Like many other investors, I too sometimes worry about the prospects of 2011. Well 2010 was reasonable for many emerging markets with double digit returns. Even matured markets fared relatively better.
How will 2011 perform? Will it dip impacting my portfolio? Should I hedge? What are the derivative strategies to follow? The dark clouds at the horizon are many i.e.
1. Oil prices above USD 120 p/b.
2. Inflation is a threat in many economies, partly thanks to high oil prices
3. Interest rates go up, partly due to inflation
4. Lesser credit off take, thanks to higher interest rates
5. All of the above can lead to lower economic activity
6. Many people criticize massive US deficits and China surpluses
A calmness of a Zen monk descended on me when I read Financial Times (FT) on 12Apr2011. In the page 3, it carried an article titled "IMF sees steady economic recovery'. IMF in its recent report stated that world GDP will grow by 4.4% in 2011 and 4.5% in 2012 and optimism was expressed on advanced economies. IMF did not ignore the sovereign debt problems of Europe or the Middle East unrest. Despite such instances, they said that it was now more certain about its forecast than in Oct2010. They said that double dip threat is receded with more sustainable global economic activity. Of course, at last good news!. Respectable FT carries a news article that says things are looking better despite all troubles. I felt calm and happy.
But it did not last long. The page 11 of FT of the same date (12Apr2011) had another article title "Tighten seatbelts; 2011 could be worse than 2010". It said that the macro economic risks are now higher because of Arab Spring (Middle East political changes), Japan's earthquakes, slippage in US growth estimates, tightening of US fiscal policies, etc. It says that if the oil price increase continues, it will impact the growth. Well some of my worries returned with vengeance.
In New Testament, Roman Governer (of Palestine) Pontius Pilate asks a question to Jesus "What is truth?” The apt religious answer to this question is also given in New Testament. (Those who want to know this truth may read the New Testament or seek the help of a biblical scholar). However the truth I seek now is more of financial in nature. Which of the above two views expressed in a respected financial newspaper is the truth?
Do you think FT is sending out a confused message? FT is not alone. Even the chairmen of reputed supra-national mutual funds are also confused. One of them recently remarked that despite all the issues, emerging economies like India will attract investments and said that India is a growing market of around 8% growth in real terms. This should translate into corporate earnings growth of 14%-18%. Hence there is no way that anyone investing can ignore India.
After a few days, the same person said that high crude prices (which possibly could hit USD 200 p/b), lacklustre industry data, scams, interest rates etc are not good for Indian economic growth.
As I write this today, Indian market sharply shot up on its last trading day by 2.2%. A paradox?
It is clear that FT is confused. Same is the case with MNC Mutual Fund gurus. Among these troubles, Warren Buffet seems unconfused or probabily not worried about the current investment climate. No doubt half a century of experience and skills would help him. Recently he acquired Lubrizol and was in India seeking investing opportunities.
Let us turn to the master investor for some clue how to handle situations like this. He is basically a long term player, although he has his own type of short term bets. His long term focus proved to be a very powerful approach to manage a portfolio, which helped through market ups and downs. His company has seen several crisis – 1973 Oil crisis, 1987 stock market crash, 1991 Gulf war, Dot com crash of early 2000 and recently 2008 Global crisis. The portfolio of investments, comprising listed and unlisted companies, performed satisfactorily, despite all these troubles.
If you are convinced that the stock market would do well over the long term, you can win by limiting the downside of the portfolio during bear markets. This is one of the important guidelines of Warren Buffet (often mentioned in his letters) as his focus seems to be on limiting the downside to his portfolio. For him a performance of (–)10% of the portfolio vs. (-)20 % of an Index (say Dow or FTSE or Nifty or Nikkei) is better than a +20% portfolio performance vs. +10% of an Index.
Thursday, April 14, 2011
Monday, March 7, 2011
Black Swans
MENA region was taken for granted. Whilst some countries had namesake elections for presidents, others were ruled by monarchs. Some of the monarchs are better than acclaimed democracies in the world. The best example is UAE where the governance is much better and where both nationals and expatriates live side by side and enjoy living standards better than in the western world.
However, not all of the MENA is like that. Many are poor and corrupt with exploding population due to large families with five or more kids, who fought from childhood for chances of betterment of life against intense competition for limited opportunities available.
Overall comparable to the situation in France in 1789. Such frustrated population, if enlightened by non-religious thinkers speaking fearlessly about ‘Equality, Liberty and Fraternity’ is capable of making a radical change. French revolution was aided by the technology of that day, i.e. printing machines. Once the French decided to revolt, Europe was never the same again. The revolutionary ideas resulted in the separation of state from the religion, which enabled the free thinkers to explore ideas with new inventions and theories, without fearing the backlash of ‘traditionalists or religious extremists’ who dwindled away as the new thoughts and ideas took root in the minds of population and new generations.
