In times of volatility: A menu driven approach

The stock markets are swinging wildly now not knowing which direction to head in.  At 15,800 levels of the Sensex it currently looks  very shaky – which it has been for long- and it is likely to hover between 14,000 and 17,000 levels for a while. What is more interesting than the movement however, is the reasons that are offered by the media and so-called expert commentators every time the movement happens either way.

 

So let us say you are a rookie financial journalist and are assigned to write about the stock market movements every day.  How are you going to justify wild daily movements based on macro-economics and fundamentals?  These things do not change on a daily basis!  But never fear, public memory is short. It is so short that they forget what you wrote yesterday. So all you need is a menu from which you pick. Let us try to construct such a menu to help our rookie reporter.

 

First, start with the US situation.

 

The negative outlook for the US is as follows:

 

The US economy is not yet out of the woods. Unemployment is still high, which is because jobs are not coming back to the US manufacturing sector which is still in the doldrums. Blue collar jobs are increasingly scarce in the US and those jobs are the core of any economy. 

Housing starts have not recovered to levels existing when it was boom time. House prices are still not back to early-2008 levels and a lot of people still have mortgage balances that exceed the value of their properties.

 

Budget deficits are still high, and any attempts by the politicians to cut spending is only rhetoric. When they talk of cutting 50 billion dollars it sounds big, but on a base of trillions, it is not even a decimal point.  Unemployment benefits and healthcare costs are ballooning.  About dollar three trillion (not confirmed – our reporter can check and put the number here) of treasuries are held by outsiders, of which the Chinese government is a significant third.

 

Policy making is paralyzed. Barack Obama is seen to be increasingly ineffective and it not able to push through anything of significance by way of much needed reforms.  The US is already into the election cycle. Elections are due in November, so in any case do not expect any hard initiatives to come out of the government now.

 

QE 1, 2, and God knows what other QE have shown no signs of having any impact. Money at near-zero rates has an unanticipated effect of restricting lending. This is because  the rates were reduced since there is an increased perception of risk in the market place. The perception of increased risk has resulted in the banks being unwilling to lend! So the money is being diverted to driving up commodities and asset prices across the world. And, paradoxically, buying back US treasuries. It has still not resulted in high inflation in all fronts – there are signs everywhere of inflation firming up but it is too early to say that the QE's have resulted in inflation – but that could happen as well.

 

The world is, currently, to put it mildly, in deep shit. At such times, all money flows back to "safe havens". Paradoxically, US treasuries are considered a "safe haven"! Currently lot of money is flowing back into US treasuries. This has a negative impact on markets across the world since money is being sucked out of other assets and is finding its way back to the US.  With the European situation being what is it is (more on that in the next article), it is increasingly certain that the dollar is going to be the reserve currency for a long while to come. The Chinese, the Russians, and all other kinds of people are not going to like that, but that's the way it is. The current depreciation in the Indian rupee is also due to this reason.

 

The US situation commands an inordinate amount of attention when it comes to analyzing the world economy since they are the world's biggest consumers by far, both on an absolute and per capita basis. When the US catches a cold, the world sneezes, and for some time now, uncle Sam is a sick man with flu, so the world is having repeated sneezing bouts.

 

Our  rookie reporter is happy. He has a good menu of negative news that he can twist and turn around in various ways to make his recipe for the day. He also happens to have passed out from a good reporting school where they have taught him how to make reports look impressive by putting graphs and charts of important looking statistics. Like this:

-----------

Extracts from an Associated Press article:

A surge in apartment construction gave home builders more work in November. And permits, a gauge of future construction, rose largely because of a jump in apartment permits (sic!).

The New York Times

The rise in permits provides hope for the housing market, though 2011 is still shaping up as one of the worst years in history for home builders.

Builders broke ground on a seasonally adjusted annual rate of 685,000 homes last month, a 9.3 percent jump from October, the Commerce Department said Tuesday. It was the highest level since April 2010. Still, the rate is far below the 1.2 million homes that economists say would be built each year in a healthy housing market.

