraged loans and high-yield bonds will crater. This is only 1% of GDP, but lending standards will tighten for a while, just as they did after the telecom bubble burst. Because of this outlook, WL Ross portfolio companies raised $2 billion this year to eliminate outside financing needs. More recently, we provided a modest $50 million debtor-in-possession financing to American Home Mortgage, the tenth-largest subprime lender, as it entered bankruptcy. Ultimately, we will make a major move into mortgages, because lending to weak borrowers makes sense at premium rates with proper due diligence and appraisals. After Japan's real estate bubble burst, we used a similar strategy to rehabilitate Kansai Sawayake Bank. It was earning 17% a year on equity after one year, almost twice the return typical of a Japanese bank

Market corrections are coming by Jim Rogers

Founder of the Rogers Raw MaterialsIndex

We've had the worst bubble in credit we've ever had in American history. As the bubble got bigger and bigger, it spread to emerging markets and leveraged buyouts and all sorts of things. And it hasn't been cleaned out yet. I don't think you can have a bubble like this and clean it out in six months or even a year. It has always taken longer.

Look at homebuilders, for instance. Historically, when an industry goes through a retrenchment like this, you have two or three big companies going bankrupt and most of the companies in the industry losing money for a year or two or three. Well, we haven't gotten anywhere near that in the homebuilding business, so I think that bottom is a long way off. As far as the credit bubble, we have another several months, if not more, of mortgages that are going to reset and people who are going to find themselves with even higher monthly payments. There are many, many more losses to come, most of which we won't know about for weeks or months.

Normally you have markets go down 10% or so every couple of years. We haven't had a 10% correction in the stock market in nearly five years. I don't know if this is the beginning of it, but we've got a lot of corrections coming. It wouldn't surprise me to see a little bounce--say if a central bank cuts rates. But that will just lead to the markets falling further late this year or next year. It would be better for the market, it would be better for investors, and it would be better for the world if we went ahead and cleaned out the system. If they do cut rates in the U.S., it would be pure madness. Because the market's down 7% or 8% from an all-time high? My gosh, what's that going to say about the dollar? What's that going to say to foreign creditors? What's that going to say about inflation? The Federal Reserve was not founded to bail out Bear Stearns or a few hedge funds. It was founded to keep a stable currency and maintain its value. I have been and continue to be short the investment banks and the commercial banks. If they bounce up, I'll probably short more. I'm certainly not buying anything. The market's only down 8%. I don't consider that a buying opportunity. The things that I'm short, some people probably think are buying opportunities, but I don't. I've been short the banks for close to a year, and for a while it was not fun. But I added to my positions, and now it's a lot of fun.

Subprime lending: Much ado about nothing?

2007-08-18T12:04:00.000+05:30

Click on image for clearer view.

TMF 1, 2 & 3

Remembering a Classic Investing Theory

2007-08-16T19:23:00.000+05:30

by David Leonhardt

More than 70 years ago, two Columbia professors named Benjamin Graham and David L. Dodd came up with a simple investing idea that remains more influential than perhaps any other. In the wake of the stock market crash in 1929, they urged investors to focus on hard facts — like a company’s past earnings and the value of its assets — rather than trying to guess what the future would bring. A company with strong profits and a relatively low stock price was probably undervalued, they said.

Their classic 1934 textbook, “Security Analysis,” became the bible for what is now known as value investing. Warren E. Buffett took Mr. Graham’s course at Columbia Business School in the 1950s and, after working briefly for Mr. Graham’s investment firm, set out on his own to put the theories into practice. Mr. Buffett’s billions are just one part of the professors’ giant legacy.

Yet somehow, one of their big ideas about how to analyze stock prices has been almost entirely forgotten. The idea essentially reminds investors to focus on long-term trends and not to get caught up in the moment. Unfortunately, when you apply it to today’s stock market, you get even more nervous about what’s going on.