I don't know about any such non religious thinkers in MENA region; however a revolution did take place in Tunis late last year. It is reported a poor frustrated fruit vendor when his fruit cart, which was his only livelihood, was confiscated by the police, in the moment of desperation, he set himself on fire. The rage of frustration that gripped the population was unleashed and spread like wild fire across the region, of course partly technology – i.e. social media. Like in French revolution the army sided with the people and turned against 'monarchs'. It was repeated in Egypt. It looks like it may repeat in Libya and who knows who is next. Let us hope this revolution will bring in 'Equality, Liberty and Fraternity’ into MENA region. Also hope that MENA region will produce free thinkers, new inventions and theories, without fearing the backlash of ‘traditionalists or religious extremists’.
If you talked about such events will take place 6 months ago, no one will believe you. Such events have all features of 'black swan' theory developed by Nassim Nicholas Taleb. The theory ridicules the belief that today’s 'normalcy' will continue into the future and hence predictions are possible. It says that the high-impact, hard to predict, rare events shape the history, science, finance and possibly anything human. Nassim goes on to say that once such rare and unaware events happen, the human nature find explanations for its occurrence, and wonder how they missed it i.e. makes it explainable and predictable.
Well, based on the events in MENA the prediction gurus are out there forecasting possible oil prices beyond USD 250 p/b and the problems and opportunities it could bring in. Whilst every one agree that the normalcy of MENA is upset with 'outlier' events, the financial markets in the world more or less still behaves in 'normalcy standards'. Although the oil prices have moved up significantly, which will impact automobile manufacturers to transportation to energy based manufacturing companies and almost all players in the oil based global economy, the world economy tries to behave as if 'normalcy' continues.
The recent past when the oil price touched USD100 p/b was in the early 2008 (due to demand > supply?) and peaked in July 2008 at USD 147 p/b. However, when world of finance crashed along with Lehman, oil price also crashed. Now the oil prices are back at USD 100/- plus due to entirely different reasons.
Many investors are now worried about their investments, which is quite right. What should be the risk appetite? Should they sell now and place them in fixed deposits? Or since many markets are down in double digits already during this year, is it not the time to buy? Best example is India. Again should not we buy into the possible rally of economies coming out of recession in style with several positive indicators on the horizon? The best example is USA.
What will be the oil prices after one year? Answer to this question will solve the concerns about the future performance of many stock markets in the world and hence consequently several portfolios. Of course you can try to predict the oil prices and can have an investment or portfolio strategy depending upon your views.
But be aware of the 'black swan' that could be lurking somewhere out there.
However, not all of the MENA is like that. Many are poor and corrupt with exploding population due to large families with five or more kids, who fought from childhood for chances of betterment of life against intense competition for limited opportunities available.
Overall comparable to the situation in France in 1789. Such frustrated population, if enlightened by non-religious thinkers speaking fearlessly about ‘Equality, Liberty and Fraternity’ is capable of making a radical change. French revolution was aided by the technology of that day, i.e. printing machines. Once the French decided to revolt, Europe was never the same again. The revolutionary ideas resulted in the separation of state from the religion, which enabled the free thinkers to explore ideas with new inventions and theories, without fearing the backlash of ‘traditionalists or religious extremists’ who dwindled away as the new thoughts and ideas took root in the minds of population and new generations.
I don't know about any such non religious thinkers in MENA region; however a revolution did take place in Tunis late last year. It is reported a poor frustrated fruit vendor when his fruit cart, which was his only livelihood, was confiscated by the police, in the moment of desperation, he set himself on fire. The rage of frustration that gripped the population was unleashed and spread like wild fire across the region, of course partly technology – i.e. social media. Like in French revolution the army sided with the people and turned against 'monarchs'. It was repeated in Egypt. It looks like it may repeat in Libya and who knows who is next. Let us hope this revolution will bring in 'Equality, Liberty and Fraternity’ into MENA region. Also hope that MENA region will produce free thinkers, new inventions and theories, without fearing the backlash of ‘traditionalists or religious extremists’.
If you talked about such events will take place 6 months ago, no one will believe you. Such events have all features of 'black swan' theory developed by Nassim Nicholas Taleb. The theory ridicules the belief that today’s 'normalcy' will continue into the future and hence predictions are possible. It says that the high-impact, hard to predict, rare events shape the history, science, finance and possibly anything human. Nassim goes on to say that once such rare and unaware events happen, the human nature find explanations for its occurrence, and wonder how they missed it i.e. makes it explainable and predictable.
Well, based on the events in MENA the prediction gurus are out there forecasting possible oil prices beyond USD 250 p/b and the problems and opportunities it could bring in. Whilst every one agree that the normalcy of MENA is upset with 'outlier' events, the financial markets in the world more or less still behaves in 'normalcy standards'. Although the oil prices have moved up significantly, which will impact automobile manufacturers to transportation to energy based manufacturing companies and almost all players in the oil based global economy, the world economy tries to behave as if 'normalcy' continues.
The recent past when the oil price touched USD100 p/b was in the early 2008 (due to demand > supply?) and peaked in July 2008 at USD 147 p/b. However, when world of finance crashed along with Lehman, oil price also crashed. Now the oil prices are back at USD 100/- plus due to entirely different reasons.
Many investors are now worried about their investments, which is quite right. What should be the risk appetite? Should they sell now and place them in fixed deposits? Or since many markets are down in double digits already during this year, is it not the time to buy? Best example is India. Again should not we buy into the possible rally of economies coming out of recession in style with several positive indicators on the horizon? The best example is USA.
