At Yahoo, I write on the Irrelevance Of The Sensex:
In a recent trader meet, a speaker asked on stage where the market closed last. Answers were "4714" and other figures around the 4700 number, but the speaker was looking for another answer. It dawned on us soon that he was looking for the Sensex, which none of us knew even to the closest one thousand. Read the rest of this entry »
From my piece at Yahoo.
Twenty six of the 27 European nations decided to move forward with "tighter integration" and a closer "fiscal union" which seems to have cheered markets tremendously. (The lone dissenter was the UK.) These grandiose statements provide way too little detail in exactly how such a pact would work, and be palatable to the vast electorate at the same time.
The idea is that a tighter control of both spending and taxes by a central body will ensure that no country will go overboard and thus harm the Euro. The central body would almost surely be loaded towards Germany and France, and why would a Greece, a Holland or a Portugal allow such a body to not just determine how much tax they would pay, but also how much they can spend and on what? It is highly unlikely that just because German and French banks own the debt of certain countries, that Germany and France will be allowed to violate their sovereignty; although it is a big statement, I doubt everyone will see eye-to-eye when Germany decides that Italian pensioners need to take a 10% pay cut.
The decision making process — which currently requires an okay by all Euro countries — could be changed to introduce an "85 per cent supermajority", which means a small country can't hijack an issue by voting against it. France and Germany want this — they are part of the 85% - and opponents are smaller nations like Finland and Slovakia.
Also, the leaders mention that there will be "penalties" for any nation violating spending or collection rules. But even Euro membership came with rules, like a 3% fiscal deficit and a 60% debt-to-GDP limit, both of which have been violated continuously, even by Germany (debt: 83% of GDP). It's not entirely clear how a penalty can be a deterrent if it hasn't been enforced earlier. ("If you don't stop, I'll say stop again, and louder!")
Finally, think about how it will work: An euro country, like Portugal, decides to spend too much on, say, schools. The European Court of Justice decides this is unacceptable by deficit considerations and refuses to allow it. The Portuguese people protest; like the Greeks are protesting now against externally enforced austerity. This sort of thing simply won't work unless they're all willing to be one country, and one region is willing to sacrifice for the sake of another.
The plan needs to be cobbled together into an agreement and then passed by voting in all EU countries, which they say will take three months. This sounds implausible; getting the Euro on the road took over 9 years after the first agreement. The democratic nature of the EU requires citizens to be with the program, and it's quite unlikely the voter in Germany sees things on the same level as the one in Greece. And within three months? Don't hold your breath.
This is only important because Europe needs a solution fast. Bloomberg says more than 1.1 trillion Euros of long and short-term debt will come due in 2012, much of it in the first half alone. Recently, Italian bonds crossed yields of 7%, only coming down as the ECB stepped in to buy bonds. But bond buys by the ECB, reek of moral hazard — the banks that bought this debt originally made a bad investment; they are getting bailed out by the ECB, which in turn is backed by every taxpayer in the Euro region. The idea that the privately taken risk — by a bank — is being transferred to the taxpayer was frowned upon by Germany, which insisted that private lenders be forced to take a part of the hit. On Thursday, though, they climbed down from that position, because of fears that if private lenders take a hit, they will contract future lending and hurt everyone in the short term.
This is a justification used often — that we need a "lender of last resort" and that the US Fed has paved the way by intervening in 1987, 2000 and 2008. Recently, it has lent $29.6 trillion in total — the maximum outstanding on any day was $1.2 trillion, which is about 12% of the total US money supply (M2). In comparison, Indian money supply is Rs 50,00,000 crore, and even in the crisis less than Rs 150,000 crore was borrowed overnight by the banks.
On Thursday, the ECB committed "unlimited" funds to banks for three years, and lowered interest rates to 1% from 1.25%. Additionally, it made collateral requirements looser — banks are supposed to pledge something in order to borrow from the ECB, but it seems that now the ECB will accept just about anything printed on a piece of paper. This, they hope, will encourage banks to buy government bonds — after all, they can pledge those bonds to the ECB for the money. This is the way the ECB intends to get away from the German opposition to actually printing money and buying those bonds themselves. (The Germans are scared of printing induced hyperinflation — they faced the specter of it in the 1920s when they printed up to 60% of the country's money supply every day)
Additionally, the 17 Euro countries and the 10 others in the EU will provide 200 billion Euros to the IMF, in what is another circular way to invest in troubled country debt, since that is what the IMF will buy. A "European Stability Mechanism" (ESM) will be created with a capacity of 500 billion Euros to further help. There are, again, no relevant details.