Most Wall Street analysts, of course, say there is nothing to be worried about, at least not beyond the mortgage market. In an effort to calm investors after the recent volatility, analysts have been arguing that stocks are not very expensive right now. The basis for this argument is the standard measure of the market: the price-to-earnings ratio.

It sounds like just the sort of thing the professors would have loved. In its most common form, the ratio is equal to a company’s stock price divided by its earnings per share over the last 12 months. You can skip the math, though, and simply remember that a P/E ratio tells you how much a stock costs relative to a company’s performance. The higher the ratio, the more expensive the stock is — and the stronger the argument that it won’t do very well going forward.

Right now, the stocks in the Standard & Poor’s 500-stock index have an average P/E ratio of about 16.5, which by historical standards is quite normal. Since World War II, the average P/E ratio has been 16.1. During the bubbles of the 1920s and the 1990s, on the other hand, the ratio shot above 40. The core of Wall Street’s reassuring message, then, is that even if the mortgage mess leads to a full-blown credit squeeze, the damage will not last long because stocks don’t have far to fall.

To Mr. Graham and Mr. Dodd, the P/E ratio was indeed a crucial measure, but they would have had a problem with the way that the number is calculated today. Besides advising investors to focus on the past, the two men also cautioned against putting too much emphasis on the recent past. They realized that a few months, or even a year, of financial information could be deeply misleading. It could say more about what the economy happened to be doing at any one moment than about a company’s long-term prospects.

So they argued that P/E ratios should not be based on only one year’s worth of earnings. It is much better, they wrote in “Security Analysis,” to look at profits for “not less than five years, preferably seven or ten years.”

This advice has been largely lost to history. For one thing, collecting a decade’s worth of earnings data can be time consuming. It also seems a little strange to look so far into the past when your goal is to predict future returns.

But at least two economists have remembered the advice. For years, John Y. Campbell and Robert J. Shiller have been calculating long-term P/E ratios. When they were invited to a make a presentation to Alan Greenspan in 1996, they used the statistic to argue that stocks were badly overvalued. A few days later, Mr. Greenspan touched off a brief worldwide sell-off by wondering aloud whether “irrational exuberance” was infecting the markets. In 2000, not long before the market began its real swoon, Mr. Shiller published a book that used Mr. Greenspan’s phrase as its title.

Today, the Graham-Dodd approach produces a very different picture from the one that Wall Street has been offering. Based on average profits over the last 10 years, the P/E ratio has been hovering around 27 recently. That’s higher than it has been at any other point over the last 130 years, save the great bubbles of the 1920s and the 1990s. The stock run-up of the 1990s was so big, in other words, that the market may still not have fully worked it off.

Now, this one statistic does not mean that a bear market is inevitable. But it does offer a good framework for thinking about stocks.

Over the last few years, corporate profits have soared. Economies around the world have been growing, new technologies have made companies more efficient and for a variety of reasons — globalization and automation chief among them — workers have not been able to demand big pay increases. In just three years, from 2003 to 2006, inflation-adjusted corporate profits jumped more than 30 percent, according to the Commerce Department. This profit boom has allowed standard, one-year P/E ratios to remain fairly low.

Going forward, one possibility is that the boom will continue. In this case, the Graham-Dodd P/E ratio doesn’t really matter. It is capturing a reality that no longer exists, and stocks could do well over the next few years.

The other possibility is that the boom will prove fleeting. Perhaps the recent productivity gains will peter out (as some measures suggest is already happening). Or perhaps the world’s major economies will slump in the next few years. If something along these lines happens, stocks may suddenly start to look very expensive.

In the long term, the stock market will almost certainly continue to be a good investment. But the next few years do seem to depend on a more rickety foundation than Wall Street’s soothing words suggest. Many investors are banking on the idea that the economy has entered a new era of rapid profit growth, and investments that depend on the words “new era” don’t usually do so well.

That makes for one more risk in a market that is relearning the meaning of the word.

