Markets - A Recovery or A Fluke - Part 1

Markets always have the dubious nature of surprising everyone, a bull market will make even the biggest bulls gasping for breadth while a bear market would in the end make even the most vociferous bears taking cover. While I am not at all convinced by the recent upswing in the market but then I could be one of the many who are thinking the same and the market could prove all of us wrong, nevertheless it would be foolish to go short in such a market, at best short condors/butterfly static trades might work for the time being.

The reason I wrote the last article was to set a setting for this article and the following ones, to emphasise on the importance of asset over cashflow. Hold this thought while you read on. The world was on the verge of a collapse (literally), the governments across the board came up with stimulus and relief packages, with relief packages of over 10% of current world GDP flowing in a span of 1 year it's a lot of money coming into the system in such a short span of time.

Ceteris Paribus if I put this kind of money flow in this basic Keynesian equation:

Y= C +I +(G-T) + (X-M) the economy size increases proportionately. The issue here is that this is just a very instantaneous type of equation i.e. captures just the moment. The point is that because of such Herculean government spending the global economy that was falling apart at rapid pace not only stopped falling but infact has even started to grow for the time being.

What the government's across the world did was important and should have been done but it would not be enough because there is a structural misplacement in the global economy (would discuss this in the next blog) and that the worst is yet to come and this is just the part 1 and unfortunately the global slowdown might be longer than earlier anticipated. Here is the thought process behind this argument.

By end of this year the debt of the great American nation would equal it's GDP, in other words the nation has to grow at around 3.5-4% annually to even pay it's interests!!! or else get into a debt trap or sell assets. Even at the best of the times US grew at around 4%, so simply put it US assets are going under the hammer, A 12 trillion dollar economy is currently driven by around 60 trillion dollar of assets, an impressive return of around 20%. But when this quantity of assets start going down the growth itself would start coming down and lower growth would mean more asset dilution leading to further lower growth leading it into a vicious circle. Europe is even in worst shape with debt ratios of many countries almost matching that of the US but even less growth. Lesser assets would further mean more exposure to event risk(last blog) and lesser financial stability. So while I believe that this temporary hump is because of this huge government spending all it has done is to shift the leverage from private balance sheets to that of government and the bolts of this ship would start falling apart once again but maybe not before it converts the last of the bears to bulls.

The next article I shall walk through the major countries of the world and talk about their debt situation and if and how they can come out of it, then after painting this doomsday scenario I shall talk (probably in the 3rd article) on how ultimately this issue would be resolved, by talking about the structural problem the world is facing today, till then hopefully enjoy the bull run......

Land or Stock where to Invest

The markets are at an interesting crossroads these days..... The classic "Bear Market Rally" dilemma - Is this rally a Bear Market Rally or a Bull market. But anyways let's leave this discussion for some other day..... Let's get to same basic investment dilemma, where to invest the money: Land, Stock.........

Let's first analyse Land as an investment asset - Let us say on a piece of land one is able to produce a crop yield of 100 rupees in one year. Taking a discounting rate of 10% we can come to the conclusion that the land would then be valued at 1100 rupees. 

Now let's say there is a productivity rise next year due to discovery of some new seeds, the rise would mean that the same land can now produce 10% more. The value of land rises to 1210 rupees. However if nothing of this sort happens my land still remains at 1100 rupees.

Now let's say that instead of just buying the land, I rent it start a business to grow crops and try selling some stocks of my business... at the average level of productivity of the economy I would

make almost no money and the value of my stock would be, yes you guessed it right "zero"

However I might be better than the average and could produce the crop at a higher productivity, so let's say instead of producing crops worth rupees 100, I produce crops on the same piece of land worth rupees 120..... My business would starts to make a profit but thats not all the 20 rupees I get can be reinvested in getting better seeds and that lets say increase my productivity by 9% anually!!! well because as I make more money I can buy even better seeds so now the value of my stock would be 2200 rupees!!!......

The story is still not over looking at my production strategy all those moron farmers copy it and now to my disadvantage (but to the advantage of the economy and the asset holders) start growing more. The value of land would then rise again and would catch up to 2200 rupees. What's more next year there is a drought that puts me out of business, the land prices suffer a decline but comes back to it's normal price that following year, unfortunately the business is not that lucky!!!

Now let's go to the third and final scenario.... I buy the land and start to till it.... Sell stocks in the market for this business, even if I am growing crops worth rupees 100 but can mantain the 9% productivity growth my stock would now be valued at 12,100 rupees!!!........ and now even if there is a drought next year my stock would still be valued at something as I still hold my asset which is land.......