But is it enough? Just Italian debt totals over 2 trillion Euros. The EFSF, with 440 billion Euros, is now considered adequate for just Greece. The magnitude of the problem is far greater than the money being readied to attack it, and taxpayers in the region are already balking at the size of the current war chest. With every increase requiring negotiation between more than 20 entities, and Germany firmly opposed to printing money, there will be consternation at every mini-crisis that happens.
One alternative is for countries to break away from the monetary union and issue their own currencies. While this seems unlikely, it will be a real decision if talks reach a deadlock — and a Euro exit may cascade into a point where the Euro ceases to exist. The uncertainty caused by such a decision will surely put much of the world into recession, but it may be a better idea than having multiple nations with vastly different economic situations attempting to have central governance.
For troubled countries, issuing their own currency and devaluing it will increase their competitiveness; who it will hurt is Germany, which hugely dependent on exports, and which will see its own currency rise in comparison and thus, hurt its exports. But it will undoubtedly destroy the banking system as we know it today, though some would say they will only be replaced by different, stronger banks in the future.
A Euro breakup will impact the entire world, but it seems like it might be better than keeping us in limbo forever. Will the agreement, if it happens, change everything? The next three months will tell.
(From my Yahoo Piece)
The government has not been able to divest public sector company shares in the market, due to depressed investor sentiment as markets have fallen over 20% in the year. The lack of this "extra" revenue means that total government receipts — or "income" — have fallen 18% compared to last year (as of October 2011). With expenditure growing at 10%, the fiscal deficit is at Rs. 3 lakh crore, which is already about 4% of GDP. It is only expected to grow.
Last year, a significant amount of revenue came from non-tax income. A Rs 100,000 cr windfall was made from the spectrum auctions to telecom companies, and another Rs 22,000 cr came from divestments in government owned enterprises like Coal India, SAIL, and MOIL. The divestment target for FY 2011-12 was Rs 40,000 cr, of which the government has only managed a little more than Rs 1,100 cr through a follow on offer of PFC.
Recently the government has been asking public sector companies to buy back their shares to help plug the fiscal deficit. This is an interesting move — it wants government-owned companies which have surplus cash reserves, to use that money to buy back their shares. In India, buyback procedures have strict rules, to prevent rogue promoters from siphoning cash into their own pockets.
Companies can buy back shares in two ways.
Market buybacks are where the company decides to buy its own shares back from the market. They first take shareholder approval for how many shares they intend to buy, at what maximum price, and for how long they will do it. A merchant banker is then appointed, and the company reveals to the exchanges how many shares it bought back every day, until the goal is met or time runs out.
While many companies have taken this route, it is largely a method used to pull wool over investors' eyes. The announcement of a market buyback is largely intended to keep the share price high in anticipation; the reality is that it does nothing because companies, for the most part, don't really intend to buy a lot of shares back. What they do is try to rig the share price upwards, going by the public disclosure of shares bought or sold each day; if the share price goes up, the buyback on that day is furious, but if the share price falls, the purchases go down to a trickle. Having learnt this over the years, investors do not pay much heed to market buyback announcements.
The government can't use a market buyback approach —it's not actively trying to sell shares in the market, for one. For another, the anonymous trading exchanges don't allow you to selectively buy from one participant — the best price will always win. That means the government can't ask a merchant banker to buy government owned shares first; the shares purchased will be those with the lowest "offer" prices in the market.