What will be the oil prices after one year? Answer to this question will solve the concerns about the future performance of many stock markets in the world and hence consequently several portfolios. Of course you can try to predict the oil prices and can have an investment or portfolio strategy depending upon your views.
But be aware of the 'black swan' that could be lurking somewhere out there.
Thursday, February 10, 2011
India's Industrial Production during first 9 months of FY2010-11 is 8.6%, which is very good
The cumulative growth for the period April- December, 2010-11 stands at 8.6% over the corresponding period of the previous year. Month on Month growth is 1.6% higher as compared to the level in the month of December 2009.
The December industrial output was always expected to show growth but at a moderate level as the Dec 2009 output was extremely strong.(i.e. calculation of the index from a higher base of Dec 2009)
Overall Indian growth story is intact and continues to be Strong
The December industrial output was always expected to show growth but at a moderate level as the Dec 2009 output was extremely strong.(i.e. calculation of the index from a higher base of Dec 2009)
Overall Indian growth story is intact and continues to be Strong
Sunday, February 6, 2011
India's Growth
India is a great nation. No doubt about it. Even its enemies acknowledge it. If you go back to history, you can always see that India was the magnetic attraction of the world. Alexander the Great had only one dream, reach India and he did. He defeated one of the Indian Kings, Porus in a battle, however returned his kingdom and established friendship and went back. That was the respect he had for the king and kingdom.
Romans, Chinese, Arabs and a host of other nations vied to come to India for trade and make money. Migration to India was like the migration to west these days. Parsis, Middle East Christians and Muslims all migrated to India in the past. If you visit Kerala state still you can see the evidence of thriving Jewish culture for thousands of centuries, till Israel is formed, however the way things are going at Middle East, it is possible that some Jews may return. Chinese fishing net popular in Kochi shows the historical connections to the China.
Then the west was desperate to come to India, which they did through Vasco Da Gama, which changed the fortunes of the west for ever. A plague ravaged poor nation of Britain came the mighty nation of the world due to the trade with India. No doubt India has tremendous potential.
Even now, if you go to USA it is acknowledged that the most thriving immigrant community is the Indians. They top the list of non-westerners as the CEOs of Fortune companies and in similarly in all spheres of life,
There is no need to elaborate further, it is beyond any doubt that India has great potential and Indians abroad have established their hall mark.
Indian growth story was strong till Oct 2010 and almost all economists told that India will grow at 10% p.a very soon, possibly in FY2011. Everything changed all of a sudden as we started 2011, now many are busy cutting the Indian growth rate. We don't hear anyone even stating even 10% now. WHY?
This is because Indians are capable screwing up good things. It seems that they dislike good things. As the growth was zooming, the CBI suddenly decided some of the top banks have made 'corruption' in lending huge sums of money to the business world of India. They put the top bankers behind jail. Well I don't justify their action, but has a question. It is well known that there are many corrupt politicians in India. How many of them are humiliated the way the top bankers have been humiliated?
Bear in mind that Indian Bankers are top class and comparable to the best in world. Although they are as talented or even more talented than the rest of the world, their salaries are pittance compared to the rest of the world. A junior associate in Goldman Sachs may be drawing more salary than the CEO of SBI, which is among the Fortune 500 of the world!
What did CBI achieved with this raid? Has the corruption been routed out? No. But many bankers became now afraid to lend after the raid. This has impacted the businesses across India. Somewhere in India, an expansion plan is on hold. Some businessmen are unable to fulfill their growth forecasts and bank officials are gripped with fear. The cumulative effect of several such instances means that growth of India gets affected!
Then came CAG report that an astronomical amount was subjected to corruption in 2G scam. Then some minister came out and said that the assumptions by CAG may not be appropriate. There was a huge argument in the press, diverting attention from the new economic activities that should have been focused by Govt. Even the parliament did not meet peacefully to discuss the country's affairs. Negative publicity is an inevitable consequence.
After this incident many government departments are reluctant to approve projects as the fear grips them. The result is that several Infrastructure projects (road construction, etc) by government departments are put off. Again, the slowdown in such big projects may make a dent in the growth of India!!
India's environment minister seem to enjoy the lime light of the media. Several Projects are denied or made costlier for the promoters by him. The best example is the Lavansa Project, which covered about 20000 acres and would have created truly modern facilities. Imagine the amount of investments flowed into the economy and its multiplier effect and accelerator effect. Remember USA's rejection of certain environmental treaties if it hurts their economic growth. Earth, during its existence, tracable back to millions of years, has already gone through several ice-ages and hot-ages and will continue to do so going forward. Whilst we should care for the environment, it should not be at the cost of economic growth. (With the demand factor high in India, the annual growth rate of 10% is a low hanging fruit).
Now it is the turn of prime minister and finance minister. Recently, the prime minister said that the inflation will affect the growth because interest rates may go up. The rates are already high in Brazil and it grows. Moreover, the rates will not remain high for long. India is planning to import food stuff to curtail the food inflation. These positives were not mentioned! Whilst all agree that Indian prime minister is among the best in the world and highly intelligent and knows how to take India’s growth to 10% or above, he need to be careful when tackling media
Need to learn from Obama and Warren Buffet. When they speaks about the US economy, they are optimistic, however bad the economic numbers may look like. They know that these numbers are temporary. The duty of the commander or a team leader is to be positive and motive the team, not otherwise. When the nation’s leaders are optimistic, the business confidence grows. This encourages more investments, capex, expansion plans, etc which will benefit the economy and brings in the growth.
