The Compleat Trader

Rising Support for Yuan as a Reserve Currency

2010-06-26T21:31:00.001+05:30

CHINA VS. INDIA

More than one year ago, I had written on this blog regarding the global ambitions of China; in particular its push to get Yuan accepted as international reserve currency (Of Triffin's Dilemma and China's Ambition , April 6, 2009). Since then, things have moved slowly, but almost surely in favor of this move. The latest voice to be added to this growing 'movement' is that of Asian Development Bank, which released a report this Thursday suggesting Yuan 'has the potential' to become an alternative to the US dollar (Yuan can become alternative reserve currency to US dollar-ADB).

At this point, it is not known how long it will take for the Yuan to "internationalize". That is irrelevant. What matters is the reality of China becoming more and more important in the international financial system and its implications.

China has emerged as a stabilizing force over past 18 months in the aftermath of the global financial crisis. It has done favors and most likely would have been promised rewards in return. Furthermore, China's continued cooperation is important for the world to avoid lurching back into the deep, black hole that was barely missed about 18 months ago. In other words, the timing is just right for the dragon to stake its claim to its rightful place in the world.

That brings us to the next question: what is dragon's rightful place in the world? That question gets answers as diverse as the 'color depth numbers' on the latest LED TV models; right across the spectrum. There are those who just can't stop loving China, staking everything on its economic juggernaut. There are those who just can't help being skeptics. Then there is the newer, emerging view that China is just like Japan in the late '80s; overrated, but just a spent force about to go belly up.

Truth is likely to stranger than all these punts. Punts they are because it is hard to know China despite all those 'research dollars' being thrown at it by consulting firms, investment banks and brokerage houses, trying to make sense of the puzzle that China is. Instead of relying on these 'house views' and 'in-depth studies', it is better to simply look at the growth curve of country and something rather simple: human behavior.

And the human behavior dictates that the internal consumption story in China has not even woken up yet to its full potential. Per capita GDP numbers hide a vast gulf of disparity between China's elite and its have nots. The have nots have kept quiet so far due to the ability of the system to deliver and the system has been delivering. Why should they put their faith in anything else? As soon as their turn comes, an army of consumers will rise. There is nothing to stop them.

There is a historical precedent to it as well. Much to the chagrin of purists, the US of A provides the prime example of an economy in transformation; exactly one hundred years ago. The economy had just been finding its feet after a 50-year growth run with per capita incomes of about $5000 in today's terms (about $1000 higher than today's China, but then you can't be exact about this stuff). What happened after that is anybody's guess. Runaway growth, wild capitalism, rampant bull runs; only to be tempered by a Wall Street crash and global depression twenty years later.

Folks, the dragon has barely begun. More on this later.

Ciao. And apologies for disappearing for so long.

Why We Need a Stop Loss

2010-04-08T11:53:00.002+05:30

TRADING PSYCHOLOGY

My favorite piece from Zen literature.

Master Caotang Qing said:

The fire that burns a meadow starts from a little flame, the river that erodes a mountain starts drop by drop. A little bit of water can be blocked by a load of earth, but when there is a lot of water it can uproot trees, dislodge boulders and wash away hills. A little bit of fire can be extinguished by a cup of water, but when there is a lot of fire, it burns cities, towns and mountain forests….

When people of old governed their minds, they stopped their thoughts before they came up… Therefore the energy they used was very little while the accomplishment they reaped was very great.

- Zen Lessons, translated by Thomas Cleary, Shambhala Books, Boston

I don't think I can say it any better than the Master said. So I will just shut my trap and let you meditate on it.

Confirmation pouring in: We are in the middle of a commodities boom and a dollar flood

2010-04-06T13:03:00.001+05:30

GLOBAL ECONOMY; GLOBAL MARKETS

I did not expect confirmation of my yesterday's views so early. Of late, confirmation has generally been arriving pretty soon for what I have been observing. On NIFTY breakthrough (Violent and Brief), it took the market barely one day to cross the long held resistance.

There is sporadic evidence emerging for the hypotheses I proposed yesterday (Recovery : Final Confirmation, Twin Deficits and Rising Inflation). Broadly, my argument is on the following lines.

Recovery in the West has been underway for some time and now we are seeing final confirmation of the same.
At the same time, this confirmation is of little use, mainly because what brought the recovery is going to be a massive drag from here on.
The large US budget deficit is also going to create a massive trade deficit. This means:
- Higher purchases of US treasuries by foreign governments; this will fail to absorb the entire trade deficit.
- Additional dollar supply flooding the market; since there is no penalty for the US for letting the world slosh in its money. Exactly one year ago, I was ranting about the same thing and why China and even EU want piece of the action (Of Triffin's Dilemma and China's Ambition). It is funny how an old rant can seem new sometimes.
- Commodities on fire; the dollar flood is going to simply push commodity prices out of the stratosphere.

A cursory glance at Bloomberg page today brings the following news.

Rise in Treasury Yields Slowed as Currency Reserves Grow Fastest Since '08

Oil Surges to 17-Month High on Signs of U.S. Economic Growth

Copper Advances to Highest Level Since August 2008 on Recovery

Financial journalism tends to put a spin on everything. Right now the spin is 'recovery'. Well, there is another explanation that is far simpler; dollar flood. And then there is the Euro flood that is almost as big. And then, there is the Pound flood that is the biggest of all in relative terms (just measure the relative sizes of the budget deficits to the economies). The "gainers" of this not-so-hard earned money, on the other side, are also easy to identify. Export powerhouses like China (who incidentally refuses to let the currency appreciate) and commodity dependent economies. Japanese yen is around 93 (you can bet the Japanese are not very happy about it but will keep quiet because it will rise to probably sub-80 levels if they let it go free), Australian dollar is heading towards parity again and Brazilian Real is at 1.76. The evidence is all over the place.

To avoid confirmation bias, am still looking for that one bit of contradicting news which can disprove the hypotheses. If you come across something, please do throw it in.

Recovery : Final Confirmation, Twin Deficits and Rising Inflation

2010-04-05T18:11:00.001+05:30

INDIAN MARKETS; GLOBAL MARKETS

Much has been made of the recent job growth numbers out of the US. They are a very positive sign of course. But what does it augur from markets' point of view?

Not very much, not at least from the US markets' perspective. Here is why. In any typical recovery, most of the indicators start registering a positive long before growth starts showing up in job numbers. As an indicator, growth in jobs is probably the one that lags the farthest behind. The reason is not difficult to see, no matter how rosy the outlook starts becoming, you will always want to check twice before you add those extra workers to your payroll. If you have any doubt, you will most likely opt for paying overtime or other such temporary measure.

Hence, the value of the indicator is in confirming that a recovery has actually taken place. Yes, it makes not a very convincing confirmation since the number has been positive only twice. But if you are waiting for further confirmation, you are already way behind the curve.

It does not augur necessarily well for the US stock markets. Much of the move has already happened and there are major challenges going forward. The toxic assets that caused the problem in the first place are still stuck somewhere in the system. The large stimulus, even though it drove the recovery, is going to be a major drag in the form of fiscal deficit in the US.

For emerging markets, there are many positives though, particularly for India. India came out of the shock with relatively little 'stimulus' and whatever has been provided has been rolled back. Fiscal position is looking good. Hence, the growth is solid. Furthermore, even financing crunch (due to lack of liquidity) is likely to ease, as explained below. All looks well for Indian market, except that inflation is going to be a complete pain.

Rising liquidity

Huge budget deficit in the US is going to drive a huge trade deficit too (they are two sides of an equation, no matter how much hot air US policy makers blow, there is no way you can eliminate one without eliminating the other). Which means the world is going to get inundated in dollars too. Whether you like it or not, a dollar flood with continuously falling interest rates is inevitable over next one year. Some of it will go back to the US as Central Banks buy US treasuries, some of it will simply be funded by excess money supply. Such is the prerogative of those supplying the reserve currency of the world.

Commodities again

No turning back the commodity inflation cycle from here. Once again, the rollicking days of ever rising commodity prices are here. That is likely to be the situation for next one year. If you bought some of those metal stocks here when they were going cheap, you are going to be rich pretty soon! Jokes apart, we are looking at a repeat of the late '70s here, nothing less.

Violent and Brief

2010-04-02T22:39:00.002+05:30

INDIAN MARKET

So we did have a dip from the 5300 levels afterall (Waiting for the Breakthrough) on the NIFTY. Nothing very surprising there. The market has bounced back from its minor correction (if you want to call it that). We are back on the gates of the 'zone de résistance' and things might get stuck here again.

Or they might not. I do not know whether the bearish side of the market has had its fill of adventure or not. If not, we will see another skirmish. But at some stage (possibly in this very move), the zone is likely to be overrun.

And it is likely to be overrun in a big way. This is not the first time that this level is working as a major resistance. Post the Lehman dip, this level has alwathings might get stuck here again.

And it is likely to be overrun in a big way. This is not the first time that this level is working as a major resistance. Post the Lehman dip, this level has always held. It was not broken during the post election rally, held out once again against medium term trend and is proving tough to breach for the medium term trend move.

The strong resistance means that a break is likely to be fairly forceful and swift when it happens. There is a lot of pressure built up that is likely to be released when the breach comes. All the doubtful bulls sitting on the sidelines will jump in at the sight of a convincing breach and that will make the move quite sudden.

For those salivating at the thought of making a quick buck in the move, here is a sobering thought. Given that a large chunk of the market is now dominated by robo-trades, there is no way exact timing of the move can be predicted. Going aggressively long has its risks, as you can get caught in the 'sucker bet' downmove generated by automatic algorithms. At the same time, there is no telling when the market may make a sudden breakout. In all likelihood, it is going to be a very violent affair, and a very brief one. Given the nature of trading in the market, it may be over before you can say "gotcha!!!"

A Questioning Mind

2010-04-01T14:16:00.002+05:30

TRADING PSYCHOLOGY

Yesterday's piece cited one recent piece of research that insists there are specific 'centers' in the brain that control temptation. Also, 'stimulating' those centers somehow seemed to alter the level of temptation subjects could bear. Does it mean we should snap electrodes to our heads to stimulate our brains before sitting down in front of the trading screens?

The answer to that brings us to another important trait that makes a successful trader, a questioning mind. On the face of it, the research seems innocuous and straight forward. But it might not be. There are too many give-aways. The first one is the intent to produce a 'drug' that can help you control temptation. I won't even get into the ethics of doing this. The other is the fact that there could be a much simpler explanation for the phenomenon observed. We all know (thanks to a movement that took this principle to the height of stupidity) that the right side of the pre-frontal cortex processes information holistically while the left side processes sequentially. So it is not hard to imagine that stimulating the 'holistic' side will help you thwart temptation while working the sequential, 'next step only' side will drive you right into its clutches.

This is too simplistic, of course. As simplistic as the right-brain left-brain movement, which incidentally made the assumption that 'using your right brain' was a simple matter of shutting down half of your brain (a truly "half-brained" approach). Let us not even get there. But the moot point is that you can avoid questioning 'given wisdom' only at your own peril.

The same applies to investing also. "Very well known" you would say, "tell us something new". Well, the new thing is that 'cultivating the questioning mind' is something different from what it is made out to be. What does not matter is how many questions you raise, because simply raising questions is not enough. What matters is what questions you are asking and what you are willing to accept as an answer.

The importance of asking the right questions and framing has been explored long ago by behavioural finance pioneers Tversky and Kahnemann. Those who are interested in the area would enjoy their brilliant work and how ingeniously they separated the motivations at work layer by layer. In most of the cases, path breaking conclusions look extremely simple in hindsight, though getting to those solutions to begin with might have been extremely hard (due to orthodoxy, 'given wisdom', etc.). The beauty of their work is that most of what they say is so counterintuitive that even today it never fails to startle. To come up with answers that are counterintuitive yet startlingly true, not only against the 'given wisdom' of the time, but still amaze three decades later requires a rare quality. A truly questioning mind.

More will follow.

Hard Wired Traders?

2010-03-31T23:07:00.001+05:30

TRADING PSYCHOLOGY

There is some good news on the trading horizon. At last, you have a way to literally shock your brain into doing the right thing. All traders have known for ages what the right thing is; take your losses, sit on your profits, so on and so forth; but succumb to temptation.

New research indicates that "maturity" (or lack thereof) of the pre-frontal cortex is to blame for people falling to temptation (try this Yahoo link for the full story). This has fairly strong implications for people who want to become active traders or investors. It is no longer a matter of following some standard advice on 'taking your losses'. It boils down to whether you are wired or not for taking the high pressure situations this profession puts you into.

Ability to delay gratification or to withstand temptation is a core measure of maturity of a person. The trait is valuable across the board. It is the best predictor of future success at an early age. It can determine whether you live a healthy, well adjusted life or will indulge in self-destructive behavior. It is at the heart of decisions like whether to get up early in the morning to exercise, give up that next drink so that you can drive home safely or give up the dessert after dinner despite being presented with truly sinful but delicious option. It also has implications like whether you will diligently plan your finances or will run budget-busting credit card bills. But nowhere is this more visible than in investing and financial markets.

Trading and investing (I do not necessarily differentiate between the two, it is just the time horizon that separates a trade from an investment) definitely requires an ability to give up short term pleasure, even bear extreme pain (remember the last stop-loss that you took?) for long term gain. From start to finish, trading is all about sticking to the discipline of doing the right thing.

This advice has sounded very easy to follow. But real world stands testimony to how difficult it is to practice. Barely 1% of traders are profitable in the long run. The usual explanation for this has been 'trading talent', but it has remained elusive what this talent is all about. How do you differentiate who will be a good trader and who will wilt under the temptation of letting that loss-making trade run just a little bit longer in hope of salvaging something?

Surely, trading involves a lot more than just brutally enforcing your stop losses. It requires diligent research, a sharp and keen mind and a great run of luck. Still, some of us could use just a little bit more of that discipline to make the difference.

So where does this lead us? Shall we all wrap electrodes around our heads and start "stimulating" the correct regions of the brain? May be not so fast. More on that later.

A Strong Sense of Entitlement, or Something Else?

2010-03-30T20:43:00.001+05:30

TRADING PSYCHOLOGY

Last week, there were two very interesting headlines Times of India's Delhi Edition had on its front page (of course, hidden behind the annoying half page of advertisement that simply kills the pleasure of picking up a paper in the morning). The first one was on the fire in a building in Kolkata. The story writer ranted on 'unapproved additions to the building', lack of safety norms and so on. The conclusion was that the civic authorities had failed completely in their duty.

This is not interesting on its own. The interesting part was the second story. Again, the writer ranted on cancellation of day one of fashion week in Delhi. The arguments were on the lines of authorities having been informed sufficiently in advance, people waiting in queue, authorities not getting their act together, etc. Buried somewhere in the story was the fact that the organizers were not able to meet all safety guidelines and that delayed approval.

So there you are. As a society, we are heading to a situation where we cannot tolerate even a minor disruption of what we want to have. We want our gratification, right away. Somebody else owes it to us and we will shamelessly lash out even when we are at fault for delay.

That attitude kills an investor or a trader more than anything else. In this game, there is nothing worse than getting into the ring (figuratively, now that everything is electronic) with a strong sense that the market owes it to you. Even a small dose of this poison can do irreparable harm to portfolios carefully nurtured over long periods of time.

For a trader, it is even more dangerous. You cannot blame market analysts, policy makers, the government, media or anyone for anything. The trader has to take responsibility for all that happens to her position. The trader cannot blame even the tools, so what if a tested technical pattern did not hold out on a particular day and you lose money? The market does not owe you anything, nor do Mr. Head and Shoulder, Mr. Double Bottom or Ms. Third Wave.

Why am I writing all this? Because after years of reminding ourselves over and over again, there still is a day when the stop losses get hit and we just cannot help cursing that analyst whose 'advice' provided that extra bit of justification needed for putting on a trade. You can laugh at them, berate them or otherwise disagree; but you cannot blame them. The blame lies squarely with you, the Trader.

Waiting for the Breakthrough

2010-03-29T13:16:00.001+05:30

INDIAN MARKETS

The market is stuck at a strong barrier, the strong resistance of getting past a previous high in the recent past. The general prediction in the market seems to be that the resistance is too strong and this is the time to take profits. Is it really?

Let us consider the pure momentum argument. This market has had a lot thrown at it over past one month. High inflation in India, tightening stance by RBI, possibly higher interest rates, international risks (e.g., possible Greek meltdown) and so on. The result? The market barely blinked.

On top of that, we have had a sizeable portion of the market yelling that the market is ripe for a break and it is time to take profits. Still, the market has refused to break down.

Instead, the market has spent considerable time getting consolidated in each "resistance" range. And then breakouts have happened, very quick movement and then you get stuck again at the next "resistance".

All this means only one thing, the "resistance" is the last stand of the bearish crowd who have made tons of money in the past taking similar positions and are waiting for another repeat of the "same old thing".

I do not know whether this "repeat" will happen or the market will break through this time. I am completely agnostic to either. But given the strong amount of resistance at the moment, any break from here is going to probably pause only once (may be 5500?) before the last barrier is broken and the floodgates open. Once that happens, this market might not stop before revisiting its all time highs. Who knows?

Who is right?

2010-03-12T15:45:00.001+05:30

GLOBAL MARKETS; INDIAN MARKETS

Globally, things are in a flux. There seems to be some consensus that the economy is on the path to recovery. Still, global economy is going through a lackluster phase and the net data flow is neutral at best. This is perhaps the best time to observe what predictions people make and how those predictions pan out (and most of them will end up doing something pretty "rude" to themselves, that is an almost foregone conclusion).

As usual, when things are finely balanced, opinion gets split in the middle. With one half seeing catastrophe ahead and the other seeing recovery, where does the market end up? The most likely answer is 'nowhere'. Performance gets lackluster and things do not look like moving. Rangebound movement is usually the result and whipsaw is frequent. But what is the prognosis?

For a trader, the best thing to do is to admit that no one knows a damn thing about the future at such a juncture. That includes the trader himself/herself. It is like driving blindfolded and is probably the most interesting (though very bank-balance destroying) trading experience.

Some things can work. Including running very tight stop losses and trading ranges. Some things cannot, as this is the worst possible time for trend followers. As the trend in the global market will take some time to emerge, there is some time for money for trend followers to show up.

The implications for Indian market are clear. Any sustained upmove in the interim period is going to be amplified by global funds as people chase higher returns. Also to be expected is a higher churn as money moves due to the shifting sectoral share in growth. While currently the Indian market is also very dull, this clarity will start dawning sooner rather than later and an amplified move can be seen emerging any time over next month or month and a half.

Good time for people who believe in accumulating stock slowly and make good money in a sustained upmove.

But keep one thing in mind; no one knows.

What not to touch in the markets?

2010-03-11T14:16:00.001+05:30

INDIAN MARKETS

While the market has started moving in a direction that looks more positive, there are several danger signs that need to be watched out for. Also, many sectors in the economy are going to put in a lackluster performance and some are secular laggards over next few years. Here is the list of things that you need to avoid in the coming one year.

FMCG. All said and done, where is the growth for the sector? The only answer to that is the rural market. The food component of the business will continue to grow as the economy accelerates but the rest is not likely to grow too fast. How many soaps can you consume in a day? How much extra can you get from the same consumer for the same set of products? What do you do about the low cost competition from the unorganized sector? These are the questions that made FMCG a big underperformer in the previous bull run. Nothing has changed now to make it an outperformer.
PSUs. Other than infrastructure and perhaps banking, there isn't any sector where PSUs provide a superior growth story versus the private sector counterparts.
IT and BPO. Regardless of what people thought, reality is that a recession in the west is not a dampener for most of outsourcing related work. As firms seek to cut costs, there is countercyclical force in favor of outsourcing based businesses that dampens the effect. Now the situation has changed with anti-outsourcing sentiment as strong as ever, pressure to outsource ebbing and a currency that is strengthening; the attractiveness of the sector would be at an all time low; no matter how many "signature deals" you see. It is no longer a "growth industry". You are looking at a mature industry with moderate growth rates and valuations it deserves are more like FMCG and less like renewable energy.
Retail. The model that fueled runaway growth has failed. Period. Like the internet boom of early this decade, the industry is going to be around, just not in the same shape with the same value proposition. Rejigging the model takes time. So watch out for retail's comeback, only not in 2010.
Textiles, garments and other also rans. With the policy dice heavily loaded against this sector; little hope of a comeback. A real pity though, this is the sector with highest employment generation potential with just a little amount of training (unlike software that takes years of education). No wonder every developing country has this sector on top priority. But Indians do things just differently…

Avoiding these sectors is important for the health of the portfolio. But a winning strategy takes more than just a list of stocks to buy and to avoid. More on this later.

Time for a Secular Bull Run? Part - III

2010-03-08T17:45:00.001+05:30

INDIAN MARKETS

The theme for past one year has been dominated by consumption growth (led by rural demand) and resumption of the commodity cycle. Metals were poised to gain the maximum from this theme. So were two wheelers, telecom and other consumption led sectors.

This part of growth story is not going to be as strong for next two months. The effects of bad monsoon will take some time to clear up. The disposable income delivery by the agri-sector would have happened in 4QFY10. The sector has turned out to be weak and the resulting impact on disposable income will dampen demand from this sector.

At the same time, the changing fundamentals of the economy are likely to kick-in over next 12 months. I want to caution that all the positives we have identified are slow acting and none of them is going to deliver a sharp jump up in the markets. Still, a slightly positive bias is likely to rule for next 12 months.

Which sectors are likely to lead the charge over next 12 months? There are quite a few, which provides very good diversification options to investors and traders alike (though traders will need to trade with a longer time horizon than usual to gain from this).

Banking. Favorite whipping boy of the bear runs, will likely get back in the forefront over next 12 months. Several positives, stable interest rates will not steal the wind from bond portfolio sails, rising credit offtake (particularly from housing sector), lower threat of bad loans to name the few. Some banking stocks are a "must own" in any balanced portfolio.
Real Estate. Finally out of the woods, the sector is likely to limp back to its footing over next few months. The recent withdrawal of "teaser rates" is actually a vote of confidence in the sector by the anxious bankers. They no longer feel the need to offer sops to borrowers (a "not so important/risky" set of customers) to make sure the riskier and more lucrative set (builders) stay solvent and afloat. Back to the times of rising greed and runaway prices?
Capital Goods. Must own over next 12 months. Like it or not, capacity expansion theme is here to stay. Last 18 months have seen capacity expansion disappear as "captains" of industry turned into anxiety–ridden wimps. Now that the scare is over, sooner or later, everyone is going to get the scare on the other side: "we are not poised for growth anymore".
Auto: Mildly positive. Caution needs to be exercised, with an eye on next monsoon. If it turns out to be good, two-wheelers will gain only at the fag end as rural income growth comes back.
Media: As confidence goes up, the lifeblood of the sector, AdEx, should also start rising.
Infrastructure and related (cement, etc.): Make no mistake about it, India is so starved of infrastructure today, any project is likely to make money. One of the best bets if you want safe, assured returns as a big ticket investor. The only question is, can the government get out of the way fast enough?

Along with these sectors, there are some that need to be kept at a distance. A note of caution, since they are not likely to do much over next 12 months does not mean they are easy shorts. Instead, they are more likely to be lackluster, yielding gains to neither bulls nor bears. A detailed look at some of them tomorrow.

Time for a Secular Bull Run? Part - II

2010-03-05T16:45:00.001+05:30

INDIAN MARKETS

The consolidation mode markets went into over past few months has hidden a major shift in underlying fundamentals of the economy. A number of things have happened in this period.

Fiscal profligacy has come down. All said and done, the government did not fall for unlimited stimulus. I suspect a strong underlying theme would have been food inflation. Whatever the reason, a very wise decision.
Economy is recovering, though not out of the woods yet. Still, recovery sans major fiscal stimulus flowing into the economy is impressive and means that the economy can grow from here.
Liquidity. Helped in no small part by forex inflows. Government borrowing has also not gone to the level of crowding out everything else. Bond yields, as a result, have stabilized and are likely to either stay there or slowly tick down from there.

There are several negatives also, though it is better to view them as leading a 'shift' rather than pure negatives.

Failed monsoon. The impact will linger for some time. For past one year, the economy has grown on the back of a strong rural consumption story (as I continuously pointed out in my posts exactly one year ago) and negative growth in agriculture puts a spanner in that. While things should recover, rural disposable incomes will stay depressed for next six months. That shifts the focus away from consumption theme for next six months.
Low capex. A worrying trend has been the low capacity addition in the economy. It means current growth is the result of higher capacity utilization instead of capacity creation. Does not bode well for medium term growth.
High interest rates. Will take some time to come down. They are high despite good liquidity in the system and a stable sentiment. Which means any reduction in rates will be based on a slow, gradual reduction in the proportion of governments borrowings in total debt in the market.

The interesting part is that none of this makes for a drastic rise or fall in the stock markets or the fortunes of the economy. Instead, this makes for a slow and steady movement where things improve (or deteriorate) slowly.

This does not do any good to the rampant bull (or bear). At the same time, it makes for a steady secular slightly bullish market in the medium term where interest rates are either stable or slowly ticking down, economy is growing, liquidity is comfortable and consumption gradually improves as agriculture/capital goods sector gets out of the woods and capacity addition resumes.

My last year's picks, metals, auto in general and two-wheelers in particular, telecom, etc., turned out to be exactly the right picks for the market. But the changed market requires a complete reassessment of which sectors to be in. That analysis follows.

Time for a Secular Bull Run? Part - I

2010-03-04T15:32:00.001+05:30

INDIAN MARKETS

We have had an extended sideways trade going on in the Indian stock market for some time. While I did anticipate December and possibly January to be a slow month, the market just continued to be dull for longer than anyone had anticipated. In hindsight, it looks just logical for it to have been like this.

On the surface, it looks like the market was waiting for the budget to come out and the fiscal stance of the government to be clearer. And it also looks like that the budget provided some clarity that has seen the market attempt to break out of the long held trading range.

In reality, the doldrums stem from another factor. It is now clear that the government started the task of fiscal consolidation long before the budget. It shows in the expenditure numbers and fiscal deficit estimates. It probably won't do much good for advocates of "stimulus" who have been clamoring for more. But it does a lot of good for the long term health of the economy.

There lies the bind the market has been in. The economy has been growing all the while when government spending has been in check. Tax level sops will probably continue for some more time to come, but low spending means there is very little "real stimulus" flowing into the economy. So there you are, the recovery is definitely there, though not on a sure footing yet. That would keep the markets from tanking outright. On the other side, there is very little "push" coming from the fiscal side. That would prevent a massive upmove also till the time things stay unclear.

The budget has brought a lot of clarity indeed, from the macro numbers point of view. It is now clear that fiscal deficit is not expanding as rapidly as some of the market participants have been factoring in. With disinvestment proceeds and 3G auction money flowing in, the need for the government borrowing drops drastically in the coming year. The government being committed to an aggressive debt-to-GDP ratio target in the medium term also points to reduced borrowings in the market.

This changes the dynamics underlying the market for a number of reasons. Working out the new market drivers for next one year would be essential for making money in the next one year. A detailed analysis follows in the next post.

NIFTY: Targets Met, Markets to Go Into Doldrums

2009-11-12T14:53:00.002+05:30

INDIAN MARKETS

The yesterday's move completes the minor "rally" target on the Index and the market is exhausting its energy to create major swings. The fundamentals are not going to show too much of a change over next few months. By now, everyone is convinced about the recovery. Things are not as bad as they were supposed to be. In fact, from now on, it is going to be just a mundane update on economic numbers as far as this part of the world is concerned.

