Archive for March, 2008

Welcome to another episode of the Indian Stock Market free falls, where every day is getting worse than earlier. With today's 6% slide down to 4500, we're at the levels when the upmove really started, in August 07.

[Actually that's when I started my trading portfolio and Jan end or so is when I finished it, with the portfolio up around 58%. I've sold nearly everything - readers will know that I've been bearish a long time now - and it looks like I was right, in hindsight.]

Now is this the bottom? Uhem. Nifty's P/E is still 19.6, which you might agree is a tad high for the current state of the world. We should be valued at sub 15 levels, which is another 20% lower than here. That is value. Today we are still hoping for momentum.

Bear Sterns, one of the largest US investment banks, nearly went bust. Last Monday the company said, "Bear Stearns' balance sheet, liquidity and capital remain strong." On Thursday the stock was around $60 per share, and on Friday it tanked to $30. Today it was bought by JP Morgan for $2 per share.

$60 to $2 in TWO DAYS. What a nightmare. Will we see such a situation? I sure hope not.

Uhm. Orchid Chemicals is down some 38% today, ICICI Bank down 13.3%, and a lot others completely beaten up. It's not a nice thing but let me say this: this is still a good enough level to get out. Not worth staying on, and there may be a rally after this to help but these are just levels to cash out. Shorting is tough at these levels, you need to look for a strong rally, preferably after this month's expiry.

Coming to investing: We will soon come to levels where "value" becomes apparent. Please don't rush in. There is a lot of latent bad news and we need to go through all of those, overreact, take it completely down until there seems to be no hope. And that is the time to invest.

More "derivatives" madness is on the cards. From ET's "Rising Yen gives companies the jitters":

As the dollar slipped below Y100 for the first time since 1995, hundreds of corporates and institutions were exposed to a brutal currency market. On Thursday, the dramatic surge in yen (as well as swiss franc) activated several high-risk structures, like ‘knock-in’ options, which were lying dormant for months in corporate treasuries ...

...

...The big hits will be in cases where firms have bought knock-in structures. In derivatives, the ‘knock -in’ structure is activated when a currency gains beyond a level. Till that level, the corporate can buy it at an attractive rate.

But once the currency breaches the level agreed in the contract, the corporate has to buy it at the prevailing market rate. If the currency has surged, he has to fork out so much to meet the monthly or weekly outgos as specified in the synthetic contract.

According to a banker, several corporates had done a deal with 1$=Y100 as the knock-in level. For Swiss franc — the other currency that has shown a similar appreciation against the dollar — the knock-in level is 1Sw Fr= $1. On Thursday, the SwFr was trading at 1.0070 — a dangerously close level for the auction to be knocked in. For Euro, the knock-in levels are E1 Euro = 1.59-66, as against the spot price of 1.56.

What many companies may have done is first enter into swap — a transaction that will convert its high-interest rupee borrowing into significantly cheaper yen/Sw Franc loan. Almost simultaneously, they enter into an option contract to protect the risk on such swaps. But these knock-in structures offer only a conditional production. “Some of the global banks may push up the swiss franc to get the contracts knocked in, and in the process make corporates pay up,” said a banker.

Since many contracts will mature between April and August, and several more will get the knock-in contracts triggered in the next few days, some of the local banks are trying to ringfence themselves against difficult clients.

In short, either the corporates or the banks are screwed. No idea about extent of losses, and no idea about who the the corporates or the banks are.

When there is a downturn, all negative news comes out of the woodwork. Things that seemed like a "perfect hedge" unwind themselves in the most unpredictable way. The news may be exaggerated in some cases, like when people say "Sensex will go back to 6,000" and all that. (There is no way of predicting an outlier like that. If you're wrong no one will remember, and if you're right everyone will praise you. No risk in making a statement like that, anytime. For the record I predict that the Sensex will either hit 6,000 or 25,000 in the next fifty years. Ha.)

There is likely to be more bad news, or regular news that in these times, becomes bad news. Like they say in Bangalore, yen-jaay.

My goodness, what a bearish day! The Nifty tanked about 280 points to close at the 4600 levels, and the bottom seems to have dropped out of the market. I don't like this one bit but there are some global factors to it.