The truth is that India is growing faster than most economies in the world (except may be China, but whose numbers are accused to be fudged) and there is no reduction in its pace. India will continue to grow at even faster rates than at present. If the stock market drops in India, lick your lips and barge in like a kid in a candy store.
Romans, Chinese, Arabs and a host of other nations vied to come to India for trade and make money. Migration to India was like the migration to west these days. Parsis, Middle East Christians and Muslims all migrated to India in the past. If you visit Kerala state still you can see the evidence of thriving Jewish culture for thousands of centuries, till Israel is formed, however the way things are going at Middle East, it is possible that some Jews may return. Chinese fishing net popular in Kochi shows the historical connections to the China.
Then the west was desperate to come to India, which they did through Vasco Da Gama, which changed the fortunes of the west for ever. A plague ravaged poor nation of Britain came the mighty nation of the world due to the trade with India. No doubt India has tremendous potential.
Even now, if you go to USA it is acknowledged that the most thriving immigrant community is the Indians. They top the list of non-westerners as the CEOs of Fortune companies and in similarly in all spheres of life,
There is no need to elaborate further, it is beyond any doubt that India has great potential and Indians abroad have established their hall mark.
Indian growth story was strong till Oct 2010 and almost all economists told that India will grow at 10% p.a very soon, possibly in FY2011. Everything changed all of a sudden as we started 2011, now many are busy cutting the Indian growth rate. We don't hear anyone even stating even 10% now. WHY?
This is because Indians are capable screwing up good things. It seems that they dislike good things. As the growth was zooming, the CBI suddenly decided some of the top banks have made 'corruption' in lending huge sums of money to the business world of India. They put the top bankers behind jail. Well I don't justify their action, but has a question. It is well known that there are many corrupt politicians in India. How many of them are humiliated the way the top bankers have been humiliated?
Bear in mind that Indian Bankers are top class and comparable to the best in world. Although they are as talented or even more talented than the rest of the world, their salaries are pittance compared to the rest of the world. A junior associate in Goldman Sachs may be drawing more salary than the CEO of SBI, which is among the Fortune 500 of the world!
What did CBI achieved with this raid? Has the corruption been routed out? No. But many bankers became now afraid to lend after the raid. This has impacted the businesses across India. Somewhere in India, an expansion plan is on hold. Some businessmen are unable to fulfill their growth forecasts and bank officials are gripped with fear. The cumulative effect of several such instances means that growth of India gets affected!
Then came CAG report that an astronomical amount was subjected to corruption in 2G scam. Then some minister came out and said that the assumptions by CAG may not be appropriate. There was a huge argument in the press, diverting attention from the new economic activities that should have been focused by Govt. Even the parliament did not meet peacefully to discuss the country's affairs. Negative publicity is an inevitable consequence.
After this incident many government departments are reluctant to approve projects as the fear grips them. The result is that several Infrastructure projects (road construction, etc) by government departments are put off. Again, the slowdown in such big projects may make a dent in the growth of India!!
India's environment minister seem to enjoy the lime light of the media. Several Projects are denied or made costlier for the promoters by him. The best example is the Lavansa Project, which covered about 20000 acres and would have created truly modern facilities. Imagine the amount of investments flowed into the economy and its multiplier effect and accelerator effect. Remember USA's rejection of certain environmental treaties if it hurts their economic growth. Earth, during its existence, tracable back to millions of years, has already gone through several ice-ages and hot-ages and will continue to do so going forward. Whilst we should care for the environment, it should not be at the cost of economic growth. (With the demand factor high in India, the annual growth rate of 10% is a low hanging fruit).
Now it is the turn of prime minister and finance minister. Recently, the prime minister said that the inflation will affect the growth because interest rates may go up. The rates are already high in Brazil and it grows. Moreover, the rates will not remain high for long. India is planning to import food stuff to curtail the food inflation. These positives were not mentioned! Whilst all agree that Indian prime minister is among the best in the world and highly intelligent and knows how to take India’s growth to 10% or above, he need to be careful when tackling media
Need to learn from Obama and Warren Buffet. When they speaks about the US economy, they are optimistic, however bad the economic numbers may look like. They know that these numbers are temporary. The duty of the commander or a team leader is to be positive and motive the team, not otherwise. When the nation’s leaders are optimistic, the business confidence grows. This encourages more investments, capex, expansion plans, etc which will benefit the economy and brings in the growth.
The truth is that India is growing faster than most economies in the world (except may be China, but whose numbers are accused to be fudged) and there is no reduction in its pace. India will continue to grow at even faster rates than at present. If the stock market drops in India, lick your lips and barge in like a kid in a candy store.
Sunday, January 16, 2011
Will Third Generation BASEL make any difference?