As things stand today, practically all the important information is available and discounted. Growth targets are now well known and a consensus is emerging there. We all know general inflation is not a concern (the most fallacious indicator at the moment in India), food and primary article prices are going through the roof (jeopardizing the growth engine and long term growth prospects by skewing the income distribution), interest rates are going to stay high and so on and so forth. No surprises on any side.

So all the rallies and dips are just a way for the market to finally settle for a relatively low volatility price range. None of the variables that move the market are likely to change much over next few weeks. On top of that, international money is going to completely cease movement come December as the investor/trader/fund manager community heads for the annual break.

This makes for a very dull market over next few weeks. Of course, die hard punters will keep on trying to find direction for this market. But there isn't much juice and every move is going to dissipate more and more energy.

Clearly, time to trade ranges so long as the market shows some energy. Then shut shop and enjoy the winters and the holidays.

Cheers!

NIFTY: Is it a Correction or Beginning of a Reversal?

2009-10-27T18:09:00.002+05:30

INDIAN MARKETS

In my last post, I had surmised that we are seeing the signs or footprints of the market teetering on the verge of a change in trend. Whether this downmove is just a correction or beginning of a reversal in the market is the key question.

Answering this question is important because if you are an investor, you need to reallocate the portfolio (you might want to buy gold, for instance; which looks like an excellent choice at the moment). If you are a trader, you need to change the 'bias'. And if you are fans of CNBC 'market expert anchors', then you might want to switch loyalties (curiously, Ms. Mitali Mukherjee starts beaming when the market is going up, and Ms. Shireen Bhan is gleaming when its going down).

There are several factors that will determine where this market is going. Before that, it is helpful to recount how this market got here in the first place.

Change in growth outlook. We took out couple of percentage points from the growth outlook in the beginning this year. That on its own accounted for about 40% of the fall in the market witnessed prior to the rise. And surprise, surprise, we added it all back up.
Risk Premia. Went straight through the roof, way beyond justifiable. Several percentage points added to the discount rate (whatever you were using to value stocks and other things) and when sanity returned, suddenly everything looked cheap.
Flood of money. Critical to depressing risk premia (again) to current, artificially low levels. And boosting growth expectations to, well, artificially high levels.

So here we are. And here is where we are going.

Growth outlook. Sanguine, with cumulative factors pointing to a long period of 6% GDP growth (give or take a few bips here and there). The steroids have pushed the flexible parts of the economy as far out as they could. Now the whole thingamajig needs to move forward for growth to happen. The feedback effect between different sectors becomes important after a while for growth to happen. Managing that is a tall order because Government's own fiscal condition is going to become a large drag on the economy.
Also, you can do a selective interpretation of whether 6% is good or bad or whatever. But it clearly does not support valuations that are 20-22 times earnings for the market as a whole. True, we are not there yet (in terms of valuation multiple). But we will need higher growth for the trot to continue.
Risk. Premium will start rising again. The simple reason is that despite the cycle of despair and the euphoria, the state of the global financial systems in terms of asset quality is exactly the same as it used to be before the whole thing began. The poison is still in the system. To the extent that even the pioneers of the "good bank, bad bank" approach are yet to implement it to that canary in the coalmine, Northern Rock. European Parliament is still in the process of approving the split and eventual selloff of the bank. Clearly, the global system is far from fit and the moment the reprieve provided by trading profits ends, things will start looking tough again, on the loans side in particular. Any spike in global risk premia is going to spoil the party for Indians too.
It's nice to assume the risk has gone away. It has not. And any additional points added to discount rate will make those "attractive" valuations ever "more attractive".
Turning the taps off. One of the most hilarious aspects of past few years' inflation debate has been the dance routine performed by regulators around the inflation numbers. Its either commodity inflation, or food inflation or this inflation or that inflation; so long as you can prove that "core" inflation is in check. Well, the inflation juggernaut having run through asset prices, real estate, commodities (one by one), food articles, etc. will finally run over whatever "core" is remaining in due time. The taps will have to be turned off at some time.
The funny thing is that even turning the taps off is not needed for things to start looking bad. As with all things "stimulative", greater and greater quantities are needed to keep the same thing looking good (that is why you need to keep drinking more and more beer to keep believing that your wife looks good!). So the moment you stop expanding the pool of liquidity, things are going to look ugly again.

I guess the policymakers realize these things. That is the reason why there is so much talk of "stimulus continuing" or a "second stimulus" and so on.

Finally, the timing part. Well, the fatigue of the market has been evident. Nifty has been struggling more and more to make relative new highs. The post election euphoria is more or less over. The results are not disappointing but not earth shattering either (something everyone had assumed). From now on, it is going to be evident that from auto to telecom, from pharmaceuticals to FMCG; it is going to be a slow trudge rather than a sprint to far greater profits.

Still, can we confidently say that the reversal has begun? May be not. The market may surprise with a sharp upmove before settling down to a long, dreary sideways move of chipping away prices slowly. But the winter is certainly looking uninspiring at the moment.

Foot prints of a Reversal (Is the Bear on the Prowl Again?)

2009-10-22T22:46:00.003+05:30

GLOBAL MARKETS, INDIAN MARKETS

Short answer: Yes. Watch out.

I do not say this because that is the "consensus" among "professionals" and "analysts" out there. Those who have ever gone back far enough on this blog (for reading posts, not for searching who Mitali Mukherjee's husband is, we have a rocking piece on that which still brings tons of hits to this blog, hahahaha) would know why that is the case. There is a solid, fundamental reason why this market went up from March (globally) or from May (in India). And all the analysis behind that you can find in the posts that appeared here between January and March (and not in August, when I just did not post).

Similarly, there are solid, fundamental reasons why this market cannot sustain it any more.

Global Folly: Stimulus Season 2

Let us get it straight. Nobody knew whether the first stimulus would work or not. But it was needed. Put simply, the bloke called "global economy" (or whatever name you like, say "global financial system") had an accident. Blood was spilled and it was necessary to replace all those lost pints. Whether somebody knew it would work or not.

And now? Patient has survived. Even recovered somewhat. But is fat and bloated now (something like a reversal to the original position, though not fully). High cholesterol, high whatever, whatever… you name it. The fix? Give more transfusions! If nothing else, you will balance out the high cholesterol by "averaging it out" with the new, "fresh" blood. Okay, bad pun. But hey, the "new blood" represented by a certain Nobel Prize winner is doing just that, "averaging out" the effect of the old. Anyway, that is a different story. Let's get back to our main discussion.

Did I hear "bad example"? Of course it is! But it makes the point.

So what happens as this bloke is given more and more transfusions? I don't know. Hey, I am not a doctor!

Losing the Plot

The plot was simple. It was broken. Fix it. Get out.

But the choice finally taken is to keep pumping in more and more. Chinese economy vital to global health! Put it on steroids. Now that it has run the course, pump in some more. Same with the US. And of course, how can the rising superpower like India be far behind (I know, I know, those of you global freaks don't give a damn about India. Why don't you just shut up? There are tens of millions of investors in this country who care, besides more than a billion of us around who need to eat, sleep and make merry, well sort of!).

So, the plot is lost. In the meantime, you suffered commodity inflation again (I told you so), stock prices went up (I told you so), spending driven sectors blew the top off the charts (I told you so). The problem? NO, the market is not "ripe for" or "waiting for" a correction, as a celebrated analyst commented on CNBC India today. It is just that sectors that ran ahead of the economy were fired by steroids. The rest of the economy cannot support them beyond a point. The pullback becomes inevitable.

Closing Time

Okay, I will not write more on it today. I think it merits a detailed discussion, on India, on global economy and on China especially.

BUT YOU HAVE BEEN WARNED!!

Cheers.

The Comeback

2009-10-21T16:28:00.001+05:30

It has been quite some time since this blog has been updated (more than 5 months now). I know it is not ideal to disappear without any warning, information, etc.; but yours truly suddenly quit trading and got into the staid life of paid employment. And as luck would have it (or generally has it, if you believe the brilliant "offisial atyachaar" guys), it left no time for me to even visit my own blog; forget about updating it.

But despair no more! The Compleat Trader is back, not as a trader though, only as an observer and a commentator on the economy and how it impacts the financial markets. In any case, this blog is not a "mass" following blog, very few people read it on a regular basis. But I am really grateful to this set of readers who have been truly loyal. Despite the blog not being updated for five months, it has still maintained a sustained monthly traffic of about 1,000 visits a month! Am truly floored and feel honored. Clearly, there is something that people find of value in this. And I hope I can continue to write stuff that people find useful.

Okay, time to be arrogant! Yes, despite me not following the market, the medium term view has been a thumping success. The last word on this from yours truly was on April 24, 2009 in shape of Indian Stocks: Which Sectors should We Put our Money on? Please take a look if you need some convincing.

So folks, yours truly is back. Of course, it will take him some time to hit the same form again and deliver crackling insights for investors and traders alike. Till that time, please "bear" with me (and subsequent posts will show why the word has been emphasized).

Cheers!

NIFTY: Thumping Success on the View, Should We Book Profits Now?

2009-05-04T15:09:00.001+05:30

INDIAN MARKETS

The view on NIFTY has turned out to be quite on the mark and markets have rallied strongly. We did see a blip globally as well as in India due to swine flu concerns. But I had pointed out in my last post; it is just a temporary phase and markets would rally strongly from there.

Going into this rally, the one question that we need to answer is when to book profits. My earlier view still remains intact; the rally has steam to go past 4000 on the NIFTY. That would be another 10% from here.

However, as we get closer to our target from here, the upward pressure will weaken and market is likely to get choppy. High volatility is definitely on the card.

To Book or not to Book?

I think part profit taking is justified from here. It is difficult to predict the exact path of the market from here and there may be a pause for one or two sessions before the course is resumed. There may be a re-entry point available at a lower level on such a day. At the same time, the market may simply carry on and you may regret getting out of positions. Under such circumstances, lightening your position makes sense as you still keep a finger in the pie if the trend simply continues.

Hence, if you are itching to do something and cannot sit tight, take part profits. Re-enter if the market does test 3550.

Swine Flu Blues: Jittery? Take a Healthy Dose of Perspective, Thrice a Day for Two Weeks

2009-04-29T00:26:00.001+05:30

GLOBAL MARKETS; INDIAN MARKETS

As swine flu spreads across the world, the jitters are increasing. But so far, things seem to be under control. The encouraging fact is that the cases seen outside Mexico have been mild and most of them have not even required any hospitalization.

The financial markets have chosen to be jittery at this news. Today's selloff was quite severe but may prove to be an overreaction.

Developed World Scare

Most of the scare value coming from flu outbreaks is due to the history of 1918 flu which killed an estimated 50 million people and infected 40% of the global population.

Recent outbreaks have been tame by comparison, with counts limited to thousands instead of millions. Contrast this with the biggest killers on the planet today. Malaria kills 5 million every year. Rabies kills half a million people a year in India alone.

Partly, the scare is due to the fact that malaria, diarrhea and rabies are third world disease. Developed world has more or less tamed these problems. New strains of flu, by contrast, put them at the same level of risk as, say, a country like India.

This is not to downplay the potential harm this may cause. But some perspective can help.

Indian Preparedness

The UK has enough stockpiles of anti-viral drugs to treat 50% of its population. The US has equivalent of 15%, Japan has equivalent of about 20%. India is also stepping up to the challenge and is stockpiling enough anti-virals to treat 0.0020% of its population.

Still, India could be in a relatively safe condition due to the climate (very hot and dry) at the moment. But the onset of Monsoon will bring a totally changed climatic condition, highly conducive to spread of flu like infections. Let us hope the outbreak is contained before then.

Short the Market?

No. One, it is unethical (I have my biases too) to take advantage of such a thing. Two, as the world takes that universal cure for all things psychological, a good dose of perspective, the markets can bounce back. So shorting remains risky.

Swine Flu Kay Sholay

A senior colleague returns from the US. So it is a fit situation to enact the famous Sholay scene.

Kaaliya: Kya laaye ho Sukhiya?

Sukhiya: Swine flu laaya hoon sarkar.

Taliban Under Attack, To Be or Not to Be (Happy)?

2009-04-27T16:02:00.001+05:30

GEOPOLITICS

Associated Press reports that the peace pact between the Pakistan government and Taliban has broken after Taliban were attacked with artillery and helicopter gunships.

This attack would certainly please a lot of people, particularly the US government. But I am not sure whether it is a good thing or a bad thing. I do not know whether we should feel happy about it or not.

Uncertain Events

First, no one knows whether the events being reported are really the correct ones or not. They may be, they may not be. Information available at the moment is too patchy to form a certain view.

It is hard to believe that Pakistan government (and Army) has suddenly decided to take stern military action against the Taliban when they are retreating out of the Buner district.

The worst case would be if the attack has been faked to mollify Washington and (if India counts in this scheme of things) not to disturb the deep slumber of the neighbor next door. When I say fake, it is not necessarily fake; but something that keeps everyone happy without doing any serious damage to Taliban military machine.

Heads I Win…

Either way, it is a lose-lose situation. If the attack is half-hearted, the implications are serious. The world goes back to sleep and the Taliban suffer no serious damage (initial reports say 20 killed). If they lose only a few dozen fighters out of potentially a million at their command and have all their weapons; how big a dent is it going to make in their capability?

And if the attack is a serious attempt to check Taliban, the danger is a country slipping into a long struggle; possibly a war of attrition.

The world, especially India, does not necessarily win in either of these situations.

Jaago (Man)Mohan Pyaare…

In the meantime, let us hope that the deep and peaceful slumber enjoyed by "strategic"
thinkers and leadership here is disrupted for a few seconds to pay attention to such serious events next door.

And if you think it is only Manmohan Singh who is sleeping over this, think again. Advani, Modi, Rajnath trio of the 'patriotic' outfit is yet to wake up too. The less said about the rest (Behenji, Stone Age bhai, Comrade Karat and so on), the better.

So those who are rejoicing over this turn of events; HOLD YOUR HORSES.

Global Markets: We Don’t Need Another Black Swan

2009-04-27T11:54:00.001+05:30

GLOBAL MARKETS; INDIAN MARKETS

Outbreak of swine flu is not something anyone would look forward to at any time. Jumping forms of the virus are probably the worst health threat that we face today. The danger with a disease that can infect pigs, birds and humans alike is enormous.

It is significant that the outbreak of disease has happened in Mexico this time around, unlike China where conditions for viruses to emerge are more conducive (climate wise). So being in a dry, hot country (even India at the moment is like that) is not likely to put you at a lower risk. That does not sound good.

It also does not help that migratory birds can take the virus to any corner of the world, no matter how many quarantines you put up. It is a bleak situation and the best hope for us is that it dies out quickly.

Possibly the Worst Time

There is never a good time for an outbreak like this. But this time is particularly bad. The world is already reeling under the impact of the financial crisis. A health threat like this can derail the economy in a number of ways. It raises uncertainty, takes attention away from economic matters, puts enormous pressure on those who are worst affected (God forbid if someone loses his/her job and has to face a major health scare with it) and hampers economic activity directly. All the quarantines, restrictions on movement of goods and people come at an economic cost. Add to that the general unwillingness to invest, hire or expand in an uncertain environment.

Not a Time to be Opportunistic

At the same time, I would advise traders to not take an opportunistic view of the market. Shorting the market believing (or hoping) that the outbreak will be a major setback to the recovery is not going to be the right thing to do.

The recovery IS underway and is not likely to be derailed unless the shock is massive. And I certainly do hope that it gets contained quickly.

Maintain Longs

For now, the call remains the same and the bias is bullish. India is unlikely to suffer a major setback till the elections results are out. If you are long, stay put.

Weekend Crap: Fake IPL Player and Knightmaster and Other Crappy Things

2009-04-26T22:47:00.003+05:30

WEEKEND RANTS

Guess what? This is the 100^th post on this blog. And it is only fitting that this landmark post is actually our most popular section, weekend crap. Yeeeeehaaaawwww, pardner.

Knightmaster D***o

The best thing happening during the week was of course the Fake IPL Player blog. I particularly like the name given to Badshah. Somehow it sounds quite similar to Crimemaster Gogo of Andaz Apna Apna fame.

Strange things seem to be happening to Badshah D. May be he has been so disheartened with KKR's 'exploits' that he has lost all sense of dignity. May be the Fake Player has driven something up his, well, pants. Otherwise, why would he sign up for totally shitty, brainless ads like the current Dish TV one? The one with the 'leddddy daunnnnh'. May be he has spent all his money on 'Phoren Babas'.

We Still Love our Politicians

What is going on guys? When we keep on declaring our undying love for politicians, they just keep on getting more and more uptight about it. Otherwise, why would Munnabhai be made to suffer for an innocent intention to give a 'jhappi and pappi' to a popular leader loved by everyone? And then, Mr. N Modi of a certain G affiliations (Gujarat, Godhra, Gandhi-baiting, etc.) has been ranting and raving about all things Italian.

Well, whatever these Italian guys are, they certainly are sporting. Take their PM Berlusconi. He has been painted in the nude along with a nice minister (here is the Telegraph link). Now, for just a moment, imagine if someone were to do that in India…

Nice painting though ;).

Inflation and Expansion Plans We would all Love to See

Okay, enough about trivial things. Now some serious economic thinking is needed.

One disclaimer though. This is serious stuff and click on the link only if you are an MCP (like me) and are over 18. You should not be easily offended also :-).

So here it goes, the youtube link

http://www.youtube.com/watch?v=H9__0vttcyg&feature=PlayList&p=9A3BFEFD0D0CE4D6&index=1

This is one inflation a lot of us would like to see.

Cheers!

PS. This post was supposed to go up yesterday morning, but due to a weird technical snag, is going up only. Hope you enjoyed your weekend.

Weekly Wrapup: Cracking Performance by NIFTY and More

2009-04-24T16:03:00.003+05:30

WEEKLY UPDATE

An eventful week. Several new things started that could go far. Here goes the update.

India Goes to Polls in an Uncertain World

Tough times internationally as Taliban seem to be closing in on Islamabad and Pakistan. Not a good development for India.

Internally, polls are going on. But the dark underbelly of our internal affairs got exposed as Naxals took 700 hostage and a whole block of villages effectively declared they are not part of India. Not good signs for long term health of the Republic and its economy. Check this week's Geopolitics posts for details.

Stock Market on a Decided Uptrend

Am a contrarian again. I have been bullish on the market for past few weeks. And today turned out to be just the day when confirmation for this bullish bias was delivered. In my last post on the topic yesterday (Technical Check: NIFTY Update, Impending Breakout?, I had posted the graphs with the signal. Here is the update.

As you can see, the signal is loud and clear. The path is clear for the next leg of upmove. If you are long, just hang on. If you are short, hope you had a stop loss in place.

SEBI Cracks the Whip

In a surprise move, the one you see only once in many years, SEBI banned Nirmal Kotecha for manipulation. That is definitely NOT like us, we do not harass 'value creators' like Mr. Kotecha too often. But then, these are unusual times.

The key question is, when the entire market knows that there hundreds of his kind, will SEBI do something real to check their ways? This class has swindled thousands of crores out of investors (Kotecha alone an estimated 500 crores).

I would love to know what Professor JR Varma thinks about this. Will keep an eye on his blog.

Monetary Policy

Brought no surprises. Unlikely we will see much path breaking action in the monetary policy department. Except the fact that RBI will keep on increasing its QE efforts as CPI ticks down due to higher base effect.

Have a good weekend.

Indian Stocks: Which Sectors should We Put our Money on?

2009-04-24T15:26:00.001+05:30

INDIAN MARKETS; TRADING STRATEGY

One of the key questions for "long only" investors at any point of time.

I do not think a "long only" strategy is optimal. But there is a serious set of investors who are not happy shorting any asset and instead prefer to either stay long or stay out of the market. Nothing wrong with this approach, if it gives you peace of mind.

So, am compiling a list of sectors that are likely to be outperformers over next few months. And also a few underperformers too. This list comes with a huge list of disclaimers. The primary one is that I am not responsible for any profits or losses occurring from any trades based on my opinion. And it is just an opinion after all. It is true that I have been right almost all the time in past six months. But still, I am only human. So exercise your own judgment.

Outperformers

Okay, beginning with the list. This list is based on the current information and may change over next few weeks. The likely outperformers in this market are the following.

Banking. Falling bond yields, treasury profits, lower cost of funds, will all combine to outweigh any increase in NPAs in the near term. Banks have been very smart in managing their spreads. They have resisted reducing PLRs arguing high cost of deposits. Cost of deposits was high for less than one quarter, applying possibly to a fraction of all deposits. High PLR applies to 100% of loans. Smart indeed!
Steel. Metals are my favorite bullish play. Demand destruction has run its course. As economy recovers, demand will grow. Monetary expansion helps.
Cement. One of the best sectors to be in. Just be careful and select companies that are pushing down energy consumption aggressively. A company like Dalmia Cement is a good pick based on energy consumption.
Telecom. Another favorite because of strong domestic demand story.
Transportation. The sector leads any uptick in the economy. All indications point to a normal monsoon, another positive for the sector. Great time to buy into good commercial vehicle stocks. Ashok Leyland would be a great pick.
Two Wheelers. Self evident case. Just to recount, rural India marches on and can't buy enough of them.

Underperformers

Now, the ones to avoid. They won't necessarily go down, but are not likely to match market returns. So be circumspect when buying.

Pharmaceuticals. Those who believe Ranbaxy's woes are an isolated case are dead wrong. Suddenly, US FDA has woken up and finds all Indian companies have one problem or the other. Add to that increasing domestic competition and fewer new product launches. Huge forex losses accumulated by most of pharmacos would be just the last straw. Avoid.
IT/BPO. The US is getting rabid about H1B and all sorts of things. Expect low growth from here on for a few quarters till the hysteria dies down.
Oil. As global commodity cycle turns up again, a huge avoid.
Organized retail/Real estate. The secret is out and it is not pretty. Out of these, real estate will turn the cycle in one quarter. Stay away from retail at all costs.
Aviation. A dream gone sour. Enough said.
Media. Several will die. Those who remain will struggle as the cash they have is burnt out and no fresh money is available. They will spoil the advertising market in a last ditch survival attempt.

So there you are. This weekend, there is enough to meditate on. Choose well, and enjoy a healthy portfolio.

India Bond Yields Show Clouds Thinning on the Bullish Side

2009-04-24T13:02:00.001+05:30

INDIAN MARKETS; TRADING STRATEGY

"I think the most important question facing humanity is, 'Is the universe a friendly place?'

Albert Einstein

My favorite topic again, bond yields in India. Right now, the most important thing we need to know is whether the market is optimistic or not. All the fundamentals are aligned to turn neutral at the moment. This bodes well as the gloom of past six months starts to dissipate.

So, now the question, whether markets are optimistic or not. If they are optimistic, it should lead to a further reaction to excessive gloom of the past. And what better thing to test that than the bond market?

Good Proxy for Liquidity

Relationship between bond and equity markets tends to be fluid. In a 'flight to safety' situation, bonds tend to gain while stocks fall. In an 'appetite for risk situation', stocks gain while bonds stagnate. But there are situations when both can gain or lose together.

We have exactly that situation at the moment in Indian markets. Primary concern with the economy and the markets right now is liquidity. Higher liquidity brings bond yields down and helps the economy. Hence, the positive correlation (agree that it is unusual, but we are in unusual times).

What Yields are Saying

As of now, the yields are coming down after hitting a peak. We are seeing new lows vs. past few weeks. This indicates liquidity is returning. Certainly, the OMOs by RBI are helping this situation. As the higher base effect of last year's inflation starts giving benign CPI numbers, RBI is likely to feel less apprehensive about pumping more liquidity in.

Going forward, we are likely to see further easing in the situation, though not an all out "stimulus".

So, bond yields are the thing to watch for now. They will also tell us whether markets are a friendly place or not. And that, my friends, is the most important question facing us.

Cheers!

Pushing with a String and Other Cynical Thoughts

2009-04-24T00:20:00.001+05:30

INDIAN ECONOMY

The policy options for the government coming to power in India are not many.

It is not that India is struggling with this problem alone. Governments around the world are facing the same problem. Consider this article from Bloomberg, Gilt `Indigestion' Looms as U.K. Plans Record Bond Sales of $318 Billion.

Still, India's problems are a bit more peculiar. One, there is a lot riding on the monsoons. So far, the indications are good but we need to keep our fingers crossed. Two, the government still has not figured out how to handle the economy in a crisis mode other than free riding on RBI's management of the monetary system.

"Mental" Recession

Add to that the Indian mentality of manufacturing recessions out of thin air.

Consider this. Wipro's BPO business has doubled in the current environment. The company is talking about possible salary cuts.

Hero Honda is enjoying record sales. Telcos are adding record number of customers.

But there is a general environment of gloom that has been created. Corporates have cried themselves hoarse for sops, have handed out salary cuts shamelessly and are not willing to spend at all.

True, some have been hit hard due to mindless currency punts and forex borrowings. But does it mean the entire economy should grind to a halt?

This is an Indian phenomenon. India took three years to come out of the dot com bust. Despite the fact that India did not have a dot com bubble.

Getting the Economy Going

Still, this economy needs to get going.

And I have mentioned before that using monetary policy alone is not enough. Monetary policy works like a string. You can pull it to tighten things; you cannot push on a string to loosen anything.

The problem is that the next government:

Will have no fiscal headroom to jump start the economy.
Will have no apparatus to implement any infrastructure development programs.

The latter were systematically dismantled by Manmohan Singh's key minister who would not move on a single project unless… All the work done by Vajpayee's government was systematically undone. Of course, Manmohan Singh is a nice man. Firing such a person is out of question.

The net result is that the next government will be hard pressed to implement anything, unless Dr. Singh comes back to power. If he does, he can start pushing on the string again, like he is doing right now.

Corporate Mantra

Cry recession, even when your sales are rising in double digits and profit growth is 20%+. Cut salaries. Fire people, ask those who are left behind to pick up the extra load.

This mindset is going to get a severe backlash. The tight job market of past five years is likely to return after about one year and a lot of employers are going to face the flak.

Wonderful Thing

The best thing is that the politicians will keep quiet as the corporate world uses scare tactics to cut compensation blatantly. But once salaries start rising fast, there will be talk of 'cap on private sector salaries to maintain social equity'.

Strange are the ways of the Lord!

Technical Check: NIFTY Update, Impending Breakout?

2009-04-23T23:22:00.003+05:30

INDIAN MARKETS; TRADING STRATEGY

Today's price action on NIFTY was important. A dip from today's opening level would have broken the support line that looked "far away" on 21^st early morning.

But the consolidation pattern on the charts is almost complete and the breakout seems to be impending. This is despite the gloom shown by several pundits. It is also important to remember that FII data has turned strongly positive today.

Past few sessions have been in a range that has been trending down. That channel is about to be broken.

Next day or two will be critical in price action. Generally, it is not a good idea to predict which way a channel is going to be broken. Still, the bias remains bullish and shorting is going to be detrimental.

Bulls rejoice!

Udayan ‘Uvaach’ (Quote)

2009-04-23T18:26:00.001+05:30

"…tune in to find out whether the bottom is behind us…"

Well, mine is behind me, I do not know about others ;-)

The Art of Burying Your Head in Sand

2009-04-23T17:07:00.001+05:30

GEOPOLITICS

The recent advances by Taliban have seen several responses, most of them have come from the US. The one missing is from India, where people are too busy calling each other old/young, weak/strong, wimpy/tough and so on. But a matter of such import has been completely ignored.

I do not want to do any scaremongering, but want to highlight two important items that point to the dangers being faced by India and how Indian state response is multiplying risks attached with them.