The other form is the "tender offer" buyback. Companies can use spare cash to buy shares back from all investors who tender their shares, in a proportionate manner. Piramal Healthcare did this recently, when it sold part of itself to Abbott for over Rs 16,000 cr. The buyback at Rs. 600 was way more generous than the existing stock price (Rs. 460). Since only 20% of the company would be bought back, if all shareholders tendered their shares, only 1/5th of any investor's shares would be bought back (the rest returned). Piramal Healthcare ensured a "proportionate" buyback — that is, where a portion of every investor's tendered shares would be bought back, not favouring anyone in particular.
Proportionate buybacks mean that the buyback must be offered equally to all investors, and where the government owns only 50% of shares, it cannot hope to get more than 50% of the money used in such a buy back. The government will have to use this route, and it holds around 90% in many profitable PSUs. Yet, they can't be asked to pay their entire cash hoards to buy back shares (they will need capital to survive or grow, and they are likely to have debt on which interest must be paid).
The subject of buybacks is also important for unlisted companies or startups. In some cases, a co-founder or an early investor intends to leave, and the company has the money to buy his shares back. But the buyback rules stipulate that all investors must get to participate; so to get one investor out, startups will need to convince all other investors to stay in (and thus, not tender their shares). Subsequently, for six months, the company can no longer issue new shares, which means the exit of one investor will delay any fund raising rounds.
Using buybacks to fund the deficit might solve the immediate problem for the government but it really should consider divesting stake even at depressed prices. There is no reason for keeping 90% of a Coal India or 84% of an NTPC. There is demand at low prices; prices that are still high enough for the government to cover a deficit. But it seems that the government has gotten enormously greedy when it comes to IPOs, as nearly every of their recent IPOs is off substantially. An example: NHPC — a nice hydro power utility company — was priced at a ridiculously high price of Rs 36. More than a year of disappointment followed, and even with much improved performance, the share languishes at Rs 23, and IPO investors have lost a third of their money. The MOIL share is also down 30%, in what seems like another overpriced IPO. To regain investor interest, IPOs must be priced much lower.
If the cash is available in their companies as a real surplus, then the government could use dividends as a better way to pay themselves; at one level the government will get a dividend, and at another, the dividend tax of 15% comes straight to them as revenue. It also avoids the associated costs of a tender-offer in the form of SEBI approval and banker fees.
Yet, the amount of money the government gains from the exercise will take money out of the corporate and into the hands of an entity that is likely to fritter it away in useless bailouts such as Air India, which has requested Rs 43,000 cr till 2021. The idea of taking from performing enterprises and putting it into non-productive areas has only political benefits, not economic ones. Tomorrow, don't be surprised when conservative taxpayers will be asked, through higher taxes, to pay for an increasingly profligate public sector. I wonder what it will take for us to buyback governance.
From my piece at Yahoo!
Much has been made of the fall from grace of Kingfisher Airlines. The King of Good Times — the Kingfisher brand byline — is a Pauper of Bad Times, it seems. The largest airline by market-share (according to its own investor presentation, Oct 2011), Kingfisher recently cancelled a large number of flights from November to January, and rumours persisted that the airline's planes were seized by the rental companies for non payment of dues.
In its investor presentation, Kingfisher reveals that it has over 6,000 cr. of debt. This is after a debt recast earlier this year, when more than 1300 cr. of bank debt and 745 cr. of promoter debt was converted to equity, at a price of Rs. 64.48 per share. Apart from the debt, there are payments pending to oil companies for fuel, to rental companies for aircraft leases, and, it seems, even to pilots for salaries. Altogether, on the deep-in-the-doo-doo scale, Kingfisher ranks at "Neck".
At the current market price of Rs. 25, the shares of the company are worth — in entirety — just 1,250 cr. , less than the amount of taxes a buyer may save because of the accumulated losses (of over 3300 cr.) that Kingfisher has. The stock price crash means the banks will take a big hit on their portion of equity, as well as losing out on the debt portion if Kingfisher becomes a full fledged defaulter.
The calls for a bailout seem to be largely media generated, as the flamboyant Vijay Mallya has stated that he requires no public help. There are others, like the ex-Infosys-biggie Mohandas Pai, who write that Kingfisher deserves a bailout anyhow (note: it's tongue-in-cheek, I think) because:
Now, Kingfisher does fly abroad and still lost money (surprise!) — the last quarter saw a loss of Rs. 76 cr. on the international operations alone. So that excuse can't be applied to Kingfisher, and the rest of the pack seems happy to be losing money on local operations.
