Another Foolish Rate Hike?

For the 14th time, since Mar 2010, Reserve Bank of India (RBI) is likely to raise interest rates again on Tuesday.

That could be a record on rate hikes!!

The purpose of all these rate hikes is to curtail inflation, especially food inflation. However, the recent inflation figures show that the overall inflation, especially the food inflation remains high at 10% or slightly higher.

Evidently, the rate hikes are not working. But it seems that RBI is bent upon doing the same thing again and again to reduce inflation (Someone told sometime back that one of the symptoms of lunacy is doing the same thing again and again and expect a different outcome!)

Financial Thoughts view India's inflationary scenario differently as follows:

1) Interest rate hikes + Petroleum product (diesel, etc.) prices will ultimately drive up the cost of production at farm level.

2) The food prices in India are lowest among the world. That means the farm profitability in India ought to be among the worst in the world. No wonder many farmers in Andhra Pradesh decided recently to leave their farm uncultivated. If you travel through the picturesque Kuttanad region of Kerala state you can see hectares after hectares of agriculture land uncultivated, just because it is no longer profitable.

3) A recent article on rice exports has shown that the rice from India is the cheapest in the world. (http://gulfnews.com/business/economy/indian-rice-exports-will-rise-as-floods-cut-thai-supplies-1.903088). This implies two issues (i) there is potential to charge more (ii) if the profitability of the uncultivated farm lands are ensured, the supply would increase, partly contributing to the Supply in the Indian economy which would ease inflationary pressures

4) Those who support further indiscriminate rate hikes must go back to US in 2006 when US Fed was blindly hiking the rates in pursuit of a mirage, which achieved nothing but a fantastic economic collapse in 2008

5) The solution for the inflation in India is increase the Supply side. A booming India has insatiable demand for more vehicles, better food, better & new road networks, travel facilities, more air ports, better ports, more metro railways, and other infrastructure facilities. But the mind boggling corruption at the high places is stifling the Supply side. Billions worth of infrastructure projects are not yet approved or actioned by several government (both central / state) levels either fearful of intrusive media/investigation agencies by honest officials or just because the dishonest ones negotiate better bribes as there seems to a rapid inflation in bribe rates as well.

As Infosys Chairman Mr Moorthy mentioned, after all it may be better to legalise corruption in one way or other - as some of the western countries legalised prostitution!

6) Let the food prices increase and let it stabilise at a higher level (than current levels) so that the farming becomes a highly profitable venture so that the teeming millions of India can turn to farming, instead of turning away from it and migrate to cities, which in turn chokes them and create infrastructure nightmares.

Based on the news and information, it appears that the rate hike is highly likely. That could trigger a stock market correction. Hence, I am going to take protection for my portfolio through some cheap puts and preparing to buy selectively as the market crash could possibly offer some good stocks at deep discounts.

Happy investing! 

Another proof that Warren Buffet is the Most Intelligent investor !!

In 1934, Ben Graham has written one of the best investment books “Intelligent Investor” and a very wise and intelligent investor read it at the age of 19. The reader of the book (who till then tried his luck with charts and technical analysis) understood the value of the book and complied with the principles religiously. And he became the most intelligent investor in today’s world and currently enjoys position as the second richest person in the world.

Almost every investor ought to know this person - None other than investing genius Warren E Buffett.

Now he asks American rich to give back some of their wealth to the government so that it can balance itself while walking on the tight rope of fiscal balance. US deficits are so high that it can topple the fiscal balance and drive its economy deep into recession and stagnation over the next decade.

Warren Buffett supports taxing the rich and knows a lot about becoming wealthy.

BUT most of the American rich class refuses to do this. The stupid rich who refuses to help their own Nation at this moment of crisis lacks the intelligence of Warren Buffet due to the following reasons:

1. Rich can become richer only in a growing economy. Hence, by paying more taxes and saving the US economy, the rich is helping themselves. A decade of recession doesn’t benefit anyone, including the Rich. Whatever tax they pay now, can be recouped easily through higher profits from their businesses and increasing asset values. Warren Buffet knows this.

