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Alright To Be Wrong…When Investing

1 Comment » Written on February 20th, 2012 by
Categories: Yahoo

At Yahoo, I write about how it’s all right to be wrong when investing:

In 1973, the Kreditbanken (bank) at Norrmalmstorg in Stockholm was attacked by robbers, who held bank employees hostage for five days. After the drama, it was evident that the hostages sympathized with their captors, even though they were held against their will. The situation is now considered an academic study — the Stockholm Syndrome — where people get emotionally attached to people who obviously try to do them harm.

More apparent, perhaps was the case of Jaycee Lee Dugard, who was held for 18 long years — from 1991 to 2009 — but got so emotionally attached to her abductor that she even helped him in his business and met customers. Being an unwilling hostage, or in other cases, just being in an unwelcome situation with no way out, makes us rationalize in favour of our position.

Less dramatically, we become hostage to our own opinion. We simply can't let go of what we believe is "normal", even in the face of facts. If your blood tests show you have a high cholesterol level, your immediate reaction is to hope the problem will go away on its own, or imagine that the tests were incorrect. A person abused at work — sometimes with lewd suggestions — will initially justify it as harmless workplace banter. The victims of a drunken driving accident will side with the driver saying how good a driver he "usually" is. We simply don't want to see it, even if we know it.

In the financial world, our beliefs are tested often. In 2011, the markets fell over 24%, with the situation in December as dire as it could be; the government was running out of money, industry was slowing down, inflation was high and everything looked bleak. In January 2012, we saw the Nifty and Sensex rise 12%, with no apparent improvement in any of the other pieces of data. This rise has bewildered most analysts, who continue to believe, at every stage, that the market will reverse back down. Consistently, nearly every day, the market sees a rise, but the sage opinion is that this is a fake rally, and that this will come down like a ton of bricks.

It might. The analysis may be spot on, that the Indian story has hit a pause button and not worthy of very high valuations. But at some point, we need to admit that the tide has turned, and prices keep moving north. Our conviction is worth the paper it was never written on — but we carry the weight of it on our shoulders altogether too long. Such irrationality can cost money —a trader that stays short despite a stop loss being broken, almost in anger against such a furiously rising market, continues to lose until eventually giving up. An investor who decides a stock is great and watches it fall, keeps buying until the stock becomes an abnormally large investment, and later feels serious regret when other stocks do better.

If you strongly believed in the Indian telecom story, it was lost on the stocks. From Bharti Airtel to Reliance Communications, the stock prices are way lower than their highs in 2007. We have more air travel than ever before, but airline stocks are in the doldrums. India is spending an enormous amount of money on infrastructure, but the road-builders and power-plant-owners are scraping the bottom of the barrel in the markets. Yet, the question I first get when I say all this is: "Good time to buy?"

The correct way to deal with markets is to expect to be wrong. You have to consciously look for information that counters your thought process. If banks are supposed to be in trouble, then look at their positive results, and look at how strongly the RBI is supporting the system. If buying IT companies on a falling rupee sounds exciting, consider reports that customers are quite aware of the fall and demand corresponding concessions, which they don't reverse easily as the rupee recovers. If you like to buy stocks when they make a new one-year-low, test out how many times you would have made money investing in a broad array of such stocks in the past. (I have checked, and results are horrendously negative at a portfolio level though there are a few that will shine)

It's not easy to stay fluid and keep switching sides as the tide turns — society values loyalty much more than rationality. Being wrong is okay, but staying wrong is evil; in the markets, we can't get married to our opinion.

Posted in Yahoo

India’s Dangerous Fiscal Deficit

No Comments » Written on February 19th, 2012 by
Categories: Slider, Yahoo
India’s Dangerous Fiscal Deficit

At Yahoo, I write on The Dangerous Fiscal Deficit Situation in India:

While we are battered with news about abandoned babies, victories and then losses for telecom firms, elections in UP and surging stock markets, it's useful to note the quietly released data on the fiscal deficit that are seriously alarming. Read the rest of this entry »

Posted in Slider, Yahoo

Consumer Prices: A Better Inflation Indicator

3 comments Written on February 15th, 2012 by
Categories: Inflation, Yahoo

At Yahoo, I write on Consumer Prices: A Better Inflation Indicator

"Inflation is when you pay Rs. 100 for the fifty rupee haircut you used to get for 25 rupees when you had hair"; a quote I received on twitter. In India, when we speak of inflation, we've never really talked about haircuts. No, I'm serious, stick with me.

The Inflation Index that our country talks about is based on the Wholesale Price Index (WPI), which is a weighted sum of product prices at the wholesale level. That means stuff that you can buy at wholesale markets, such as vegetables, copper, fuel, or even liquor. But it doesn't include the cost of services; the WPI will indicate the cost of vegetables and meat to your favourite restaurant, but it won't add up the cost of chef/waiters' salaries, rent of the premises, air-conditioning costs and valet parking. In the haircut example, they'll note that the scissors or shampoo got more expensive, not that the haircut costs you more.

The world over, what is used is a Consumer Price Index (CPI), which uses a basket of goods that you are more likely to consume and uses end-user prices (not wholesale). CPI is more indicative of inflation that the common man faces. India has taken uncoordinated steps in that direction, with the labour bureau releasing three monthly CPI numbers for Agricultural Labourers, Rural Labourers and Industrial Workers, and the Ministry Of Statistics and Programme Implementation (MOSPI) releasing the CPI for Urban Non Manual Employees (UNME).