Internal

I will not highlight the highjacking of a train by Naxalites. But the one that is even more illustrative is the Lalgarh standoff. A fairly large area (covering more than 100 villages) in West Bengal is under Naxalite control. This block had completely denied access to all police, security and government personnel. They were not allowed to set up polling booths for elections too.

The standoff has ended now, with a compromise being worked out. The solution is that polling booths will be set up at the fringe of the area in question. But government officials are still not allowed.

This is a bleak example for our democracy. If you have to negotiate with extremist groups in every part of the country to even hold elections and feel everything is okay with the country, it is delusional.

External

Well, Taliban are close to Islamabad. That is enough to alarm Obama. Of course, we are not alarmed. Our strategic interest is the responsibility of the US. That is what we have always been like. The moment we get attacked by terrorists, we are furious with the US for not being able to control Pakistan or whosoever is behind the attacks.

This development is disturbing, to say the least. In my series , Danger at the Doorstep, I had discussed the implications of Pakistan Army siding with Taliban. So far, the Army has not responded to increasing boldness of the Taliban. That is not a good sign.

Indian Response

Missing.

I do not think anybody noticed both of these things. I do not think anyone bothers to see the link between the two, a state not willing to watch out for its own interest.

I do not think it is one political party being weak. It is more a matter of institutionalized apathy.

Implications

Ominous.

It is not just the frequent terror strikes. It is the fact that disruptive forces are encircling India like never before. Countering them all means stretching our already strained security apparatus even more.

But to defeat your enemy, you must know him. That is what Sun Tzu said more than 2000 years ago in Art of War. Faking that you know him does not count. But our establishment is showing no signs of even understanding what is going on here.

Economically, this does not sound good. We are already reeling (God knows why) from the impact of slowdown. A conflict is not going to do any good to our dreams of becoming a global powerhouse. Keep your fingers crossed and watch with bated breath.

Monetary Policy: No Surprises, only Confirmation of Current Policy

2009-04-21T17:51:00.001+05:30

INDIAN ECONOMY; INDIAN MARKETS

In my early morning post today, I had commented on the tepid nature of likely announcements in the Annual Policy Statement of Reserve Bank of India. Practically all that was surmised in that post, including the 25bps rate cut, has materialized.

I will repeat what I said in the morning, the cut is irrelevant. It is a symbolic gesture in these circumstances because there is a wide gap between the policy rates of the RBI and actual rates in the economy, whether indicated by bond yields or BPLRs of commercial banks.

Delivering What Matters

This gap is not due to whims and fancies of RBI or the banks. This gap is created by the liquidity position in the market and the fact that adequate liquidity exists in only two places; the interbank market and the empty brains of "market analysts" suffering from a virulent bout of inanity.

In my boring and painfully long post Back to Fears of Depression written on January 10, I had explained that ample liquidity in interbank market does not mean the entire economy is adequately supplied with money. To repeat, there are many levels of liquidity in the economic system. First, liquidity in the banking system, measured through inter-bank market activity and rates. Second, liquidity in the organized commercial sector; measured through corporate bond market, commercial paper market and BPLR. And third, lower levels that reach MMEs, households, etc.

Central bank can control only the first level directly, which is usually enough to regulate the overall money supply under normal circumstances. In a crisis, the linkages break. The primary channel of interbank market may be flush with funds; the commercial sector still does not get enough.

"Moralsuasion" and Clarion Calls

Going back to today morning's post, the only thing to watch for in today's announcement was a signal by RBI on liquidity. What has been delivered is, instead, a call to banks to lend more.

I am not saying it does not carry weight. In an economy where majority of the financial system is under government control and central bank doubles up as government's money manager, "moralsuasion" is a powerful tool.

Why is it not working? I have only two explanations. One, banks are afraid to lend in current economic circumstances. But I suspect it goes beyond that. Second, there is a genuine lack of liquidity in the monetary system outside the inter-bank market.

Bond Yields Again

If there was sufficient liquidity in the entire system, bond yields would not have jumped up by close to 2% as policy rates went down by a similar amount. That brings us to my pet peeve, RBI is still not infusing enough liquidity in the system to counteract heavy government borrowing program. This has changed in the past one month (as was anticipated, I can gloat sometimes) but still RBI is not likely to do much more than barely compensate for government borrowing.

Clear Signal

That is where the significance of today's policy statement lies. By not announcing any concrete ways to provide more liquidity, by not even mentioning how it will jack up money supply, by opting to give a public call to banks to raise lending, the RBI has signaled that the current policy is going to continue. The rate cut is just a sop, something that the market was anticipating any way.

Will cover the implications of RBI's lowering GDP forecast in a later post.

Why Reza Aslan Matters for India

2009-04-21T15:23:00.001+05:30

GEOPOLITICS

Ostensibly, Reza Aslan has nothing to do with India. An Iranian-American, he is a writer and theologian and holds a Masters in Theological Studies from Harvard Divinity School.

What he argues is important. While the Bush administration worked hard for years at creating an image of a monolithic enemy in the shape of Jihadi Islam, reality is quite different. If you look at the current US policy in its 'war on terror', all kinds of 'enemies' are clubbed into a single entity. Whether it is Hamas in Palestine, bombings in Iraq or Taliban in Afghanistan; Bush policy was simple. Paint them all with the same brush, and then proceed to bomb them or throw missiles on them.

By painting every terrorist movement in Jihadi colors, the US is shooting itself in the foot. In a term used by of David Kilcullen, a counterterrorism expert, the US has created an 'undifferentiated enemy' by creating a universal image of Jihadi Islam. This is a gross oversimplification that only confounds matters. By fighting against a fictional enemy, nothing can be achieved. No wonder, the US has been stuck in a stalemate in its 'war on terror' for years now.

Knowing the Enemy

The problem with the Indian approach is much worse. We not only tend to lump all the disparate elements together, our response is primarily anger and rhetoric.

But first things first.

What do you find common between Kashmiri separatists and Afghan fighters fighting in Kashmir? They may be fighting in the same position but are they ideologically same? Are they motivated by the same factors? Can you equate the Naga separatists with the bombers in Karnataka or with the Mumbai attackers?

This failure to differentiate these elements from one another leads to a single approach applied to all. The result is clear. For how many years have we been fighting Naxalism, Naga separatism, Bodo separatism? The result is similar to what the US is struggling with in its 'war on terror'. Years go by as you keep fighting to obliterate the 'enemy', only to discover that the problem has become much worse.

An Emotional Response

Our response to terror always tends to be anger and rage. Displaying an emotion is not a way to deal with terror or to convince others (the US or the global community) to deal with it on your behalf. It simply borders on naiveté.

Worse still, it prevents any rational understanding of what is happening around us. Without a good understanding of what is happening, evolving any doctrine of responding to threats is impossible. What you get instead is the familiar tamasha of people shouting hoarse post every terror strike.

The Battleground

That is why it matters for India to sort its response out. Unlike the US, India is not just a party to this conflict, it is the battleground. And the impact is not minor.

Today, large parts of the country are practically out of bounds for most of us. Traveling to the North East requires army permission, going to Kashmir may not be safe and even policemen do not venture into the Naxal controlled areas of Andhra, Orissa or Jharkhand. This is not just an inconvenience. It has grave economic consequences for people living in these areas, and for the country as a consequence.

Beyond Ideology

I cannot and do not want to argue about the ideologies involved. My primary concern is the response. By adopting a simplistic response to all these situations, we are doing ourselves harm. By shouting 'military strikes' every time there is a bomb blast in the country, we are losing precious time because we do not do what can be done.

That is why Reza Aslan matters for us too.

His new book 'How to Win a Cosmic War' releases today.

Monetary Policy: What are the Options for RBI?

2009-04-21T10:14:00.003+05:30

INDIAN MARKETS; INDIAN ECONOMY

Today, as Reserve Bank of India (RBI) unveils the monetary policy for the coming six months, it is going to be probably one of the most tepid announcements of late. There is not much room for maneuver and much of the action of the past few months has been relatively ineffective.

Limited Policy Options

The policy options with RBI are not many. Past few rate cut actions have not resulted in any impact on the market. Take bond yields for example. In my post dated January 2 (QE on the Cards), I had pointed out the worsening liquidity position. In an immediately following post on January 6 (Bond Yields Point to Headwinds), I had pointed out the impact on commercial sector too and had surmised that increased borrowing program of the government is going to neutralize all monetary policy action of RBI.

Bond yields prior to surprising large rate cut of January were around 5.25%. From there, yields rallied by close to 2%, and have settled only after RBI undertook some serious QE action.

Where Do We Go?

I have been of the view that any meaningful QE can happen only during current fiscal year as the conditions were too difficult to manage for RBI in last quarter. This quarter, things are likely to be slightly easier and RBI can undertake some QE action through open market operations.

Still, it is unlikely that RBI's liquidity infusion is going to do much more than counter the massive borrowing program of the government. Pulling out all the stops to make it a serious "stimulus" runs the risk of shoveling too much money into the system and stoking consumer price inflation.

A Rate Cut?

The case for a rate cut is not very strong. A rate cut can work only on the margin and is effective in sufficiently liquid markets. It loses much of its impact in a market that is struggling with low liquidity. Indeed, the past few rate cuts have done nothing more than keep the market mood from getting too surly.

Still, we may see a token 25 basis point cut to keep the sentiment slightly positive. It is, frankly, irrelevant in the current conditions. Much more than the rate action, it is the actual management of liquidity that is going to drive the markets.

Hence, the real thing to watch out for is what RBI signals on liquidity conditions and its own planned action in the area.

Technical Check: NIFTY in a Consolidation Pattern

2009-04-21T08:55:00.003+05:30

INDIAN MARKETS

The market has paused a little bit after an impressive rally over past one month. It is a good time to take a close look at the market and ascertain where it is headed.

On the fundamental side, I have already explained why my call is on the bullish side. It is time to look at the technicals also and see whether the signal from charts is bullish or bearish.

Market has been in a rally since hitting the bottom on sixth of March. The run up from there has been impressive. Looking at the following chart, it is clear that the trend line supporting the uptrend is still far away from being broken.

From the chart, it can be seen that not only is the uptrend unbroken, the current market move is actually forming a congestion pattern on the top in a small triangle. This is an extremely healthy sign for an uptrending market because given such a large rally, market has been due for a correction.

Instead, the market has just paused and is consolidating in a part sideways move. The bearish pressure seems to be largely missing because not many people are long in this market. That means if the market starts advancing again from these levels, there is not much resistance on the way for next few hundred points.

A check on the Elliott wave is also warranted. The following chart shows one possible wave count.

The current rally looks like wave 3 in a pattern starting from the October 26 bottom for the market. In a large, broad wave pattern, the period since early November has seen a sideways consolidation move. From there, the market has rallied to form Wave 3 in the current upmove.

The current upmove had the following fibonacchi targets, 2941, 3058, 3175 and 3550. The first three have been taken out quite unceremoniously. The last one is where the market has begun to consolidate. If the market just moves sideways here and then rallies, the extended target for this move works out to be 4160.

Watching the market over next few days is important. If the market breaks this pattern on the upside in the coming week or so, there is a good possibility of seeing 4000. Even if the market does not rally, it is not going to be easy to trade the short side. Bears, tread with caution!

Metals Rally, Will it Continue?

2009-04-20T21:49:00.001+05:30

GLOBAL MARKETS

In my Themes for 2009 post early in the year, I had surmised that commodity rally will resume at some stage during the current year. More than that, metals are likely to lead the overall commodity rally. The view has turned out to be largely correct.

It is unlikely that commodities will suffer another meltdown in prices in the coming months. The reasons for this are many.

Demand destruction in the developed economies has likely run its course. There does not seem to be much more scope left for demand to dip drastically. That should put a floor under the prices.
Chinese consumption has started picking up again. China accounts for anywhere between 25-35% of global consumption for most of the base metals. Demand surge in China is definitely bullish for metal prices.
Unwinding of speculative positions and investment holdings is over. Unlike last year, "investment" holding of precious and base metals is fairly low at this moment. A metal like Copper had been a favorite of commodity traders and had seen large investment demand. Unwinding of these positions had put downward pressure on the prices.

Getting into Congestion

At the same time, these factors have been impounded in the rally till now and will not provide any further upside. The prices are likely to spend some time consolidating. Moreover, some of the price movement has already discounted the large Chinese stimulus plan. Since China is not spending the full stimulus money at the moment, some of the rise in prices may be given back.

Still, the overall direction for metal prices seems to be upwards. Next few months should see a nice consolidation pattern form on the charts. Once the overhang of Chinese plan clears and actual spending starts, prices should resume their upward trend.

Inflationary Pressures

At some stage, the massive amount of money pumped into the markets will start having some effect on prices. I will not hark back to Friedman with monetary arguments. I will invoke Adam Smith instead, who recognized more than 200 years ago that metals are a better store of value; implying monetary expansion generally sees a rise in metal prices first.

As the excess amount of money works its way through the system, we are likely to see a resumption of a commodity rally. Metals, quite likely, will be in the forefront of it.

India: Danger at the Doorstep Part-3

2009-04-20T17:47:00.002+05:30

GEOPOLITICS

You cannot avoid a war. You can only delay it to your own disadvantage.

- Niccolo Machiavelli in The Prince

The first two posts in this series examined the way things have gone in Pakistan. They clearly pose a great danger to the Pakistani society. But more than that, they present a clear danger to the idea of Pakistan as a nation and to its sovereignty. The latter is already gone to some extent as the country has ceded vast amounts of territory to Taliban and other jihadist forces.

The Irony Continues

The irony is no less on the other side too. There is a good chunk of 'right wing' ideology in India that has been wishing for Pakistan's move to a failed state status. They do not know what they are asking for.

If the divisive trends in Pakistan continue to gather pace, it is only a matter of time before they start spilling over into India. A divided Pakistan is the biggest geopolitical danger India faces today. Once the buffer of a large professional army keeping things under control is removed, India may have to gear up to face the menace on its own.

The Indian Response

One word: Stupor. And petty short-termism.

The Indian establishment wakes up only when there is a big terror strike on Indian soil. The response routine is now quite well established. Raise a stink, start yelling at Pakistan, create noise internationally. And then just shut up and forget about it.

This clearly does not work. And it cannot work. If you do nothing to improve border patrolling, if you do nothing to maintain preparedness of armed forces, if you deplete your military resources in five years of sheer neglect, if you have no doctrine for responding effectively to such incidents, how can you expect any measure of success in preventing future attacks?

I do not want to get into the debate of whether elements attacking India are under Pakistani control or not. I do not know and I do not care to know. It is irrelevant. What is relevant is what you do in response.

Till this day, the Indian government has not adopted any coherent doctrine on dealing with this growing menace. It is convenient to make Pakistan sound like an enemy, but we should remember that this "enemy" has to be dealt with on a day to day basis as well. It is Pakistani armed forces who are going to keep a lid on a large scale threat like this and not Indian forces. It is in Indian interest to persuade this "enemy" to deal with this threat effectively.

Dove/Hawk Strait Jacket

That is where a new mindset for dealing with terror is required. You cannot treat everything in isolation. The worrisome part in India is the tendency for people to pick up an individual aspect of the problem and harp on it. Clearly, there are multiple facets to the problem and better border patrolling, better armed forces preparedness, better international diplomacy are all part of a comprehensive approach.

India's Interest

I want to argue that persuading Pakistan and engaging Pakistan in this matter is in Indian interest. This stance is not dovish. It is certainly less dovish than shouting about military options and then giving MFN status to Pakistan or allowing duty free cement imports by land route into India.

India's interest is better served by tying everything together and pushing Pakistan to deal with this threat that endangers both the countries. And this push should be supported by linking economic incentives and diplomatic support to real progress made on measurable criteria.

Economic Implications

Unchecked, these threats are the biggest danger to India's economic dream. If the Taliban does take over Pakistan, it will not take Pakistan alone back to Stone Age, India will also be burdened with an economic penalty for several years.

Since we are talking more about economic issues and impact of international developments on financial markets, a short comment there is warranted.

Any more negative developments in the region are going to send a very strong negative signal to international investors about the whole region. Again, while the main loser in the game is going to be Pakistan, India will increasingly suffer as well (though not to the same extent) if the frequency of terror attacks goes up.

A broken Pakistan, on the other hand, is going to spell economic chaos. That is a place where we should not even want to go.

India: Danger at the Doorstep Part-2

2009-04-20T16:24:00.003+05:30

GEOPOLITICS

You cannot avoid a war. You can only delay it to your own disadvantage.

- Niccolo Machiavelli in The Prince

The first part of this article was published on April 19.

We saw during the last discussion that it is not so easy for anyone to push the Pakistani army around. It is a professional army and is quite modern in terms of its armaments and preparedness. Hence, people who keep talking about the "military option" are not being completely realistic. But there are other factors that put the region at great risk.

Closing Eyes to Reality

The quote at the top of this article is not actually intended for the Indian establishment. Quite the contrary, I have been arguing that people in India who have been advocating a military solution to the terror problem are being naïve. Besides, there are multiple other options that must be explored before a military solution to the problem is sought.

The quote is actually reflecting on the internal state of affairs in Pakistan. It is increasingly clear that the Pakistani establishment is fast losing control over the phenomenon it has created. It has tried various means to control them, including fighting them in Waziristan and NWFP. It has apparently not worked.

The arrangement struck by the establishment in Swat valley is quite indicative of what is happening. What Pakistani establishment has sought is to avoid a war against the Taliban in the region. In reality, it may have ended up only postponing it.

Grave Danger

Pakistani society, in that sense, is facing a grave danger. It is not about religion. It is a free country and if majority of the people agree with imposing Sharia or any other religious law in the country, what is there to bar it?

Still, the Pakistani civil society is about to get caught in a vicious fight. It may have ignored the problem for a long period of time (like India has ignored its terror problem) by believing it is not at its doorstep, it can no longer do so because now the menace is in its courtyard.

The establishment, by fostering the phenomenon and then avoiding it, has ensured that whenever it is forced to fight a war of attrition against the Taliban, it is going to do so to its own detriment. That does not bode well for anyone, least of all for India.

Army's Role Pivotal

Pakistan Army's role is pivotal in this ensuing struggle. Contrary to its assertions, it may have the resources to contain the growing threat, if it decides to act in time. While I have no insights into the mechanics of Pakistani polity, going by the record and what is available in public domain, a large fighting force of more than a million should be adequate to contain a fairly large threat.

But the key question is, will it choose to act? If it does not, it is akin to leaving the Pakistani society on its own against the rising wave of terror.

In the next concluding part, we will analyze the response of India and what options we have.

China’s Investment Attractiveness Increasing Vs. Other EMs (Including India)

2009-04-20T15:01:00.002+05:30

GLOBAL ECONOMY; CHINA VS. INDIA

We have discussed earlier how China is using the current crisis to get ahead in the global pecking order. China's stimulus plan is probably the most effective one as it directly stimulates demand (China GDP: Growth Surprises Pessimists but Leaves Optimists Asking for More), it is pushing an aggressive currency agenda that is likely to be highly beneficial in the long run (Of Triffin's Dilemma and China's Ambition) and is increasing its influence in the regional sphere on an on-going basis (China's Rising Clout: Impact on the Regional Balance).

There is no doubt that the world needs China at this juncture. As the world comes out of this recession, China may actually be able to deliver on the premise that perpetuated the recent bubble; that China is going to be the next engine of growth for the world.

Stirring to Get Going

In my last post on China, I had cited the March retail sales numbers (up 14.7% YoY). Even more indicators are pointing to the fact that Chinese consumption is finally taking hold as the large stimulus package starts to work its way through the economy. One of the most important indicators of the health of an economy, vehicle sales, are also pointing in that direction.

Consider, for example, that China is likely to overtake the US as the largest car market in the world (click here to see the Bloomberg story on the topic). While Indian environmentalists fret over the "ecological danger" posed by additional 50,000 a year Nanos unleashed by Tata Motors, China is likely to cross the 10 million cars per year mark this year.

This obviously has the embattled large manufacturers (including GM, Volkswagen and even Toyota) look at China as some sort of a rescuer. Again, consider the fact that even at 10 million vehicles a year, the vehicle density vs. population in China will be equivalent to the US position in 1925 and Japanese position in 1965. Clearly, car makers would see many more years of growth coming ahead from this point.

As the Chinese consumption finally starts taking shape, more and more sectors will start showing this kind of promise. The investment magnet that China has been, will become even more powerful.

EMs to Suffer

This does not bode very well for other EMs, including India. If you see a higher level of safety for your money and higher returns and better future prospects in China, your first preference will be to go to China. In a world flush with money, this is not a problem. In a world where everyone is struggling to keep growth positive and is looking for investments; this spells trouble.

Stepping Up at the Right Time

China has stepped on the gas at exactly the right time, when everyone else is reeling. The best part is, there is nothing much anyone can do, except grin and bear it.

There is already enough anecdotal evidence to it as well as some market information. Car makers will of course be heading for China, but so are hedge funds. Chinese stock market has outperformed practically the entire world right from the beginning of the calendar year. And it shows no signs of stopping. It is only a matter of time before everyone capitulates and dives headlong into China.

India could have been in a similar situation, albeit on a smaller scale. However, if you have thrown away fiscal advantage over petty differences with industry (e.g., the Cement industry vs. P Chidambaram spat), dithering over meaningless fuel price sops and a totally irrational indirect tax policy; there is no ammunition left for you to do anything. Add to that the political angle, where the PM finds it impossible to remove a blatantly corrupt minister, who completely stalls all infrastructure investments, in the name of keeping his political allies happy.

Dual Trends to Put Pressure

As the global economy recovers, EMs will now face a dual pressure on capital flows. As I pointed out in my January articles, the US tends to suck in capital in the early stages of any recovery. Now, you have another destination that is going to suck in more investments.

Over the next few months and years, we will see a clear pecking order emerging where China will be at the top and other EMs will be trailing behind. India will definitely do better than other EMs, provided there is enough left after China is done having its fill.

Executing the Large Range Trading Day Strategy

2009-04-20T09:21:00.001+05:30

TRADING TOOLS; TRADING STRATEGY

This is the concluding part of the series on trading large range days. The earlier two parts of this were posted yesterday, How to Trade Large Range Trading Days and Three Steps to Spotting Large Range Trading Days.

Once you have decided that the day under consideration is likely to be a large range day, you are ready to trade it. You do this by implementing the following three part strategy.

1 - Always Trade in Line with the Early Morning Trend

A good intra-day trade on a large range day is always built in direction of the early morning trend. If the market has taken out some important indicator (I had described one of my favorites in the last post) in the first hour of trade, it is likely that the trend established in this move is going to continue. Hence, always build up your positions in line with this early morning trend.

2 - Always Build Up Your Position in Steps

This is critical. Intra-day positions do not allow differential profit taking and stop loss levels (e.g., you cannot aim for a 100 point profit target while keeping your stop loss at 20 points). That means with a 50% hit rate, you will lose money on the transaction cost. The idea of stepping into a position, on the other hand, is to create a differential trade off if you are really into a large range day.

The first thing you need to determine is your acceptable absolute cash loss per trade. Let us say you are okay to lose Rs. 1000 per trade, that will determine your step size.

Next, determine the size of the move and set about one third to one fourth of that as your step size. You can take the range of the last few large range days.

Let us say you decide the step size for NIFTY at about 20 points and absolute stop loss at Rs. 1000. This gives you a step size of one lot NIFTY futures. Now you are ready to trade. Consider the following build with their stop losses beginning with NIFTY at 3000:

Entry at 3000; stop loss at 2980
Entry at 3020; stop loss at 3000
Entry at 3040; stop loss at 3020
And so on.

You can see that you are becoming profitable after step 3 and if the move goes up to 3100, you will be long about five lots. If the move falters on the way, you will probably exit either with a maximum loss of Rs. 1000 or no loss.

3 - Exit According to a Clear Rule Before End of Day

You have multiple exit options:

Only trailing stop loss and exit at EOD.
Exit at the fixed time of the day.
Exit when the move has reached the average of last three large range days in magnitude.

Whatever rules you adopt, ensure that the position is liquidated at EOD. Carrying these trades overnight is generally risky.

This concludes our discussion on the topic. Since volatility continues to be high in the markets, it is important to keep a strict risk control policy. That is the reason why I recommend using a strategy that limits your risk. If you have already evolved your own rules to achieve this, use them by all means. Otherwise, the basic trading rule described here is always a good fall back option.

Three Steps to Spotting Large Range Trading Days

2009-04-19T21:55:00.004+05:30

TRADING TOOLS; TRADING STRATEGY

In my last post (How to Trade Large Range Trading Days), I had talked about trading large range days. These days can be highly detrimental to the health of your kitty or could be highly profitable, depending on how you play them.

It is important to spot these days early on. Once you have decided that it is going to be a big range for the day, you just play along with the direction and start building up a good position.

Tell Tale Signs

Large Range Trading Days have a few tell tale signs. I have identified three such signals, the most important of which is the nature of market move.

1 - The Nature of the Move

While there are other signals that you can use to spot them, there is one signal that I have found to be consistently useful in finding such days.

Consider the following three graphs. (Source: NSE)

These three graphs have the following things in common.

The move is slow but steady. You do not get erratic jumps that go up by 1% in half an hour and fall back after that.
The move is quite sure footed and not tentative.
Successive peaks for downmove are lower than previous peaks and and bottoms are higher for upmoves.

2 - Early Break of Critical Indicators

The one indicator I like is the Fibonacci range for the previous day. Let me explain.

Consider the trading range of NIFTY for November 10, 2008.

Open 2973.30 High 3161.25 Low 2973.70 Close 3148.25

Here we have a trading range of 188 points. Counting from the closing point of 3148, we get the following critical trading points applying Fibonacci numbers.

R3 3336 R2 3262 R1 3219 Close 3148 S1 3077 S2 3033 S3 2960

On the following day, the S1 support is broken in the first 15 minutes of trading. That is a clear sign that a large range day is opening up.

It is critical to remember that I am not talking about a large reaction in the first few minutes of the opening to international cues. If market gaps down and has broken the S1 support or R1 resistance, then you have to wait for the break for next support or resistance for it to be a valid signal.

3 - Move of the High Beta Sector

Typically, the high beta sectors lead the changes in the market, though I do not necessarily place the maximum reliance on this indicator. You can rely on a few bellwether stocks, or an index that has a high beta or can even construct your own index. Whatever option you choose, you can use the move of such an indicator to confirm the nature of the trading day that is opening up. If a large range day is opening up, the high beta sector should be leading the broad market in the same direction.

Now that we have understood how to spot the large range day, we will talk about trading it next.

How to Trade Large Range Trading Days

2009-04-19T20:45:00.002+05:30

TRADING TOOLS; TRADING STRATEGY

One of the most persistent features of the markets in past six months has been the large range day. Even after the being into the current market for months, the large range day has not disappeared. This presents a good trading opportunity to the day trader.

The Dangers of Large Range Trading Days

The biggest danger of such a day is presented to the medium term trader and the ones who typically hold their positions for 3-5 days. The latter is typically forced to turn to day trading in this environment.

The biggest danger is getting out of profitable positions due to your stop loss getting hit on either side. This can be quite frustrating at times because one day of a large counter trend move is typically followed by trend resuming the very next day. Things get back on track the very next day while you are left nursing your wounds.

But It is Not the End of the World

Of course, a good trader will take such losses in her stride.

One of the ways a longer term trader deals with such nasty surprises is by having large stop losses. If you see such days moving the NIFTY by 100 points either way, you can always build trades that aim for a 200 point move with 100 points on the stop loss.