So what can we conclude from this whole song and dance!!!........

- While investing in land is a sure shot investment decision, investing in stock is not so....

- Never invest in businesses with lower to average productive rates

- Even if the productive rate of the business is very high when it comes to taking a call of investing in land or a business "invest in land" unless.....

- the business "own its assets" and then do their production on it... and if this is the case then owning stocks is far better than owning land.....

- Land should be owned in places higher productivity rise is anticipated and most importantly the competition level is high

- To end the discussion I would add that the productivity of the economy and which means asset appreciation would happen in a society that encourages free flow of information or in other words is an open society, else after a point of time the productivity starts to decline and all the assets become worthless, this might be happening in some countries but because they are closed we may not know so soon... you can guess which countries I am talking about.........

My Article published in Financial Express....

My article published in the Financial Express; March 01, 2009 Edition, page 2

World in a Debt Trap.. Who would pay the bill

Almost every country today is in the need of debt. Now when every country wants debt only one thing happens.....

- Someone would end up printing money !!! and lots of it....

Fortunately or unfortunately that someone is going to be the rich nations of the world (rich atleast till now); US, UK and the Euro zone. Now let's say out of these three only Bernanke & company end up printing money. Now the question is would the US dollar really depreciate against Euro and pound. The answer is absolutely No!! and why is that... well let's have a look....

When a country takes debt it has to pay it back (not your fathers money, unless you want to be occupied or sanctioned) and how do you think Europe and UK are going to pay back the debt. You can only pay back debt by:

- Selling assets

-If your future cashflows are high enough to service the debt (in this case the high GDP growth) Such kind 

Assets with Europe!!! What a joke.... All the while Europe was rich because it looted assets from around the world and remember an old adage - Such kind of income doesn't last of eternity. So it's time that this wise saying come true. The party is over boys. Money taken from Papa is gone and you have nothing left but empty coffers.

Next we move to future growth. The dwindling & aging population (poor demographics) and add to it the mounting debt burden doesn't augurs well. So the future cash flows would be insufficient to service the debt.

Result

- Many countries of Europe (including the rich ones) would become bankrupt.

- Euro as currency might fall apart

- Even to disliking of the countries, Europe and Uk like the US would end up printing lots of money.

Now lets come home. Even India's fiscal situation is bad and there are some predictions!!! (astrology) that because of this the long term interest rates would harden thus hampering future growth. Well that might happen but in my opinion the most likely scenario is this-

- The fiscal situation has gone awry because of reduced growth and increased government spending to revive it. The debt India will end up taking would be serviced by future growth and hence the Indian rupee would appreciate again. The appreciating currency vis-a-vis the currencies of the Western world would further reduce the debt burden and this would have a cascading effect leading us into a debt reducing and growth increasing cycle.

So in my opinion the ideal trade a few months down the road would be short dollar long Indian rupee and short Euro and long Indian rupee and even short Euro and long Dollar..... Till then as I always say let there be chaos before the pattern emerges..........

Rich & Poor Nations and the Process of Natural Selection

In the 18th century Adam Smith came with his opus ' An inquiry into the Nature and Causes of the Wealth of Nations'. In this book he magnificently explained the dynamics of free markets and how some nations become rich. However I always felt that a piece is still missing from what is otherwise an immaculate economic architecture ever written. Don't get me wrong I am nobody to question a genius but understanding economics and wealth creation for mortal minds requires conglomeration of material from various sources even if they seem a little unusual at the first glance.

About a couple of months back I was traveling in a train from Rome to Venice. Trains are usually a good place to learn more about a country and it's people. Sitting a couple of places from me was an interesting person who teaches mathematics in Mestre. The discussion started from countries, interest and religion and went to economics and genetics. How did  genetics came into picture well we were discussing similarities between Indian and Italian culture. But suddenly I realised how genetics and economics are interconnected. How Charles Dickens process of natural selection completes what is missing in the wealth of nation.

Natural Selection is a process by which favorable heritable traits become more common in the successive  generations

Wealth and richness follow the same principle. People become rich by some reason (explained in the Wealth of Nation) of by some accident and then over generations this richness increases exponentially and passed onto successive generations just like good genes are passed on (as explained by natural selection). However unlike in genetics whereby the poor genes are slowly obliterated in economics things behave a little differently. The rich invest their money and the asset value grows over a period of time, hence the rich becomes richer and the sheer weight of their demand push up prices making it unaffordable for poor people so in a way the rich becomes richer and the poor gets poorer. The wealth is not just created but is transfered and in economics the wealth transfer takes place as:

Poor -----> Rich (The flow of wealth)

Hey I am not promoting any socialist ideas here, all I am stating is the process of wealth creation and transfer. This is not just the case with individuals but between countries and within countries. 