Recently, a reputed training institute based in Europe sent me details of training program for Basel III. They said that their training course provides helpful details of Basel III that will be rolled out soon across financial sector of various nations across the world and will strengthen the various players in the financial sector, mainly banks.
Let us see what the first and second generations of Basel has done for the global economy. The declared aim of these systems is to bring in stability in financial system and minimize banking problems and banking collapse.
Basel 1 -first generation- was rolled out soon after the collapse of Baring Banks by the aggressive risk taking by Nick Leeson. After selling straddles on Japanese Nikkei index successful over some years, Nick Leeson licked dust the day when an earthquake hit the city of Kobe in Japan in 1992. The straddles Nick Leeson shorted in derivatives market went against Baring Bank, which witnessed massive losses. Unable to meet the obligations, the bank went bankrupt and Nick Leeson went to jail.
Then they rolled out Basel 1, which I met during my early part of the career and remember doing the Risk Weighted Asset calculation and applying the appropriate capital adequacy ratio and finding out the risk/reward pattern for each asset and portfolio in general. Several accounting firms, consulting companies and IT firms had a field day as they delivered beautiful and elegant systems that captured various risks under Basel 1 in comprehensive manner but in an incomprehensible way.
However, soon criticisms were paraded against this system and intellectuals and academicians began to devote time for an improved version. The new systems gave undue importance to risk models and opinions of rating agencies. As the new system was being formed, another near disaster hit the global economy in the form of Long-Term Capital Management or LTCM.
The collapse of LTCM in 1998 showed the weakness of the risk models which was the basis for advanced IRB models in Basel II. It is interesting to note that two co-founders of LTCM (Myron Scholes and Robert Merton) won Nobel Prize in 1997 just one year before LTCM went bankrupt. Their convergence strategy and long/short strategy that delivered excellent returns (even up to c.45% p.a) for a few years turned against the firm when Russians decided not pay its sovereign debt in 1998. Entire capital of LTCM -one of the financial giants in the Wall Street - was wiped out resulting in a financial panic. Default by LTCM loomed large giving sleepless nights to various lending banks/FIs. A default would have caused a chain reaction of defaults across US banking system and possibly in other countries which were linked to US. The fear who else is insolvent froze the financial system. Thankfully, Allan Greenspan brought together the creditor banks of LTCM who bought into the equity of LTCM and took control and avoided the crisis. Despite all the mudslinging against Allan Greenspan in the recent times, we need to praise his steadfastedness to salvage US banking system and hence the economy, without tapping into Govt support.
Despite defusing a massive financial nuclear bomb well in time, the lessons learnt in LTCM was forgotten quickly. One of the chief culprits of LTCM collapse was its reliance on financial models, especially Var (Value at Risk) which assumed normal distribution in financial markets. In fact financial and credit markets are anything but normal and there were several evidence and academic criticisms against Var and similar models. Among the leading critics was Nassim Taleb while the die-hard supporters included the Quants in JP Morgan who originally brought out this beast into the financial markets.
During the later part of career again I had to get in touch with second generation Basel and its modelling systems. I often wondered alongwith some of my colleagues that the second generation was an excellent example of making simple concepts into beautifully carved complex and complicated systems of dubious quality. Again a bunch of accounting firms, consultants and IT firms won lot of business.
As the second generation was rolled out with its heavy reliance on models, Lehman crashed spectacularly in 2008, ten years after LTCM. No one was around to save Lehman or most of its creditors and its collapse exactly did opposite what Basel-1 and Basel II was originally rolled out for. They were supposed to protect banking and financial sectors or the nations. They did everything but that. Hundreds of banks have shutdown across the world or merged with others to avoid collapse. Many banks are still alive on Govt support.
Hold your breath. Now they are rolling out the third generation!! See you in 2018 or 2019, when another spectacular financial fireworks is possible, based on the track record we just discussed.
Someone told me that Einstein had said that 'there is nothing like simplicity'. It seems that sometimes he is right!!.
Let us see what the first and second generations of Basel has done for the global economy. The declared aim of these systems is to bring in stability in financial system and minimize banking problems and banking collapse.
Basel 1 -first generation- was rolled out soon after the collapse of Baring Banks by the aggressive risk taking by Nick Leeson. After selling straddles on Japanese Nikkei index successful over some years, Nick Leeson licked dust the day when an earthquake hit the city of Kobe in Japan in 1992. The straddles Nick Leeson shorted in derivatives market went against Baring Bank, which witnessed massive losses. Unable to meet the obligations, the bank went bankrupt and Nick Leeson went to jail.
Then they rolled out Basel 1, which I met during my early part of the career and remember doing the Risk Weighted Asset calculation and applying the appropriate capital adequacy ratio and finding out the risk/reward pattern for each asset and portfolio in general. Several accounting firms, consulting companies and IT firms had a field day as they delivered beautiful and elegant systems that captured various risks under Basel 1 in comprehensive manner but in an incomprehensible way.
However, soon criticisms were paraded against this system and intellectuals and academicians began to devote time for an improved version. The new systems gave undue importance to risk models and opinions of rating agencies. As the new system was being formed, another near disaster hit the global economy in the form of Long-Term Capital Management or LTCM.