2. China growth during the last decade averaged about 9%-10% and even if it slows down (as desired by some myopic western economists), it will easily clock a growth rate of 8% while US economy will face recession. This will accelerate the takeover of No1 slot by China as the wealthiest (& largest) economy in the world. The humiliation of China overtaking the American pride as the No 1 economy will add salt to the injury. Let rich US American be greedy and stingy and cling on to their wealth as their own Nation’s pride goes down the drain.

3. Some writers speak about Warren Buffet being stingy and miserly. I don’t think so. (His middle class attitude gave him robust health and balanced approach to life that helps him to think on his feet. This attitude is comparable to Ben Franklin). On the other hand the rich class of the US who doesn’t want to help the US Govt by agreeing to more tax to reduce the debt burden of the Nation is the real miserly and misery lot.

4. Well, if the statistics provided in the recent press is correct, the poor class in the US is the fastest growing in the world. With the next possible recession in the US, the poor class in the US would rapidly rise and you can see sorrowful souls in soup kitchens burgeoning. Don’t know how the rich class in the US with see this – possibly the villain character (i.e. Scrooge) in Charles Dickens novel 'Christmas Carol', would look a gentleman compared to them.

By refusing to go by the most intelligent investor Warren Buffet’s advice, the rich class of the US is helping China, torpedoes their own future wealth and proves Mr. Scrooge is better than them.

US Economic sluggishess = 1990 Japan. World economy will grow, as in 1990s

Recently, Fed came out with the most funny statement that meant there is 'significant risk' to global economy. Are they still think too much of themselves?!. Of course, US could follow Japan of 1990s thanks to the stupidity of US Fed leadership, but the world won't follow the recession of US.

World will brush aside US just as the economic sluggishness of Japan - then the 2nd largest economy - was ignored by the world. Nikkei Index crashed during 1990s from 20000 to 8000. But during this period US Dow and SPY recorded sharp increase. So did the European indices. So, going forward, you will see corrections in stock indices of US, but Emerging Markets - especially China and India - will march ahead. And of course, those US companies with global reach and focus on these markets could also do well.

Soon US will become the SECOND largest economy in the world as China claims No 1 slot. Already they are ahead of US in many fronts. e.g the largest car market is in China now, the largest number of new millionaires. There are many who wants to see China to go down economic recession route along with US just because they export to US. But China is moving into their untapped potential of huge population with increasing wealth. China will never enter the recession zone! on the other hand it will continue to grow

On the heels is India, which will topple Japan as the third largest economy during this year or early next year. India's growth momentum is unstoppable and they do not have any significant exposure to US except IT. Hence, they are very safe in today's global economic environment.

Both China and India will benefit from reducing commodity prices.

Hence, even if US hits recession zone, these two giant economies will act as the counter balance.

Don't worry , be happy and enjoy the Discount Season in the stock markets!

Clash of Financial Titans

It is almost two months since this blog has been updated. The reason is that I was on vacation and had several other issues to be tackled including a possible shift in career. However, financial thoughts never left me because the last two months were really crazy. Major financial events were:


1. Fear of USA defaulting on its debt as the President and Congress quarreled on debt ceiling. Once again, after the disputed election of George Bush, it proven again that USA is not far from becoming a 'banana' republic.

2. Downgrade of USA by S&P and its consequences. Whilst the person who showed the courage to downgrade USA (which I believe is apt given their debt burden) has lost his position (of course USA does not use coercion!) the world financial markets went for a topspin. I made the opportunity to make some long term investments in affordable quantities of some good companies. Warren Buffet makes jokes of folks pursuing diversification as an investment strategy and states that diversification is required by ignorant investors. Well I have to admit that I am one of those ignorant ones and given the kind of corporate governance these days, I have no courage to make concentrated investments. In fact, I revisited my investment portfolio and reduced the certain investments, which I felt suffered from concentration risk.

