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!

From "3-6-3" to "10-8-out"

During the lore days, bankers typically had a 3-6-3 formula. This essentially meant "borrow at 3%, lend at 6% and be at the golf course by 3 PM!" Those were however, those good times when the stocks were rising, consumption was high fueled by the emerging economies by maintaining high surpluses and huge forex reserves and the economies growing at an astonishing rate. 

Slowly this model began to change. With rising inflation, interest rates rose. So the new formula that emerged was 4-7-3! Following this was 5-8-3, then 6-9-3, and so on and so forth. 

This continued till the time was 9-12-3 (perfect combination of 3 multiples to send the global economies into a recession for a period of atleast 3 years). 

Then came the defaults! Failing economies and pressure of governments to reduce interest rates. 

Mind you, till now the borrowing has been fixed at 9 to 10% and that is in the form of fixed deposits! This means, bankers now are obliged to pay 10% rates atleast till the FD term. 

This phenomenon explains why banks are reluctant to lend. Lowering the interest rates to 8% will essentially mean only one thing for a banker, that is, 10-8-out. This means " borrow at 10%, lend at 8% and then be fired by the bank heads for maintaining such scrupulous lending and borrowing procedures!"

Why stimulus packages fail?

Since 1929, Governments have had one policy for tackling recessions - commonly known as 'anti-depression' arsenal of government policy. Those have been

1) Prevent or delay liquidation

2) Inflate the economy in a period of decreasing rising artificially

3) Keep wages high

4) Stimulate consumption and alter savings

With the probability of defaltion high in the current scenario, governments are trying their best to avoid a credit contraction. 

However, as it is known, every boom comes with a set of evils that is corrected in a bust. The same is seen in the current scenario. The excessive lending and leveraging was the evil that is now getting corrected across businesses and industries. 

The longer the boom, the sharper the bust is. 

In fact, deflation is the best cure in the current scenario as it would bring prices to the corrected level that would help spur the economy again.

With the government aids to the "too big to fail" institutions, the depression is only getting prolonged. Organizations like GM that are not being managed effectively have to let to fall. 

Government should maintain the system of laizzez faire, let the market correct itself and take the role of a regulator.

What the government can do is to set up a system of effective governance to keep regulations in place and avoid cases like Satyam emerging in the economy.

Seeds of future crises being sowed!

The government fiscal deficit is expected at 10% levels of the GDP!

What does this mean for the future (once the sand has settled down)

The high deficits would mean higher interest rates and we would witness crowding out by private players. 

But what about the existing private players who already have a large number of future investments. 

Take the case of Reliance Power. With 3 UMPP's, it is expected to spend about 55000 crores in the next 5 to 7 years period. With no operational project, it will have to meet the requirements only by debt. (The IPO bogus issue cannot be supplemented by another bogus FPO). 

Taking the average interest levels then to be around 8-9% (or probably more), it is a matter of concern of how it would be in a profitable position. 

An example of this, now takes us to a graver problem. 

All the investments are usually in power sector, infrastructure projects or capital goods. Given the imperative role they play in the economy, the Government has to ensure that these do not go into a failure or they would be the source of the next recession

Fall in agricultural development in India

Its official. 

The GDP figures have been reported at 5.3 % year-on-year basis for the 3rd quarter.

The IIP fell to 0.8% points from 4.7% in the previous quarter.

Fixed investment fell to 5.3% from 15.1%.

Private consumption weakened to 5.4% from 6.9%.

Exports increased to 11.4 from 10.6%.

Government consumption increased to 24.6% from 7.9%

Most of these figures were predictable.

 

 Whats alarming in this is the fall in agricultural output. Agriculture contracted by 2.2% (year-on-year) points from the past 6.9% level. 

A contraction is what is alarming here. Government had predicted the output at 6.1%!

I believe, its only the agricultural sector that can help India in the present crises. The exports are expected to fall given the hilt the rupee has reached to. Rupee cannot be expected to fall further given the present low levels. In addition to the weakening demand, a fall is certainly in sight. Industrial Production also cannot be expected to rise anytime soon. 

What can help India reach the 7.1% mark (set by the Government) is a rise in agricultural output. Food is one commodity that is the last to be affected during recessions. Being an essential item for living, its demand is expected to be maintained. 

Government has to play its role in promoting agriculture by providing more incentives and trying avoiding the internal migrations that we have seen in the past decade.

I think there lies a solution for India to maximise on its efforts in trying to out beat the crises and pave the way for future sustainable growth.

China's concern

After a spate of growth for the past 30 years, China had immense internal migration from the agricultural states to the towns. It is estimated that nearly 250 million farmers had come to industrial towns in hope of a better living. 

China is a country that is predominantly dependent on exports. This January, its exports sunk by 17.5% compared to last year. With the current economic downturn, there have been reports that the unemployment may be at 10%! This means that the newly working age group of youngsters and middle age group people will now be out of jobs, with no income. 

What's important is that this can be wide civil unrests and violence in China. The mob may take to robbery, stealing and other forms to earn their living. 