ATF prices are as much a problem as petrol is for us — petrol prices are unreasonably high, and are taxed heavily by states. But we, the petrol car drivers, will not get a bailout, regardless of how much debt we have.
The unprofitable route problem is an old one — and they aren't entirely unprofitable. The hugely travelled sectors — between metros — are classified as Category I, while the less profitable routes are Category II and III. Much of the North East is covered in Category II, which needs air transport because of the long trek around Bangladesh that would hamper road connectivity. Now if there was no obligation to fly unprofitable routes, these areas would not be served, and they won't develop; which was indeed the situation when only Indian Airlines used to fly there, and people had to book months in advance. Even now, all airlines don't need to fly the other sectors — an airline that flies in excess of its own requirement can sell such excess to another airline, which makes it less stressful. And such rural obligations exist in other situations as well — telecom operators, for instance, need to have a strong rural footprint.
The biggest issue is that of Air India. Our government will infuse more than 6,000 cr. into the ailing airline, which uses the money to fund losses that it makes by undercharging customers for their travel. This hurts the remaining players and in any other sector, is called "dumping" — an anti competitive act, deemed so purely because of the seemingly unlimited government support. This can't be allowed to continue; with the privatization of India's airline industry, we must have all players private as well. (And I want no stake of the government in any bank either) Out socialist mentality forces us to think of all those poor people who work for Air India — where will they go? I ask them now — where will the employees of Kingfisher go? And Spice jet? And Indigo?
Air India won't learn if it is bailed out. It will continue to undercut other players as long as there is an implicit taxpayer backstop. The answer could be to privatize them, at ANY price, in a transparent auction. Or to let them die.
But either ways, the answer cannot be to help Kingfisher with public money. The "let them die" argument must apply to Kingfisher as well; which ironically became a public company after a merger with the ailing Air Deccan, a low cost airline that ran out of money before Mallya took it over. That was a private buyout — and surely, Kingfisher can find a private player to buy it out?
Public funded bailouts are bad. When America bailed out their banking system, they transferred public money to private hands — the grubby hands of the bankers. This is now causing outrage as part of an Occupy Wall Street movement. But bailouts continue in Europe where they are now rescuing banks, governments and nearly anything wearing a suit that screams for help. The standard threat is that if we don't bail XYZ out, the system will suffer. But it's now apparent that the system will suffer anyhow, in a much deeper way — a few years down the line. The trade-off then is about whether you want some pain now, or more pain later; and given the age of people that seem to make these bailout decisions, they just want to postpone the pain until after they're dead.
But all of us don't have that luxury; we need to put a full stop at some point. The question is: is Kingfisher at that point?
(From my article at Yahoo)
While derivatives have been called weapons of mass destruction and worse, they can provide alternative methods to participate in the markets. To a bystander, these instruments seem complex — and some indeed are so, with SEBI now requiring brokers to ensure that investors are financially capable of handling themselves before they can trade derivatives.
An alternative way to buying stock is to use a "future". Instead of having to buy equity into a company and paying up the full amount of money, we use a derivative and buy the future instead, paying only a margin amount upfront, and putting the rest of the money as cash, which can earn interest in a liquid mutual fund. I tracked the stock of ICICI Bank, bought directly versus buying with a future, since 2006:
I've assumed a single lot of 250 shares, bought for about Rs. 150,000 in 2006, that returns, with dividends. (further assumptions — 30% margins, and the return on cash is 5%)
The futures approach is 10% higher in terms of total return over 5 years! But is it really better?
The correct answer: it depends on who you are. The disadvantages of this system are mainly in the taxes.
a) You get no dividends with futures. While the gains might be baked in somehow, dividends aren't taxed in your hands, so a certain percentage of the dividend gain is lost.
b) You get taxed as business income: Futures trading is considered business income, which is taxable. If you were to lose 30% of your gains to taxes, that negates the entire difference with buying stock. In the example above, the stock gained a total of Rs. 90,000 for which, because of tax rules in India, you pay no tax. (Long Term Capital Gains is nil) But the gain through futures is Rs. 115,000, and a 20% tax will bring it down back to the levels of the stock gain itself.
c) You get no voting rights. Derivatives provide no ownership rights. But hardly any investor votes nowadays, so this is not so much a disadvantage.
d) The process has pain. With a rollover every month, and mark-to-market gains or losses that need a transaction every day, it's a lot more effort for the lay investor.