3. Fear of Greece default and its consequences on French and German banks. British, as has been consistent with their historical record, is adept in keeping distance from the continents problems until dragged on to it, is proudly claiming that their banks are immune from the catastrophe that will hit the banks in the continent. However, this confidence may be misplaced as the 'liquidity winter and freeze' that will hit the European Banking & Financial Sector should Greece default (= 2xLehman?). It will blow cold chills winds into the British Isles as well, which will force them to act. Although not in financial front, this happened during Napoleonic times, First World War and Second World War. (During my recent visit to UK, the woes of economic crisis were visible almost everywhere, which recently culminated in riots. It is a wonder how this Small Island commands respectable position in the world. It seems that the nations prayer "God Save the Queen/King' is being answered through generations)

During my vacation, as I focused the thoughts on the financial safety of my investments, the near future outlook offers no comfort. Threats of double dip in US, weak Eurozone, possible collapse of Euro, slowing Indian & Chinese growth, are major challenges. All started with the fall of US real estate market in 2007, which is caused by Ben Bernanke’s "Himalayan Blunder" of fast interest rate hikes. Allan Greenspan open the doors of Real Estate boom with low interest rates and Ben crashed it with higher rates. A handful, mainly hedge funds, FIs, HNWIs,etc made tons of money (but many and the most of the retail investors lost) when the real estate crashed. Whilst banks and institutions who lost money were supported by Govt (bail outs) whose senior management continue to enjoys bonuses, the middle class is now being pushed in poor class.. see the latest news of increasing poverty in the US.

I believe there is two schools of thoughts caused this crisis – a clash of Financial Titans ( Thoughts). Allan believed in credit, somewhere I read that he has stated that a person can be born in credit and die on credit if the welfare state looks after his needs like hospital, education, old age, etc. He believed in credit and it is stated that this reflects in the book he authored after retirement from Fed Governor position.

Ben on the other hand is a traditionalist and doesn't like too much credit and hence tried to de-leverage the US economy too soon too fast, resulting in a spectacular crash and made mess of everything. After Lehman crash, confused Ben hurriedly slash the interest rates to all time lows. (May some one ask Ben, why he hiked the interest rates in 2007 in the first place, if only he had to slash it lowest levels in just one year? No wonder there are many who believe US and World would be better if Ben is replaced!!). Remember Ben and his team could even know how the interest rates could impact the economy and wide social fabric- economic mismanagement is evident by all US admin and they are making predictions!!

Some economists say it will take a decade to clear the things up. If so, the stock market may remain sluggish. Hence, I have also decided to give equal emphasis to equity derivatives to make some gains out of it, possibly through some option condors.

Oh! US Politics

USA is now competing against Greece - US Debt level is approaching 90% of its GDP while Greece Debt level is 120% of its GDP. Some studies have pointed out any debt burden exceeding 90% GDP is a long term growth deflator in view of the interest burden and repayment commitments.

Well Greece is accused of being spending too much and taken to task in international forums. It may be noted that the ultimate burden of the debt is felt on common people who lose jobs and face other economic hardships.

Let us see how US has built up this much debt

1) During Bush era, the costly Iraq and Afgan war commenced. Both cost about 2-3 trillion dollars and still bleeding. It is true that some of the American (oil) companies made big money in Iraq, but very little has been given to the US Govt in the form of taxes.

2) 2008 Financial Folly of "great American financial innovators' mixing toxic assets with good ones created one of the spectacular financial fireworks (crashes) in the human history. US Govt had to intervene, after the initial hesitation (that resulted in Lehman bankruptcy) which cost more than 2 trillion dollars.

3) Obama Administration's idea of extending social benefits of free health care etc also added a few trillions more.

4) Then there is the financial stimulus to kick start the economy also resulted in a few trillions to the US Debt

Overall it looks US policies were as good as Greece's! Hope US won't come work with 'financial innovation' or 'financial engineering" similar to the one that brought about the 2008 Credit Crisis.

There is no doubt that the US should cut its debt. The common sense says that it can be achieved by raising taxes and reducing expenses. But Republicans do not want to raise tax while Democrat (&US President) do not want to cut expenses.