It is also estimated that the agricultural villages get nearly 30% of their remittances from the people in the towns. Even this now shall vanish. 

China will have to deal with the issue given the seriousness of the crises. Its economic stimulus plan of $586 million that plans to provide 650000 new jobs in the next two years may have to be further increased.

One good sign of the present situation is the rise of entrepreneurism in the country, not only in China but also in France. This situation calls for 'out of the box' thinking that shall be provided by the laws created. 

Phrases to remember

Plan the way (or life) a fire department plans out its work.

Politicizing Culture

The recent incidents of the Mangalore pub and the assaults on the Valentine Day are an alarming signal to the nation.

Youngsters are requiring a means to showcase their love in the open that is not acceptable to some group of people. The tolerance limit for these few people is crossing the limit, such that they enroll in numbers to take action against the lovers. Such acts should definitely be taken under the purview of the law and action should be taken. The Indian Penal Code also has sections which deal with such criminal behavior

How do you define culture: It is the set of values, goals, attitudes, traditions, practices that a group of people share. What we see now that is that it is these set of values that do seem to co-exist in a group belonging to the same community.

In the last month incident at the Mangalore pub, a group of 40 Sri Ram Sena members assaulted the women who had entered the pub in the name of their obscene behavior. The argument they gave was to prevent the Indian women to ‘go astray’. It is surprising that it is happening in the very same country that gave the world Kama Sutra. The question that we face is, is what the Sena did a part of Indian culture. Can someone break the law, assault women publicly in the name of ruining Indian culture and still go handsfree? It is a big irony that the very people are ruining the culture in the name of others.

 

 

Drinking of alcohol amongst younger generations

Drinking alcohol is increasing becoming a nuisance in India. With the pub culture flourishing, many youngsters are taken to it in the name of modernization. They binge till late night, rape women and some others indulge in horrifying accidents on the highways.

A recent study by NIPCCD (National Institute for Public Corporation and Child Development) has shown that school children are increasingly getting prone to consuming alcohol and smoking. A survey of 15000 students from the age of 5-18 years of age showed that 30% of boys and 26% of girls regularly consume alcohol.

Is this good for India?

While it is becoming increasingly clear that alcohol is the main cause for accidents, poor academic records, health related issues and deteriorating conditions at home, it still growing at an alarming rate.

Can and should the government take action?

Well, if the government does bars the production of alcohol in the country, there will be many protests across the country. Everybody shall claim that those who do not want to drink need not drink and all the stuff. So this is not a viable option. If the government does not ban alcohol, what is the step it can take to prevent excessive consumption of alcohol amongst students and elders?

There are lessons to be learnt from other countries.

In a town in Brazil, the murder rates caused by people who drink was reduced by nearly half only by putting the closing time of bars at 11 PM. In the US the increase in the minimum drinking age of students was raised that significantly reduced the number of road accidents. In the UK, pubs have been asked to follow a ‘Code of Practice’ (COP) that discourages binge drinking promotions like ‘ Buy one and get one bottle free’, North Carolina’s (US) law makes it illegal for any shop knowingly selling or giving alcoholic beverages to any person who is already intoxicated.

It is very difficult to take an action of extreme step right at the very front. But steps such as these need to be taken for reduction in the alcohol consumption, especially amongst the future generations.

 

Economic Behavior

Today on my way to the airport to pick up my father, I again encountered a traffic jam. On a stretch of a mere 100m, I ended up wasting nearly 30 min.

Studying at MDI, I just learnt an obvious fact of India: It is in India that individual rationalism leads to collective irrationalism. This reminded me of the Noble laureate John Nash. How true was he when he contradicted the theory of Adam Smith, that was imbibed in everybody since then.  Adam Smith said that a successful group occurs only when all the individuals of the group act in their own interests. John Nash contradicted it by saying that the best result emerges from a group only when the individual members act in the best interests of themselves and the group.

How true in this particular case. But then when this is true why don’t we all follow it. Why don’t we allow and wait for the other person to go and then follow. Why do we always try to cut things short and race the car to any vacuum that is created in the jam.

Well I feel that the answer lies in the people tolerance. Over time, the tolerance power of people is going down. People are just not ready to let the other person go forward. It does not matter to them how much ever time they wait, but they can’t see the other person going before them.

Hence I feel that even if the infrastructure of India improves, even if there were better roads, we would still face the problems of jams. Till we do not the change the way we think, I don’t see a solution to the problem.

The next question arises as why is this so?

Again I feel that it is in India’s education system. Note that all the people who were on that stretch were well to do people with sufficient education. Even then?

Education in India is only defined by competition. How the student is, is judged primarily by the grades of the person, regardless of other attributes. Are marks and grades the only way to judge a candidate. In the recent placements at my college justified the fact. It is in this that all of us only try to outwit and outsmart the other person without having a thought of self. This is not the case with US. There the students decide the college they want to go to and the education they seek. Though grades do play a role, so do many other things.

I feel it is this that needs to be mended in our country and imbibe this learning in our system