Rakesh Jhunjhunwala's meeting with students of IIT Mumbai

2007-08-13T18:59:00.000+05:30

The following is the presentation of Rakesh Jhunjhunwala's meeting with students of IIT Mumbai held on 11th August, 2007.

Click here for the presentation file
HT Mint newspaper has also given insights by Rakesh Jhunjhunwala here.

HIGHLIGHTS

"Markets are like women -- always commanding, mysterious, unpredictable and volatile," quipped 'Big Bull' Rakesh Jhunjhunwala while addressing a meet organised by Shailesh J Mehta School of Management, IIT, Bombay on August 10.

A champion broker, often termed as Warren Buffett of the Indian stock market, Jhunjhunwala had a full-to-the-brim auditorium spellbound as he traced how he made his fortune from a starting capital of Rs 5,000. His career path is stuff dreams are made of.

What earned him fame is his skill to pick under-valued stocks. Some of his renowned calls are Karur Vysya Bank, CRISIL and Bharat Electronics. There are, however, quite a few more. Talking about his company RARE (derived from the first two letters of his name and that of his wife Rekha) Enterprises, Jhunjhunwala says, "My company has only one client -- my wife -- so that I don't need to handle others' money."

One of the biggest bulls of the Indian market, Jhunjhunwala believes in trading by the hunches. "If in doubt, listen to your heart," is what he tells young investors. Extremely optimistic about India's growth story, Jhunjhunwala shared with his audience some valuable insights about the Indian economy, future of Sensex.

Rakesh Jhunjhunwala's secret to success

What paved the way to Jhunjhunwala's success?

A democratic growth process rather than an imposed one and a biological evolution, pat comes the reply.

He owes a lot to resurrection of a dormant and vigorous entrepreneurial gene of India. "The country has rediscovered its confidence."

There has been a strong improvement in India's macroeconomic indicators, combined with a robust banking system.

Improvement has also been observed in India's corporate performance, powered through productivity gains. Jhunjhunwala is convinced that on-going reforms would have a multiplier effect on India's economy.

Jhunjhunwala's investment strategies

Jhunjhunwala learnt investment strategies the hard way. And he was more than willing to share it with his audience. Here are a few gems from his book of learning

Necessary for any investor is optimism.

Be opportunistic but wait for the right moment

Study the market thoroughly. Refer to history

Maximise profits and minimise losses

Invest in a business not a company

Always have an independent opinion. Observe and read relevant information with an open mind

Be happy with your gains but learn to accept losses with a smile

Be prepared for challenges and risks

Predicting a brighter and better future for the Indian markets, Jhunjhunwala signed of by saying that the Indian markets will reach the peak by 2010.

Gems from Jhunjhunwala

For beginners in the market, here are a few invaluable gems from Jhunjhunwala's book:

Whatever you can do or dream you can, begin it. Boldness has genius, power and magic in it.
Do something you love
The means are as important as the end
Aspire, but never envy
Be paranoid of success -- never take it for granted. Realise success can be temporary and transient
Build a fighting spirit -- take the bad with the good
When you see a horizon, it seems so distant. When you reach that horizon, you will realize how many more horizons are within reach

5 things you need to be successful

Asked how much patience should an investor have, Jhunjhunwala said, "Get married and you will understand how patient you need to be."

"Patience may be tested, but conviction will be rewarded," he asserted. He appealed to the budding investors to go by what George Soros said: 'It's not important whether you are right or wrong, it more important how much you lose when you are wrong and how much money you make when you are right.'

To be successful in investing, five things are critical. There has to be:

an attractive, addressable, external opportunity;
a sustainable competitive advantage;
scalability and operating leverage; and
a qualified and integral management
Last but not least, it is of vital importance what one buys and at what price.