First, Carlyle Capital is going bust. From Reuters:

Carlyle Capital Corp , an affiliate of private equity firm Carlyle Group, said late on Wednesday its lenders are likely to take possession of its remaining assets after it was unable to reach a mutually beneficial agreement to stabilize its financing.

Carlyle Cap leveraged about $600 million to $20 billion or so, a 32 times leverage which is basically like playing russian roulette with a gun that has five chambers full instead of one. One of these days you're going to die.

Worse news, in the same article:

In Asia, the iTRAXX Asia ex-Japan investment grade index which is dominated by banking credits, was sold off.

It blew out by 10 basis points (bps) to 213 bps on the Carlyle news, market sources said.

From the index definition, some Indian companies (ICICI Bank, BOI, RIL, Tata Motors) are in the index. Now I don't know how it affects them, but typically debt spreads increase meaning cost of debt will go up. It means more MTM losses for those that have exposure to credit derivatives to this index.

In other news, the Yen has appreciated to 100 to a dollar. This signals the end of carry trade as we know it. Banks and Hedge funds borrow at obscenely low rates on the yen, covert to dollars and invest around the world, including India. Even ICICI bank seems to have done that. Now when they have to pay back, yen appreciation means they will get fewer yen for their dollars, and a rapid increase - like the 6 month move from 114 to 100 - just kills every profitable opportunity.

How? Because people leverage their dollars, say 10 times, and get 10x for all the money. In return they invest in instruments they can place as collateral, like bonds, MBSes, CDOs and all that. These things, in good times, give like 6-10% returns. Today it's very much negative. Even with 6%, the 14% yen appreciation results in a negative return!

With hedge funds getting calls from Mr. Margin, the credit indices for Asia also breaking down and the yen going to glory, the world credit markets are due for a fantastic collapse, coming soon to a theater near you.

What happened today, in my opinion, is that investors (some local, some FIIs) are spooked by these developments and yanking out their money when they can. Is it overdone? I don't know. My personal point is that the Nifty is really oversold only below 4000 - till then we are still over-optimistic.

I think we're in for a see-saw time. Disclosure: I have a straddle on the index today - a put and a call.

The US Fed just decided to infuse the market with liquidity of nearly $200 billion, by accepting as collateral, mortgage backed securities (MBS). This is a "Term Securities Lending Facility", which is currently for a period of 28 days from March 27.

What does this mean?

First, this is not the US govt. buying the securities. No. It's lending on the BASIS of these securities for 28 days, and the risk and recoverability is still the responsibility of the owner.

Second, this puts new money in the hands of people who own these mortgages and are probably having huge losses on them. The assumption is that the new money will allow them to lend more. I don't know about that. A 28 day reprieve? What if the fed doesn't roll it over after 28 days? And $200 billion is a lot of money.

Third, this may be funded by AAA rated MBSes, but many of them are just junk in the guise of AAA, because of lousy rating by the agencies. What happens when these mortgages turn into defaults? Nobody knows, and it's likely the Fed won't accept them as securities anymore...tough.

I'm not sure how this changes anything, but supposedly people in the US like it because their market went up some 400 points (3.5%) yesterday. We tried to follow but someone figured India is really slowing down, as the Jan Industrial output showed some sub-6% growth, and on top of that some lousy industry figures. So we started big and then went back to where we were yesterday.

So my take is: People were waiting for some good news to buy, any news really. And a lot of shorts caved yesterday and took the index higher. So in the next few days, there will be more good news - as the Fed cuts interest rates again - and some more shorts will go out the door in the US. And then we will get the next round of really-bad-news from the banks and we're back to square one. Except we'll be back to square zero this time. The 1 year trend is still bearish.

In India I'm still ambivalent. We should move DOWN in the 1 year time frame, but now it looks like a consolidation phase. Most likely violent moves up, violent moves down types. Fun times!

Disclosure: Short the Nifty index; own put options.

Bloomberg says Fidelity has been fined $1.6 million for taking favours from brokers in response for running transactions through them. The favours involved providing traders with female escorts and drugs, to flights in chartered jets and tickets to sports events.

Even Peter Lynch was charged - in a small way, for asking of favours like tickets and such.

I have no idea if something like this happens in India. Typical funds run money through their own brokerages, fairly openly, and there seem to be no strict rules. Or are there?