Multiple Consumer Price Indexes were necessary, we were told, because the spending pattern of different people was different.

A few years back, MOSPI decided to halt collection of data for the UNME based CPI and prepared data collection for a new index called, with great creativity, the "New CPI". This contains:

Pic1 

With the base year as 2010, MOSPI has released data for every month in 2011. This index consists of rural and urban data, with different weights given to each sub-head. The New CPI is envisaged to clear all the confusion among the current CPI indexes; we can only hope that someone else comes up with a "Newer CPI" and confuse the bejeezus out of everyone.

So what has inflation has looked like, when it comes to consumer prices? Since the first data point in the New CPI is January 2011, our first real annual inflation point will be revealed with data for January 2012 (since inflation is a year-on-year change). But we could extrapolate, by looking at December data and comparing it to January.

CPI inflation, thus calculated, gives us an annualized figure of 8.2%. The WPI inflation — the newspaper version — is 7.5%. This is counter-intuitive — food prices are the ones that have reduced the most, and food is nearly half of the CPI. Comparatively, food has a far lower weight in the WPI.

What has happened, then? Let's look at the components:

Pic 2

While food has fallen, much of everything else — from fuel to housing to clothing — has gone up substantially more. If you remove food, the New CPI has gone up 11.4%!

(Even within food, it is vegetables that are down more than 25% from last year, when prices of essential vegetables were shooting through the roof. Take Veggies out and inflation goes to double digits)

In the US, they have a concept of "core" inflation, which is "non-food, non-fuel" — meaning, items that are not heavily volatile. If you calculate that with the WPI, it is only about 8%. But with consumer prices, "core"inflation is 10.70%, a significantly high number. At the core level, prices are sticky — that barber who raises his haircut prices isn't going to reduce it just because shampoo just got a little cheaper.

Think of it this way: when cost prices and salaries go up, barbers will suck up the cost initially. When they can't do it anymore, they'll raise haircut prices. Now even if costs go down, their wages will not decrease — who takes a pay cut voluntarily? — so the consumer's price remains constant. This is "sticky" inflation and one of the most difficult to reverse.

CPI measures inflation you can actually see. Rents are going up. Wages — not just yours but also those you hire, are shooting up. Clothes, restaurants, fuel — all up. The inflation that we saw in the wholesale prices a year or so back (inflation at the primary and wholesale level was nearly 20%) has now moved into items where you and I can feel the pinch.

Still, it's not useful to emulate what the west does. The US attempts to mask its CPI-based inflation by making adjustments that distort the CPI itself. It uses a substitution effect — stating, in effect, that if meat prices go up too much, people will substitute it with chicken, so we'll use the lower of the two prices. They use "hedonic adjustments" to show, for example, that a computer has become cheaper even if you pay the same price, because you get more hard disk space today. These are vaguely justifiable changes, but very wrong in the context of calculating how the common man hurts. While the objective of doing such a thing is unclear, most people believe they are used because they make GDP data look better. Luckily, our tinkering with four different CPIs has kept us from such adjustments.

The CPI is, in general, a better indicator of inflation than a wholesale price index; the rest of the world also thinks so. We have a new index, and let's hope they regulators decide to use it to gauge inflation as it really is, and that index creators don't get ideas to distort the index so that it makes other data more appealing in comparison. And to address the issues with the WPI data, let's also hope that CPI data is properly maintained and promptly updated.

Maybe I'll be able to keep my hair on, just for that haircut.

Posted in Inflation, Yahoo

The School Of Hard Knocks

9 comments Written on January 30th, 2012 by
Categories: Slider, Yahoo

I write at Yahoo: The School Of Hard Knocks

Many of us desire to make money from the stock markets, because it doesn't seem to take a lot of skill. After all, like a casino, all you need is one good trade. That's what we read about — the success stories of investing talk about how Warren Buffett bought into Coke, or Rakesh Jhunjhunwala bought Titan, or Paulson shorted sub-prime mortgages or such.

Read the rest of this entry »

Posted in Slider, Yahoo

The Irrelevance Of The Sensex

4 comments Written on January 25th, 2012 by
Categories: Sensex, Slider, Yahoo
The Irrelevance Of The Sensex

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 »

Posted in Sensex, Slider, Yahoo

The Year 2011

9 comments Written on December 28th, 2011 by
Categories: Slider, Yahoo

From my year-end piece at Yahoo:

2011 would be best forgotten by the Indian markets. Stocks have fallen around 25%, making it the second worst year in market history, after 2008's drop of 52%.

The rupee has fallen another 20% against the dollar. Petrol prices are so high that pumps now sell it in ink droppers. The government has, with little prompting, carefully applied egg on its own face. Read the rest of this entry »

Posted in Slider, Yahoo

What To Make Of The Great EU Announcement

No Comments » Written on December 15th, 2011 by
Categories: EuropeanCrisis, Yahoo

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.

Posted in EuropeanCrisis, Yahoo

Buying Back Our Deficit

2 comments Written on December 9th, 2011 by
Categories: Economics, Yahoo

(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.

Posted in Economics, Yahoo

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