Now there is every effort to increase the debt level with minimum tax increase and little cut in expenses. Such actions are meaningless. Without an effort to bring it down (which won't be easy) means the problem just gets postponed! US must take negative growth and unemployment for a few years rather than risking a 'debt crisis' in the future. The way it goes now, a future US debt crisis is a 'white swan'.

Will US debt crisis become a global crisis? Well, there are many who say that it could be a global problem. However there are a few who says it need not be. But it will accelerate the predictions (UN and IMF has already published papers) about the unavoidable move from US dollar as the world trade reference currency in global trade. A debt crisis by US will erode confidence in US$. Then China and India will buy oil from middle east and minerals from Africa in rupee and Yuan which will find acceptance from the exporting countries. Or they may prefer Euro. USD decline - which is their own making - is now not unavoidable, if any only if, US stop acting like a banana republic.

It is pertinent to note that Sterling was the global currency till 1950s. About 87% of the global reserves were in Sterling in 1947. After India got decolonized, the US dollar started its journey to become the reserve currency replacing Sterling. One of the reasons for this was the preference of former colonies to have non-Sterling currency as the reserve currency. Moreover US role in the global arena increased as they had great leaders like Roosevelt, which seems to be extinct in the current generation of US.

Well for investors, these are tumultuous times. It is better to trim down the exposure to the USD denominated assets.

Nasty Experiment called EURO (Part II) & Other Issues

On 27 Nov 2010, the topic by this blog was Euro and the imbalances it causes. The article was concluded saying that as long as Euro exists, there could be troubles. We stand vindicated. Greece issue has re-emerged with vengeance. All those who are involved are in state of confusion. Whilst French banks take a realistic view of part write offs, Moodys and S&P says it will be a default - first sovereign default in Europe since the second world war. (During June 2011,both Moodys and S&P have downgraded Greece to almost default status, is causing upheavals in markets, world over.) A default will have serious issues for Euro.

Third time during the last 20 months (Apr 2010, Nov 2010 & June 2011) the world's markets were rattled by Euro problems.

Europe is likely to be hit the hardest among major economies by a potential global slowdown in 2012. Europe faces the most bleak future among major economies, in part because the sovereign debt crisis in some euro zone countries (say Greece, Ireland, Portugal, etc) is unlikely to end soon, casting a shadow over the euro's future.

The domestic market in Europe is not recovering very fast, so most likely Europe's economy is driven by external demand (but exports are also increasingly difficult - ask China). Strong economies in Europe like Germany is also facing shrinking population resulting in lower economic activities and overall Europe is not a growth story at all, even in long term.

Moreover, the global economy is slowing led by the largest economy in the world. Definitely US is not recovering fast as predicted - if not going back into recession. Many economies (including USA) will have to stop stimulus and others tighten policy. The recent squabble among US politicians on raising debt levels show that US does not much options left.

As to the challenges facing the emerging economies , many has changed their pro-growth policies (due to concerns on inflation), hurting economic performance. India and China have been constantly increasing the interest rates during 2011. More hikes are expected. Overall, emerging markets is expected to continue to raise interest rates and allow their currencies to strengthen, causing a slowdown in economic growth in those countries.

In addition, oil supplies will likely be interrupted by the unrest in North Africa and the Middle East, resulting in high oil prices, which will further dampen the economic recovery of the world.

Be ready for more problems for Euro & rest of the world, which could adversely impact the world's financial markets.

Let us hope for the best; but prepare for the worst.

Future Blackswans & Possible Solutions

Once I was watching a programme in Discovery channel on chimpanzees. Like many animals (and humans?) chimpanzees also live in communities. They hunt together, gather food together and warn each other of any dangers. Each community is led by a leader. Any perceived challenge to the leadership is met with brutal attack till the challenger shows the body language of submissiveness. However, one day the incumbent will lose power to a challenger.

Humans are no exception. Human history is full of stories of brutality for the sake of power. Many human societies (called countries) even in the so called modern times of today - recent examples include Libya, Syria, Bahrain - attempt changes to leadership (or preserve leadership positions) through brutality.

But in certain human societies mainly Europe, North America and some parts of Asia, the community leadership changes no longer occur based on brutality. Challengers are given more peaceful means of 'election' to challenge the existing leaders. But we need to remember that not so long ago; Europe also followed the path of brutality to enforce change in leadership.