The collapse of LTCM in 1998 showed the weakness of the risk models which was the basis for advanced IRB models in Basel II. It is interesting to note that two co-founders of LTCM (Myron Scholes and Robert Merton) won Nobel Prize in 1997 just one year before LTCM went bankrupt. Their convergence strategy and long/short strategy that delivered excellent returns (even up to c.45% p.a) for a few years turned against the firm when Russians decided not pay its sovereign debt in 1998. Entire capital of LTCM -one of the financial giants in the Wall Street - was wiped out resulting in a financial panic. Default by LTCM loomed large giving sleepless nights to various lending banks/FIs. A default would have caused a chain reaction of defaults across US banking system and possibly in other countries which were linked to US. The fear who else is insolvent froze the financial system. Thankfully, Allan Greenspan brought together the creditor banks of LTCM who bought into the equity of LTCM and took control and avoided the crisis. Despite all the mudslinging against Allan Greenspan in the recent times, we need to praise his steadfastedness to salvage US banking system and hence the economy, without tapping into Govt support.
Despite defusing a massive financial nuclear bomb well in time, the lessons learnt in LTCM was forgotten quickly. One of the chief culprits of LTCM collapse was its reliance on financial models, especially Var (Value at Risk) which assumed normal distribution in financial markets. In fact financial and credit markets are anything but normal and there were several evidence and academic criticisms against Var and similar models. Among the leading critics was Nassim Taleb while the die-hard supporters included the Quants in JP Morgan who originally brought out this beast into the financial markets.
During the later part of career again I had to get in touch with second generation Basel and its modelling systems. I often wondered alongwith some of my colleagues that the second generation was an excellent example of making simple concepts into beautifully carved complex and complicated systems of dubious quality. Again a bunch of accounting firms, consultants and IT firms won lot of business.
As the second generation was rolled out with its heavy reliance on models, Lehman crashed spectacularly in 2008, ten years after LTCM. No one was around to save Lehman or most of its creditors and its collapse exactly did opposite what Basel-1 and Basel II was originally rolled out for. They were supposed to protect banking and financial sectors or the nations. They did everything but that. Hundreds of banks have shutdown across the world or merged with others to avoid collapse. Many banks are still alive on Govt support.
Hold your breath. Now they are rolling out the third generation!! See you in 2018 or 2019, when another spectacular financial fireworks is possible, based on the track record we just discussed.
Someone told me that Einstein had said that 'there is nothing like simplicity'. It seems that sometimes he is right!!.
Wednesday, December 29, 2010
Great Chinese Property Bubble
No doubt China is a great country and civilization with a history going back to several millenniums comparable to India, Egypt, Mesopotamia, etc. However, recently, China is hitting headlines for some wrong reasons. (I am not sure my colleague who is of Chinese origin, but an UK Citizen, will agree with my view. He often argues that China is hitting the headlines for all right reasons.)
As China made its massive population the cheapest hardworking labour in the world, the greedy corporates of USA decided to dump the blue collar labour in their own country and exported those jobs to China. This still is one of the core reasons for record US unemployment, highest in the recent history of USA. Chinese labourers are working in poor labour (near slavery?) conditions and humanitarian track record of China is among the worst in the world. However these issues do not bother US Corporates, if money can be made cheap. Remember the recent news of suicides in several Chinese factories.
Cheap (and often stated to be of low quality) Chinese goods are flooding global markets and have created havoc in many countries resulting in closure of several industries in those countries. Recently, China won and half completed a metro railway project in Saudi Arabia undercutting several other competitors. It is reported that China is losing money in this project but happy and it means that they have now taken the undercutting abroad.
Both Saudi and China are totalitarian regimes and intolerant. One is based on communism and doesn't like religion and claims there is no God. Another one is based on extreme form of religion and insists that their way of viewing God is the only right way. It is a paradox that Saudi relies on skill set of expatriates of different religions such as Hindus, Christians, Parsis, Buddhists, Jains, etc but no religious freedom. Saudi beheads its criminals and does not allow women to drive or has any theatres. Saudi follows their religious law and restricts freedom of speech and expression, which has similarities to Chinese communism, where also both are denied. A chinese citizen -Liu Xiaobo- was awarded 2010 Nobel Peace Prize but he is in prision for the criminal offence of working for fundamental human rights in China. Whilst violent 'Communism' was exported all over the world by Soviet Union in early 20th century, now-a-days it is violent religious 'Terrorism' that is being exported around.
Now the million dollar question is whether Chinese Property Bubble will burst in 2011. It is widely acknowledged that the Property Bubble in China is much worse than that of US in 2007/08. The average price to rent ratio in China now stands at 40x vs. 23x of USA just before the onset of 2008 crisis. The main reason is that the government owned companies / banks driving up the investments to support GDP growth, even during the financial crisis. Artificially suppressed exchange rates also contributed to the growth of Great Chinese Bubble.
As in the Japan of 1990 and USA in 2008, the Chinese banks have exposure to the property market and any crash will then will result in banking crisis. A banking crisis will soon turn into a credit crisis and then economic crisis. So, if the Chinese property bubble bursts, definitely the global problems would multiply.