'India has everything'

Rakesh Jhunjhunwala believes that India has all ingredients that the stock markets value and hold in high regard. Some of them are:

Efficient capital allocation
Sustained earnings expansion driven by growth and productivity
8 per cent+ real GDP growth + 4%+ Inflation = 12%+ Nominal GDP growth
Corporates to grow faster than unorganised sector
Operating and financial Leverage to kick-in
Corporate earnings to grow at 18%+
Favourable framework for equity investing
Rising savings, yet low equity ownership -- significant potential
Corporate governance
Transparency
Effective regulation
Electronic trading
Dematerialisation
Tax paradise for equity investing under the STT regime

'Be realistic'

Jhunjhunwala also spoke about his beliefs that made a case for sustaining the India growth story.

He said enormous wealth was created over the last five years because opportunities in India have grown manifold.

Admitting that gains were going to be moderate in future unlike the manifold rise over the last few years, he advised investors to be realistic in their expectations.

'The market is always right'

Jhunjhunwala takes the cue from Warren Buffett's words: "Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well."

"Blindly following stock picks by big investors is not a wise thing to do," he warns investors. "I don't think the government is necessarily interested in hurting growth. The government is interested in growth with controlled inflation." "The market," he says, "is always right. Markets cannot be taught, they have to be learnt."

"We must have an attitude where we must balance fear and greed," was the hot tip by one of India's most high-profile investor.

Why growth will continue

Speaking on the strength in India's fundamentals, Jhunjhunwala elaborated on forces that would sustain the growth momentum.

According to him, growth enablers (such as favourable demographics, higher base of skilled people and education base), liberalisation catalysts (such as competition), fall in interest rates, multiplier effect (on account of reforms), structural changes in quality of corporate earnings and micro trends (such as change in mindset of companies who are aspiring to become global) are likely to drive India's growth story to a higher level.

Crisis gives best buying opportunities: Rakesh Jhunjhunwala

2007-08-13T18:48:00.000+05:30

Source: Moneycontrol.com

Ace investor and partner of Rare Enterprises, Rakesh Jhunjhunwala, also called ‘The Warren Buffet of India” is still bullish on the Indian markets and sees Sensex touching 25,000 level by 2012. However, he is of the opinion that world equity markets are bound to get shaken in the wake of ongoing subprime mortgage issue and the next few months will be tough for them.

Addressing Finance Continuum, 2007 at SJMSOM, IIT Mumbai, he said that crisis gives best buying opportunities. Subprime issue has hit the global markets severely and there has been a negative sentiment for past two weeks across the globe. He also feels that Indian markets will be less affected than the global markets including Asian markets.

Jhunjhunwala further added that fundamentals are still strong and Indian markets have all the ingredients to sustain the growth.

Expressing his views on overseas investment, he said that Indian markets have still to offer a lot. Jhunjhunwala has plans to explore overseas markets after 2012 and also wants to build up organizations.

Talking on house-hold savings and its importance on equity markets, he predicts that by 2012, over USD 57 billion from house-hold savings will be invested in the equity market. If his prediction comes true then Indian markets will not face liquidity crunch issues. Currently, house-hold savings investment in equity market is around USD 12 bn.

Additional Reading

The Economic Times has covered this news here: India's equity returns can be delayed, but not denied
An another note on his visit is available here.
Another blog covers this topic here.

Wit & Wisdom of Warren Buffett

2007-08-12T22:20:00.000+05:30

Source: WEB's Speeches & Writings

Warren Buffett, Chairman of Berkshire Hathaway, is arguably the world's greatest investor and the third richest man with a net worth exceeding $52 billion. He is also a great philanthropist: last year he declared plans to give away over $37 billion in charity, to the Bill & Melinda Gates Foundation.

But he is not just a man with a large heart and a matching wallet. Also known as The Sage of Omaha, he is also full of wisdom and wit.

Here are some of his gems of advice for investors who look at the stock market to make a fortune, culled from various publications, his speeches and writings:

• 'Never invest in a business you cannot understand.'

• 'Always invest for the long term.'

• 'Remember that the stock market is manic-depressive.'

• 'Buy a business, don't rent stocks.'

• 'Price is what you pay. Value is what you get.'

