Gyan

Leverage:

I have never been a big fan of leverage. in past seven or eight years I have hardly seen any one making money by taking leverage. I heard some one saying that if you trade excessively in the market and take excess leverage you are some who "eats like a chicken and pass like an elephant" I like the statement and I have seen many just doing that.

I think it is the cost of leverage and the returns that you get from any risky investment that tilts the bargain invariably for some one who give leverage. (though this time around even leverage givers i.e. banks also lost a lot, but they would have survived if they were not leveraged so heavily).

the only place where leverage may make sense is a house loan simply since this is cheaper as compared to other loans, but even this should be kept minimum.
leverage for investment (Yes, including investment in a house) can best be avoided or should be minimum.

So leverage is bad and here are my comments on the use
Leverage for buying a house is OK.
Leverage for investing in a house should be minimum.
Leverage for investing should be avoided.
leverage for Trading is a crime (Well almost)
Leverage for enjoying, God bless you.

Cheers

Gyan

Image by Getty Images via Daylife

An interestingq question;

Market crash is responsible for a slowdown in the economy or a slowdown for the crash? Tech stocks corrected because investors realized ".com" was not a feasible business modal or ".com" turned infeasible because stocks corrected. More often then not people tend to think and believe that it is the the market, which is responsible for the slowdown.

This phenomena is not only restricted to the markets, this happens in real life also, most of the time I have observed that the reasons attributed to certain events may not be the reason for the event. And more often then not the reason is categorized as "Good" or "Bad", depending on the outcome.

Like Sub- Prime and leverage are considered responsible for all the job losses we have seen across the glob. My question is how many of those who have lost their jobs, would have got a job at the first place, if you had removed the excess liquidity created by leverage?

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Gold

Post recent stock market crash and then commodity and property price correction Gold is where a lot of investor found some solace. Gold has infect moved up from about 715 $/ ounce on 11 November 08, to 880 $/ ounce after flirting with a 1000 mark for some time. If you look at past movement of gold prices, it has performed well whenever there is correction in the USD. The logic is pretty simple, if the USD corrects then to buy same units of gold you need more units of USD, since USD has corrected.

Given the current economic scenario when a lot of money is being printed by the US, most of the investors believe that these trillions of Dollars infused a lot of liquidity in the system and borrowing will become cheep again, people will start buying and inflation will go up the USD will start correcting, so buy gold.

The logic's sound reasonable except if you look at the amount of money which is being pumped in the system to what is needed to clear all the sub-prime mess. The total toxic assets are expected to be around 4 trillion in US, as compared to 2 trillion which is expected to come in the system once all the fiscal packages come in the system. Off course some of the expected sub-prime money will be recovered and some of the banks may choose not to sell some of the assets they are holding, but the money being pumped is definitely not enough to wipe out all the toxic assets. Even if it is enough this will only clear the existing toxic assets held, but will not lead to consumer demand. Till consumer demand does not come back inflation will not come back.

Against which currency: currency movements are a relative term given the current economic scenario I am not sure how many currencies will do better then USD.

The other problem is high base of inflation; till last year this time, most of the commodities especially crude was at very high levels and has come down significantly since then. US is one of the biggest consumer of crude in the world and crude price correction will continue to keep inflation in US down, at least till base does not come down, which is still about six months away.

Demand-supply: The one reason why I always have a negative bias against gold is because gold can not be consumed and can only be produced. Even gold standard is scraped now so even countries can sell gold at will and continue to print currency. Also when gold prices go up retail investors tend to delay buying, in fact last time when gold prices were about 1000 $/ ounce investors in India sold their gold. Import of gold declined during that time not only in India but also in other gold importing countries like Italy, which is another large importer of gold. Now this was a surprise given the fact that India is the highest importer of gold and the yellow metal is more then just investment for them.

One must also consider the amount of gold that can be produced; I am sure we are not nearing the end of gold reserves and high gold prices and lead to more investment in exploration. Remember Hunt brothers who accumulated 50% of then silver reserves and still went bankrupt.