However, there are many who dismiss the above views saying China is different and they can control these issues. Well, that is what I also want so that the predictable 2011 is good for investing. My portfolio would not show much fluctuations and that is good. However, it is worrying that such complacency was exhibited prior to the United States sub-prime crisis and European sovereign debt crisis as well.
If China Property Bubble bursts the initial casualty will be drying up of demand for Raw materials. China is currently the global leader in consuming major commodities such as copper, steel, cement, etc. As the commodities take the southward direction, the mining companies and mining equipment manufacturers would follow. Investor sentiment would be affected and the global stock markets may test new lows. Bears would be happiest persons.
Let us hope that as China lovers say that the Chinese government has "ample resources" to bail out its banks and other sectors, in case of a crisis, which would prevent any exacerbation of the problem.
As China made its massive population the cheapest hardworking labour in the world, the greedy corporates of USA decided to dump the blue collar labour in their own country and exported those jobs to China. This still is one of the core reasons for record US unemployment, highest in the recent history of USA. Chinese labourers are working in poor labour (near slavery?) conditions and humanitarian track record of China is among the worst in the world. However these issues do not bother US Corporates, if money can be made cheap. Remember the recent news of suicides in several Chinese factories.
Cheap (and often stated to be of low quality) Chinese goods are flooding global markets and have created havoc in many countries resulting in closure of several industries in those countries. Recently, China won and half completed a metro railway project in Saudi Arabia undercutting several other competitors. It is reported that China is losing money in this project but happy and it means that they have now taken the undercutting abroad.
Both Saudi and China are totalitarian regimes and intolerant. One is based on communism and doesn't like religion and claims there is no God. Another one is based on extreme form of religion and insists that their way of viewing God is the only right way. It is a paradox that Saudi relies on skill set of expatriates of different religions such as Hindus, Christians, Parsis, Buddhists, Jains, etc but no religious freedom. Saudi beheads its criminals and does not allow women to drive or has any theatres. Saudi follows their religious law and restricts freedom of speech and expression, which has similarities to Chinese communism, where also both are denied. A chinese citizen -Liu Xiaobo- was awarded 2010 Nobel Peace Prize but he is in prision for the criminal offence of working for fundamental human rights in China. Whilst violent 'Communism' was exported all over the world by Soviet Union in early 20th century, now-a-days it is violent religious 'Terrorism' that is being exported around.
Now the million dollar question is whether Chinese Property Bubble will burst in 2011. It is widely acknowledged that the Property Bubble in China is much worse than that of US in 2007/08. The average price to rent ratio in China now stands at 40x vs. 23x of USA just before the onset of 2008 crisis. The main reason is that the government owned companies / banks driving up the investments to support GDP growth, even during the financial crisis. Artificially suppressed exchange rates also contributed to the growth of Great Chinese Bubble.
As in the Japan of 1990 and USA in 2008, the Chinese banks have exposure to the property market and any crash will then will result in banking crisis. A banking crisis will soon turn into a credit crisis and then economic crisis. So, if the Chinese property bubble bursts, definitely the global problems would multiply.
However, there are many who dismiss the above views saying China is different and they can control these issues. Well, that is what I also want so that the predictable 2011 is good for investing. My portfolio would not show much fluctuations and that is good. However, it is worrying that such complacency was exhibited prior to the United States sub-prime crisis and European sovereign debt crisis as well.
If China Property Bubble bursts the initial casualty will be drying up of demand for Raw materials. China is currently the global leader in consuming major commodities such as copper, steel, cement, etc. As the commodities take the southward direction, the mining companies and mining equipment manufacturers would follow. Investor sentiment would be affected and the global stock markets may test new lows. Bears would be happiest persons.
Let us hope that as China lovers say that the Chinese government has "ample resources" to bail out its banks and other sectors, in case of a crisis, which would prevent any exacerbation of the problem.
Saturday, December 11, 2010
Will 2012 be similar to 1932? Or Japan in 1990s ? - Part 2
This is in continuation of the article published (in this blog) couple of weeks ago titled "Will 2012 be similar to 1932? Japan in 1990s?" We discussed about the parallels between 1929 Crash and 2009 Crash and discussed some of the common reasons behind both downturns i.e. - the structural weaknesses, reckless lending, high leverage, speculation, asset bubbles, massive bank failures, stock market crash, etc were some of them.
We had also discussed about the parallels of 2009 Crash to the Collapse of Japanese economy after their fantastic economic growth in the 1970s and 1980s, where Japan witnessed fast rise in real estate, stock market and all asset classes fuelled by cheap credit policy. But mainly due to mismanagement of the interest policy regime, the stock market crashed, debt crisis followed, banks collapsed, triggering bailouts by Japanese Govt, which sound so similar to the US story of 2008 end/early 2009.