----------------- end of extract – you can google for tons more of stuff like this -----

As you can see, the beauty of the above statistics is that it can be quoted in any context, to justify a rising market, or a falling one. It looks impressive, and there is a mass of numbers which no one understands.

 

The rookie, being a modern day kid, also knows how to google well. And his newspaper has a research department to boot who can provide him tons of stuff like the housing starts statistics quoted above.

 

All right, since we are constructing a menu, what about positive news on the US economy?  You need that to justify a rising market.  So here goes:

 

The US economy is coming out of the woods. Unemployment is still high, but there are positive signs of recovery in the job market.  The companies which were almost bankrupt and on the verge of closure a couple of years back, are doing fine – take for example, General Motors, Citibank.  Consumer credit off-take is increasing and people are flocking back to the stores once more. The Christmas season just gone has shown a huge increase in consumer spending which is being interpreted as a very optimistic sign by the markets. (Author's note: I have no clue if this is the case, but if the markets go up, I can say this and have enough statistics to back it up).

 

Housing starts are recovering.  Housing starts are a leading indicator when it comes to the US economic situation. As to statistics and further comments, the same extract given above, with slight editing serves the purpose of justifying negative as well as positive news.

 

There is a focus on reducing budget deficits; however, with the economy currently not yet out of the woods, it is expected that the deficits will continue for a while. Some measures being taken now are likely to yield results in future – the trend is in the right direction, since there is a realization that one cannot run an economy perpetually on a deficit. In the meanwhile, economists  are certain that following the Keynesian model of fiscal stimulus is the way to go now, which means that budget deficits are good (Note: if this sounds confusing, welcome to macro-economics!)

 

All the QE's at last seem to be having some kind of impact. The economy is on a recovery path.  They seem to have put the steam back into domestic cosumption and, as everyone knows, more consumption is what an economy needs.

 

With the Euro showing signs of extreme weakness, even possible collapse, the dollar is back to its reserve currency status. And the world goes on meandering as before…

 

The rookie by now, is very very happy. Depending on whether the Indian stock markets go up or down, his "US economy" menu for any eventuality is ready.

 

We need to give the rookie some more menus as well – like say, Europe, rest of the world, Indian macro-economic situation, etc. But we shall leave those for a later article!

Life in the cloud: A modern fairy tale

Once upon a time there was a rich man in a village. He had a lot of land, a lot of cows, and gold tucked away under his mattress. He was a very contented man. He had earned it all in his lifetime through his hard work and had something concrete to show for it.

His son, who grew up in the village, went to the nearby city to do business. He was a very sensible, level-headed person and he was a shrewd businessman as well. He became a wealthy man in this own right by trading in grains and agricultural commodities. His warehouses were always full, and so were his vaults. His wealth was something that gave him a lot of satisfaction - and it was something he could see and feel the effect of in front of his eyes.

This man's son, who grew up with him in the city, went to the big city when he was twenty. He joined a software company, went to the land of El Dorado, quit, and started his own software company. He and his bunch of ten people wrote out some instructions to a box they called the computer, which were carried out in what they called the cloud, and serviced a few million people whom they never met. None of those people paid any money to access those services from somewhere in the ether; and the company did not earn a cent from its customers. But still they made a lot of money. Everyday there was a queue of people waiting outside its offices with sacks of money, begging them to take it. All that those people wanted in return was a share in the pie in the sky. Which our prodigal son gave, very grudgingly, and a small slice at a time. Each time he gave away a piece of this pie in the sky, what he called the valuation of the whole pie would be more than the previous time. And each time he increased the value, there were more people who were willing to pay more money for it.