Gold was a fantastic investment before the gold standard was scraped, gold moved from $37 per ounce to touch a high of $850 in 10 years, and then took almost 28 years to cross the same mark. Even if you take the high of $1000 which gold touched in February 09, that’s a return of 0.6%, in real terms one is still loosing money after so many years of wait. I am sure there are better investment avenues available even in the current market scenario to invest in.

Property prices in Mumbai

Property prices in Mumbai:

Economic crash

Till about a year back a lot of investors, big or small committed millions of dollars in the property market, and were richly rewarded because of ample liquidity in the system and a general belief that Indian economy will continue to clock 8% plus growth.

Things have changed since then. Most of the analysts are arguing if the GDP will grow at 5% or 3.5%. It is sure that it will not grow by 8% plus. U.S. is in recession and sub-prime crisis has crippled the banking system in US and most of other countries. Equity and property markets in India since then have corrected.

Mumbai property market is influenced more since it is the financial capital of India and a lot of prospective property buyers are directly engaged with finance industry through banking and broking.

Expensive loan:

The biggest impact of the crises was on liquidity and risk premium attached to lending. I was amazed to see some of the Indian corporate raising cash at 12.5% to 13% from the retail investors. What this suggests is that even toady when call market yields have come down significantly; lending rates are still pretty high.

Even for retail investors it has become difficult to get a home loan, barring SBI which is giving home loans at 8% that too for loans below 20 lakhs, for most of the banks lending rates are in double digits. The other problem is down payment, most banks are asking for a higher down payment of about 30% as the margin money for property. Last but not the lease is eligibility for the loan which has also gone down from a high of about 60 times your monthly salary to about 40 times your monthly salary. All these factors put together have drastically reduced a person’s ability to buy a house. Understandably credit off take has come down significantly.

Demand supply:

One more thing that has influenced property markets is a few changes in the regulations that have increased land supply in Mumbai.

ULCA has been scrapped: an expected 25,000 acres of land should be free for development.
Approval of construction on salt pans: total area covered is about 5500 acres in Mumbai.
Auction of defunct land mills in Mumbai: total area covered about 900 acres.

(60% of Mumbai lives in slums which is about 6% of total area, that’s why redevelopment of slums may have a limited impact on the overall supply)

All of this put together give access to more then 11,000 acres of land in Mumbai. I understand that construction will not start on all the land and most of the land might takes years or may be decades before construction starts. But the land is available and even if 5% of this land is made available every year a healthy supply will keep coming to Mumbai for construction.

Parel in Mumbai is a good example of this, where a lot of supply came because auction of defunct textile mills. The total area which is being constructed there is expected to be about 16 million square feet. This is roughly 11 times of the total office area at Nariman point. If all this is occupied, BMC will have to ban cars in the area other wise traffic congestion will ensure that one never reaches his/ her office.

Investors not willing to take a plunge:

Typically property market is made up of first time home buyers, who buy a house to live in it, and investors who give it on rent or sell it for a profit. I significant number of houses are bought by investors but due to the recent correction in the property market and economic slowdown the expectation of a price correction in property is keeping these investors away from the market, this significantly reduces the number of transactions and put pressure on real estate companies who are sitting on huge inventories and expensive debt.

Tier ii / iii cities:

If you are looking to buy a property in a tier iii city, this may not be a bad time to start looking at buying opportunities. In last one year or so Indian government has done many things to put money in the hands of Indian middle class. Some of the examples are

Sixth pay commission
Farm loan waiver
Increased tax exemption limit
Treating home loans below 20 lakhs as priority sector (this has reduced the rate at which bank give these loans)

Also traditionally investors in smaller Indians cities prefer investing in bank FDs or other secure investment options. This also helps to keep property prices steady in such places

Fixed income

Image via Wikipedia

Fixed income:

With equity, property, crude and other commodity crashing, fixed income investment have attracted a lot of investment from HNIs and corporate. Last six months returns from fixed income instruments have also been very choppy, but most of the investors have persisted with their investments.

GILT:

Last year on 15 July GILTS touched a high of 9.474. There were multiple reasons like; flight of money from emerging market, high fiscal deficit, which touched a high of about 12-13% of GDP and then a bigger then expected borrowing program announced by government. All this kept GILT yields high. What worsened the situation is a high crude price especially when domestic currency was depreciating. Since then things have improved significantly. Crude has corrected from a high of 150 $/ barrel to more humble price of about 50 $/ barrel. All other commodities have also corrected. This has improved the fiscal deficit albeit marginally, but expectations are that this should improve going forward.

