3 principles of investing by Benjamin Graham - the guru of Warren Buffet

According to Graham, investing consists of 3 main elements:

1) One must thoroughly analyze a company, and the soundness of its underlying business, before one buys its stock.

2) One must deliberately protect oneself against serious losses - can be achieved through diversification.

3) One must aspire to "adequate", not extraordinary, performance.

Thought for the Day

"More than any other time in history, man faces a crossroad. One leading to despair and utter hopelessness and the other to total extinction. Let us pray we have the wisdom to choose correctly." - Woody Allen

Crises of UK

The article earlier mentioned the problems of the US. Lets understand now the issues that were present in the UK.

UK is the leading center for trading activity. It is significantly influenced by securitised credits and shadow banking activities.

Like US, UK too has a current account deficit. However, the deficit is not matched by purchase of bonds as in the case of US. Instead, it is done by private corporations investments.

UK is also characterized by many foreign banks operations. Many banks like, Deutsche Bank, Icelandic Banks etc. have their operations.

The important point in UK is that the US Mutual funds and SIVs are major investors of the securitised credits models.

Also, major banks of the UK are established in the 'acquire and arbitrage' model. They depend the premise of 'liquidity through marketability'. Hence when the credit dries up, their inherent model fails, making them very vulnerable to the crises.

UK banks mainly function through the sale of securitised credits and wholesale banking. In a situation of liquidity and confidence crises, the market for such bonds dries up, essentially leading the failure of major banks.

Northern Rock, Brigleys and Bingley and HBOS failed primarily because of the reasons mentioned above.

Hence the problems in the UK are aggrevated to a larger extent as compared to the US.

Dollar hegemony

China has about $2 trillion worth of US dollars, Japan $680 mln, India about $250 bln.

Effect of US Govt. fiscal deficit and bond issues will have effect on the currency and in case of a depreciation in value, it could be a huge loss for the economies. Its the case of countries like ours and China being affected for no fault of theirs and because of ill-managed US.

This, in its very essence questions the hegemony of the US currency.

It is for this reason that India joined the BRIC countries have suggested the creation of a supra-national currency that can stand up to the dollar and provide a hedge against the fluctuations against the dollar.

Understanding the roots of the crises

To understand what is the sub-prime and the subsequent financial crises, it is imperative to understand that it is not a period of 4 or 5 years that caused the crises. The roots of the current crises were sowed around 15 years back.

Macro-imbalances

Many oil exporting, capital goods exporting countries and those countries that had a high savings rate had a massive current account surplus. On the other hand, there were countries like the US, UK, Ireland and others who were consuming more. This led to countries like China accumulated claims on the Government Securities of the US. The result of this was that the yields on the Government Securities fell from aroun 4 % in 1995 to about 0.75 to 1 % during the mid 2000's.

As the interest rates in the economy were related to the yields of the T - Bills, we saw an overall reduction in the interest rates

Financial Market Innovation

With the yields decreasing, investors looked for opportunities to increase their returns. This lead to surge in the securitised credit and other innovative products. Many financial pundits praised the role of credit derivaties claiming it as a means to reduce banking system risk and cut costs of credit intermediation. The risk of the derivatives was supposed to be passed on the end investors. This reduced the need of bank capital to be blocked. However, when the crises broke, it was observed that most of the toxic derivatives were not in the hands of end investors, but highly leveraged banks and bank-like institutions.

While some of the banks were practicing the policy of 'orginate and distribute', some of them were also in the business of 'acquire and arbitrage'. The banks that were orginating and distributing the loans, had to put in some amount of capital on their balance sheets. Under a condition of liquidity drying up, these banks faced a liquidity strains and potential losses. This was a major cause of failure of the Northern Rock.

There were the following results of the above mentioned activities:

1. Growth within the financial sector: There was a phenomenal increase in the growth of financial sector debt as compared to the corporate debt. The growth of the relative size of the financial sector debt, increased the potential impact of the financial system instability on the real economy.
2. Incease in leverage: creation of off-balance sheet vehicles (SIVs) and conduits - which were highly leveraged but whichwere not included in standard measures of either gross or risk adjusted leverage.
3. Shadow Banking System
4. Misplaced reliance on sophiticated math
5. Mistimed haircuts, margins and triggers
6. Lack of adequate captial buffers

The above is a brief to the understanding of the global financial crises.

A deeper understanding can be obtained from the Turner Review 2009 that explains the crises in a beautiful way!

Imagine! Russia's raising interest rates!

People of talking of possible deflation.

People of talking of falling interest rates in banks and financial institutions.

But what is Russia doing. Precisely the opposite.

Since 2008, it has been raising it interest rates for the 6th time! The question that we next ask what about its economy. Well, we need to understand the Russian economy for this. 

Russia is supported by the enormous natural resources it possesses. It ranks 3rd globally in oil production, has 2nd largest coal reserves and 2nd largest consumer of energy. 

Its economy was supported by the boom in the commodity prices of natural gas, oils, metals and timber that make up 80% of the exports.

The raising of rates helps the economy in stabilizing the fund outflow, thereby averting a steep appreciation in the currency. The bank is also trying to artificially to value its currency to keep its exports competitive.

The solution for Russia lies in lowering their dependency on oil and focusing on investment in agriculture, science and innovation. Russia should also build the entrepreneurial spirit in the students that help them in creating small scale industries that responsible for job creation and growth in any economy.

GM's next!

Guys!

Don't get carried away by the recent stock market bull run seen in the past week. The Sensex has reached the 10500 mark and the Dow at 8000, it may be too early to say that the economic crises is over. 

GM will be the next to go in two months from now.. This is not my supposition. But that is what the market demands. The consistent flow of tax payers funds cannot keep the company going for long. The end has to come in some way or the other. 

The major problems that GM faces are

1)      Major Cost Disadvantage : Pension and health benefits for all its past employees

2)      Government imposed restrictions : Corporate Average Fuel Economy (CAFÉ) standards of 1975, Cap-and-trade regulation imposed by Obama administration

While the restrictions are good for the American economy as a whole, it the first problem that is causing most of the troubles. The assured benefits to all its previous employees is causing the operating margins to go down and even into losses as seen for the past couple of quarters. 

In this situation, a Chapter 11 filing that will help in the restructuring of GM and its operations seems to be the only possible solution. It will not cause the company to cease to exist but help it in recovering the lost ground to Toyota; and who knows, we might see a better GM in the future!