The prodigal son invested some of this money in reaching his services to more people whom he never met, and soon there came a point where those people started coming in greater and greater numbers to visit his cloud, since the people they knew were visiting too. They all met somewhere in space, no one knows where, and they chatted, celebrated, mourned, hung out, discussed, debated, protested, grouped together, banded, disbanded - did all the things that people do in real life, but they never met each other face to face. They were all happy meeting in the cloud, where connections were instantaneous - you did not have to travel physical distances to meet. All you had to do was think of a person, the other person would tune in to your thoughts and think of you, and you were connected. Whether the other person actually existed in this world, or had an existence only in the cloud, was in several cases hard to determine. In fact, there were several cases where people fell in love with someone in the cloud, wanted to meet them in real life, and then found that they were actually talking to a ghost. After many disappointments like this, a few of these people had a brainwave. They started embodying for themselves a life in the cloud. They went and created an identity for themselves, in a completely new and different world called thirdlife. All their friends in the cloud, whom they had never met, did that too. Each of them created his own identity in thirdlfe, and there they met. In this process, they got more and more disconnected from their physical life here on earth. Their second life was in the cloud where they met people they knew somewhere they knew not where. The thirdlfe was in the newly created world, where they met new embodiments created by people they knew, in forms that were new, in a piece of real estate created in the cloud. They even got married in thirdlife and raised children.

How is our prodigal son connected to all this? He was not the creator of third life, but being the shrewd businessman that he was, using the money he got for his cloud, he bought a lot of real estate on thirdlife, near the temple of the cloud god. As thirdlife took on a viral form, and everyone had an embodiment in it, these embodiments wanted to stay near the temple of the cloud god in thirdlife. Now the cloud god was famous for curing problems stemming from insecurities caused due to embodiment of disembodied souls, and our shrewd son had rightly estimated that this would be a major problem among all the souls residing in thirdlife. He converted all the real estate he bought near the temple of the cloud god into sanatoriums, and charged by the day. The payment was in cloud real estate only, and thus he grew his empire. He soon became the richest man in thirdlife.

He still had lots of money left in his physical avatar out here. This was real money, and he needed further avenues to invest it. He went and bought some disembodied wealth in the form of what they called securities, and received a sixteen digit number with a twelve digit password. These securities were not ordinary securities. By some mysterious process which involved millions of people punching some numbers into the cloud through what they called trading terminals, the value of his securities changed by the day, by the hour, even by the minute. He would get messages every fifteen minutes from the cloud informing him about the status of his wealth.

The prodigal son was rich. He had all his money in the disembodied securities cloud, and in the embodiment of the disembodied cloud called thirdlife. On days that his wealth grew by five percent or more, he felt very elated. On days that his wealth declined by five percent or more, he felt very depressed. There were many days when the price movements in the cloud were so extreme that he could not sleep, either due to too much elation, or due to too much depression. It soon became too much for him to handle. All his joy and sorrow stemmed from the cloud, but he still had to handle it with his body and his mind, very physical resources which were rebelling at this overload.

The prodigal son could not take it any more. Wherever he turned, he saw embodiments of disembodied souls, handling vapors of different colors they called wealth, standing on clouds. He turned mad. His doctors advised a rest cure.

He went to his grandfather's village - yes, the grandfather was still alive - for rest. There he met some real people, walked on hard ground in real green fields, and shared in real joys and sorrows of his neighbors. He got cured in a month, and never went back again to his former life of disembodiment. And thus he lived happily ever after.

Time to sit on cash?

Volatility is the order of the day today. Markets go up by a few hundred points the day Merkel and Sarkozy meet and make vague promises, when BIg Ben announces US Quantitative Easing with a Twist, when Chidambaram and Pranab grudgingly make up after a meeting with Madam, when inflation data is bad, and on the days it is particularly cloudy. Markets go down by a couple of hundred points when people feel Merkel and Sarkozy's promises are vague, when they feel that Ben's efforts are not yielding any results, when they feel Chidambaram and Pranab are still plotting against each other, when inflation data is bad, and on the days it looks a bit sunny. The whole world seems spooked right now. The sins of the past are reappearing to haunt us; we are afraid in our heart of hearts of the consequences of economic catastrophe that will follow, which we do not want to acknowledge; and everyone is looking at others to see how scared they are. If everyone feels everyone is scared, everyone pulls out money from some assets and puts it into some other assets like US Treasuries; and if everyone feels everyone is confident, everyone pulls out money from US Treasuries and pushes up prices of all other assets by their buying.