• 'Stop trying to predict the direction of the stock market, the economy, interest rates, or elections.'

• 'I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.'

• 'Wall Street is the only place that people ride to in a Rolls-Royce to get advice from those who take the subway.'

• 'Buy companies with strong histories of profitability and with a dominant business franchise.'

• 'It is optimism that is the enemy of the rational buyer.'

• 'As far as you are concerned, the stock market does not exist. Ignore it.'

• 'The ability to say 'no' is a tremendous advantage for an investor.'

• 'If you're doing something you love, you're more likely to put your all into it, and that generally equates to making money.'

• 'My idea of a group decision is to look in the mirror.'

• 'Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well.'

• 'The smarter the journalists are, the better off society is.'

• 'Success in investing doesn't correlate with IQ once you're above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.'

• 'Diversification is a protection against ignorance. It makes very little sense for those who know what they're doing.'

• 'You're neither right nor wrong because other people agree with you. You're right because your facts are right and your reasoning is right - that's the only thing that makes you right. And if your facts and reasoning are right, you don't have to worry about anybody else.'

• 'There seems to be some perverse human characteristic that likes to make easy things difficult.'

• 'In the short run, the market is a voting machine but in the long run it is a weighing machine.'

• 'It's only when the tide goes out that you learn who's been swimming naked.'

• 'Somebody once said that in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if they don't have the first, the other two will kill you. You think about it; it's true. If you hire somebody without the first, you really want them to be dumb and lazy.'

• 'There are three kinds of people in the world: those who can count, and those who can't.'

• 'It takes 20 years to build a reputation and five minutes to lose it.'

• 'The first rule is not to lose. The second rule is not to forget the first rule.'

• 'Wide diversification is only required when investors do not understand what they are doing.'

• 'Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years.'

• 'We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.'

• 'Our favourite holding period is forever.'

• 'If past history was all there was to the game, the richest people would be librarians.'

• 'Why not invest your assets in the companies you really like? As Mae West said, 'Too much of a good thing can be wonderful.''

• 'Your premium brand had better be delivering something special, or it's not going to get the business.'

• 'You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.'

• 'We do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own assets.'

• 'Accounting consequences do not influence our operating or capital-allocation decisions. When acquisition costs are similar, we much prefer to purchase $2 of earnings that is not reportable by us under standard accounting principles than to purchase $1 of earnings that is reportable.'

• 'Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.'

• 'The critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price.'

• 'Risk can be greatly reduced by concentrating on only a few holdings.'

• 'Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell.'

• 'Lethargy, bordering on sloth should remain the cornerstone of an investment style.'

• 'An investor should act as though he had a lifetime decision card with just twenty punches on it.'

• 'An investor needs to do very few things right as long as he or she avoids big mistakes.'

• 'Turnarounds' seldom turn.'

• 'The advice 'you never go broke taking a profit' is foolish.'

• 'It is more important to say 'no' to an opportunity, than to say 'yes.'

• 'It is not necessary to do extraordinary things to get extraordinary results.'

• 'An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.'

• 'It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently.'

• 'In the business world, the rearview mirror is always clearer than the windshield.'

• 'A public-opinion poll is no substitute for thought.'

• 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

• 'The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective.'

• 'Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.'

• 'The investor of today does not profit from yesterday's growth.'

• 'Of the billionaires I have known, money just brings out the basic traits in them. If they were jerks before they had money, they are simply jerks with a billion dollars.'

• 'I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.'

• 'I don't look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.'

• 'I always knew I was going to be rich. I don't think I ever doubted it for a minute.'

• 'We enjoy the process far more than the proceeds.'

• 'You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing.'

• 'I buy expensive suits. They just look cheap on me.'

• 'Let blockheads read what blockheads wrote.'

• 'I do not like debt and do not like to invest in companies that have too much debt, particularly long-term debt. With long-term debt, increases in interest rates can drastically affect company profits and make future cash flows less predictable.'