But this means you are giving up large number of trades that otherwise could be quite profitable. More than that, you are giving up the opportunity to trade such days in a profitable way.

Enter the Step Method

My preferred way to minimize the impact of such days and to trade them profitably is to use the tried and tested step method of building up a large position. While my earlier articles have touched upon this method, it is time to explain it better to enable better trading opportunities.

The idea behind the step method is simple. As a trader, you do not want to bet on the direction of the move, but the quantum. The difference is crucial. If you take a directional view, you will probably go long a falling market or would short a rising one. If you take the quantum view, you can get rid of having to guess the direction.

Next, we will talk about how to spot a large range trading day and how to deploy the method.

Weekend Crap-2: Feminist Rage over Michelle Obama and More

2009-04-19T18:26:00.001+05:30

WEEKEND RANTS

Okay, why am I writing the second edition of Weekend Crap for this weekend? Well, nothing better to do. I had prepared extensively for catching the IPL match between Mohali and Delhi. This match always promises to be interesting because my wife is a die-hard Delhiite and me being a pukka Punju have to support Mohali.

But the match is getting rained out and does not look like happening. What better to do than write some weekend crap?

First, the Feminist Rage

Well, the entire Feminist community is up in arms against Bonnie Fuller of Huffington Post because she called Michelle Obama a MILF. In an article titled Cougars And MILFs Rule! 40 Year-Old Women Are WAY Hotter Than 20 Year-Olds!, she waxes eloquent about sex appeal of women over 40. That is a fair point, but some people find the word MILF objectionable.

Read the piece for yourself. I don't care about what you want to call them, but the page sure has a lot of eye candy (hey, if a woman can call Michelle O a MILF, why can't I call these models eye-candy?) and you can even vote for your favorite ones! The best thing? You get comparison between a few gorgeous ones and their 20-something equivalents. So go for it.

We Love our Politicians

Of course, we love them so much. That is why I am not surprised by an emotional confession by Sanju Baba for his desire to give a "jaadu ki jhappi and pappi" to Behenji. I do not harbor any such emotion for Behenji but I do confess that I had a crush during my teen years for some time on none other than Puratchi Thallaivi J Jayalalitha. Yeah, yeah, she is called Amma now, but she was not always Amma.

Few people, by the way, know that Jayalalitha acted in a hindi movie too. It was quite a hilarious pot-boiler called Izzat starring (guess who) Balraj Sahni and Dharmendra in a double role. One of the roles played by Dharmendra is that of a "dark" guy and Dharmendra starts being orange/green in the beginning of the movie and keeps on getting oranger and greener throughout. The high point of the movie is a song called 'jagi badan mein jwala' in which Jayalalitha leads a village dance. The song starts like a nice gentle Bhajan and proceeds to a military marching beat in the background. If you can drop the modern famished to death sense of beauty, you can see why she had built up such a following.

Here is the youtube link, in case you want to watch the video.

Sorry, No Third Thing This Time

Okay, the match has started and Mohali is raining sixes on Delhi. So make do with what is already there. More stuff next week, of course.

Cheers!

India: Danger at the Doorstep Part-1

2009-04-19T17:00:00.005+05:30

GEOPOLITICS

You cannot avoid a war. You can only delay it to your own disadvantage.

- Niccolo Machiavelli in The Prince

Things have been going horribly wrong in India's neighborhood for quite some time now. The Taliban threat has been rising consistently and now it is reaching an alarming proportion. The Indian establishment has taken these developments lightly and that does not bode well for stability of the country.

Someone Else's Problem

So far, the trouble with Taliban has been treated as a problem that either belongs to the US or to Pakistan. But what is happening now clearly threatens the survival of the Republic. And the Republic cannot take it lightly.

It has been fashionable in Indian polity to call Pakistan a 'failed state'. Whenever there is a need to 'talk tough', Pakistan has been an easy target and calling them names is always handy. But soundbites do not make a prepared nation and politicians with attention spans of 10 seconds do not make good policymakers.

Implications of a 'Failed State'

As Pakistan has steadily inched towards that status, it has started dawning on the world what it is going to mean. There is a good reason why Obama, who has been pushing to the hilt to withdraw troops from Iraq, is willing to commit more to Af-Pak.

The implications of letting Pakistan slip are horrifying. It has a massive army, more than 600,000 strong, that is armed to its teeth by China and the US (India has about a million, but when you consider the large border, its internal commitments for fighting insurgency and multiple enemies, Pakistan almost squares up). It has nuclear weapons whose command and control is a grey area. And then, there are possibly up to a million students of religious schools around Pakistan who can join the ranks of Taliban (that is where the word Taliban originated, it is a plural of the word Talib, meaning a student).

Now consider the fact that Pakistan's intelligence agency ISI (thought to be a 'state within a state') is packed with elements sympathetic to Taliban whom it created and trained. Also, consider the fact that Pakistan army command and control is also thought to have been infiltrated by Taliban. Nobody knows what percentage of Pak Army is sympathetic to Taliban. But once the balance tilts in their favor, there is no stopping this force from running over the more secular forces and gaining control over entire Pakistan.

Worrying Trends

26/11 showed where things are headed. It has become abundantly clear during past six months that the current civilian regime is turning out to be a puppet in the hands of more powerful forces in Pakistan. And the impunity with which Taliban are now moving into hitherto out of bound areas like the Punjab province; it is clear that these forces are gaining strength by the day.

The writing is on the wall. Now, sources in US intelligence community openly acknowledge that things could break down any time soon in Pakistan and it could get into either a civil war or could be controlled by multiple warlords or, the worst case scenario, become a single, Taliban controlled country.

Not As Easy As Afghanistan

Pakistan is NOT Afghanistan. It is a populous country, has a large professional army. If it goes the way of Afghanistan, it will not be possible for the US or India to control the situation in military terms.

The US succeeded in dislodging Taliban in Afghanistan because there were opposing forces that just needed a helping hand. The Taliban fighting force was also less than 100,000 strong and other factions could inflict a good damage on them with the help of the US. Pakistan, God forbid if things come to that, is not going to be so easy.

The strength of Pakistan Army is not in its numbers alone, though they are also impressive. Wikipedia lists the army to be about 619,000 active duty personnel, around 302,000 paramilitary and 520,000 in reserves pegging the total strength at 1,400,000. It is a modern professional army with close to 3,800 battle tanks in service (with 3000 more of a new Al-Khalid II MBT planned), around 3500 armored personnel carriers, around 2000 field guns in artillery among other armaments. It has a variety of missiles, some of which are nuclear capable. Its air force deploys about 700 aircraft that include 44 F-16s and close to 200 Mirages. Add to that advanced AWACS systems supplied to it in late 1980s and early 1990s by the US (India is still looking to acquire them). The same goes for navy also. And then, there are nukes.

Clearly, this armed force is not a pushover. And if this military machine sides with an insidious force like the Taliban, God help the world!

Killing Children in the Name of Education

2009-04-19T13:35:00.003+05:30

NO MARKETS

This post is not on markets or anything like that. Please excuse this diversion, but it is important to me personally.

A few given "truths" rule the average Indian's psyche. A teacher's place is above that of God. A physician can do no wrong. A teacher can do no wrong either. The dark side of these beliefs is what we see happening today. In Delhi, you see kids routinely either suffering seriously or dying due to physical abuse by teachers who think nothing can stop them or touch them. Even questioning them is treated with indignation. Other places are no better though such cases may not be so publicized.

General Apathy

The all round apathy shows up in the fact that despite numerous deaths happening in the education system (whether due to teachers' barbarity or due to their apathy in checking things like ragging), there is no serious attempt at reform. Whenever such a case happens a few noises are made and then the issue is forgotten.

A Class Issue?

Most of such cases, where teachers are directly involved, are happening in schools or institutions that cater primarily to the poorer sections of the society. Municipal schools or government schools are not the places where children from middle class India (forget about the true elite, they wouldn't be caught even passing by the gate of such a place) go for their education. These places "serve" the poor and those who cannot afford a decent "private school" education.

That is the reason why teachers from "decent middle class families" can do whatever in the name of imparting education. Beatings are common and public humiliation is the norm. Children are treated like cattle and a word like "dignity" is not part of vocabulary. Why is reform not happening? Because we all believe that it does not affect us. Why should I worry because my child does not go to a municipality run school?

Keeping India Uneducated

It is not that all teachers in these schools are like this. But there is enough number of sadistic beasts who derive pleasure from these activities. That is the reason why corporal punishment is cited as one of the prime reason behind high dropout rate in these schools (ranging from 40% to as high as 65% in some regions). The number of such sadistic low lives may be low, but their impact happens to be big. The fact that the remaining 'silent majority' does not object to their antics only enhances their influence. And the perverse role of the low lives is lost on everyone, ranging from 'liberal' educators to 'custodians of culture' like Sri Ram Sene.

The latter will jump up and down so furiously over a few girls going to pubs that their balls will get lodged in their throats. But when it comes to serious issues that hobble the society, they are oddly ignorant. Perhaps because they believe in a system where cutting off and offering your own balls to a deranged guru is supposed to be the highest honor. It is no wonder that their support comes from the section of society that routinely executes ('sacrifices') their own children because a Tantrik baba told them to. Murder, rape, pedophilia, all is par for the course for this section. Those who are too shocked to believe this can check this report covering 2002 when at least one such murder was happening every month, half of them being committed by parents themselves.

Getting Away with Murder

The result of apathy is that these low lives are able to get away with murder. What is infuriating is the argument offered in defense. Take the latest case in Delhi (Shanno, 11 years old, died in coma after being beaten up and made to stand in sun for 2 hours).

The family of teacher alleges that the girl was epileptic, had a medical history. They are implying that

It is okay to kill an epileptic child or one with medical history.
It is okay to mete out extreme punishment to a sick child because if she dies later on, you can always blame the sickness.
It is okay to be dastardly mean, brutal, sadistic and physically abusive to a child who actually needs to be treated with sensitivity because of a medical history.

What is the worst is that such arguments given by such scumbags are accepted by everyone. Shame on a society that is so callous about letting these monsters feed on our children like this.

Countering the Deranged Perverts

What will you call someone who takes pleasure in beating 7-year olds to death? The cases that come to light are the extreme ones, where a child ends up dying. What about the rest who are routinely beaten up for something as little as a torn notebook or raising too many questions?

The solution is not in some 'sensitization program' or lamenting low-pay for teachers or overworked teachers. If you are so damn- peeved about the low-pay, just get lost and find another job. These are just excuses to get away without any serious consequences.

Unless these cases are treated the way they should, as abuse and murder, this menace is not going to stop. By all means, treat teachers with dignity. But giving them the right to kill and beat and maim children for pleasure? That is not done.

Indian Stock Market Rally: Three Things that Set This Rally Apart

2009-04-18T18:29:00.002+05:30

INDIAN MARKETS

The current Indian stock market rally has been not only been spectacular but is different from what is normally associated with rallies of such a magnitude. It just helps to remember that the market is close to 40% up from its March low and has rallied despite the whole trading community expecting to break October lows and slip much further from there.

Most of the analysts have been caught by surprise and have ended up being proven wrong in this move. The two who have been relatively successful are Ashwani Gujral and to some extent Rajat Bose. Others have been so consistently wrong that you could have made money by fading them.

This rally is different from what can normally be characterized as a bear market rally. At the same time, it is markedly different from the beginning of a bull market.

How does it matter? Getting a hang of it is crucial because it tells us what the potential of this market is. So here we go, trying to look at the grain of this move.

1 - The Quantum of the Move Is Much More than a Usual Bear Market Rally

The size of the move itself is telling. A typical bear market rally goes up to 20-25%, more than that is unusual. This rally has seen close to 40% and is not showing signs of tiring out.

Why do I think that? Because majority of the market is still talking about this rally fizzling out any time. The moment the rally slows a bit, people start shorting as if there is no tomorrow. Upmoves are nice and gentle trots (except on the day post Goldman Sachs results), corrections are nasty, possibly meaning that not only profit taking is happening but massive shorting also takes place on such days. No, this market is certainly not tired.

2 - Volatility is Too High to Make it Another Bull Run Beginning

The flip side is that it is not looking like a bull run beginning either.

Markets at the beginning of a bull run are generally very quiet, taking their time to build up a nice move. Corrections happen periodically, but they do not look like the world is falling apart. Volatility is generally low, and slow accumulation is generally the tone as people test the waters.

At the same time, this could be deceptive. The world has been a scary place of late and bulls just might not have the confidence to keep a rally going and may be taking profits quite early. Coupled with incessant shorting, it would make the market much more volatile than usual.

So, here is the contradiction. Volatility is too high to make it look like a bull run beginning. But it could be deceptive. Again, my call (like my posts on April 7, 11 and 16) remains an upward bias.

3 - Underlying Conditions are Changing Dramatically

I can lay the claim to being the only one consistently saying that global economy is going to turn by September. This call was put on this blog in December, 2008 and I was the only one stupid enough to stick to this call for four months.

Now, changes are showing. The US financial sector will probably take a few years to sort its mess out. But the world is certainly moving on. We are not out of the woods yet, but looks like we will be. It is no longer the hopeless situation that prevailed for six months.

So there you are. I won't repeat the cliché 'this time it's different'. But this rally certainly has the potential to give a nasty surprise to the bears.

Weekend Crap: CNBC’s 20th Anniversary and Ms. Mitali Mukherjee’s Growing Popularity and Some More

2009-04-18T15:27:00.003+05:30

WEEKEND RANTS

This post was supposed to be uploaded yesterday, but somehow got pushed out to today. Anyhow, here we are. With this week's edition of WEEKEND CRAP.

Yesterday was 20^th anniversary of CNBC, the main US wallah. Naturally, both Mitali and Udayan Mukherjee were in a highly upbeat mood. Mitali Mukherjee was very happy to see that Maria Bartiromo got a big ugly card from a Wall Street type broker (name withheld to avoid a big law suit). She also got a very 'heartfelt' comment (that sounded quite sloppy to me) that was basically about Maria being the "face" of CNBC.

This somehow had Ms. Mukherjee beaming. I do not know what caused that to happen. May be she was imagining herself getting a similar large, ugly card from a Bambaiya broker, and a great compliment like being the "face of CNBC-TV18".

New Study in "Evolutionary Adaption"

Okay, whatever I am writing is not connected to anything written in the previous paragraph. Please proceed only if you agree with this disclaimer.

Okay, we are done with the legal stuff. I am very scared of the Wall Street type, itching to sue poor blokes for obscene amounts of money. You might remember the case of Monica Wong of HSBC, Hong Kong who sued her dance instructor for $8 million just because he asked her to "move her arse". Well, it is a bit more complicated, you see. Ms. Wong, a poor "widow of 61", was looking for "the last bit of glory in life" wanted to win this amateur dance competition. She had agreed to pay this instructor US$15 million (yeah, you read it right) for taking "dance lessons", had paid up $8 million and now wanted it back.

Okay, I getting scatterbrained again. Yeah, so this research has been out for some time that women get more orgasms if the person *#$@ing them happens to be rich. In fact, the richer the better (we live in a relative world). So face it you dumbass. Guess what, no matter how much time you spend in the gym, that fat banker always gets to score over you. This piece is "enlightening" (from TimesOnline, UK).

…the phenomenon is an "evolutionary adaptation" that is hard-wired into women, driving them to select men on the basis of their perceived quality.

Yeah, perceived quality it is. If you own a Porsche Carrera or an SLK 500, it certainly helps "perception".

Back to Mitali

So, getting back to our current topic, there is a lot of speculation that seems to be going on about Ms. Mukherjee's marital status. Looking at the traffic to this blog, I see a lot of Google searches on whether Udayan Mukherjee and Mitali Mukherjee are husband and wife, a lot of people mistakenly believe that Udayan and Mitali are married. Even I used to think that Udayan and Mitali are married.

I am proud to say that this great debate of national and international importance was settled on this blog. Yes sir, this very blog written by this very… well… me, when I was lauding the glory brought by Ms. Mukherjee to this country by beating worthy opponents like Maria Bartiromo to be part of a list of 25 sexy anchors created by some "very well known" ["bahut hi achchhe blogger hain"] blogger out there. This very blog was instrumental in bringing this matter of national importance to a satisfactory conclusion ['isi blog par… isi blog par sabse pehle… sabse pehle ye khulasa hua ki…']. A great fellow blogger going by the name of Mihir laid this great mystery to rest, for which we are grateful to him (I am assuming it's a "him", phew man, it is so hard nowadays to tell from a name).

Okay, now I can safely apply to Rajat Sharma's India TV for the position of a news anchor too!

More Mitali Mukherjee

The world seems to appreciate Ms. Mukherjee more and more. Consider the following postings at different places on the web.

Mitali Mukherjee. CNBC TV 18 Anchor. Laughs Ha! Ha! Ha! at 0:46….

Or, consider this posting, again the Ha! Ha! Ha! Video perhaps.

Or, consider this one, "Mitali Mukherjee. CNBC TV 18 anchor. Saying Hah!"

Come on guys, she is a good anchor. And she knows her job well. But is she so good that you catch every Ha! said by her? When will this fascination for people who have an excellent knowledge of stock markets end?

Okay, no more Mitali Mukherjee

Now to some less serious stuff. So this week's pick for the "ridiculous thing of the week" is Woman calls 911 over fried rice. This lady, apparently, has taken the idea of citizen friendly police too far. So, the chef did not put enough shrimp on your fried rice? Call the friendly neighborhood cop.

I wonder where Delhi Police will end up with their slogan: with you, for you, always…

Cheers, and have a good weekend.

Trading Success: Five Things You Must Do As a Trader

2009-04-18T02:16:00.001+05:30

TRADING STRATEGY, TRADING PSYCHOLOGY

Trading success, ah, that sweet situation when you trade effortlessly, when everything you touch becomes gold, every trade you make pours money into your account. You like this stock and buy it, and it surges 50% in three days. You don't like that stock and short it. Kaboom! And it crashes to the ground. You are trading like a maniac and making money left, right and center and again in the middle. Wow, trading success.

'Wake up, you damned fool!', was the shout from my mentor when I first described what 'trading success' meant to me. After that, it has been a long grind that taught me that trading looked nothing like what I had imagined it to be. Quite the contrary, it is the sort of game where the defining characteristic of success is discipline.

While you may have read many "serious" articles on trading tips and investing strategies, you may still not be paying enough attention to the few cardinal rules of trading that cannot be ignored. That is not the way to achieve trading success. Trading success comes with discipline. Diligently applying these time-tested trading principles is the first step to build the trading discipline that brings lasting success in markets. So here we go with the list.

1 - Trading Is a Game, Play It like a Pro if You Want to Win Big

Every game has it rules, requires skill and takes patience to learn. And it can be played like a weekend hobbyist, an amateur or a pro. You do not play tennis only on Saturday evenings with your co-worker and aim to win the Wimbledon.

Trading takes as much effort to master as any professional sport. A learning attitude, detailed study of your markets, discipline and dedication to the craft are necessary conditions for trading success.

2 - Do Not Listen to that Broker

Your broker may be brilliant. You may have even made some money by listening to him once or twice. But you are playing with fire.

Taking others' trades is always risky. A trade works only if it suits your trading and risk management style. Taking a broker's trade is highly risky. It lulls you into false confidence because you assume he has some insider/market dope, you do not know the real or perverse incentive behind it. Besides, it is still someone else's trade.

Listen to them to get their views or market updates or to ascertain how others are trading. But do yourself a favor. Build your own trades.

3 - Do Not Change the Rules in the Middle of a Trade

We have all seen it happening. Trader spots an opportunity. Trader creates a trade. 'Buy Euro at 1.3250 with a target of 1.3350, stop loss at 1.3200, a three day trade at the most', let's say. Now trader sees the original hypothesis being validated and changes the profit taking rule in the middle of the trade to 1.3500 and makes it a one month trade.

Some are able to get away with it. Most are not. The reason is simple. The moment the trade starts, you lose a valuable thing called objectivity. After that, half the arguments you give yourself are damned lies as your mind plays tricks on you. Either you get greedy and invent tales to keep a flagging trade going or you convert a short term trade to a "long term investment" because you don't want to act on the stop loss. Any which way, you are not trading any more, you are fantasizing.

4 - Take That Loss, Fast

The best way to ensure success in markets is to keep your losses limited to the minimum. I am not talking about stop losses only, though they are a must.

Look at it dispassionately. Every trade is an experiment. You build a mental model of the market (however crude or sophisticated) and surmise that a security is going to go up or go down. And then you put your money to test this "hypothesis". If your hypothesis is right, you make money. Otherwise, you don't. It is like conducting that fifth grade science experiment to test whether metal expands when heated.

Now, suppose you went in with a hypothesis that gets discredited. There is nothing left in it for you. If the trade is showing a loss, however small, get out even if your stop loss is miles away. The faster you take that loss, more money you will preserve.

5 - Remember, There Will be a Market Tomorrow

Again, this is not only about staying out of the markets at times. Of course, markets cannot be traded all the time and you should stay out when the markets move in a whipsaw.

But the rule goes beyond that. Consider a scenario; Trader has been waiting for that stock to break out for a month. He is taking a contrarian view, so is safe in assuming that the move will be sharp and big once it happens. And suddenly, it happens!

Our Trader here is seeing the opportunity of a lifetime. 'At last,' he thinks, 'this is the time to go for it and make a killing'. He puts his last penny in. The break-out turns out to be a false signal. Trader loses half his capital. 'Another six months to get back where I was yesterday morning', he shakes his head in dejection and goes to Gold Rush to catch the latest strip show.

Do yourself a big favor. Do not assume the trading opportunity you are seeing is the last big opportunity of your trading career. There will be more tomorrow. So, stay out if you can't build a sensible trade. And don't bet your underwear along with your shirt, hoping to be George Soros by next Monday.

Concluding Remarks

You may have looked at these rules earlier, or some of them may be new for you. Nonetheless, these fab-five are my favorites to ensure I preserve my underwear and my sleep on a long term basis.

There is a lot more dope on trading in the tools, behavioral finance and psychology sections. Some of the stuff I have written there is pretty sophisticated, useful only for the pro. These, by contrast, are just the basics. But take my word for it, amateur or pro, no one can do without them.

So, there you are. Get ready to trade like a Poirot, with a method behind the madness. And you can pick up that tennis racquet and start training for the Wimbledon.

[This article assumes a good understanding of the trading context and assumes some familiarity with the markets and common trading axioms. I intend to do a simpler version of this at a later stage for people who are completely new to the field of trading.]

Satyam Fraud: Trail Already Gone Cold?

2009-04-18T00:26:00.001+05:30

INDIAN MARKETS

CNBC-TV18 reported today that SFIO has not been able to conclude anything on siphoning of funds in Satyam. The key reason cited is: lack of jurisdiction.

In my piece Satyam Sale: End of a Sordid Tale?, I had lamented about the way things are proceeding and the fact that no one seems to be worrying about recovering the stolen money. This news item just confirms the worst of our fears. The Satyam fraud is being treated more like an accounting problem.

The Satyam Sale

It is in this context that the Satyam sale becomes so noxious. Right in the beginning, the government declared its intentions to sell the company. No attempt was made to find out whether the company could be viable as it was or not.

More than that, the shareholders were not even involved in the decision to sell the company or in the choice of the board members. The board also has kept itself limited to the task of selling the company out. Clearly, the shareholders have been given a short shrift in this entire game. My January 21 post, Saving Satyam and Rescuing the Indian Equity Markets, discusses this issue in detail and why it was an inherently bad idea.

Letting the Ball Drop

Clearly, the Satyam board has not bothered to keep the ball "in play" on a critical matter, recovering the money. As I pointed out in the Satyam sale… post, recovering even 10% of the money would have eased the financial stress on the company and would not have necessitated a sale.

There is another factor that pushed the sale ahead. A government appointed board and management do not have a mandate to run the company in the long run. In that sense, the board was a management "in transition" and could not have done any better than sell out the company.

But the key question remains. Is the management not responsible for safeguarding the interest of the shareholders? If that is so, are they not supposed to push for recovering an amount of money that is bigger than the market cap of the company?

We Are Like This Only

This is the explanation you finally end up with. Find a few scapegoats, keep them in the prison for a few years, do all sorts of nautanki around it. But never even try to recover the money. This is what happened in case of Harshad Mehta scam. The whistleblower in the case was arrested and kept in prison without trial for five years. So was Harshad Mehta. How much money was recovered? Go figure.

This is what is likely to happen in Satyam case also. The Brothers Raju will stay in for a long period of time, while the trial drags on. Then, one fine day, they will get bail. Whether they will be found guilty or not, we do not know.

Do not expect to see the money come back. That is not our style. And we are like this only…

Russian Withdrawal from Chechnya: Implications

2009-04-17T01:16:00.001+05:30

GEOPOLITICS

The announcement on Chechnya comes at an odd time. After fighting for a decade in Chechnya, suddenly Russia has declared that it is not a terror fighting zone anymore. What are they up to?

An Unusual Pattern

When you start linking up the announcements coming out of Kremlin over past few weeks, the pattern is a bit strange. Criticizing the US early on economic policy was just the usual bellicosity. It was a time honored tradition that was served by Putin in Davos.

Creating a new armed outfit to control North Sea resources is definitely more than time honored tradition. Noises about the aging nature of the Russian armament and plans to rearm the military also do not fit in the same pattern. Pulling out of Chechnya when there is no international pressure or change in the situation there also goes the same way.

One blog asked the question, where the troops will go now that they are out of Chechnya. The author was of the opinion that they will be used in another region trying to break away. But that is not a foregone conclusion. It seems that the Russian goal is to put pressure on the US and stress test the current administration. If the hypothesis regarding Russia trying to test the Obama administration is correct, we should see an announcement concerning Central Asia pretty soon.

Defining the Sphere of Influence

Central Asia, essentially, is the heart of the strategic problem for Russia. Clinton administration had kept Russia strictly pinned down in the 1990s. Part of the problem for Russia then was its economic misfortune. But the US kept up the pressure, kept expanding the NATO, kept economic incentives high for Central Asia and did not give any room for maneuver to either Yeltsin or Putin.

And then Chechnya happened. The start was brutal and the frustration of a mighty empire, suddenly fallen from grace, was vented on the small region. But the situation has been "stable" in Chechnya for years now (that is, nothing much has changed of late to warrant a change in Russia's Chechnya policy). Why now?

Giving Up the Advantage

The US policy changed with Bush. In one fell swoop, the US developed tunnel vision and suddenly Russia, along with it Chechnya or Central Asia all disappeared from the US radar.

The result is a massive loss of influence for the US. Till 2000, Russia was finding it hard to get access to Central Asian republic gas and oil pipelines. Today, the US is completely out. Till 2000, "Russia's backyard" was dying to be part of NATO. Today, the US has been unceremoniously thrown out of its only air base in the region by Kyrgyzstan.

What Next?

Putin, being the wily strategist he is, will not like to let the US get back in the game. The commodity price boom fueled by unlimited money shoveled out by Bush helped him beef Russia up. Now is the time to up the ante and test Obama's will to respond. The best way to do that would be to make an aggressive move. Pulling troops out of Chechnya may well be the first step in that direction.

Expectations Belied, Tale of a “Reformist” Government

2009-04-16T15:20:00.002+05:30

ECONOMIC POLICY

This government came into power with high expectations. Choice of Dr. Manmohan Singh as Prime Minister made everyone sit up. He was credited to be the architect of reforms under PV Narsimha Rao. Similarly, P Chidambaram as Finance Minister enthused many people. His budget proposal in 1997 as Finance Minister under IK Gujral paved the way for current tax regime. Tax rates came down from regressive levels (above 50%) to more sensible levels.