At this point in time, it looks there is very little good news on the horizon. Europe is teetering from one promise to another, hoping to stave off the current crisis to some time in the future; the situation will get clearer by end-November. China is not going to get out of its slump in a hurry. The Indian economy seems to be slowing down due to a variety of factors including high inflation, RBI's efforts to fight it by raising interest rates, an ineffective government where paralysis seems to have set in, and of course slowdown of growth across the world. We don't know if the world is going to face a full-blown recession, but it certainly seems like there is going to be prolonged phase of low growth and uncertainty.

So at this point in time, what should be our investment strategy?

Buying stocks in the current situation seems a little risky. A lot of good stocks are available at what appears to be reasonable valuations. However, the benchmark to judge what is a reasonable price is the market itself and the markets seem to be highly uncertain right now. The upside seems to be minimal at this point, and the downside even from current levels could be significant. If you are convinced about any particular stock that you have been tracking for long, or if you are betting on or against specific events like buying stocks that have been affected by the recent mining ban in Karnataka in expectation of the ban not lasting for long, then go ahead and buy. But remember that the broad market is influenced to a high degree on FII and Institutional flows, who are in turn influenced by world trends and who tend to have a follow-the-herd mentality, which magnifies movements either way.

Gold has seen a steady rise in the last few years, with the last couple of years showing very high increase. The current consensus is that given all the uncertainties in the world economy, demand for gold will continue, and there is still scope for significant increase in prices over the next year or two. I would continue buying gold in small quantities.

Silver has dropped steeply in the last couple of months. It now seems to be quoting at attractive levels, and it looks like it may be a good time to buy. Silver is highly volatile, and may even go down further. In case it does, buy more. I am very bullish on the long-term prospects of silver - I think it is good to keep accumulating, especially on declines since the prices are highly volatile. The slowdown in the world economy should keep the prices down for a while, since silver has many industrial uses, but its value as a precious metal (like gold) and the fact that a lot of it gets consumed or used up, should ensure silver's long term value.

Real Estate prices have not dropped in the last few months, in spite of the increasing interest rates and tightening of liquidity by RBI. In fact, in the quarter ended June, real estate prices seem to have firmed up - across India the prices of apartments were twenty percent to forty percent up compared to a year ago. Real Estate prices always lag the economy and stock markets. Prices at these levels may not be sustainable, and the affordability problem of paying EMI's will show effect at some point. Expect real estate prices to decline from now till March.

Having said that, real estate is also about identifying good properties that are set to appreciate due to location, development in the locality, and other factors that could influence demand. If you get the right deal that you are convinced about, you should invest. It is worth looking at Tier 2 cities - in Bangalore check out this new area Budigere that all builders are flocking to.

Cash is good. Interest rates are reasonably high (though of course inflation is high too making real interest rates close to zero) and it is a good idea to park your money in FD's or income funds for a while. Get into cash, and wait for the right opportunities to invest in stocks or in real estate. Good opportunities are bound to come up with all this volatility in the markets.

Whoever said investment is a passive activity? "Invest in SIP's a given amount every month, don't worry about price movements, and in the long run you will emerge the winner!" I don't know if that is the right strategy any more, given this kind of volatility and greater positive correlation among all asset classes. Perhaps we need to get more savvy about the investment options available, keep track of them, and be ready to capitalize on opportunities when they arise.

Happy Investing!

And then the chickens come home to roost

The US has still not come out of its recession. Europe is teetering on the brink. There is political turmoil in the Arab states. India is caught in a mire induced by corruption and mis-governance scandals. The Chinese growth engine is sputtering. Unemployment onshore is increasing everywhere as jobs are being offshored. Offshore jobs too are going away or being relocated too even more lower cost locations. Stock markets, commodity markets and all other kind of markets are yo-yoing wildly for the last four years, swinging from intense bouts of pessimism to uncertain optimism. 