The "who you are" helps: for many foreign institutional investors, gains or losses may not be subject to Indian tax laws, in which case the above disadvantages are irrelevant. It would help many Indian institutions as well (such as mutual funds or insurance companies, which aren't taxed on gains) but they have strict regulations about how much exposure they can have in derivatives.
Lastly, a trader or a proprietary trading house might benefit from using futures; the taxation disadvantage might be offset by business losses or valid expenses, and will justify the returns.
And there are advantages. For one, you can participate in the downside. Sometimes stocks get overvalued, and it is considered proper trading to short-sell a stock, expecting to profit from a price decline. But in India, you can't short-sell stocks, because there is no liquidity in the "borrow and lend" market. Futures give you an easier way.
Creeping acquisition rules do not allow individuals to hold stocks without notifying the exchanges and thus, the public — so a large chunk of shares acquired will trigger interest and could take the price high before an organization can finish its buying. Futures, on the other hand, have no disclosure requirements so a buyer could participate in the growth of a stock with no one else ever getting to know.
This lack of disclosure creates many problems as well. In 2008, shares of Volkswagen went up more than three times as Porsche, its owner, declared that it now owned 75% of VW through some derivative instruments. Short sellers — who had a negative view of the stock — had to scramble to buy back shares which were not available (as Porsche had effectively cornered most of the free float), and for a while Volkswagen became the world's most valuable company. The main issue was that Porsche never disclosed the stake, since it wasn't required to report derivative positions. Regulators have realized that derivatives need to be brought into similar disclosure norms that equity shares require.
In India as well, Reliance Industries got into trouble — and still is — for having profited through derivatives in the shares of a subsidiary (RPL) before it sold shares on the market. While creating a hedge, Reliance had used futures to short-sell RPL shares that it eventually sold; but it seems that in the process, it took on greater positions than would be considered a hedge, and therefore is being investigated for insider trading.
It is also quite likely that much of the insider trading market has moved to single-stock futures. Promoters must reveal every single share they buy or sell, but not their futures and options trades. On a piece of news that is known only to a board member, a quick profit can be made through a futures transaction with very little chance of being caught. I would be surprised — given the low level of enforcement or investigation in futures trades — if this is not rampant.
Finally the derivatives bazaar gives you the ability to take more than a "Stock Will Go Up" or "Stock Will Go Down" approach. You might believe that a stock will stay in a range. Or, that the stock will go down, but not too far down. Or that it will go wildly in either direction. With the use of options, along with a stock, you can create synthetic positions that let you profit from even such imprecise notions. Traders have named them exotically, so you will hear of Strangles, bearish put spreads or straddles — the respective positions you will use to trade the aforementioned beliefs.
It is such synthetic positions that have been used to create "structured products" — where, with options, futures and cash management, a financial product can offer you "complete downside protection with 100% upside" — meaning, you lose no money if the market falls, but you make just as much if it goes up. These products are very useful for a risk averse audience, who might otherwise never even participate in the markets.
Given that we just saw a global crisis because of abuse of derivatives, it is only logical to be afraid of them. But if real estate stocks have fallen 90%, stocks aren't necessarily risk free either. If you consider that we sit in November 2011 at an Index level that is about the same as January 2010, that the US markets are about at the same place they were 11 years ago, or that Japan has fallen 75% from its highs 30 years back, it will seem useful to explore alternative investment strategies that don't require the market to go straight up.
(From my post at Yahoo)
In a new notification, the RBI has provided for a complete savings bank rate deregulation, in which banks are allowed to set their own rates for savings bank deposits.
A savings bank (SB) deposit is what is called a checking account abroad, which you can write cheques against, and where money is withdrawable "on demand".
Copyright (C) Deepak Shenoy 2011
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