Having these two gentlemen in these two positions was like having a "dream ticket" for the economy. Among the list of expectations were things like labor reform, more disinvestment, policy rationalization and above all, fiscal consolidation to secure India's future growth prospects.

Squandering the Mandate

If you look back trying to assess what has been achieved in past five years, you get a one-word resounding reply; NOTHING. This has happened despite the fact that we had the good fortune of being in an unprecedented global boom that saw money being poured into India by the bucketful. The resulting jump up in growth meant the government had the political capital to push reforms, the revenue backup to force fiscal consolidation and a thriving job market to painlessly introduce some labor market reforms.

Instead, we saw this "dream team" squander everything away for petty gains. When inflation was not a concern and growth was high, the government chose not to dismantle a relic like controlled pricing of petroleum products. When jobs were being created by the million, simple measures like allowing dead organizations to formally close down and release precious resources (e.g., land) were not adopted in the name of protecting employment. And worst of all, instead of building a fiscal buffer against future economic shocks, the government magnified the risk by being blatantly populist.

Standing up for the Wrong Cause

All the way through its tenure, the Singh government blamed its dependence on Left parties for going slow on reform. The Left parties exploited this real or imaginary dependence shamelessly; blocking everything that could have done some good to the economy with a vengeance. They were allowed to go to such an extent that one wondered whether their loyalty was for India or some other country.

But when it suited this government, the Left parties were shown the door quite unceremoniously. That is where the interesting part starts. 'Now that the Left is off their back, they will push reform' was the expectation.

That is where the biggest disappointment lies. The recent boom could have been used to put India on a permanent path to growth. Undoubtedly, we have seen a good growth spurt during this period. But, it has turned out to be just a lost opportunity. We have been here before, the growth spurt of early 1980s was just as spectacular, lasted just as long. But given the absence of any real reform, it led to stagnation of late '80s and financial crisis of 1991.

Let us hope things turn out differently this time. For that,we have to pin our hopes on the next government.

China GDP: Growth Surprises Pessimists but Leaves Optimists Asking for More

2009-04-16T11:51:00.001+05:30

GLOBAL ECONOMY; CHINA

Q1, 2009; one of the gloomiest quarters in economic history of the world. I do not know what the great depression was like. Most of us don't. But this quarter looked as scary as it could get.

There was hope, of course. Promise of a new regime and new thinking in the US; the willingness to throw everything but the kitchen sink at the problem and so on. And then, there was China.

Promise of the Dragon

Views on China have been quite diverse. Some have argued that China can provide support to the global economy as its own consumption can easily compensate for demand destruction in the West. Some have argued otherwise. Their claims were somewhat supported by what happened in past six months. The "decoupling" myth died the moment bad times arrived. It suddenly turned out that EMs and BRICs were as vulnerable, if not more, to financial trouble in the West as the developed world.

Reality, as usual, has turned to be more complex. China did suffer a shock due to fall in exports. But it did post growth still. China did criticize the West over economic trouble caused by a discredited financial system. But it did step up to the plate and joined the global effort to stimulate the economy. While the numbers pushed by the US and others dwarf anything imaginable of late, China's own stimulus has been massive (almost touching India's GDP number).

And there is one critical difference that sets China apart from everyone else.

Packing a Bigger Punch

China is the only country with a proactive stimulus plan. It is the only country with something that is likely to work, and work fast. Let me explain.

The US and the UK have shoveled more money out the door, faster than one can imagine. Still, it has all been backward looking. There is a big hole, a deep gash caused by past stupidity and you are just trying to fill it. It keeps widening by the minute and you don't know when it's going to stop. You just hope that the world does not come to an end while you are trying your rescue act. At home, Indian stimulus has been puny and as lame. Lower fuel prices and some indirect tax cuts do not make a stimulus.

China, on the other hand, has gone full throttle on spending. And it shows.

Disaggregating the Numbers

The number reported by China is the lowest in 10 years. The number is higher than what the pessimists have been predicting, some as low as 3-4.5%. Still, it is nowhere near what the optimists would have liked to see.

But the composition of the number is revealing. Exports continue to shrink, hence remain a drag. Industrial production and investment has surged ahead. Industrial production rose 8.3% in March YoY and urban investment by 30.3%. This means stimulus is showing up somewhere

A bigger surprise is the consumption number. Bloomberg reports that retail sales rose 14.7% in March YoY. This means the famed but always sleeping Chinese consumption giant may be beginning to stir.

Long Road Ahead

It does not mean all is well and the world can go back to happy days. China has ample woes of its own, some well known and some well guarded. Growth is well below its target rate of 8%, stimulating consumption more may be important as exports continue to fall.

And there is only so much China can do for the world. It can keep its economy afloat and help others by sucking in raw materials. It cannot sort out the mess created by free-wheeling Bush and Greenspan days.

But again, reality is a complex beast. Keep your hopes up and cheer for the Dragon.

Pre-Election Rally Update: View Remains Intact and Upward Bias Should Continue

2009-04-16T10:45:00.003+05:30

INDIAN MARKETS

Again, my market view has turned out to be correct, (see Enjoy the Rally till Elections posted on April 11) for the moment. The global rally is taking hold and as anticipated, Indian stocks are continuing their run. They will continue to do so till the first estimates of election results start coming out.

I am of the view that some emerging clarity on political front has helped this rally (see the previous post Indian Elections: Congress Likely to Come Back?). In the run up to elections, markets have been quite nervous with the prospect of a lame duck government coming to power. It would mean political instability, lack of direction on policy and no reforms (not that a "stable" UPA bothered to implement a single "reform" when the going was good, more on that in my next post).

It was certainly impounded in the valuations and part of the reason behind massive clobbering stocks got. The bounceback from there has been robust.

Will It Last?

That is the question all of us have been asking. Some of us have very definite sounding answers, some not.

I will admit upfront that I do not know. I can only surmise, and this is what looks like happening.

Since part of the gains are coming due to euphoria over likely come back of Dr. Manmohan Singh, part of the rally will fizzle out the moment there is complete clarity. The cardinal rule of stock markets. By the time you have complete information, the game is already over.
FIIs are coming back to India. This is strictly due to growth differential India has over other markets. I hear you, India growing at 6% and so on. But remember, being an EM, expectation is that it should give an additional growth of about 2-3% (oodles of economic data on this, write to me if you want a good bibliography) to be treated on par with a developed economy. So India with 6% is attractive till the west does not recover.
Western recovery is still in the doldrums. Doubts still persist and I do not know whether my earlier estimate of its start by September is correct or not. This means we will still be relatively attractive for another month or so. Beyond that needs reassessment.
Currency is stabilizing and old poison of bad hedges can start clearing. Corporate India seems to have stopped shooting itself in the foot. Of course, bleeding due to bad hedges will continue for some time, but firing new shots is less and less frequent. Rupee stability also will help. Stable corporate outlook helps a lot to calm nerves.

So the view is intact. Trade with an upward bias and do not listen to naysayers who keep chirping 'bear market rally' as a matter of habit. Shorting is dangerous, so keep tight stops if you decide to venture on that side.

Indian Elections: Congress Likely to Come Back?

2009-04-16T09:39:00.003+05:30

ELECTIONS IN INDIA

During past few weeks, there seems to be some clarity emerging from the chaotic activity preceding the elections. Congress has been gaining momentum and voices emerging from there are increasingly cohesive. Their actions, whether it is Manmohan Singh's sneers on Advani, or an open attack by Rahul or his timely defense by Priyanka, seem to be well coordinated.

On the other side, there seems to be clear lack of spirit on non-Congress group's part. Many of them, including the BJP, sound like they are still a few months away from elections. Things that should have been sorted out months ago are still open questions. Pre-poll alliances are still in the works and internal squabbling is high. Only Congress seems to be buzzing with the poll fever while other are still trying to get their act together.

There Is No Alternative (TINA)

This may have to do with the fact that today Manmohan Singh is the new TINA man. Within Congress, he is holding the reins for Rahul Gandhi. The Gandhi family will not find anyone else who is competent enough to run the country and is docile enough to step out of the way when time comes for Rahul to take over. Curiously enough, there does not seem to be any viable challenge to Singh from outside Congress also.

Outside Congress, it is mayhem. Let us take the BJP. LK Advani has been sparring actively with Manmohan Singh but, clearly, lacks support. Unlike Congress, where Manmohan Singhs's snubs to Advani are being adequately buttressed by star power of Rahul, Priyanka and other leaders; Advani's associates are more of a handicap to him. Rajnath Singh's brush with Sudhanshu Mittals and Neera Yadavs makes Laloo's RJD look like a party of saints. Worse than that, he is seen openly undermining Advani. Modi, a competent administrator he is, still carries the stinking sludge marks of post-Godhra outrage. And that's it. BJP runs out of its list of "stars" right there.

Left is exactly where it has always been. The 3^rd front, the 4^th front (and possibly 5^th also if every party with an MP continues to nurse hopes of having "their" prime minister) are gross anomalies in anatomy.

So, for the time being, there seems to be no viable contender.

Gearing up for the Fight

Victory in Indian parliamentary elections no longer means getting a clear majority of 272. The benchmark for being able to form a government has been coming down steadily. There was a time when Rajiv Gandhi chose to sit in the opposition with 197 seats after 1989 elections. Today, anyone crossing 150 seats becomes a contender to lead the government.

Congress seems to have sniffed that it is in striking distance of a viable number. This shows in the confidence of key people. The tone has changed and momentum is increasing.

Hopes of Stability

No one can reliably predict the final results of these elections. I won't even try. But, in terms of sentiment, the high level of uncertainty seems to be giving way to hopes of a stable government post elections. It seems that Congress will be able to come back with a reasonable number that allows it to lead another coalition. For the country, and an economy struggling with the aftermath of global financial crisis, it is a welcome respite after months of uncertainty. So, enjoy the feeling while it lasts.

Stone Age Rhapsody: Mulayam ji ki “Jai Ho” and a Moving Journey Through Time

2009-04-14T10:03:00.002+05:30

RANTS

Okay, this is not the weekend, but this piece is filed under Weekend Rants. Also, me had gotten lazy and had not written this section for quite some time. Now suddenly, everything has changed and I am writing quite enthusiastically. What has caused this noble change?

Call it the power of words, the charisma of a great leader or whatever you might. Mulayam ji's thoughts on English language, computers and such degrading and dehumanizing things moved me so much that I was moved to move to my computer and do some cool moves on my keyboard to move my thoughts from my head to some virtual paper.

We Love the Stone Age

Mulayam ji is not the only great leader in India who loves the Stone Age. There is Mr. Ashok Gehlot, CM of Rajasthan, who is quite happy to let builders build malls, but does not want mall culture because it is against Indian values. I see his point. I also miss the charms of village fares where lads and belles came dressed in traditional Indian dresses, gaily frolicking around, happy in their wide-eyed wonder. It is such a moving thought that it almost brings tears of nostalgia to my eyes.

Moving on to other such illustrious leaders. There is always dependable Mr. Bal Thakre who never disappoints. There is the usual ensemble of Togadias and Muthaliks who keep bobbing up and down in popular stream consciousness, capturing our imagination with their vision of Stone Age India where everyone was innocent. Our great land was unspoilt by filthy, rotten influences of something called progress and something called phoren culture. How happy we were, carving topless goddesses in our temples and writing Kamasutras and appointing official nagarvadhus.

Breaking through the Clutter

But Mulayam ji is in a different class altogether. In one fell swoop, he has given severe heartburn to all marketing men. Who does not dream of a great positioning? Who does not dream of breaking through the clutter? Who does not dream of a great idea that has endless potential?

In one stroke, Mulayam ji has proved that a rugged son of the soil can trump all Harvard and IIMwalahs when it comes to marketing genius. Jai Ho!

A Glorious Past… Er…Future Unfolds

Ever since I read his glorious thoughts, I have been wondering with awe about the potential of the idea. Let us ban computers. What if a few lakh BPO jobs and a few million software jobs are lost? We will more than make up for it when these enthusiastic young men and women return to the soil, merrily singing and dancing as they work their fields and milk their cows and pick up gobar and spread manure in their fields.

Let us also ban satellites. See how many jobs these ISRO has eliminated? Prior to weather satellites, there used to be at least one fakir or sadhu or ojha in every village who could predict weather with an uncanny and remarkable accuracy. Let us ban ISRO and revive this great cottage industry. While we are at it, let us ban medical education and doctors too. Jhaar phoonk is such an effective and time-tested treatment of all ailments ranging from buri hava to cancer of the rectum.

Let us ban phones too. Friendly neighbourhood pigeon operators will spring up by the million to send that cute little message from you to your sweetheart. While we are banning tractors, let us ban fertilizers too. That will create a huge industry of manure makers as everyone owning a cow has the necessary raw material to start up.

The possibilities are just endless.

What an idea sirji… jai ho.

Satyam Sale: What To Do Next if You Want to Trade It?

2009-04-13T21:56:00.001+05:30

TRADES

Okay, now that I am done venting my ire at the way Satyam sale has been achieved, we can focus on some other issues as well.

First, the sale has been a huge boon to Tech Mahindra. Professor Jayanth R Varma examines the "Option" argument on his blog in his usual brilliant style. You can find the link here. It is so well written, I do not want to spoil anything by trying my hand at repeating it and messing up the entire effect.

Instead, I want to focus on what this sale means for the acquirer, Tech Mahindra.

Getting Something for Nothing

Tech Mahindra has everything to gain from the acquisition. Prior to Satyam purchase, it was a single customer also-ran in the industry. Suddenly, it has access to a vast pool of customers. That makes it a real software player.

And the threat of US class action liabilities has been used as a fig leaf to trick everyone into believing that the price on offer is a really fair one. Well, it is not.

The Trick in Pricing the Satyam Sale

Satyam has been sold at half its annual revenue. By any stretch of imagination, it is a fire sale and a steal for Tech Mahindra. The threat of class action lawsuit? Prof. Varma explains it quite well. Tech Mahindra could just transfer all the accounts to itself and leave Satyam as a shell company that can easily go bankrupt. Still, if you are doubtful, just read his piece.

So What Should the Investor Do?

Buy Tech Mahindra, of course. Over next six months, most of Satyam business and employees will end up with Tech Mahindra, either through a "slow bleed" or a merger. And Satyam at this price is a steal. If you haven't bought it till now, just go ahead and do it. Compare the relative valuations, reasonable value of Satyam at 2X revenue, assume it will be impounded in Tech Mahindra valuation in six months and you have a potential multi-bagger.

Satyam Sale: End of a Sordid Tale?

2009-04-13T19:49:00.002+05:30

INDIAN MARKETS

Today, there was euphoria in the Indian markets. Satyam, the software giant embroiled in the biggest corporate fraud in India's history, got finally sold. The buyer, Tech Mahindra, happens to be an also-ran in the software business who is essentially a one client company. A lot of people can rejoice in this story. Satyam employees can heave a sigh of relief. The interim board of Satyam can now claim victory, hand over the reins to a new management and get back to their usual jobs. Satyam customers know they will get serviced.

More than anyone else, Government of India can declare victory. Satyam fraud was a big blot on India's international image. The government of India acted swiftly, decisively in the interest of corporate governance. Now, everything is sorted out with Satyam being sold. The government has proven to the world that the Indian government can react decisively to such issues. India has the right institutional framework to deal with it. Investors do not need to look at India as a risky investment destination. Satyam sale has settled it all very well.

The Hogwash

In reality, what has been achieved? Let us start probing that from the point of view of a few key stakeholders of Satyam.

First, let us talk about Satyam employees. The current course of action has been pushed largely in their name and the need to save their jobs. But I am not sure whether Satyam employees are going to gain anything from this sale. At best, they will now be employees of a software industry nobody. It is quite clear that Tech Mahindra is not going to bring incremental value to Satyam. If Satyam business does not grow, or Satyam does not get new customers, the business will shed jobs in net terms. The only thing Satyam employees gain is additional time for their job search.

Other stakeholders also may not gain much from the sale. Satyam customers, for instance. It is not entirely clear that they have gained something from this exercise. What is clear is that the government just achieved a fire sale of the fourth largest software company of India.

The Forgotten Entity

What about Satyam shareholders, the entity completely forgotten in the entire episode? We should not forget that this is the group that has actually been defrauded by Messrs Raju.

Right from the beginning, the Satyam shareholder group has been kept completely out of the proceedings and has not been asked even once which way they would like Satyam to go. Do they find it better to keep Satyam going as an independent company with new management? Would they like it to be broken up into separate entities? I am not saying the shareholders should have been allowed to do whatever they wanted. But Satyam shareholders, as owners of Satyam, should be allowed to at least say what they want to do it.

Debunking the Myth

Virtually all the issues cited by the government for the sale fall apart on closer scrutiny. Consider the following:

Government argument: Moving quickly was necessary to safeguard interests of all the stakeholders.

Alternate argument: The same speed could have been achieved still including shareholders in the process. A quick EGM of shareholders could have installed a new board and management at the same speed.

Government argument: Satyam sale was necessary to restore investor confidence in the economy.

Alternate argument: If this is the case, why did all institutional investors in Satyam sold out at whatever price they could get? Quite the contrary. The move means if there is any problem in the company you have invested in, your interest comes last.

Government argument: Satyam sale was the only way to keep the company going.

Alternate argument: In reality, if the government had focused some of its attention on recovering part of the stolen money, Satyam would not need fresh infusion of cash at this stage.

We can go on and debunk all the arguments given in favor of this course of action. But that is not the point.

Sweeping Real Issues out of Public View

Now, consider what has not been done. Consider what a competent Satyam management should have done. And consider the outcome versus that.

Satyam has been defrauded, what happens to the money? A billion dollars have been taken out of the company. A competent management should have and would have moved quickly to try to recover something. In fact, this should have been the first priority for all involved, including the government. Move quickly. Identify where money has been parked. Freeze everything. Proceed to recover.
Instead, no one has bothered to move one bit on that count. Satyam management has "focused" on getting "accounts restated" as if the money lost is just an accounting disclosure issue.
Recovery of stolen cash would mean Satyam did not need be sold. Why did Satyam go for a fire sale? The company was in such a deep financial hole that it would not have survived otherwise. Or would it?
Satyam board, in its post sale press conference today, stated that in all, Satyam needed to borrow about Rs. 300 crore from PSU banks to tide over its financial requirement. That amount of money is less than 6% of total money siphoned out of Satyam. In other words, if someone had exerted enough to recover just 10% of the total money stolen, Satyam would not need fresh money from investors.
Where is the trail? No one has bothered to establish the trail of the crime. When did Satyam balance sheets start showing false cash balances? What happened to the money in Satyam accounts held till now? What was the mechanism used for taking money out?
Months after the discovery, we do not know anything about it.

Should the Satyam management have found out what happened to the money? Should they have tried to recover it? No, the only prudent course of action was to find a buyer and make a fire sale.

Shielding the Culprits?

I do not know and I do not want to get there. But it does beg a question. If no one is bothered to find out where the money went and whether it can be recovered, why is that so?

And what about punishing the guilty? If there is no evidence gathered on the trail of events (conducting raids does not mean evidence has actually been collected), how will they be punished? If even the trail of the crime has not been reconstructed, how will evidence be collected?

We only have questions at the moment and answers don't seem to be coming any time soon.

Covering up the Ineptitude

In the end, the entire Satyam saga seems to be an effort to cover up gross ineptitude. Instead of making choices that safeguard interests of all involved (including owners of Satyam), the powers that be have ensured that a cosmetic fix is applied, there is enough "feel good" sentiment in the market, poll agenda has been served by claiming to save jobs. The real beauty is that no effort was needed to be exerted to achieve this. No painful institutional overhaul. No embarrassing exposes linking Satyam fraudsters to politicians. No giving back of the siphoned off money.

Everyone should be happy with such a perfect outcome.

Enjoy the Rally till Elections

2009-04-11T15:33:00.001+05:30

INDIAN MARKETS; TRADING STRATEGY

The rally in the Indian markets has taken a lot of analysts by surprise. But the primary driver behind the rally happens to be global and is not local. If you examine the data for past few weeks, the real turn in sentiment has been an increase in investment by FIIs. Though, the trend in domestic institutional investment has been mixed.

There seems to be a clear reason behind the change in sentiment. The global environment has eased considerably over past few weeks, housing market in the US seems to have bottomed out and new home sales are picking up there. I have written about it in my earlier posts in recent weeks (Some Nostalgia and Some Lessons of April 7 and Investment Strategy in Changed Times).

I have held the view for quite some time that a global recovery in equity markets would start after March, 2009. The view has turned out to be correct. I have also held the view that Indian market will participate sporadically in the rally and will end up underperforming. So far India has participated wholeheartedly in the global rally. This post examines how far this rally can go and whether there is enough juice left in the Indian market for investors.

To some extent India is gaining because the fall in Indian stocks was much harder than global equity markets. Dow Jones, for instance, had fallen about 53% from its October, 2007 peak in first half of March, 2009. The corresponding number for CNX Nifty was about 60%. If we compare the bottom reached by Dow and Nifty, the difference is even more.

Current Rally

Since early March, Dow has rallied by about 24% from the level. Nifty, on the other hand, has gone up by almost 30% versus the same level. This takes out, to some extent, the higher fall in relative terms. Today, Dow is valued at about 57% of its peak value while Nifty is valued at about 53% of its peak value. Indian market has bounced back more sharply probably because of an overdone fall, economic conditions in India have been much better than the West in relative terms and pessimism on India was a bit overdone.

But some of this has been corrected in the stronger rally till now. From some point, India will probably continue to rise, but will underperform the global markets from here.

Elections a Pivotal Point

Like every time, elections are going to be a pivotal point. All policy in India is dependent on the whim of a few individuals instead of being set in an institutional framework. Elections tend to weigh heavily on financial markets due to this reason.

To some extent, there is an emerging consensus in the market that the current outfit will be able to come back to power. All the alternatives seem to be in a weaker position at the moment. The prospect of a relatively stable government returning to power has given some footing to the market.

As usual, the market will probably have completed its move by the time full information is available on the outcome of elections. By middle of May, most of the rally fueled by prospect of a stable government will have run its course.

Long Grind Afterwards

Post elections, India is in for a long grind due to mismanaged public finances. There will be a divergence for some time as India starts consolidating public finances while the world marches on with the recovery. India is likely to resume growth full blast post this grind towards first half of 2010.

Trading Strategy

In this environment, the market is likely to retain an upward bias till elections are over. It is too early to say how the markets will trade after the elections, but at the moment trading with a short bias is risky. Tighter stop losses, shorter duration trades, etc. are necessary to trade the market successfully from the short side.

On the long side, the potential for options is far greater than trading futures or directly buying shares. Strategically picked options allow one to build large positions at a relatively lower cost. 3500 Nifty call, for example, is currently a good way to play the market on the long side instead of going long on futures. It also takes care of rampant volatility that is likely to continue to some extent.

Investment Strategy

There is only one recommendation for investors at the moment: accumulate good stocks. I have written quite a few times in recent weeks on this theme, so will not repeat the reasons for this. This is a great opportunity for investors to start picking up solid stocks.

One stock on which the entire analyst community is negative is Tata Motors. This is going to deliver a nasty surprise to naysayers who are ignoring the fact that Nano has gotten amazing reviews from trade analysts, Jaguar has suddenly shot up to most reliable spot in the US in JD Power survey and any economic recovery is preceded by an increase in commercial vehicle sales. All its three major ventures (cars, commercial vehicles and JLR) are showing very healthy signs.

Conclusion

Overall, times are becoming interesting again as the seeming bear consolidation is actually coupled with high volatility, something quite unlike a normal bear consolidation. It may point to a much shorter time at the bottom for global equity markets.

For Indian market, elections are going to be a watershed. Volatility in Indian markets will stay high till then and consolidation phase will begin after the elections. But we are probably in the last 6-9 months of the bear market where downside seems limited, sideways movement will become the norm after May and accumulation for the medium to longer term makes a lot of sense.

China’s Rising Clout: Impact on the Regional Balance

2009-04-09T23:36:00.002+05:30

GLOBAL ECONOMY; CHINA

In my post of April 6, I had discussed the impending shakeout in the international financial system. We had examined the possible motives behind the new-found love exhibited by the Chinese for a "better" international monetary system. After examining other possibilities, we arrived at the conclusion that it is not likely to be anything more than a push for greater spoils of the system. China has found a sudden increase in its international clout and wants to use this opportunity to push its long term agenda.

China is pushing this agenda quite openly unlike some other powers, but reasons for that seem to be obvious. China is in a very strong bargaining power at the moment and can tilt the balance of global recovery quite significantly. The two critical levers at its disposal happen to be its stimulus spending (the lesser lever) and holding its currency steady (the greater lever). Indeed, it is the latter that the world will fear the most.

If we go back to the South East Asian currency crisis of a decade back, China was in a similar situation. Everyone needed China to hold its currency steady in wake of massive devaluation by its primary competitors. China obliged, but only after extracting its pound of flesh (tacit support for Chinese entry into WTO at very liberal terms, human rights abuses like Tiananmen Square being put into the closet, to name a few). A decade later, China is finding itself in a similarly advantageous position. There is a critical difference this time. The necks on the line happen to be that of Uncle Sam along with all the sidekicks. For obvious reasons, the dollop China is looking for is far larger. Still, it is unlikely that China will get any significant chunk of the spoils as far as the West is concerned.

Staggering Ambition

What China is aiming for is something really ambitious. The goal may be no less than getting its currency accepted as a legitimate medium of exchange and trade internationally. To understand how ambitious this task is, we need to understand a little bit about the Chinese monetary system.

China does not have a convertible currency. Most of the people would dismiss Chinese claim on this count alone. A non-convertible currency on capital account means that China may refuse to convert Yuans to any other currency at any time unless it is on trade account.

But there is a huge difference in internal convertibility and external convertibility. In fact, Chinese are masters at creating artificial barriers in currency movement and using such barriers to the maximum possible advantage. Very few people outside China know that it is not possible in China to send money from one city to another. Part of the problem is infrastructure. There is no inter-city network linking banks in different parts of the country, there is no inter-city check clearing system and so on. As a consequence, businesses in China end up relying on one or two proprietary networks owned by foreign banks for any inter-city transactions (for a more detailed discussion on this topic, please refer to my post China Blues posted on January 11, 09). This allows the Chinese authorities to control different segments of the economy in silos without worrying about overflows in one part of the system affecting another.

So the technical argument regarding lack of convertibility can be easily surpassed by the Chinese. They can make it convertible only for people outside the country. In the extreme scenario, they can get past this hurdle by making Yuan fully convertible for other Central Banks. No questions asked, so long as the counter party happens to be a central bank.

And therein lies the scale of the ambition. A country that does not allow or does not even have the means to allow free movement of money within its own boundaries is aiming to be a medium of exchange internationally. And it is no mean feat. The staggering nature of this ambition can be understood only by those who are familiar with inner workings of the international financial system.

Regional Ambition

As we discussed before, China is going to leave the table with something and that means ascendancy of China on regional and global scale. This crisis has come as a great opportunity for China. It has accelerated the Chinese drive for asserting its clout internationally.

It is too early for this to cause any worry to any of the Western countries. And China may not even be aiming for that. For all the setbacks and problems, the US-led financial system still retains its ideological footing as well as vigor. It will be foolish for anyone to declare its demise and start hoping for a new global economic regime any time soon.