In Europe, the PIIGS countries are still wallowing in the muck of their own creation. The protected welfare state structures of the past are not going to survive – there has to be a fundamental shift in the way the population lives and the transition is not going to be easy. Transitioning from a life of unsustainable luxury to living within one's means never is.  If Greece defaults, it could take the rest of Europe along for a very bumpy ride, since the lenders to Greece are banks from other European nations, led by Germany. So they will find a way to bail it out, but not without pain all around. Italy will have to tighten its belt and face tough times ahead. Ditto with some of the other countries in the EU. Some of the weaker nations may have to pull out of the EU – it is unlikely that sugar daddy Germany can keep subsidizing them for long. The Euro, which for a while held out promise of being an alternative currency to the dollar, is on its deathbed or at the very least, extremely sick.

 

China, whose economic might is only rivaled by its political ambitions for influence in the world, is facing its own set of problems. Exports are sputtering because the world cannot afford to buy more and more and is battling its own demons at the moment. Inflation at home is high and interest rates have been raised, just like in India. Wages are rising making exports less competitive. The housing bubble and infrastructure bubble fueled by excess borrowing and unsustainable creation of capital is showing signs of collapsing.

 

The Arab countries have always been run by the sheikhs, propped up by powerful "friendly" superpowers, in return for favors that oil can bestow. For all their sanctimonious posturing about democracy and human rights, the US is the country most responsible for propping up regimes without any legitimacy for economic and political gain. Some of those cozy equations are being shaken with current developments, and new ones will take time to form.

 

India is caught in its own web of corruption and mis-governance. We have several versions of the TINA (there is no alternative) syndrome, one of them being "There is no alternative" to corrupt governments! Confidence in the government is low. The economy has slowed down considerably. The common man is facing the pinch after years of sustained inflation, and lower wage increases. The poor are facing it even more since food inflation has been even higher.  A lot of the growth that was in the past led by housing and infrastructure is slowing due to the current high interest rates. In spite of the RBI raising interest rates a dozen times in the last year and a half, inflation shows no signs of abating, while growth certainly is. The stock market is teetering at 17,000 levels, not very sure which direction to head in; in the meanwhile, it swings wildly either way.

 

The US is yet to emerge from its troubles. The cheap money policy with QE1 and QE2 does not seem to have effected its magic. Growth has stagnated, there are no jobs, the housing market is still in the dumps, politics is in a mess, confidence is at a low, and it seems like the country is running out of options. The irony is that the dollar still continues to be the reserve currency of the world (and will be for some time to come) since There is No Alternative! US budget deficits are unsustainable, which they have been, for a long time. Decades of unsustainably high standards of living fueled by borrowing from the rest of the world is having its impact. Like the proverbial ostrich, the US continues to bury its head in the sand and expects that the problems will go away.

The world over, the chickens are coming home to roost. None of these developments should come totally as a surprise – they are the inevitable consequences of self-induced flow of events. However, the current times seem to be exceptionally uncertain since too many of these things are happening at the same time.

We do not know how each of these events will pan out but can only guess that will all eventually settle into some kind of uncertain equilibrium. Each of these events has the ability to swing markets wildly and none of them has settled into any kind of stable state.   In such a situation, it is perhaps time to re-evaluate investment options and strategies.  The usual mantra of buy and hold for the long term, do SIP, diversify across asset classes including foreign assets, may still hold good but perhaps with a twist. It is time to look at some strategies that are defensive while at the same time being ready to grab opportunities that will inevitably arise in wildly swinging markets like these.

 

More on that in the next.

On Steve Jobs leaving Apple

The world gasps in collective horror,

When one man rides into the sunset.
Why should one man make such a difference,
or his leaving generate such interest?

Some men come to define an age,
embodying all that it stands for.
Some men create and rule the stage,
Where only they play the leading part.

Some men create things that are new,
Changing the way that people live,
And some, they build institutions,
Monuments, conjured from the air.

A few there are who make it rich,
Starting from a place of nothing.
Enriching others are fewer still,
Creating gold by their passing.

Very very few, do it all,
Magicians passing through face of earth.
We wonder at such miracle men,
Who, through their lives, defy even death.