• 'My grandfather would sell me Wrigley's chewing gum and I would go door to door around my neighbourhood selling it. He also sold me a Coca-Cola for a quarter and I would sell it for a nickel each in the neighbourhood, so I made a small profit. I was always trying to do something like this.'

• 'A public-opinion poll is no substitute for thought.'

Investment Nuggets by Peter Lynch

2007-08-12T22:13:00.000+05:30

Peter Lynch, who managed the Fidelity Magellan Fund from 1977 to 1990, is regarded as one of the most successful fund managers in America. Lynch’s books, One up on Wall Street and Beating the Street express his investment philosophy.

His most famous principle was, “Invest in what you know”. His other stock-picking principles include, “Do your research and set reasonable expectations”, “Know the fundamentals”, “Invest for the long-run’.

Some investment nuggets from him:

“Investing without research is like playing stud poker and never looking at the cards.”

“Everyone has the brainpower to follow the stock market. If you made it through fifth-grade math, you can do it.”

“Bargains are the holy grail of the true stock picker. The fact the 10 to 30 per cent of our net worth is lost in a market sell-off is of little consequence. We see the latest correction not as a disaster but as an opportunity to acqu ire more shares at low prices. This is how great fortunes are made over time.”

“Things are never clear on Wall Street, or when they are, then it’s too late to profit from them. The scientific mind that needs to know all the data will be thwarted here.”

“You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in the markets.”

“... We’re forcing people to do the wrong things. They look at what’s hot. They spend so much time trying to figure out if the market is going up. That’s so unimportant. It’s about earnings. They need to follow the earnings.”

“If you spend more than 13 minutes analysing economic and market forecasts, you’ve wasted 10 minutes.”

“It is the rare investor who doesn’t secretly harbour the conviction that he or she has a knack for divining stock prices or gold prices or interest rates. In spite of the fact that most of us have been proven wrong again and again, it’s uncanny how often people feel most strongly that stocks are going to go up or the economy is going to improve just when the opposite occurs.”

“When it comes to predicting the market, the important skill here is not listening, it’s snoring. The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as lo ng as the fundamental story of the company hasn’t changed.”

“Absent a lot of surprises, stocks are relatively predictable over 10-20 years. As to whether they’re going to be higher or lower in two or three years, you might as well flip a coin to decide.”

What to make of this global crisis?

2007-08-11T19:09:00.000+05:30

by Ajit Dayal - Equitymaster.com

Yes, Radha, the bust in USA will hit us in India.

In May 2006 when the BSE-30 Index declined by 17% in eight sessions, we wrote about the bubble in the Middle East markets - Markets Do Fall and said, "Better economic and GDP growth is not an assurance to a perpetually booming stock market".

The link between financial markets in the US and Indian stock markets Today, as the Indian markets get lashed by something called sub-prime mortgage, we are being asked to remain calm and cool as there is no linkage between what happens to the financial markets in the US and to the Indian stock market.

Well, that is a partial truth and, in effect, a partial lie.

Stock markets are influenced by 2 factors: 1) how much do companies earn, and 2) how much are people willing to pay for those earnings.

The earnings power of a company is a function of the business of the company, its management, and the overall growth rate in the economy in which it operates. There is little change here in our view and we should safely assume that India's GDP will grow at a 6% to 6.5% per annum rate for the next few years. (Many more optimistic people have a higher GDP growth rate for India at 8% plus but we don't subscribe to that view as yet.)

Understanding liquidity & sub-prime debt How much people are willing to pay for those earnings is a function of what economists call "liquidity" and though there is no clear definition of what "liquidity" is, one can assume that it is how much money is sloshing in the system. Imagine you are at a bar and everyone is feeling a little good from the various other liquids that the bar tender has to offer for a price, of course. Then the bar tender says, "Hey, folks, how about I cut the price of the drinks by 50% - anyone want some more?"