China's main ambition seems to be regional. There is an eerie similarity between what China is pushing for now and what Japan was doing in late 1970s and 1980s. Barring a few cosmetic differences (e.g., Yen was fully convertible back then too, unlike Yuan); the mode was similar. The dollar was crashing like anything on an intermittent basis, the US was pushing all the central banks to buy dollars (the famous Baker Summit of mid 1980s was the culmination of this), Japan was relentlessly pushing its main trade partners on supply side to use Yen for trade as well as settlement (crack quiz: does anyone remember what a Samurai bond means?). Japan, back then, became the largest donor to developing countries, something China is trying to do for Africans today.

The outcome in this interesting parallel was that Japan became, for some time, a dominant economic force for many developing economies. Unfortunately, the 1990s proved to be the undoing of the Japanese and the juggernaut came to a grinding halt. But there is no reason China cannot attempt the same.

China vs. Japan

If there is any developed economy that is going to be pitted against China in this pursuit, it is likely to be Japan. Much to the chagrin of India loyalists, India is too small a player in this game to be taken seriously. For Japan, on the other hand, the consequences can be quite significant.

To begin with, Japan cannot take China lightly. China is the largest trade partner of Japan and its importance has just gone up a notch after Japanese exports to the US took a massive hit. As the Chinese manufacturing machine accelerated, the Japanese took pains to embed themselves in China in a way that their international markets were safeguarded and China's ascendancy worked to their advantage. The flip side to this entanglement is that they cannot block China in the global economy. At the same time, China is the main competitor to Japan when it comes to influence among the developing world. Africa is a case in point; it used to be high on Japanese agenda at one time, but was forgotten in the 1990s. Now, it is the main playground for the Chinese.

Militarily also, Japan is the only major power that has an overlapping sphere of influence with the Chinese. Again, a few people would be able to recall the saber rattling that used to happen between Japan and China on Chinese military expansion till mid-90s. Then the symbiotic relationship started and military ambition went to the backburner.

Displacing Japan

From the mode that the Chinese have adopted, as well as the area of their influence, it seems that some growth in the Chinese influence will come at the cost of Japan. Japan continues to be an economic giant, the second largest economy on the planet. But China is about to wrest that spot from Japan pretty soon (some estimates say as early as 2010). By playing the game Japan played in the 1980s and by deftly using the current crisis, China may be able to get a greater spoils of the international monetary system too.

There is little doubt that China will continue to displace Japan in the international economic system. Though the financial crisis has given the Chinese an opportunity to accelerate the process, the trend has been underway for some time and will continue unchecked unless something drastic happens.

On Japan's part, they seem to be resigned to their stagnant fate.

Conclusion

Take Jim Roger's advice, teach your kid Mandarin.

Do not buy Chinese stocks. Remember Japanese stocks went into a twenty year decline after they were done making themselves the new messiahs of the world (okay, this conclusion is outrageous, but hey, empirically it is correct).

Start billing your customers in Yuan. Since Chinese are unlikely to devalue their currency to be nice (they are nice guys) to the world, you are likely to make a good forex gain, or at least avert a forex loss.

Okay, on a serious note, this shakeup in the international pecking order is going to have serious impact on the regional balance in Asia. No Asian economy can take this event lightly. That includes India too. The issue definitely warrants a closer examination of how things will pan out regionally. We will examine the implications in greater detail in a separate, subsequent post (I know, I know, my record for writing follow up posts is quite abysmal, but I have been improving of late).

A more serious discussion on implications for the Asian currencies will also follow.

Found a Pattern, A Valuable Clue or Just a Flawed Observation?

2009-04-09T01:35:00.004+05:30

BEHAVIORAL FINANCE, TRADING TOOLS

One key problem that hobbles a lot of traders, investors and portfolio managers is called "Law of Small Numbers" in behavioral finance. Those who want a detailed discussion of the law itself can go to the following link that gives an excellent mathematical example:

The Prime Glossary: law of small numbers

In short, it means that you cannot rely on a recurring signal unless you have explored a large number of signals. You do not know whether a signal showing in a small sample actually holds or not.

Clearly enough, it afflicts all the key decisions that you need to take while building a trading system. While the system may generate many possible models that look tradeable, the pattern may simply disappear once you move on from back-testing to actual trading based on the model. The problem is so prevalent that most of the people relying on hunting past patterns may end up losing money.

The Problem

While the root of the problem is mathematical (in some cases, the first exception to the seeming rule may happen rather late; making it hard to find out whether the rule works or not), the problem itself is behavioral. In majority of the cases, we tend to accept the pattern as valid even when a little probing would reveal that the pattern is only a quirky coincidence. True, in some cases, it is extremely hard to find the exceptions to the rule. In reality, most of the times, an attempt to find the exceptions is never made.

This is particularly true for financial markets where this tendency gets mixed up with all sorts of other biases. A particularly acute case occurs when this tendency gets combined with "Gambler's fallacy". In such a case, a negative event is interpreted to increase the probability of a positive event in subsequent occurrences. Let us take the example of a "trading system builder". Let us assume that such a builder stumbles upon a rule that generates money in 6 out of 10 cases (thereby making it profitable on an overall basis). Now, let us assume that the "system" generates a signal that creates a losing position. The system builder takes it as a positive sign; asserting that since the system worked about 6 out of 10 cases during testing, the probability of next trade being a winner has gone up. It is not hard to guess the consequences of such an approach.

An even more serious problem is caused by this belief when it creates die-hard system builders, people whose sole pursuit is to keep trying different tricks on data to find out something that gives a positive result historically. Whether you use specialized software or an excel sheet, the typical approach goes like this: set up a test with two or more moving averages; put some artificial conditions regarding trades (e.g., brokerage, transaction cost, etc.) and then run some buy and sell rules regarding moving average crossover or some other parameter. If you torture the data enough, there will be some set of rules that show a "profit". If you relax the conditions a bit (assume no brokerage or slippage), you can get many "patterns" that look mouth watering.

I do not know whether these system-builders make money or not. But they are certainly die-hard in their approach. If one pattern does not make money, the next will. Taken to the extreme, such a tendency can cause a serious damage to one's financial health in the long run.

The Impact

The implications of this tendency are not limited to system building or back testing alone. It affects investment choices across a wide spectrum. The negative serial correlation part ("Gambler's fallacy") combined with the base-rate fallacy and mean reversion causes people to buy stocks post a major fall. Choice of a Mutual Fund is swayed substantially by most recent performance though frequently there is no correlation between short term and long term performance of a fund. In a paper titled "Do Sophisticated Investors Believe in the Law of Small Numbers?", G. Baquero and Marno Verbeek conclude that "apparently, even sophisticated investors exhibit psychological biases that may have adverse effects on their wealth". Like all investment biases, this bias too costs money, sometimes a lot of it.

Avoiding the Bias

Now that we know the enemy (which happens to be us), we need to know how to avoid defeat at its hands. The fix for this bias happens to be as simple as attending a Statistics 101 class. A good instructor is supposed to tell something like the following to every student.

A seeming correlation between two sets of data or a pattern in data can be valid ONLY IF you have a plausible underlying hypothesis.

This is the only antidote available to fight this problem. Do not accept any pattern unless you have a plausible underlying explanation. If you happen to be a system builder, you need a plausible explanation why a crossover of 20-day moving average on a 100-day moving average makes money. If you are picking a mutual fund, the explanation for superior returns should be more than just a "hot-hand" of the manager.

It is important to explore alternate explanations too. Perhaps, the star fund manager is investing only in high-beta small cap stocks or in a risky sector. Many fund managers take extremely high risks to give high returns in the short term. In India, investors discovered to their chagrin that many mutual funds, mandated to invest money in stocks as diverse as technology to infra, were actually making unsecured loans at high rates of interest to real estate developers.

In the end, it helps to have a skeptical attitude to patterns in short term data. A healthy dose of skepticism can save you a healthy amount of money.

So, Should I Build a System?

By all means, yes. But the approach cannot be "have excel, will find a pattern". You can follow two approaches that can work equally well.

Strong underlying relationships: The underlying relationship comes first. For example, during the last quarter, bond yields in India showed a negative correlation to stocks because the government has been crowding out the private sector by borrowing heavily. Hence, bond yields have been proxy for the credit squeeze faced by the commercial sector. For about nine months in 2008, dollar-rupee had a direct correlation with crude oil price. So long as crude oil price was high, oil was a large chunk of Indian imports. With the fall in oil prices, the relative impact of oil on Indian BoP has gone down. The correlation no longer exists.
Whatever the relationship, it needs to show a clear link of cause and effect before you start building a system around it. Without such a link, it is probably coincidence.
GANNs based on large samples: You can ignore the underlying relationship, provided you deploy GANNs and use large amount of data. Use of a GANN is essential to avoid bias and to uncover the underlying relationship. Use of a large data set is essential to ensure that if there are exceptions to the rule, there is a good chance of finding it.

Whatever the approach taken, combining good risk management with the trading model is necessary to ensure trading success.

Some Nostalgia and Some Lessons

2009-04-07T18:53:00.001+05:30

INVESTMENT STRATEGY

Going through my notes and some old articles from 2002, I could not help but marvel at how things come full circle. There is an eerie similarity in the headlines, the themes and the content of what the financial press was fretting about then and what they are fretting about now. Even the general press themes sound strikingly similar. Thus, WSJ articles happen to be as dismissive of the global efforts to reflate as they were then (of course, there is a difference of scale). The economist was talking about massive international imbalances and how the world needs a total overhaul of international financial system. Bear side (and influential) people like Jim Puplava of Storm Watch and Prudent Bear sounded exactly like they are sounding now. Even articles in Indian publications like India Today were talking about "jeopardizing the economic future of the country" and so on.

Of course, there are differences. What was shocking in 2002 would probably not even earn a second look in 2009. India was yet not recognized as an emerging power. Vajpayee was prime minister and he openly lamented in upper house of Parliament in April, 2002 that his primary concern was achieving 8% but Hindutva brigade was not allowing him to govern. Here we are, post many years of 8% growth and Manmohan Singh is prime minister. It is another matter that he cannot be as candid as Vajpayee and admit openly that Sonia Gandhi, the communists and the allies did not let him achieve even 5% of reforms he was able to push under Narsimha Rao or what Vajpayee was able to achieve.

The Lessons

But moving beyond nostalgia, these similarities and differences point to something very interesting. I am pointing them out at this juncture because they provide a good perspective. And currently, when no one knows where the world economy is headed, whether we are recovering or sinking, whether we will come out of this intact or not, where umpteen different solutions are being touted, where nothing is good enough and so on; perspective is what we need. So some of the lessons that we need to keep in mind follow.

One, the degree to which financial press becomes negative tends to remain constant, regardless of the gravity of the situation. I have been reading comparisons with 1930s and the Great Depression for decades now. The crash of 1987 was akin to 1929, then the recession that followed in early '90s looked like that. It is a different matter that this recession turned out to be one of the mildest on record. There are financial fanatics, if you can call them, who will start getting hysterical the moment things start turning bad. There is the gold standard lobby who blames paper money for all our ills and wants nothing less than 100% gold backed currency. Never mind the fact that the gold standard played a big part in the Great Depression. There is a clear correlation between when a country abandoned gold standard and when they came out of depression. You cannot, therefore, judge the state of the economy and its future trajectory from the hysteria generated by financial press, economists, analysts and the like.

Two, barring a few exceptionally good years, the world does look like it is going to fall apart if you believe the press. Partly, it has to do with the nature of news reporting industry. Bad news sells much better than good news. The profession also probably attracts people who tend to wallow in misery all the time. But part of the reason is that the world IS a messy enterprise. It moves forward only by hurtling out of control time and again. If you take a snapshot of the world at any time, it does look like it is falling apart. Take 2005 for example, there was a raging war in Gaza, oil had breached $40 and people were crying hoarse about the impact on the world economy, dollar was tanking and gold standard brigade in the US was beating its collective chest. This is the nature of the beast. Freeze frame, and it looks unworkable. Get the picture moving and the world looks like one of those new age fighter jets that are built to be unstable. They fly straight because their computer keeps on making thousands of tiny adjustments every second to keep them flying.

Three, everything is relative. Today, things are much better than they were in 2002 for a large majority of people. Why the current time looks so bad is because we are comparing it with the rip roaring days of 2007. Nassim Nicholas Taleb explains this very well in his books Fooled by Randomness and The Black Swan. If you begin with 100,000 and reach a million, your happiness is dependent on the path you took to reach the million. If you reach the million in a straight line, you are likely to be very happy. But if you reached 5 million and then got back to 1, you are likely to be pretty unhappy about it; even though the absolute change in your wealth is no different.

The last of the three is important to keep in mind because a large part of the recession now is psychological. Jobs in the US are being lost because the sentiment is bad and people are not spending. But sentiment is bad because people are losing their jobs. This circular situation will be seen in many areas and is not confined to employment situation alone.

Implications

At this stage, I will not argue based on data. There is ample data in my previous posts, and ample amount of analysis. But analysis does not give you perspective and that is what this post is all about. So how does this perspective help me shape my investment strategy?

One, I will build my investment strategy on steady gains instead of a quick buck. If I were punting in 2002 for a quick gain, I would have lost out on all the big gains. However, a five year horizon in 2002 would have served me extremely well. I think it is going to serve me very well even now.

Two, when I put the economic data through the wringer as well as probe the financial press for something truly disastrous; I am ending up with nothing. Sure, housing prices are still falling, banks are not lending and so on. But the underlying panic is gone. There seems to be an invisible line when danger has passed, true panic gets turned into vague fears and empty rhetoric. Suddenly, we have seemed to pass that line. Of course, different people will perceive it at different times, depending on their relative optimism or pessimism. But most of the fluff that you get in the name of financial news is just meaningless scare, designed to trick you into staying hooked. So postponing investment decisions due to this reason is counterproductive; whether you are an individual or a business.

Three, there IS a recession out there. Averting disaster does not mean you will not have a recession. But there is a vast degree of difference between a complete meltdown and a recession. The first is like metastatic cancer, no hopes of survival. The latter may be more like a fever, painful but therapeutic (though to the people who lose their jobs and businesses, the immediate difference is cosmetic only) at the macroeconomic scale. My contention is that we have averted disaster but the world still will go through a painful recession as some of the past imbalances will get corrected. So I will make my investments like you would make in a recession. Long term investment horizon, diversified portfolios, good asset quality and so on.

Conclusion

I know I have been harping on this "long term horizon" theme for many weeks now. But this is one of the tests that you should apply when working out your investment strategy. Whether you probe the data, or apply behavioral finance principles or go for historical perspective; if the answer you get back is "long term horizon", it has some significance.

It is definitely better than the usual mumbo-jumbo that you get like

"…fundamentals of the company are strong and technicals are indicating a break-out, but there is a congestion forming on the charts and there seems to be a lot more pain in store; may be you can buy for a short term gain with a tight stop loss, otherwise you should buy for the long term and sit tight…" (made up example, any similarity to an actual quote by an analyst is purely coincidental)

No offence to the practitioners of this art, but this does not tell me anything. I would rather go in a steady accumulation mode or will strictly punt when the market is hot. Right now the market is saying "go accumulate" no matter how I probe it. So that is what we need to do.

Cheers.

Investment Strategy in Changed Times

2009-04-07T00:49:00.001+05:30

INDIAN ECONOMY, INDIAN MARKET, TRADING STRATEGY

SLOW AND STEADY IS THE NEW MANTRA OF SUCCESS

Monday's Economic Times editorial highlights a few important trends coming out of economic data in India. One part underscores the strength of the rural economy. As the overall economy in India has been slowing down, rural economy has continued to grow in a healthy manner. The editorial talks about robust growth enjoyed by Hero Honda and Maruti as well as FMCG majors like HUL. The second part concerns the sharp dip in trade numbers witnessed recently.

Strengthening Undercurrents

Disparate as these may sound, these emerging threads are parts of a single underlying process that the Indian economy is currently going through. I have talked about this ongoing change in the economy earlier. In my new year post, Themes for 2009 and a few following ones, I had discussed the nature of transformation that has happened in India. The Indian consumption story is not about the rich getting richer, it is about the poor migrating into the lower middle class. It is this section of the society that starts consuming FMCG output as it improves its quality of life. As this segment moves up the value chain, it buys mobile phones, TV sets, two-wheelers and so on. And a vast majority of this segment happens to be in rural India.

I had predicted in my early posts this year that this is the segment we need to bank upon to see India through the current crisis. The other section of the society contributing to consumption, the urban upper middle class, has been decimated in the current economic crisis. Their dependence on ever rising salaries, high exposure to equity markets as well as real estate has become their bane. In the current environment, this is the section that has seen job losses, salary cuts and large scale destruction of wealth. It is unlikely that this section can provide any consumption support to the economy.

The rural consumer, on the other hand, is still in the process of going through a complete consumption transformation. As this transformation continues, industry sectors that depend on this segment are going to gain on a long term basis. Thus, cement (good demand push by irrigation projects), two wheelers, FMCG, telecom are likely to continue to do well. On the other hand, sectors that depend on upper middle class salaried segment will show only fleeting signs of recovery. High end consumer durables, real estate, luxury goods, are all going to underperform significantly.

External Sector

Despite all the stimuli happening globally, external demand is unlikely to revive in a hurry. Adding to the problems of the export sector, majority of Indian exports happen to be highly vulnerable segments. Raw material and commodity exports are likely to suffer due to the current commodity cycle, though things may pick up as commodity cycle revives. But manufactured goods happen to be either in discretionary spending segment (e.g., gems and jewelry) or in items with stiff low cost competition (textiles). This has put enormous pressure on the external sector.

Ongoing Transformation

This means that India will increasingly be relying on its own steam for growth to continue. Fortunately, India is much better placed than other Asian economies in this regard. While exports account for more than 40% of GDP of most of the Asian economies (for details, please see Asian Gloom: Can We Escape the Pain?, January 13, 2009), value added exports account for only 13% of GDP in India. The largest component happens to be consumption which accounts for more than 55% of GDP. It is important to note that on a long term basis, only a few developed economies have higher ratio than this (US long term average is 67%; being the highest in the world).

I do not want to undermine the importance of the external sector. At 13% of GDP, an annual growth of 20% in value added exports adds more than TWO PERCENTAGE POINTS to the GDP growth. A dip, likewise, shaves off a similar point from the growth. At the same time, it is much better than other economies that happen to be far more vulnerable than India.

Choice for Investors

Going forward, most of the growth in India is going to be driven internally. Also, most likely big ticket items and glamorous industries are not going to participate in it. This has important implications for investors and traders alike. Any successful investment strategy needs to account for this changed reality to deliver superior returns. Am listing a few, please feel free to add more through the comments.

Most of the industries likely to gain from the process are staid, non-glamorous ones. Unlike industries of the last boom (e.g., organized retail, real estate) which delivered phenomenal growth and returns on a small base; industries that are going to perform in the coming year or so will be building on a fairly large base. Unless something truly drastic happens, Cement, FMCG or the two-wheeler industry are unlikely to deliver a triple digit growth number.
Growth in valuations is likely to be far more slow and stable as a result of this versus the last time. If most of the leading industries are large-base, staid industries, variability in growth and earnings falls drastically. If an industry shows 12% growth in a very good year, 8% growth in an average year and 4% in a bad year, it is unlikely to show 300% returns in a year no matter how good a stock picker you happen to be. It is better to get used to slow and steady valuation growth, quite unlike the heady days of the last boom.
Other industries are going to see a tug of war; between hope and reality. People who are unwilling to accept that times have changed will keep on chasing high returns and will keep pushing high beta sectors like real estate. The end result is huge underperformance for majority of such investors (and outperformance for a lucky minority of extremely lucky traders). But it pushes the overall volatility of the market to high levels. There is only one way to ride out this high level of volatility, expanding investment horizon as well as going for a broad portfolio.
Days of obscene returns based on obscene level of risk are long gone. Get down to the grind and ride it out is the new recipe of success. The quicker an investor gets used to it, better the opportunity.
Further affecting the investment strategy, public finances in India point to a protracted and a slow recovery process. It means that an extended and slow accumulation mode of buying stocks is going to be far more successful than dumping all one's money in one go and hoping for quick returns. Opportunities to buy will be many and will keep on recurring. Investors who do their research, take their time and choose wisely will gain. Those who enter through small, bite-sized additions to the portfolio are more likely to do well than those who gobble everything up in one go.

Clearly, the time favors a steady accumulation of good stocks in sectors that are likely to lead growth in the future. While immediate returns may not materialize, long term prospects seem to be good for this strategy. If there was any time to go for an SIP kind of approach, it is probably now.

Of Triffin’s Dilemma and China’s Ambition

2009-04-06T20:19:00.002+05:30

GLOBAL ECONOMY

CHINA BELIEVES TIME HAS COME TO PUSH FOR YUAN TO BE TREATED AS A "HARD" CURRENCY. IT MAY BE RIGHT.

On March 23, Zhou of People's Bank of China issued a statement concerning the role of dollar in the international economic system (find the full text here http://www.pbc.gov.cn/english/detail.asp?col=6500&id=178). The statement assumes significance as it comes on the heels of another well publicized comment by Wen Jiabao, "warning" the US for keeping the value of dollar intact. Both the statement make a similar point. China is the largest investor in the US today, holding about $1.4 trillion worth of treasuries. Being such a large investor in the US government, China is worried about the value of its "assets". China has a right to ask the issuer of the debt to make sure that the asset quality does not deteriorate. And given the unprecedented turmoil in the global economy, it has decided to make its concerns public.

But is this all? Does the Chinese "concern" regarding the dollar begin and end with a desire to safeguard its assets and a philanthropic desire to make the world a more equitable place? Or is there something much more than meets the eye?

The timing is remarkable. China has accumulated most of the US treasuries it owns at a time when the dollar was in a multi-year decline against practically all the currencies of the world. During this long decline of the dollar, when Euro almost doubled from its bottom against the dollar and all major and minor currencies posted an unprecedented rally, the "largest investor" never uttered a word.

Triffin's Dilemma

First, some explanation of the economic paradox that was quoted by Monsieur Zhou to support his premise predicting the end of the US dollar. Triffin's Dilemma is a phenomenon that was highlighted about five decades back when the US first started struggling with a large trade deficit and insufficient gold reserves to back the then prevalent gold standard and fixed currency rates.

An expanding economy needs more currency to continue growing and to avoid deflation. This is true at the national level, where the government keeps on introducing more currency into the system. This gives additional spending power to the government and works as free revenue for the government (a right known as Seigniorage).

The same is true at the global level as well. An expanding world economy needs an increasing supply of global money. If one country is supplying this "reserve currency" to the rest of the world, this increasing supply of money happens through a current account deficit. The larger the deficit, higher the money supplied and vice versa.

Triffin's dilemma was first articulated around the 1960s during the days of the gold standard. An expanding world economy needed higher amount of money and the US supplied that through an ever expanding current account deficit. The US gold reserves depleted quite fast throughout the 1960s as the rest of the world kept on converting dollars to gold, fearing an inability on part of the US to meet this obligation on account of a large deficit. This eventually forced the US government to abandon the gold standard.

Even after abandoning the gold standard, worries remained. If the US stopped running a deficit, global growth would be impacted. Too large a deficit, on the other hand, would cause the world to lose confidence in the US, causing the dollar to collapse.

The last fear of the US did not materialize. It turned out that the rest of the world was quite happy holding dollars even when the currency was not backed by gold reserves or even when the US was creating gigantic current account deficits. Quite the contrary, massive deficits during the past decade fueled unprecedented growth as the world got flooded with cheap money from the US.

The Happy Equations

The economic equation dictates that the following relationships always hold:

Internal and external accounts are linked through the savings account of the country. A net savings deficit in the country (S-I being less than zero) will need to be funded by the external account. This means that a net deficit in savings will always produce a current account deficit.
If the households do not save anything, then the government net savings will always be equal to current account balance.
If the government is running a large budget deficit, there will be a mirror current account deficit.

This relationship forces most of the governments into a strict budgetary discipline. Too large a budget deficit and you will end up with inflation as well as a large external account deficit. Currency reserves are finite and eventually you need to cut back on your external deficit as well as budget deficit to balance your accounts.

There is one exception. If your external account can be funded by simply printing more money, you can keep on spending indefinitely so long as the world is willing to accept your currency as good money. Large trade deficit? Simply print more dollars and pay it off. Large budget deficit? Issue more treasuries that will be bought by your suppliers with the dollars you gave them. This cycle suited everyone, especially the US.

The real gain for the US in this arrangement comes from the fact that as an issuer of currency of the world, it can create wealth at the expense of everyone else. It has been done before, particularly in the medieval economies when public finances in the current sense of the phrase did not exist, Princes had to borrow and repay debts like everyone else; except that they had the right to issue currency. Adam Smith pointed this out more than 200 years ago in Wealth of Nations:

…the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees diminished the real quantity of metal, which had been contained in their coins… By means of those operations, the princes and sovereign states… were enabled, in appearance, to pay their debts and fulfill their engagements with a smaller quantity of silver… their creditors were really defrauded of a part of what was due to them.

This applies to the world even today. In the short term, an abundant supply of dollars does not seem to have any impact. But in the longer run, people are defrauded as true value of the currency falls on a continuous basis. In fact, if you measure the value of dollar against a more enduring store of value, precious and base metals, the dollar has been debased quite drastically over past few years. It has also taken a lot of other currencies down with it, ensuring that the loss of real wealth is not limited to dollar alone.

The Coveted Spot

The US derives huge advantages from being the reserve currency of the world. It is in absolute strategic interest of the US to ensure that dollar continues to be the reserve currency as it allows them to spend without restriction and keep on getting their consumption being funded by the rest of the world indefinitely.

The strategic advantages coming from this enviable spot are quite obvious. It also allows a country to project its military power globally as the military expenditure also gets funded by the rest of the world. The Colonial machine of the 19^th and 20^th century was built on this principle. A conquest enabled the colonizer to appropriate the resources of the colony for virtually nothing, giving it the necessary resources to colonize more as well as to continue to control the existing colonies. Whether it is colonization or a world economic order that gives right to appropriate resources by fiat (or by issuing fiat money), the effects are the same. You can get all the resources you need without giving anything in return (as a colonizer) or giving something that costs you nothing (as the US).

The current economic system is even more sinister than colonization in one aspect. Unlike colonialism, less dominant economies around the world today give their resources of their own will; in exchange for fiat money that the issuer prints copiously without regard to any constraints. They get the "comfort" of high reserves in return for continuing to feed the consumption of the big.

Dominant military power is the key to maintaining this economic spot internationally. This link between the military and economic dominance has been demonstrated time and again in the recent geopolitical history of the world. During past 50 years, the US has acted numerous times militarily to extend interests that are primarily economic.

It naturally follows that the US would not like to give up this position, unless forced to do so. And it will defend this right with all its might, political, economic and military.

A Marriage of Convenience?

Why has the world agreed to this arrangement? Because the system worked and suited everyone; for a while. The world needed a consumption engine, the US provided that. Fast expanding global economy needed rising money supply to keep the growth going; huge US current account deficits supplied that money. So long as the cycle continued to feed growth, everyone was happy. But now the excesses have gone too far, and everyone is feeling the pinch.

(For those who would like to go through the complete history how we got to this messy place, there is a very interesting exhibit on the IMF website. It chronicles the events that led to current monetary system and can be found at http://www.imf.org/external/np/exr/center/mm/eng/mm_cc_01.htm).