So even in India we observe that the rural income growth is just 2-3% while the income growth in services sector is 18-20%. While the Inflation rate is around 6%. This means that people in cities employed in the services sector are becoming richer and the people in villages are getting poorer. This is not a very comfortable situation and can lead to social unrest unless checked quickly by introducing some structural changes in the rural agriculture sector (more on this in some other article)....

So India being a poor country, a part of the reason is because US is rich. Ofcourse I am not blaming US for being rich or shifting blame for ills in this country to US it's just a process and like any process this process ends and reverses. Eons ago Dinosaurs ruled the world but one single event changed all that. Something similar happens in economics. People, countries become rich and richer till some event happens and the pedestal changes. The events happening today may be just that event and if thats the case we are lucky to be witnessing history and being on the right side of the history. So hold on watch as the history unfolds in front of your eyes.......

This Diwali It's The Economy....some verse

.........................................................................................................

Stepping out of my house, I see the empty looks that these malls bore

Slowdown has hit the Indian shore

Till last year the Goddess Lakshmi shone

This year people wonder where has she gone

Or was it a dream from which we woke

And has the Midas touch gone and left people broke

Nothing to worry says an old sage

‘Greed and Fear’ this is how the market behaves

Every dusk precedes a dawn

This nation will move on

The pedestal is shifting from West to East

The cycle of millennia is getting complete

Till then let there be chaos before the pattern emerge

India will be stronger post this deluge

Religion and Economy....' Money is just a Medium of Exchange'

No I haven't turned socialist and neither has the feeling of greed for more money died down within me....The article is just about an interpretation of what I observed on my trip from Hardwar to Gaumukh. 

Here I enter into Hardwar and I observe the market economy at work to the fullest.....The product of the region..'Religion'....It's a city whose economy drives itself solely on the basis of religion...At every step you can find temple and dharmsalas each selling some USB to attract bakhts (customers), as you step into the ghats for watching the aarti you are appaled by the its untidiness and don't want to sit on the dirty floor (looks like the we had to do the long wait and watch the whole aarti standing) but wait the market economy comes to your rescue....you find children selling paper sheets to put under your b**ts.....and as you settle in would come hoards of people selling you Diyas, milk and flowers to offer to the holy Ganges, so even if you never wanted to take it but when you find other people buying it you are tantalised to do the same...(the usual herd beaviour in the markets thus creating a market for a product out of nowhere)....

Next let's  cut short to Gangotri....almost 300 km from Hardwar....the need for money seems to have subsided here though not completely gone...at 3200 metres above sea level the food is a little expensive and you still need to tip the waiters...though the needs here are limited and so is the need for money...that brings me to the first major point in the article:

1) The need for money is driven by the increase in need and luxury..... Half a century ago a monthly salary of 500 rupees was thought to be good!!! simply because the articles costed much less as there was lesser cash in the world and there were not many funky gadzets. The worlds money supply grows at around 20% annually!!! and at this rate the amount of money the world would have had now would have grown by over 8000 times!!!, however even if someone's assets might have grown at this pace he would still have been the same of as he was some 50 years ago when it comes to luxury articles (articles not essential for survival and basic living) so if you want to become richer make sure that first of all you have a good asset base to start with which then grows at a rate faster than the money supply of the world and add to it the rate of growth of your needs (no idea how you can quantify it though!!!)......

Coming back to the story on the top of Gaumukh glacier with nothing around us but simply ice...money looses its value completely, well not really...we just realize that money practically had no value to start with...it was and is just a medium of exchange and derived it's value mainly from because it can buy you the needs by being the easiest medium of exchange but here at 4250 metres above sea level this medium of exchange doesn't work...One of our fellow trekkers tried to offer some of this medium of exchange to a sadhvi on her way to Tapovan...she just laughed and went passed..probably she was clever to know this at the first place.........

Now back in Delhi...the value of money is back...(Thank GOD!!!)...probably that was a different planet but the lesson I learnt there can be encapsulated in one line:

"Money helps in making the market efficient however its value is derived from the inherent inefficiency in the market"......

In other words just because money is the most convenient medium of exchange it has a value, so its critical that for wealth creation only a small portion of your portfolio is in the form of cash the rest should always be invested in some asset or the other.........