What did Japan do during the 1990s after the gigantic economic shock? Among the steps by Japan, zero interest rate regime was the most famous to create demand. But deflation set in Japan creating lot more problems. Stock market index (Nikkei) that touched 38,957 in Dec 1989 is still hovering around 9000 levels today. The real estate prices are now going at the fraction of bubble times. Why did the deflation set in the Japan? Many reasons are highlighted by various authorities.
a) Sharp drop in post bubble asset prices. It is partly emotional. After burning the fingers in the crash, many investors (including retail investors) won't touch the same asset class and may even warn their children.
b) Risk averse banks: Post bubble, many banks were literally destroyed by the large percentage "non-performing" credit assets(i.e.loans that had to be written off). This reduced the credit risk appetite of banks.
c) Businessmen, who recently experienced the trauma of economic collapse and witnessed drying up of demand and non-payment by debtors did not take risky decisions. They were reluctant to borrow and expand questioning whether the hard pressed consumers will buy more.
d) Japanese people became fearful of banks' collapse. They bought gold or invested in United States/Japanese Treasury securities instead of bank deposits, reducing the funds available with banks.
A university professor at Tokyo University in a recent research of young adults stated that "the lost decade made young people timid and afraid of what to do; it is made them even more risk averse". It is not good news for Japanese, who are famous for their hard work and astonishing growth from the shambles of Second World War.
Against this background, it is understandable why Ben Bernanke is pumping money into the US Economy through Quantitative Easing. Deflation should never be allowed to lift its ugly head. Deflation was the major problem in post 1929 crash also. As we mentioned earlier in this blog, the Governor of the Fed had studied the 1929 US depression (and got PhD). Those days the dollar was pegged to gold. Because of this peg, the Fed in 1920s couldn’t just print dollars to counter deflation. Thank God, there are no more gold standards out there.
Let us hope USA won’t witness a lost decade. USA has a more dynamic economy than Japan with greater employment mobility and entrepreneurial energy. The working age of Americans is not shrinking unlike Japan. Moreover, USA has sprung back from its previous recessions since the Second World War smartly because its free economy allowed the economic agents greater flexibility to cut costs or lay off or recruit resources. Let us hope this dynamism will ensure that there is no lost decade for the USA, which will benefit the world, since US is still the biggest economic player in the world. Let us also hope China will not play a spoil sport in this great recovery game.
What this mean to you and me? Well Be on Guard. Your hard earned money is always at risk of a possible economic upheaval. Remember the best two principles of Warren Buffet (a) Never lose money in investments/savings (b) Always remember the first rule. As you know, it is not an easy job; but very little alternatives.
We had also discussed about the parallels of 2009 Crash to the Collapse of Japanese economy after their fantastic economic growth in the 1970s and 1980s, where Japan witnessed fast rise in real estate, stock market and all asset classes fuelled by cheap credit policy. But mainly due to mismanagement of the interest policy regime, the stock market crashed, debt crisis followed, banks collapsed, triggering bailouts by Japanese Govt, which sound so similar to the US story of 2008 end/early 2009.
What did Japan do during the 1990s after the gigantic economic shock? Among the steps by Japan, zero interest rate regime was the most famous to create demand. But deflation set in Japan creating lot more problems. Stock market index (Nikkei) that touched 38,957 in Dec 1989 is still hovering around 9000 levels today. The real estate prices are now going at the fraction of bubble times. Why did the deflation set in the Japan? Many reasons are highlighted by various authorities.
a) Sharp drop in post bubble asset prices. It is partly emotional. After burning the fingers in the crash, many investors (including retail investors) won't touch the same asset class and may even warn their children.
b) Risk averse banks: Post bubble, many banks were literally destroyed by the large percentage "non-performing" credit assets(i.e.loans that had to be written off). This reduced the credit risk appetite of banks.
c) Businessmen, who recently experienced the trauma of economic collapse and witnessed drying up of demand and non-payment by debtors did not take risky decisions. They were reluctant to borrow and expand questioning whether the hard pressed consumers will buy more.
d) Japanese people became fearful of banks' collapse. They bought gold or invested in United States/Japanese Treasury securities instead of bank deposits, reducing the funds available with banks.
A university professor at Tokyo University in a recent research of young adults stated that "the lost decade made young people timid and afraid of what to do; it is made them even more risk averse". It is not good news for Japanese, who are famous for their hard work and astonishing growth from the shambles of Second World War.
Against this background, it is understandable why Ben Bernanke is pumping money into the US Economy through Quantitative Easing. Deflation should never be allowed to lift its ugly head. Deflation was the major problem in post 1929 crash also. As we mentioned earlier in this blog, the Governor of the Fed had studied the 1929 US depression (and got PhD). Those days the dollar was pegged to gold. Because of this peg, the Fed in 1920s couldn’t just print dollars to counter deflation. Thank God, there are no more gold standards out there.
Let us hope USA won’t witness a lost decade. USA has a more dynamic economy than Japan with greater employment mobility and entrepreneurial energy. The working age of Americans is not shrinking unlike Japan. Moreover, USA has sprung back from its previous recessions since the Second World War smartly because its free economy allowed the economic agents greater flexibility to cut costs or lay off or recruit resources. Let us hope this dynamism will ensure that there is no lost decade for the USA, which will benefit the world, since US is still the biggest economic player in the world. Let us also hope China will not play a spoil sport in this great recovery game.
What this mean to you and me? Well Be on Guard. Your hard earned money is always at risk of a possible economic upheaval. Remember the best two principles of Warren Buffet (a) Never lose money in investments/savings (b) Always remember the first rule. As you know, it is not an easy job; but very little alternatives.
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