The Chinese Itch

Against this backdrop, the Chinese urge to speak up can be understood quite clearly. First, the timing chosen seems to suggest there is more to the push than mere financial interest. Consider this:

The dollar has been losing value for more than half a decade against all the major currencies. But the Chinese outburst has come at a time when the dollar has been gaining. The Chinese are actually getting richer by holding dollar denominated assets. Why did they not complain when they were losing money? Why are they complaining when they are making money? This effectively rubbishes the "economic logic" behind the "warnings".
Chinese economic might is rising and even the Western countries are seeing them as some sort of saviours in the current economic crisis. This is a dream come true for China that has been working for years to raise its international profile (including the wholly overdone Beijing Olympics). The Chinese perceive a unique "leadership opportunity" that needs to exploited right now or will be lost for the foreseeable future.
There is an interesting twist on the military side. The Obama administration is scaling back defense budgets, has put weapons programs on review, is scaling back overseas involvement and so on. China, on the other hand, is spending more on defense, is pushing "disruptive technologies" (technologies that can fundamentally alter the balance of power in their favor) and is getting more aggressive on Tibet. The Pentagon has gone to the extent of issuing a statement on the matter which, of course, has been vehemently denied by the Chinese.

It is in this context that the Chinese aversion to the US dollar needs to be understood. China has suddenly gained clout. Just a year ago, it was being derided for causing environmental havoc and poisoning its own citizens through polluted water and air. Its ambitions were scoffed at. It was perceived to be too unstable and pundits predicted it would collapse the moment economic growth dipped below 8%.

Today, China is the pillar of stability and calm. Its role is vital in maintaining a sustained path to recovery. This has automatically thrust a leadership opportunity on China. Coupled with the level of dissatisfaction with the US economic system worldwide, this newly gained clout has enabled China to push its agenda in a very effective way. Not surprisingly, China has led the rhetoric against the dollar, and the world has chimed in to give chorus. It goes like, "the world has suffered mainly because of the US dollar; the world needs an alternative; IMF should step up and push SDRs as reserve currency of the world" and so on.

Most of the world leaders are fully aware that SDRs have virtually no chance of working. They have been around for four decades, were originally intended to play precisely this role, but the way they have been set up makes it next to impossible for them to be effective. Any new financial arrangement, anyway, has to happen with the US approval at this stage. And the US will never approve anything that actually has a chance of becoming a viable alternative to the dollar so long as it maintains its current military and economic might.

The Mad Scramble

The current imbroglio does not mean that the US is about to give up its dominant position out of goodwill for the world (notwithstanding any show put on by the new administration). It also does not mean the US will be able to walk away from the table carrying all the loot. Suddenly, the world has woken up to the fact that it is being defrauded. A defiant mood is in the air as the US-led system has been stripped off its ideological garb and stands fully exposed. Clearly, we can expect a shake-up in the system.

This clearly sets us up for a mad scramble where considerable economic goodies are up for grabs. The US knows it has to cede some ground at the moment. There will be ample opportunity to get back so long as it maintains its economic and military strength. It will also take a while for the world to find a viable consumption alternative to the US. Ponder this, if there is a true world currency forcing the US to close the current account deficit, who will consume the excess production of the rest of the world?

Notwithstanding the "anger", the "frustration" and ideological posturing, this game is headed for only one climax. Others get to share a bit of the booty that the US has enjoyed for decades. Gordon Brown has shown immense "leadership" during past six months, including hosting the new Summit; deftly creating the impression that Britain is a "worthy" leader of any new economic system (or at least a part of it). If Euro becomes a stronger contender for the reserve currency status, Eurozone is a gainer (that should explain the angry outburst of the current head of the European Union against the US and the dollar).

The agenda is quite clear. In a new world economic order where deficit spending is not a dirty word, getting the right to print limitless currency is indeed a worthy goal. Grab as much as you can right now, you can decide later on what to do with it.

Chinese Stakes

The Chinese understand this dynamic fully well and realize this is a once-in-lifetime opportunity. This is the right time for them to push their agenda considering the following.

Global disenchantment with the US-led system will dissipate as the world economy limps back to recovery. The "principled argument" against the dollar will sound hollow one year down the line when the pain has lessened.
World needs Chinese cooperation to pull out of this deep hole. Chinese stimulus (which happens to be almost equal to India's GDP) is key to reflating the economy. China must hold its currency steady, a devaluation will be highly disruptive at the moment. China knows this and is willing to cooperate, for a price.
China is sitting on a huge mountain of cash. If the US and the developed world do cut their trade deficits (which seems possible under the Obama administration), the power of Chinese mountain of cash will keep on diminishing with time.

Of course, China is not aiming for a true world currency or anything even close to that. Creating a truly global currency outside the influence of a single nation is a herculean task. To begin with, the institutions supposed to govern this (IMF or World Bank) do not have even a shred of independence required for playing the role of a global central bank. Nor can China square up against the economic might of OECD or military might of NATO, both of whom will eventually kick into action to assert their dominance.

Yuan as a "Hard" Currency?

The sole aim, like everyone else, to gain a piece of the pie for itself and get the Yuan accepted as one of the reserve currencies. It also knows fully well that developed economies are not going to make Yuan a reserve currency overnight. You cannot imagine the US, the UK and Japan holding their reserves in Yuan. It is not aiming for that space either. The developing world, however, is a different story. That is the area where China can hope for making a rapid progress.

It has already started doing that to some extent. Wherever China is seen as a significant trading partner, it has started pushing for settling the trade accounts in Yuan. There is ample scope for China here as it has emerged as the largest investor and aid-donor for some African countries. It controls natural reserves, provides technology, pumps-in aid, buys majority of their output (which are raw materials for Chinese manufacturing machine) and supports regimes (Sudan, for example). If China gets the Western nod to push its currency agenda there, it can become the reserve currency provider for much of Africa as well as some parts of the developing world.

This is a development that the rest of the world may not resist. There is already a hushed talk that the world is not "unipolar" any more and it is good to have a bipolar world with China being the second pillar of the new world order. China has emerged as a responsible country, willing to contribute to the cause of global stability. It currency is stable, backed by a large mountain of reserves and a robust trade surplus. Anyway, broadening the basket of reserve currencies will have a stabilizing effect on the world. As you can see, all the right noises are being made in all the right corners.

Yuan as one of the reserve currencies? Majority of trade in developing countries happening in Yuan? The way things are going, there is good chance of seeing it happen.

Global Markets May Recover But India Likely To Linger Here Longer

2009-03-31T11:25:00.001+05:30

INDIAN MARKETS; GLOBAL MARKETS

March proved to be a month where most of the views posted on this blog have turned out to be right. Crude is back to the region of $50/bbl poised to start an upward trend. Steel prices have stabilized. Global markets tested their October lows and bounced back. Indian bonds tanked as yields soared due to heavy borrowing program by the government. Overall, from financial forecasting point of view, the month of March turned out to be exactly as anticipated.

Going forward, we are entering probably the choppiest part of the current market. There are multiple signals that the market is getting from the real economy, some suggesting that the end of the tunnel is in sight, some signaling that we will continue to go down the tube. Nerves tend to be shaky and confidence takes time to build up. Till then, every piece of negative news brings up traumatic memories (and responses). At the same time, there are sharp rallies whenever there is good news as practically everyone is sitting short with a highly bearish sentiment.

Still, some strands are emerging in the global market situation that do indicate that things are changing. One, the short term bottom seems to be in place in the markets as the retest of the October lows is past us and the markets did not go substantially below that level. It indicates that the worst case scenario is not going to take the markets much lower from here. Two, economic data have begun to show mixed trends rather than persistent downward trends. Of course, some economies like Japan are posting consistent downward data but that is more due to their heavy export dependence and trade will take some time to pick up. Three, regardless of the so-called differences among the global leaders, no one believes that the financial system will be allowed to go belly up after throwing many trillions of dollars at it. Of course, there is too much at stake. But there is sunk cost fallacy as well and more money will have to be thrown at the problem simply to safeguard (if nothing else) what has been spent earlier.

We are not out of the woods yet, but the market will keep on looking for signs of an end to the current hopelessness. In this situation, the following assume significance:

Global markets continue to be oversold. People who have made money on the bearish side will continue to run shorts. But there is a problem with that stance. To be able to make good money on the bearish side, you need to believe that markets will fall by 10-20% at least from these levels. This is a contention which may not be tenable. As more and more people move away from this contention, a sustainable rally may be likely.
Commodity and trade indicators do not support an Armageddon scenario. Crude oil is 40-50% above its recent bottom. Baltic dry index is at three times the bottom. Be it steel, aluminum or any other commodity, prices are higher than their 2005 level. While it may a shock to traders and producers (who went in for highly expensive acquisitions), it is not an indication of an economy going down the tube. Despite all the pessimism, real demand has stayed stubbornly high to keep commodities at these levels.
So far, the huge infusions of money into the system have not had an impact simply because of one factor. High pessimism leads to a free run for hoarding instincts. Falling velocity of money and money multiplier would directly offset any cash infusion. But as confidence comes back slowly and activity picks up; a rapid recovery in the money multiplier will expand money supply much faster than anyone can control. Two, this time around, central banks are likely to dither on early signs of inflation. No one would want to kill a nascent recovery and hence, early indications of inflation are likely to be ignored. This means delayed monetary action and a nasty inflationary surprise. In the initial phase, this is positive for the stock and commodity markets.

What Goes Up Stays Up

Contrary to popular conception, it is true for some things. An inflationary overhang that has taken a decade to build up is likely to take a lot more pain to abate, especially when every government around the world is bent upon keeping it alive. This means a boon for commodity producers in the medium term. I have been predicting the resumption of a commodity up-cycle after March for quite some time and have not found any reason to change my views till now.

Stock markets, on the other hand, still need another year or two of consolidation before the build up of the next bull run. This does not preclude a short term rally in the markets that is more than likely.

Indian Markets

India stands in a unique position. On one side, the real economy has shown resilience, especially the consumption led sectors. The headline number, however, will continue to disappoint. But the international interest in India is likely to be shortlived. The current interest in India is due to the fact that India is likely to deliver 5% growth in the middle of no growth. That will change over next 9-12 months and as global markets rally, India is likely to underperform the global equity markets. The single reason behind this underperformance is going to be government. By blowing money on ineffective measures (fuel price cuts beyond warranted, ineffective tax cuts, etc.), it has created a big hole in public finances. To pick one example, the excise duty reductions have all been absorbed by the producers to boost margins. That has led to the familiar specter of the government having to bully and threaten the car producers to pass on excise cuts or else… Demand stimulation? Possible, if the government has the resources to monitor a few thousand large industry units (and a few million SMEs). Complete choke on the industry and crowding out? Quite likely over next few months as the government appropriates all the necessary resources in the economy to plug such massive holes in its finances.

While economic activity will continue to recover on the ground, I think the runaway growth phase is far away. Instead of improving, things will continue to worsen on the credit front as money keeps getting sucked out of the system. There is no credit available for risky two-wheeler financing today, SMEs are not getting enough money, banks are threatening to refer perfectly good borrowers to CBI and CVC (in a bid to avoid "diversion" of working capital); these are not signs of credit delivery improving.

More pain for those who hope to make a bundle in India over next six months. But there is a silver lining to the clouds. India typically takes years to recover when there is apparently nothing wrong (three years post the dot com bust, when there was NOTHING wrong). It means a great opportunity for slow accumulation of stocks. Go for SIPs, gradual acquisition, accumulate a good portfolio at leisure. And reap the reward half a decade later… If the government does not melt it down completely in the meantime.

Cheers!

Bond Market Check

2009-03-26T13:25:00.001+05:30

INDIAN ECONOMY

This post comes after a long lag, and for a good reason. For past one month or so, there was time to just sit back and enjoy, watching things pan out as one had anticipated. Along came the "bewildered" protests by friends and fellow colleagues wondering "why" things were going the way they were. Anyway, enough gloating.

Bond market is exhibiting the beginning of a long government borrowing overhang, something that is going to last for at least one full financial year. This is visible in the benchmark yields, now touching 7%. This goes contrary to the earlier expectations of bond yields falling below 5%. As I pointed out in January, that may not happen in a hurry.

The critical factor to watch out for is whether and when RBI decides to go for QE in a substantial way. My call since January has been that QE is likely to become substantial only after April. That causes a lot of heartburn to people who have built up massive positions hoping for a bonds rally. They point out the fall in WPI, an economy in crisis and so on, hoping for more rate cuts and QE. But they are clearly swimming against the current. The current happens to be quite strong and is built up by double digit consumer price inflation, food price inflation of 8%. If the commodity rally begins globally (my call was post March and we are already hearing the rumblings of something beginning to stir, more on that later), there goes "zero inflation", "deflation", cries. In this environment, any QE action is going to be tempered and cautious and very unlikely to compensate fully for the massive government borrowing.

So the yields will continue to tick higher from here, though the 2% jump seen in the last quarter is not likely to be repeated. At some time, RBI may step up the QE efforts and go beyond the current muted operation through secondary market purchases. But expect yields to stay up, corporate rates to stay up as well and housing loan rates to start ticking up again post elections.

Good to be back. Cheers.

Buying “Undervalued” Stocks Part-4: Base Rate Fallacy and Mean Reversion

2009-03-01T18:40:00.001+05:30

TRADING STRATEGY

Buying "Undervalued" Stocks Part-3: Completing Sectoral Analysis

Buying "Undervalued" Stocks Part-2: Do Other Sectors Follow the Same Pattern?

Buying "Undervalued" Stocks Part 1: Does it Work?

We have seen in the previous posts in the series how "street wisdom" of buying hammered sectors and stocks can backfire. More often than not, once a stock or sector starts outperforming, the outperformance continues till the market conditions change. Similarly, an underperforming sector usually does not turn around till the market conditions themselves change.

The belief in this kind of heuristics still persists because of a cognitive bias known as Base Rate Neglect or Base Rate Fallacy. Put simply, base rate neglect describes how human reasoners tend to ignore background frequencies while calculating probabilities. The following example from wisegeek.com would make it clear:

Another example of base rate neglect in an experimental context would be the presentation to a group of test subjects of a list of ten students and descriptions of their habits and personalities. The presentation is followed by a question as to what grade point average any given student is likely to have. This information is presented together with base rate information on students' academic performance, which should guide test subjects in their guesses, but regularly does not. Given ten poor descriptions of students, test subjects will assign GPA estimates substantially out of line with base rates. Given ten positive descriptions, the bias occurs in the opposite direction.

What is Base Rate Neglect? http://www.wisegeek.com/what-is-base-rate-neglect.htm

In financial market context, the neglect is created by considering the prices at which a stock has traded historically. Looking at it objectively, the past price of a stock does not matter when you are valuing it based on future cash flows. To use a simple formula, value of a stock is equal to known future cash flows plus present value of growth opportunities (PVGO). What price a stock has traded in the past at has no significance in this valuation. If the future prospects look really bleak, stock has to be valued low and vice versa.

But investors frequently place undue reliance on past information, particularly prices at which a stock has traded. This creates a base rate neglect as investors pay insufficient attention to relevant information like future prospects for the stock. Hence, if a real estate stock is valued at Rs. 500 and conditions now warrant it to be valued at Rs. 100, a lot of investors will continue to value the stock at more than Rs. 100. They will continue to see "value" in stock at various price points above Rs. 100 based purely on the historical high of Rs. 500.

This bias works both on the upside as well as the downside. This is the reason why an outperformer is seldom picked up by retail investors early on. Since investors pay unduly high attention to past prices, they will continue to ignore the outperformer till the price stabilizes a bit and then get in. Clearly enough, a large chunk of the move is over by then and many times, retail investors get into a stock close to its peak.

"Fading the Fool" Theory

This is precisely why the Wall Street theory of Fading the Fool has some ring of truth to it. Do exactly the opposite of the "average retail investor" and you will make money. Whether you make money by doing it or not, the fact that majority of retail investors lose money when the market turns is due to the fact that insufficient attention is paid to relevant price information while irrelevant historical information is given undue credence.

That is the reason why retail investors seldom cut their losses short. Most of them keep holding on to poor performers believing they will regain past highs. Add on to it the reluctance to take a certain loss and keeping potential profits open (more on that in another article) and you have a portfolio busting combination. To that, we will add something that even seasoned investors are not immune to: the belief in mean-reversion.

The Giant Killer: Mean-Reversion

Investopedia defines mean reversion as:

What Does Mean Reversion Mean?

A theory suggesting that prices and returns eventually move back towards the mean or average. This mean or average can be the historical average of the price or return or another relevant average such as the growth in the economy or the average return of an industry.

http://www.investopedia.com/terms/m/meanreversion.asp

The concept of mean reversion has come from natural sciences and the principle was discovered by Sir Francis Galton in 19^th century. Along came various tools of statistical analysis and the famous bell curve of normal distributions.

Most of the complicated mathematical modeling that underlies sophisticated risk analysis models like VaR relies on the bell curve and its underlying assumptions of mean reversion. These models were at the heart of trading strategies deployed at Long Term Capital Management (LTCM) and led to one of the most famous investment debacles in recent financial history.

But the belief in mean reversion is not limited to the sophisticated investor alone. Everyone believes that there is some "mean" or "trend" value or return or price to which every security would return. This is at the heart of even sophisticated advice offered. This belief is at the core of the concept of "value buying".

Does Mean Reversion Happen?

The answer to this is yes and no. There may be evidence of growth at the economy level returning to "trend" level from time to time though the variations in between are huge. From time to time, we keep on hearing about long term growth trend of the world economy, the US economy, etc.

But this does not mean that investments based on this "trend" are going to be profitable. For one, there is no way to ascertain what this "trend" growth is going to be. In absence of more concrete tools, economists generally rely on different mathematical averages from the past, none of which may be relevant in fundamentally changed circumstances. Even if you get a good handle on the "trend", actual economic performance may vary from the trend for multiple economic cycles. That means, you need to hold on to your stocks for 10, 20 or 30 years to make money.

Survival of the Fittest

Of course, when we say that a sector or economy will average out to the "trend" over 20 years, we are talking about the economy as a whole. We do not mean that each and every company listed on the exchange will also conform to that.

That is where value investing becomes especially tough. What if your chosen sector does revert to trend over next 20 years but the company you have bought goes bankrupt in the meantime? This is a real risk because the average listed corporation does not survive beyond a few decades. You can almost take it as a rule that stocks that fuel one boom will not be the ones fueling the next boom. So what good is mean reversion if the individual components of the move back to the mean are different from the ones that you are relying upon?

Conclusion

We have seen that the standard advice offered to buy "undervalued" stuff seldom works in the short run. It might seldom work in the long term also (unless you are Warren Buffett and hold stocks "forever"). Still, it is frequently offered and accepted as a trading strategy by individual investors in particular. It leads to quite strong biases and warped behavior to the extent that you might even make some money by "fading the fool".

How do we avoid getting into this trap and escape relatively unharmed? Does this bias create trading opportunities if you are actively on the lookout for them? These are some of the questions we will seek to answer in the final and concluding part of this series.

India Q3 GDP: No Surprises But More Pain Ahead

2009-03-01T11:49:00.001+05:30

INDIAN ECONOMY

India's Q3 GDP numbers came out on Friday. The number that has come out is way below the consensus forecast (read financial press expectations), government forecast, etc. But the market did not react too violently to the information.

All key market participants have known for some time what the GDP number is likely to settle at. Most of the international fund managers have maintained for quite some time that India will grow at sub-5% levels during next one year and 4.5% is a good estimate for next year's GDP number.

Why Market Analysts Miss the Bus?

Contrary to expectations, Q4 of FY09 is not going to see a better GDP number and the slowdown is gong to continue for next few quarters. But why have the Indian analysts continued to be overly optimistic about the GDP when the writing has been on the wall?

The main reason behind the optimism of financial press has been the faulty way in which they sum up GDP forecasts. The key to getting a good handle on economic forecasts is to focus on the demand side and not on the supply side. This works exactly like a business, you do not make a budget based on what you can manufacture (of course, it represents an upper limit if you are operating at full capacity) but what the demand is going to be and how much you can sell. Likewise, unless an economy overheats and is suffering high inflation, it is likely to be operating at less than 90% capacity utilization. Under such circumstances, supply side simply tells you about potential growth, not exactly how much is going to happen. Hence, focusing on demand side aggregates is critical.

Due to this particular anomaly, you come across market analysts saying, "I don't think manufacturing will contribute less than X". What manufacturing is going to do is a function of demand, and if demand slows down, there is nothing the manufacturing sector can do about it.

Q4 – Blues to Continue

Looking at the demand side, things do not look very well. One of the key components on the demand side, exports, continues to suffer. Even though exports are just 13% of the GDP, a 20% hit on exports translates to 2.5% penalty on growth side. This is significant because during the current quarter, exports are going to witness a similar hit.

While it did seem that global trade came to a standstill in Q3 FY09, the key segments in export sector did not completely shut down during the quarter. What happened in Q3 was that orders spilling over into Q4 got cancelled and new orders did not come. All the key industries we spoke to actually said that they still had some orders to service in Q3, it is Q4 that is likely to go completely empty.

Taking into account this one quarter lag between order receipt and actual servicing, the current quarter is likely to be very bad for the sector even if demand recovers.

Disaggregation of other key demand side sectors reveals further trouble. Urban consumers, particularly upper middle class, are badly hit and demand for key consumption items, housing, consumer durables, etc.; is not likely to recover soon. Rural demand has been buoyant, but a dip in agricultural output (2.2% in Q3) might see demand dipping as rural incomes plunge.

Is It a Surprise?

To a large extent, no. That is the reason why the market did not react too violently to the number, though the initial reaction was negative. Hence, in terms of expectations, we may already have hit the bottom.

But getting the bottom in sight is not enough to spark a recovery in the markets. To see a recovery in the market, we need to get an economic recovery in sight. Without that, the markets can drag on aimlessly in a tight trading range.

Recovery?

Is far away at the moment. Previous posts on the blog have recounted the reasons numerous times, but the latest fiscal adventures of the government have postponed the painful consolidation phase also to after the elections.

First, a bit on why these measures will delay recovery rather than aiding it. One, the government is running a huge deficit on the oil account which it does not even include in its deficit numbers. What is the rationale for continuous fuel price cuts? Just because the government wants to see an artificially depressed inflation number before the elections. Does it help the economy in any way? No. the real inflation number is the CPI, which is not going to be affected by this cut. It is foolish to assume that cheaper diesel or petrol or cooking gas will stimulate demand in the economy. The economy was much better off had the prices been kept at a reasonable level and money was spent on stimulating demand.

Two, the value of tax cuts in stimulating demand is quite dubious. I have written enough on it in the past and will not revisit the issue. But you cannot avoid the nagging suspicion that the government is resorting to tax cuts instead of spending because it doubts its own ability to spend anything in an efficient manner.

Fiscal Drags

All these things create a drag of their own. The bigger hole in finances due to these populist measures needs to be plugged at some stage. We sincerely hope that it happens immediately after the elections, the best time to effect a consolidation. That will mean about a year of pain followed by a good economic recovery.

If, on the other hand, the new government also chooses to be populist and refuses to reverse these "measures", we might see a prolonged slowdown that can even threaten the Indian growth story.

In any case, next one year is going to see a lot more pain and no early respite.

Buying “Undervalued” Stocks Part-3: Completing Sectoral Analysis

2009-02-27T17:00:00.005+05:30

TRADING STRATEGY

Buying "Undervalued" Stocks Part 1: Does it Work?

Buying "Undervalued" Stocks Part-2: Do Other Sectors Follow the Same Pattern?

So far, we have seen that the evidence in favour of buying undervalued stocks (when they are hammered versus the broader market) in hopes of a sharper bounce back is mixed at best and goes against observed behavior at worst. Today, I would like to complete the sectoral analysis so that we can move on to why this kind of biases, right or wrong, persist and their implications on market behavior and trading strategy.

IT Sector Index

The IT sector index does show some reversion to the market returns during the bullish phase. The index, by and large, outperformed the Sensex throughout the entire bull run and gave sub-Sensex level returns only towards the fag end of the bull run, as shown by the chart below.

During the bearish phase also, the index has outperformed the Sensex on a sustained basis. That means barring a few months at the fag end of the bull market, the index has maintained its outperformance over an extended period of time. This goes directly against the hypothesis we are trying to test.

There is another peculiar feature of these two charts. IT has now matured to an extent that it is now almost as good a "defensive" bet as healthcare or (as we shall see later) PSU stocks. In fact, it is better than pharma/healthcare because it has outperformed both during the bullish phase as well as the bearish phase. What it does to our hypothesis is a different matter of course.

Oil and Gas Index

To be objective, we should not be looking at Oil and Gas Index for comparisons because of the highly warped policy impact on the sector. Government policy for this sector is driven more by electoral considerations and less by economic sense. Still, for the sake of completing the comparison, am printing the charts below. Conclusions, if any, are again not supporting the hypothesis being tested and again there is no evidence that buying a beaten down sector or selling an exuberant sector is a good bet unless there is a change in the general nature of the market (i.e., from bearish to bullish or vice versa)

Bullish phase chart

Bearish phase chart

It is noteworthy that the index actually outperformed the Sensex in 2008 when oil prices were rising and Indian oil companies were under a tremendous amount of pressure due to lack of any clarity on the policy front. Other than that, please draw your own conclusions.

Power Index

This is a relatively new index and we do not have full history of the index extending to starting of the last bull phase of the market. But we do have significant amount of information pointing to the fact that the hypothesis is not directly supported. The bullish phase chart is reproduced below.

The sector did outperform right upto the end of the bullish phase. On the bearish side, the underperformance is still continuing on a sustained basis.

Though the data here is inconclusive, the returns of the sector are yet to get back to the Sensex level.

PSU Index

This one is my favorite, because it can allow for a lot of myth busting.

The PSU index was an underperformer throughout the bullish phase of the market, particularly in the latter half of the bull market. This underperformance, however, did not allow any investor to make any value picks "within" the bull market and anyone buying on relative underperformance would have continued to lose money right up till the end.

Furthermore, it highlights another factor (though unrelated to our discussion) regarding the policy folly of sinking significant taxpayer money in public enterprises where markets can do a better job. If the PSUs in general are going to underperform the broad market to the extent of 20-40% during very good times, exactly when are they going to create value?

The situation would be rescued a bit if PSUs were countercyclical and outperformed the market during bearish phases. But there too, things do not square up.

Here also, the PSU index has kept mainly in line with the Sensex, outperforming only for last two months of the analysis.

The broader point here is the relevance of the government staying in business of providing services that are much better provided by the private sector. As I said before, it is not pertinent to our discussion here, so I will not dwell upon it further. Suffice to say, the data again does not support the contention of buying "undervalued" stuff and the investor may not be rewarded even when the market sentiment changes completely.

Realty

Last, but not the least, the sector that sparked the entire debate.

We do not have full bullish phase data for the real estate sector. But that is also due to the fact that real estate got "hot" only towards the middle of the bullish phase and companies like DLF got listed a bit late in the market run-up. That said, the sector turned in a spectacular performance and outdid the main indices by a long shot.

The 4:1 outperformance is quite significant. The stocks, by any definition, were quite overvalued purely based on the returns generated by them. But anyone who sold or shorted the stocks at any time would have paid a heavy price.

The bearish phase data also paints a similar picture.

Once the sector lost favor of the investors, there was no stopping the slide in all key stocks. It has continued to underperform the broader market.

It is difficult to say whether the sector is going to reverse the slide once the broader market stabilizes a bit. Given the evidence from other sectors and earlier data available, it is quite unlikely. Unless we see the end of the bear market and beginning of another secular bull phase (something that is not in sight at the moment), investors in the sector are more likely to lose money than gain it back.