You bet! The crowds get bigger and people feel even more elated. With all those drinks available on the cheap, they lose their sense of judgment. Human nature is anyways tuned to drift into flirtations. With a few more drinks, the drifting becomes a reality. The poor bloke standing next to you in this bar - a total stranger - suddenly feels like a friend. You begin chatting. By the end of the fifth glass, the poor fellow who works as a waiter in some corner restaurant in some obscure town in USA now looks like a promising young man who could one day start his own restaurant, build his own mall, and maybe have a chain of restaurants. So you lend him money to buy a house. He is actually what the credit rating agencies would call a "sub-prime credit risk". But, because that bar tender gave you all those free drinks, in your eyes he becomes a good risk and better still, you turn to the other drunk next to you and re-sell the loan you made to this sub-prime fellow for a profit. And why do you sell the loan for a profit? Because the guy you sell it to (a European, Japanese, Middle Eastern, whoever) is more drunk than you because the bar tender in his country also gives him free drinks. And he cannot assess the risk profile of that sub-prime American any better than you can. So all the drunks are happy. And you use that profit to make another loan to another poor sub-prime fellow and so on and so forth......

Since 2003 all the drunks are having a good time, lending and buying and selling sub-prime loans to each other.

All the sub-prime folks who got this silly money in 2003, 2004, and 2005 from the folks at the bar thought they were rich and started buying big houses and big cars and spent money which was not earned, but borrowed.

The bar tender is serving the drinks because he needs to make sure everyone feels good. There may be an election around the corner. Or if he serves his drinks quick and fast, some big bank group may come in and hire him as a consultant or make him a chairman of a global financial conglomerate riding this tide of global liquidity.

So the central banks were the bar tenders, doling out drinks and money as if their printing presses had to print, and print and print. Rather than being the men in grey suits with grumpy faces worried about the fate of the financial world, they became the stars on TV channels and the toast of conventions: their suits were grey but they were talking about this perfect world and this goldilocks, fairy tale.

And that fairy tale found its way to India and the rest of the emerging markets. From being the poor countries with corrupt governments and inept governments that have consistently failed to look after the needs of their people, these countries got a new name: BRIC. They became the darlings of the drunks. Yes, while there have been significant improvements in many countries - including India - the perception of the depth or the sustainability of these improvements were exaggerated when the drunks at the bar came calling.

India has seen nearly US$ 50 billion of foreign inflows - of which US$ 40 billion have come in since 2003. Yes, the Indian companies and the Indian stock markets did deserve a lot of that but the assessment of risk has been, in my opinion, absent.

The sub-prime fall out The sub-prime blow has so far seen some US$ 2 billion of losses from funds that have been closed down. There is maybe another US$ 50 to 100 billion of losses that may yet be exposed, according to people who track this industry. While US$ 100 billion is nothing in a world where the market cap of stocks is US$ 30 trillion (300 times the potential losses) and where bonds worth maybe US$ 100 trillion float around, the bar tenders are now serving less of that booze. The drunks are getting more sober. They now see that sub-prime person as someone who may be lucky to keep his job in a restaurant as opposed to their previous assumption (over the rim of their liquor glass) that they were lucky to stumble on the founder of the next new big restaurant chain in USA. And they will price that loan accordingly.

And they will see the investment opportunities in the emerging markets with a little better understanding of risk. Don't get me wrong: the fundamentals for India are fantastic, and money will flow in to India over the next decade. Sensible, risk-assesses money. But for now, the silly money will go out. The P-Note folks will vacate and that will cause the Indian market to suffer.

India has, via its P-Note policy, linked itself to silly money. We enjoyed the ride for the past 4 years, now we will feel a bit of pain.

Keep your money ready to invest. Stay disciplined, never be carried away, politely tell the bartenders to keep their extra, free drinks. And you will profit: steadily but surely.

Ajit Dayal is Director, Quantum Advisors Private Limited. Ajit is the founder of Quantum Asset Management Company Pvt. Ltd. and also Quantum Information Services Pvt. Ltd., which owns Equitymaster & Personalfn.