Interestingly, there are other common elements in the animals living in communities and humans, other than leadership. Interested readers may wish to explore more on this topic. However, the human societies are much more complex and have two distinct elements which animal kingdoms can never boast of - religion and money.

Various religions dominate different regions of the world. In certain communities (or countries) religious leadership takes the role of community leadership. If religion is strictly enforced, the society faces a big problem. Almost all religions do not tolerate challenge against their religious laws. In countries where religion is strictly enforced, the kids are trained only in religious laws. So the community is always forced and brainwashed to think 'within the box' stifling creativity and progress. If the religion is separated from community (state or country) leadership, then at least a few will dare to think 'outside the box' unleashing invention, creativity and progress. That is why countries such as Japan, Korea and West comes out with innovation after innovation. Let us hope the current MENA revolution will do what French Revolution had done for Europeans. However, at this point, when I write this blog, it seems that Egypt (equivalent to French during their revolutionary period) leadership will be taken over by the dominant religion (Muslim Brotherhood) who will force the community to think and act 'within the box' with predictable results & with no hope of creativity or innovation. Egyptians, who want to enjoy the flagrance of freedom, will continue to try to escape to the West. Let us hope Egypt will become a role model for the rest of MENA by electing a non-religious leadership to guide the Egyptian community who may re-create the times of Great Pharaoh's, whose technology (e.g. construction techniques used in Pyramids, preservation of mummies, etc) still amazes the scientific world.

Another distinct element of human society is the use of 'money' as a medium of exchange, which replaced barter system (some studies have pointed out that some animal communities also follow a kind of crude barter system to exchange favours!). It is interesting to note that Russia was able to do survive its economic crisis in 1998 and brush aside any offer of help from IMF as they focused more on barter system. (http://www.richardccook.com/2010/01/10/in-time-of-crisis-barter-works-and-may-have-saved-russia-in-1998/).

However, modern human societies, irrespective of religion and race, hold on to money. Money is a common factor defining purchasing power, status, wealth and it is something all communities tell their kids to aim for. Whilst individual nations have their own currency (money)to facilitate exchange of goods & services within its borders, there is only one global currency -the mighty dollar. But it is heading towards a collapse. China and other nations who stock the paper money called dollar is already nervous and it is a matter of time that they turn against US dollar and seek other medium to store value. Americans are not producing any goods and services to exchange with the rest of the world. But they buy as much as they can and settle them in paper. Once the world stops accepting the valueless paper, American economy is doomed, which will impact the rest of the world too. A dollar collapse will bring in 10x misery to Americans than they experienced with Subprime collapse. Let us hope USA gets its act together and start exporting something really worth, other than its paper currency.

These two features of human society - religion and money - have the potential of unleash future blackswans in the medium term. If MENA region slips into further religious and political leadership turmoil, then oil price could go through roof, unsettling many economies in the world. If the dollar collapses, then only history can tell us what will happen to the US economy and all economies linked to it. Many economies are significantly dependent upon on USA as it is their major consumer market - e.g. Chinese products, Indian IT and Arabian Gulf Oil. Given the impact of dwindling population of many western economies, they also look to US markets for exports.

Given the possibility of a black swan lurking around, you may wish to protect your portfolio against a disaster scenario. Well, I think stock options may be one of the answers. For those who are not familiar with stock options, broadly it can be defined as a form of insurance, especially Put options. It may be worth to expense off cost of options while waiting for the black swan, which could in fact unleash a profitable opportunity, which actuarially could repay the cost of options many times over. Or you may explore a combination of options, wherein you place a structure by selling and buying call and put options.

Let us hope for the best, but prepare for the worst.

PS. A Word of Caution/warning: The risks involved with trading stocks, options and other securities may not suitable for all investors. Prior to buying or selling an option, an investor must evaluate his/her own personal financial situation and consider all relevant risk factors. Also See: Characteristics and Risks of Standardized Options (http://www.optionsclearing.com/publications/risks/riskstoc.pdf).