Conclusion

Considering all the sectoral evidence, it is clear that the contention of buying "undervalued" sectors during a bearish hammering may be more of a myth than reality. Some sectors like banking to exhibit a shorter cycle within a bullish or bearish market, but that may be due to the fact that banking is much more readily affected by monetary policy stance and as economy expands at a higher or lower rate and as central bank adjusts monetary policy and rates, etc.; the sector responds to those cues.

All the investors who have been thinking of making some easy money or a killing as they buy stocks that have been pounded into the ground may be in for a nasty surprise. The truth is, once a stock starts falling, there is no bottom for it. During the 1992 bullish phase, investors saw an Apollo Tyres falling for a high of Rs. 1600 to single digit levels. A decade later, the experience was repeated with Himachal Futuristic. I will not quote Satyam during the current phase because of a scandal influencing the market prices. But the point remains the same. If you buy a stock with a peak of Rs. 1000 on the way down at Rs. 500, there is no certainty that it will not fall to Rs. 50.

This truth eludes investors quite often as they indulge in what behavioral finance labels as Base Price fallacy. I will also add to it another notion that tanks investors quite frequently, that of reversion to the mean. The latter, in fact, is so rampant that it affects not only retail investors but is the nemesis of real pros as well.

We will continue this discussion in the remaining two parts of this series.

Rupee: The Move Begins?

2009-02-27T12:01:00.001+05:30

INDIAN RUPEE

I have maintained for some time that we are approaching the stage where the Reserve Bank of India will begin to slowly abandon its defense of the rupee. Though in my yesterday post Going for Broke, I had conceded the possibility of a protracted defense of the currency, but that goes against the policy stance as well as independence of RBI.

The writing has been quite clear on the wall for the rupee. The fundamentals have been aligned against the rupee for some time now and pressure has been rising. In this backdrop, it was unlikely that RBI would mount a long standing defense of a particular level. Going by the history, RBI generally likes to soften the blow instead of stubbornly blowing good money for defending a meaningless level.

Capital Flight?

It is important to note that FII flows have been generally negative since Satyam story breaking out, barring a few days in February. The recent change in outlook for India by S&P also creates pressure on debt flows as funds mandated to invest only in investment grade paper gear up to exit if a rating downgrade happens.

Clearly, capital flows will continue to be negative for quite some time for the rupee which has its own implications on the economy. I have argued time and again that foreign capital is key to Indian growth story as it helps to plug a long standing gap between savings and investments. But that story apart, the immediate impact is going to be on the rupee.

No Long Standing Defense

It is interesting to note that the massive defense of the rupee mounted by RBI during last quarter of 2008 was more of an exception rather than the rule. Highly negative global environment endangered the currency to the extent where a panic could have developed had the central bank not intervened.

I still maintained the view that RBI's defense of the currency lasted a bit too long, more than what the situation demanded. Afterall, a weaker currency would have helped the beleaguered export sector salvage some of the situation. But RBI is a conservative central bank and moves in a sure footed way rather than taking hasty decisions (we like RBI for being like that, though). But now the situation is clearly out of the panic mode and fundamentals have to take over at some stage.

Where Do We Go?

From here on, it is quite likely that RBI will let the deteriorating fundamentals reflect in the currency, though in a slow, delayed, lagged fashion. It also has to keep in mind the fact that a strong defense in face of worsening fundamentals just invites predators to profit at the cost of the central bank. The market will get where it has to get anyway.

On the technical side, a move beyond 51 is likely to take the rupee in the 53-54 zone over a month or two. This is probably the last chance to buy dollar cheap for any treasurer in India.

Buying “Undervalued” Stocks Part-2: Do Other Sectors Follow the Same Pattern?

2009-02-26T17:49:00.006+05:30

TRADING STRATEGY

The first part of this article was published on Feb 4, 2009.

During the last discussion, we found that the hypothesis we are testing for was inconclusive based on analysis of auto sector and the banking sector. It warrants further testing with other sectors data to find out whether we can conclude either way.

Metal Sector

One of the hottest sectors in the past boom, the metal index is a good proxy for the active markets we had in equities in the last boom.

The bull market information, again, is not very clear. Whenever the sector reverted to the returns offered by the index during the bullish period, the index did bounce back. Yes, there is cyclicality in the returns versus the main index, there is no evidence still that the market could be traded based on the hypothesis of the sector being overvalued or undervalued.

The bear market graph is more insightful. If the earlier hypothesis was to hold out, the sector should have seen a fairly good bounceback by now, especially since the sector returns have tanked to half the level of general market. Still, there is no such bounceback in sight.

At best, this is weak evidence for the hypothesis. At the same time, it also allows the opposite conclusion that an outperforming sector during the bullish phase continues to outperform throughout the bullish phase. Likewise, a laggard in bearish phase is likely to continue being a laggard throughout the bearish phase.

Consumer Durables

Popular perception has been that the consumer durable sector was one of the laggards during the last boom. But the data does not support this contention. Contrary to perception, the sector was one of the outperformers during the latter phase of the bull market.

The first leg of the bullish market again supports the contention that a sector that is relatively undervalued versus the market tends to outperform later on. The earlier dip around February 2004 is followed by a relative peak in October 2005. But is there any evidence to follow up on that?

The answer to that seems to be no. The sector continued to outperform the broader market from February 2005 onwards right upto the end of the bull market. That is a long period of time and anyone banking on the overvalued theory would have lost a lot of money.

The bearish phase also brings out the same phenomenon. Once the sector started underperforming, the difference between the returns offered by the sector versus the broader market has been growing and there does not seem to be any respite.

This clearly indicates that during any cycle, it is quite possible that a sector can outperform the market for extended periods of time. In fact, in case of some sectors, we can even argue that it is more the norm than otherwise.

Capital Goods

Capital goods also exhibits exactly the same phenomenon. The fundamental reason for this is quite clear. During bullish years, investments are on an uptick giving a boost to the sector. The trend completely reverses during a downturn.

Or does it? What about all the additional spending by the governments on infrastructure and all? What about lower interest rates fueling demand? And overall economy also tends to shift to a lower growth. Then why should the sector not exhibit the same pattern of returns?

Anyway, the data is quite unmistakable on this count too. The fundamental logic apart, the outperformance or underperformance tends to last for almost the entire bullish or bearish phase. So here we go.

The bear phase also showcases the same situation.

Again, the sector does not follow any rules of reversal during the entire cycle of the market. During a particular phase, if it is outperforming, it continues to outperform during the entire market. During a bearish phase, underperformance tends to extend for quite some time.

Consumer Goods

The FMCG sector again follows the same pattern. The sector was a laggard during the entire bullish market of five years and anyone who bought on undervalued theory would have underperformed the market. At no point during the market move did the sector show any signs of improving against the broader indices.

The situation completely turned around during the bearish phase as strong underlying demand became a strong selling point for this sector and returns have been outperforming the main indices ever since January, 2008.

This sector too supports the hypothesis that an outperformer tends to stay an outperformer for an entire bullish or bearish phase and vice versa. Anyone taking the view of buying undervalued sectors or selling overvalued sectors would tend to lose out versus someone following the broader market alone.

Healthcare

The last sector being considered for this article today also follows the same broad pattern. I will not repeat the arguments. Will just reproduce the charts.

Bullish phase

Bearish phase

Conclusion

So far, we have not found any convincing evidence whether the hypothesis of buying undervalued stuff really works in the market. While the evidence in last article was mixed, the sectors examined today clearly point to the opposite direction; sectors that are outperforming or underperforming tend to continue to do so for an extended period of time.

We will continue to extend this analysis and wrap up the analysis part in the next post.

Going for Broke

2009-02-26T13:00:00.001+05:30

The government seems to have made up its mind at last. After dithering for a long time on "stimulus" and hesitating in the face of a possible rating downgrade, there seems to be clarity on which way it is going to go. Hence, ahead lies more pain, more disenchantment and possibly a rude shock to growth aspirations of India.

The Fiscal Mess

The mess on the fisc is now complete. After a lot of hesitation, the government has decided to make a complete hash of the fiscal situation. The excise and service tax cuts are going to just widen the hole in the finances of the government. More than that, it is doubtful whether a service tax cut is going to do much to stimulate the economy. In fact, a waiver of the FBT would have been far more beneficial for the corporate sector than a cut in the service tax.

But the government has gone beyond that and seems to have decided that populism is the way to go. Hence, we may get another diesel price cut any time soon. This has nothing to do with economic logic, needs of the hour or sound governance. It means that petty electoral gains count much more than the future health of the economy.

Is a Downgrade Avoidable?

It was probably just a coincidence that the change in the economic outlook by S&P came side by side with the announcement of duty cuts. But the impact is not going to be lost. With these duty cuts, it seems that the government as well as the rating agencies have thrown in the towel and a downgrade is now imminent. If S&P's revision in outlook is followed up by duty cuts and populist squandering of resources, it means that both the rating agencies and the government must be preparing for an almost inevitable downgrade of the country's rating.

While earlier we were sitting on the borderline and were on the brink of a downgrade, the recent moves have raised the risks tremendously. It makes avoiding a downgrade fairly hard, if not impossible.

Going by the history and convention, the agencies typically wait for at least a month or two before making a downgrade after a revision in outlook. That means a downgrade can happen as early as March 31 for India. Which means that from April 1^st, we are going to see a lame duck government, a country in deep fiscal mess and foreign money being pulled out amid worsening economic environment.

Impact of Downgrade

The primary impact of downgrade is going to be on gross capital flows, particularly on FII flows into debt. It is quite difficult to predict how the equity fund managers are going to view a rating cut, though in a generally deteriorating environment, the bias is going to be that of pulling money out. But on the debt side, it is far more certain. FIIs will have to pull out.

The reason behind that is legal and has nothing to do with the individual choice of the fund manager. Once a security loses its investment grade status, all the funds that are mandated to invest only in investment grade paper do not have a choice but to exit.

A certain portion of FII money, therefore, will have to pull out of India because of mandate and binding covenants, regardless of their view on the economy and the markets.

Rupee Blues

This is likely to put the rupee under a tremendous amount of pressure. Going by the recent moves on the policy front, it is likely that the currency will be defended well before the elections (though it goes contrary to independent policy stance followed by RBI). That will mean squandering forex reserves for chasing a worthless goal.

But there is more to it than just reduction in currency reserves. When governments fight the markets, the markets eventually win. I think the government thinking is pretty clear on this. They just want to hold the fort till the elections. Post that, the fight is likely to be abandoned. The markets will eventually win anyway. Hence, a painful adjustment process awaits us post the general elections.

The Way Out

A prolonged ride at the bottom seems to be in the offing. If the adjustment process in the economy begins somewhere around July/August instead of right now, it means a delay in the recovery plus a slower recovery as the excesses being created now also need to be cleared out. As of now, we do not know when global recovery is going to take place, but India cannot start regaining the growth trajectory before mid-2010 anyway.

Indian Growth Story

So far, the long term growth story for India has been intact. Even with the current moves, the fiscal deficit is far below the highs seen during mid-1990s. But a worsening banking sector, lowered tax revenues and need for deficit spending for infra sector may continue to put more pressure on the fisc. Moreover, all the excess borrowing by the government needs to be serviced and continuously high deficit leads to a much higher interest burden which can spiral out of control.

Quite clearly, this turn in the cycle has the potential to derail India's growth engine. If these excesses by the government are not reversed post elections and instead become medium term policy, we are seeing a possible step-down in India's growth potential and 7% growth may become a difficult target to achieve over next few years.

Currency Risk Rising

2009-02-06T13:54:00.001+05:30

INDIAN RUPEE; GLOBAL ECONOMY

I have been writing for quite some time on the rising pressure on the rupee that has been held in check by the central bank till now. What we have seen over past two months has been a stable phase for the Indian economy with only one adverse event, Satyam, impacting the market. But this phase is likely to end pretty soon as event risks multiply disproportionately and different EM currencies start feeling the heat.

The assessment in terms of vulnerability has focused more on currencies like the Korean Won. The reasons have been simple. Bad currency hedges have put a lot of pressure on the exporters there, exposure to short term bank loans is high and roll overs are necessary to prevent a credit default and so on.

But, like all things that are… well unexpected…, this time the currency pressure starts from another source of randomness, the Russian Ruble. Russia is facing a huge risk of capital flight as people believe that a massive depreciation of the currency is on the cards (see Brad Setser's excellent piece on this). That in turn puts more pressure on the currency. Talk of a self-fulfilling prophecy!

But people do not have a right to complain when they have happily taken advantage of the self-feeding cycle on the upside. Now that the cycle is turning, everything that worked on the upside has to work on the downside. The most a central bank can do is try to soften the pain. Something that the Russian central bank attempted and has been "rewarded" with a downgrade.

Falling Like Ninepins

There is a good reason to believe that if Russia gets badly mauled during the current pressure on the currency, it puts all the EMs under a tremendous pressure. Slowly, but surely, the risk perception is going to rise and the next weakest link is likely to fall anytime soon. It means that any economy with

A currency that is overvalued or is seen to be overvalued; or
A big exposure to the external account; or
A big debt obligation that is hard to roll over; or
A very bad fiscal situation

is going to see a massive pressure on the downside on the currency.

This covers a fairly wide spectrum. The entire Eastern European (EE)sector is at risk, Korea is at risk and so is India.

Indian Situation

Post the Russian situation, I think things have undergone a fundamental change for the Rupee. One, it should have an impact on the willingness and commitment of the central bank to defend a particular level. So far, the Reserve Bank has defended 50 quite well, though it ended up throwing away $50 billion + of reserves in the process. Should the pressure mount again, I do not think this can be done again.

The second thing to watch out for is the "line in sand" level of reserves that the country needs to maintain. Sure, there is no fixed level, but there is still a fuzzy "line" beyond which the foreign currency rating becomes vulnerable. Can the central bank let the reserves fall indefinitely? Absolutely NOT! Particularly when we do not even know what the government's fiscal position is going to be like.

The Fisc and RBI's Role of the Rescuer

The entire problem is exacerbated by the poor data collection and archaic accounting practices of the government. It takes months for the government to find out whether it is seeing a positive or negative surprise. Under stable circumstances, it is inconsequential. Under current circumstances, it is critical.

As I have noted so many times, the central bank is the sole savior in the current crisis for India because the government never preserved any ammunition for the "real war". Honorable Ex-Finance Minister Mr. P Chidambaram fired everything that he could lay his hands on the moment he saw it. When you fire all your shots when you don't need to, you are left with nothing at the time of need. The fact that the post of Finance Minister has been left to languish speaks volumes about what the government thinks it can do to tackle the current crisis. To me it sounds like 'nothing'.

So RBI is the chosen firefighter for the moment. And there is a lot it has to do. Among them, compensate for the deteriorating fiscal situation that can spring a surprise at any moment. The fact that credible information is available with a long lag makes it very hard for RBI to calibrate the policy response properly. And it runs a significant risk of either undershooting or overshooting on the policy side, a situation that is wholly undesirable.

Why Aiming Right Matters

The case for this is quite straightforward. RBI cannot underdeliver on stimulus because the task of keeping the economy afloat is quite critical. On the other side, overshooting runs big risks. It could turn off international capital just at the time when we need it the most.

I have a high regard for the RBI's capability in managing it. And I do believe that they are going to be as cautious as they have been so far in managing the policy response. A lot of commentators have expressed different levels of frustration with their pace or the way the crisis is handled. But in hindsight, everyone agrees that RBI has gotten practically everything right.

This time around too, the cautious approach will continue and we are likely to see more and more unwillingness to defend a particular level of currency as the reserves fall. Let me enumerate why that is the case:

Deteriorating fisc means rating pressure going higher on a continuous basis; if India has to avoid a currency downgrade, this requires maintaining "adequate" reserves.
RBI spent about $50 billion in the last wave of currency defense. The assumption at that time would have been that it would get a chance to "refill" the reserves as soon as things "normalize". That is a remote possibility, to put it mildly, under the current circumstances.
Capital flows have turned decidedly negative. This was not necessarily part of the equation of the earlier defense mounted by the central bank.
Now the killer. Rupee is STILL overvalued on a long term basis despite such a massive correction. Any guesses on how the outside world is going to view an overvalued currency in a developing economy with a massive fiscal deficit and a massive trade deficit?

The resolve to hold a particular level is going to be markedly different if the next wave of bearishness hits the rupee.

Where Do We Go from Here

All the elements are aligning for the next wave of reality check for the Indian market. Slowing demand, slowing manufacturing, slowing real estate, stubbornly bearish stock market, negative outlook on the currency; these are the risks facing the economy. Is all of it going to materialize? Probably not. Only the most cynical and only career bears will believe in this scenario. But things are not very rosy either.

In my view, a "perfect storm", if it happens, is going to be shortlived. The most bearish scenario is applicable only when policy response is absent. At least on the monetary side, that is not the case. In all likelihood, RBI will choose to soften the blow instead of a stubborn defense, preserving valuable reserves. In all likelihood, RBI will focus more on injecting liquidity through QE instead of cosmetic interest rate cuts that do not work. In all likelihood, they will calibrate their response quite carefully instead of firing all their shots at the wrong time.

What we need to guard against, in the meantime, is a global event. It is the unforeseen risk at the moment that needs to be watched out for.

Fitch Downgrade of Russia: Dangers of Being a Fiscal Gunslinger

2009-02-05T12:48:00.001+05:30

GLOBAL ECONOMY; INDIAN ECONOMY

Fitch downgraded Russia yesterday. This clearly brings out the dangers that India faces during the current downturn. Given the current state of the fisc, there is not much room to do a good stimulus package. In these times of uncertainty, doing nothing is not really an option either. But how much can be done and what impact will it have?

In my January 27 post, Monetary Policy Review: Why We Admire Reserve Bank of India So Much, I had touched upon why doing too much on the fiscal side is difficult (section titled "Bold" Advice). India is a developing economy and not a developed one. Hence, jacking up public debt (government borrowing) to above 100% of GDP levels is not an option at all. That is a luxury available to the likes of the US and Japan only.

Debt Trap and Fiscal Bloat

There is another reason why there needs to be a cap on the borrowing levels of government. Not many people today are aware that barely a decade back, Indian government was caught in something called a debt trap. If you read through the federal budget of any 1990s year, you would realize that the interest outgo on the government borrowing tended to be close to or more than 50% of total revenue receipts of the government.

This is the reason why there has been such a great emphasis on fiscal consolidation in the early years of this decade. The government runs a bloated affair. If 60-70% of your total revenue receipts are going to be eaten up by the cost of running the bureaucracy/government and your interest burden, where is the room for spending money on development?

More Burning Issues

But that is more a longer term issue and people in India do not necessarily care about it too much provided they get to keep their jobs and homes. The problem is that international agencies and investors may not share the same view. And too much aggressiveness on the fiscal side may bring a swift downgrade for India.

As I said in my earlier post, this is NOT AN OPTION for India. A downgrade at this stage is going to be a big negative, the proverbial straw to break the camel's back. We cannot afford it.

Painted in a Corner

Quite clearly, the rating action on Russia is going to make the government much more defensive than before in terms of fresh spending. The vote on account is going to be much more cautious than was likely earlier and hopes for any further meaningful action on the fiscal side should be abandoned quickly. Anybody banking on a fiscal package needs to reassess the assumptions of their investment hypothesis.

Market Action

Market action is unlikely to get affected immediately. But there is ONE NOTE OF CAUTION. Once the election guidelines kick in, the ability of the government to respond quickly to any negative newsflow is quite limited. All these constraints, whether they are on the fiscal deficit side, need to maintain reserves or the election code of conduct; mean that the ability to react is the lowest when the event risk is probably at the highest in the current bear market (for details, please see Event Risk Rising).

This enhances the risk of next breakout being on the downside considerably. Trade with caution.

Buying “Undervalued” Stocks Part 1: Does it Work?

2009-02-04T17:02:00.003+05:30

TRADING STRATEGY

Many times, you get advice from many market analysts on buying stocks that have been "beaten down". The reasoning applied is that when the market bounces back, these stocks will outperform the market. But does this strategy work? Or this is also one of those stock-in-trade phrases deployed by market analysts?

The premise on which such a piece of advice is based is that there is some fundamental value to a sector or stock that does not move around too much. If, therefore, prices move away too far from that, they are likely to revert to that fundamental value.

But does this approach work in the market? I have heard this particular set of advice so many times that I am tempted to test the validity of this assertion. Moreover, as we will explore in the later parts of the series, this kind of thinking is instrumental in creating one of the most enduring investor behaviours in the stock markets. There is certainly some value in exploring this. Either way, we can use the results to build a specific trading strategy around it.

Okay, the argument we want to test is the following:

If one of the sectors in the stock market is "beaten down" (which means it will underperform some benchmark index or indices in a significant way), it is an indication of undervaluation of the stock/sector. When the benchmark starts recovering, the sector is going to outperform the benchmark and will show higher percentage returns.

Since we are setting up a quasi-statistical test of this argument (sorry folks, complete statistical validity requires a lot of time and we do not have that), the other two aspects of this argument also need to be outlined and tested.

The Corollary. The opposite of this argument should also hold true. Thus, if there is one sector giving a massive outperformance of the benchmark indices at a time, it can be termed "overvalued" and it should be possible to enhance returns by switching out of this sector or by shorting this sector and going long on the benchmark.
Timescale. This needs to be shorter than the business cycle. Since the change in the business cycle alters the fundamentals of most of the sectors, any "turns" that happen after the cycle is over neither prove nor disprove the hypothesis we are testing.

At some stage, we will get into the intellectual merits of the argument as well, because there are important implications of that on the trading psychology side. But, before we get into the merits of the argument, we will go through some evidence whether it holds out against market data or not.

Let us take two time periods; May, 2003 – January, 2008 and January, 2008 – January, 2009. The first period was an out and out bull market. The second period has been an out and out bear market. This clear cut off allows us to test the hypothesis in a very neat and clean way.

Also, in terms of data, let us go by what is available in the market, so we will pick up some indices like Bankex, etc. and compare performance with Sensex. I am picking up BSE indices because there are quite a few sectoral indices available. Out of the total 10+ indices that BSE computes, I am picking up practically all the sectoral ones for analysis: Auto, Bankex, Metal, Consumer Durables, Capital Goods, FMCG, Healthcare, IT, Oil & Gas, Power, PSU and Realty.

We begin our analysis with the Auto sector, something that has not seen something of an outright bullish or bearish sentiment. Even during the downturn, there have been mixed trends in the sectors. While Bajaj Auto has underperformed, Hero Honda has outperformed and so on.

Auto Sector

Looking at the relative performance of the Auto Index and Sensex during the outright bull market, we see some possibility of making money by being relatively short vs. Sensex in case of auto index. But it is not very clear. Thus, when autos started outperforming Sensex in May, 2003; the trend continued right upto June, 2004. That is one FULL year of outperformance before some sort of moderation of performance happened.

On the other hand, the sector qualified for "beaten down" tag between Q1C06 and Q4C08. Anyone who got out of a broad portfolio consisting of Sensex stocks to get some "value picks" in auto sector would have either lost money or would have underperformed the market.

Moving on to the outright bearish phase, the auto sector relative performance looks like the following:

During the bearish phase of the market, there is some credence to the assertion that you can make some money when a sector is relative underperformer vs. the broader index. But here it is important to remember that the difference in performance is less than 5%. Hence, technically it does not qualify to be called overvalued or beaten down at any stage.

Banking Sector

The second index in our series is the Bankex. Here also, using the same methodology and taking relative movement vs. the Sensex, the following plot is obtained.

Looking at the Banking index, there seems to be some sort of "mean reversion". Of course, we are not arguing here on HOW to enter and exit positions that exploit the relative under or outperformance. We just want to know whether someone following this strategy can make some money.

Hence, in case of the banking sector, if you can find a way to pick the turning point in performance, it should be possible to make some extra money in the market. It is interesting to note that during mid – 05 and mid – 06, banking stocks were actually big underperformers despite a highly rosy economic scenario, demand for credit booming and good treasury income coming to banks. Still, the sector underperformed versus the broad index.

Looking at the bear phase graph, the evidence is a bit less convincing:

But still, the index does show some sort of reversion, meaning it outperformed the broad Sensex during Jun, 08 to Dec, 08.

Initial conclusion

So, our tests of first two indices do show a partial support for the view that you can trade an "undervalued" sector or an "overvalued" one. Whether this is a broad hypothesis or just a coincidence will be examined in the following parts of the series.

Cheers!

Event Risk Rising

2009-02-04T10:46:00.002+05:30

TRADING STRATEGY

By now, we know that most of the "regular" bad news has been factored in by the market. In that sense, we are approaching the middle of a bear market formation. This is the point from where on, the market is technically poised to test the earlier lows and then start moving in a sideways formation.

At the same time, the reverse impact of the stock market (termed "reflexivity" by Soros in his book The Alchemy of Finance) is probably the maximum at the time of bear market approaching its "half life". The reasons for this are quite clear. Due to lags in data etc., all the bad news is probably just getting out now. Which means that the investor confidence is probably at the bottom. It is interesting to note that all forms of scandals and sleazy news starts breaking out in the middle of a bear market and continues till the end.

During such a time, most of the businesses are going through a painful readjustment to a much lower level of economic activity. Some are affected more than the other. E.g., real estate has gone into a phase of complete drying up of sales. Inventory backlogs, high cost base, etc., on the other hand are still putting a lot of pressure on margins. The situation can be likened to a long, heavy train applying breaks suddenly but only on the engine. If the bogeys do not have breaks of their own, not only will the train slow down only with time, but the front will slow down while the real continues its momentum. This would put an enormous amount of strain on the middle.

Essentially, this is what happens in the middle of a bear cycle. This makes the next few months extremely stressful for the companies, till they adjust to lower business activity levels.

This raises the event risk associated with weak companies significantly. It is hard to predict what is going to break and what is not, but in terms of probability, something going belly up is much more likely over next three months than in subsequent one full year.

Trading strategy: it is wise to run a small, out of the money put options position over next three months.

Banking: When Will the Bad News Be Factored In?

2009-02-04T00:13:00.002+05:30

Slowly, the market is becoming a bit more sensitive towards the likely problems to be faced by the banking sector in India. As always, this time too international investors a bit ahead of the curve. Hence, listening to Chetan Ahya was a bit illuminating.

The points he brought up were quite clear. Indian banking sector is quite well conversant with high NPAs, as high as 6%, the level last seen in mid to late 1990s. That is something which I feel quite worried about. The impact on bank balance sheets apart, it has a cascading effect on the economy as banks get extra cautious in lending. SME sector is the hardest hit under such circumstances as the flow of funding completely dries up.

I have long maintained the view that during coming few months, the credit crunch is going to get worse and only the top rung corporates will have access to money at reasonable rates. This does not bode well for the economy because big corporates account for only a small chunk of employment and SMEs are primary drivers of employment and consumption. A dent there will have a strong impact on any hopes of economic recovery.

Clearly, mere interest rate cuts and government directives to lend are not going to be of much use under such circumstances. One reason why bank credit freezes up so badly for small sector during crunch times is the poor recovery mechanism available to banks. Hence, one of the ways to free up bank credit market would be to make the recovery process faster, more robust and more transparent. Of course, it sounds more like a paradox and requires political will. Something that is hard to find at the moment. We are in an election year, so expecting such a "harsh" measure is wishful thinking.

On market side, I think there is still some time for the bad news to be fully factored in. At some stage, small and medium cap stocks will start seeing the effect of the massive credit crunch and will enter a completely sideways phase. Banking stocks, on the other hand, are likely to start feeling the heat from one to two quarters down the line. Hence, share price correction should come much earlier, may be around March. Clearly, going long on banking would require some caution under such circumstances.