Inflation:

Inflation figures for the week ended on March 09 stands at 0.26%, as against 0.31% a week before. This is the lowest level inflation has touched in two decades. The figure last year same time was above 7%, which broke 11% mark in July 08 after a gap of 13 years. Going forward the expectations are that the inflation will hit sub zero numbers not only because prices are correcting but also because of a high base effect last year.

Will the interest rates come down?

The most obvious out come of deflation is a reduction in benchmark interest rates, and we have seen this in past. RBI has reduced CRR to 5%, Repo rate to 5% and Reverse-repo to 3.5%. Now the bigger question is; going forward will RBI further reduce rates?

To answer we need to look at the inflation number in a bit more detail. Inflation numbers mentioned above do not represent the true picture of price rise/ correction in the country due to following reasons;

We follow WPI and not CPI which is still high.
Primary articles which are 22% of the basket are still pretty high

These two reasons coupled with a depreciating rupee have put central bank in a precarious situation. While growth and WPI have certainly tapered off, high CPI and primary articles suggest that we may not see a reduction in the benchmark rates in the immediate future. Though I am sure that even CPI will come down in six to seven months time and this might lead to further interest rate cuts albeit six months down the line.

What should you do?

While GILT yields are still moving in the range of 6.5 to 7.2%, there are indications that liquidity is coming back in the system. Yields above 7% look unsustainable and should correct from there. This offers an opportunity for the investors.

The other opportunity is in corporate debt where the spread between AAA rated corporate bond and GILT is still in excess of 200 basis points as compared to a historic average of about 100 to 150 basis points.

Whereas in money market the overnight interest rates are below 3.5% and CLBO it is below 1%. With the expectations of liquidity further improving from here on there are no chances of this going up. That’s why do not remain attractive for investment.

Image via Wikipedia

Good time to invest in equity?

How bad things can get?

After hitting a low of 8167 on 9th march 09, SENSEX has jumped to 10,967 on 13 April 09. This is a return of 34% in a month, but this is the only good news I have heard in this time. Every other news related to economy does not look very encouraging. Starting from US where not many economists are sure that the stimulus will stimulate the economy or just be a drain on tax payer’s money. Now even car makers move closer to bankruptcy and asking for stimulus, no one knows which industry is going to be next.

Back home also things do not look pretty good. Fiscal deficit has gone up, current account balance has turned negative, and Tax mop up is less then expected numbers, which were already revised downwards. Exports have gone down by 33% and IIP numbers have shrank by .5%. The last quarter results did not offer any hope and this quarter is also not expected to be extraordinary.

Elections around the corner:

Market movement will also be determined by election results in India. It looks certain that we will have a coalition government and a few regional parties might support this new government from outside. A lot will depend on who is supporting the government, and what is the common minimum program of the parties. Like the current government if they also refrain from disinvestment and liberalization then we may see a negative impact on the market.

Glimmer of hope:

Inflation (WPI) is touching near zero level, which generally is not very good news for economy. But this time it looks a bit different. If one analyzes the numbers you realize that inflation may be zero and going down but the biggest reason for the same is correction in the commodity and crude prices, which will help the economy. as this will help reduce the input cost. For example construction cost for one sq. ft. has gone down from about 1200 Rs to 600-700 Rs. The same is true for all the industries using commodity as a row material. This will help reduce prices and increase margins. Only caveat for the investors is to move their portfolio from commodity producing companies to users of commodity like Auto.

Interest rates are correcting may correct further:

Interest rates have come down, central banks have reduces all the benchmark rates. This has led to a reduction in PLR of most of the banks, and changes are that it may further go down. This will reduce the cost of money, liquidity will be readily available. This will make most of the projects viable again and work will start on some of the projects which are stuck because lack of funds. Infect we have already started seeing some improvements on this front. Back to back price hike by cement companies is a good example of a robust demand for cement. This indicates a revival in construction and real estate companies as well. Auto numbers also indicate a robust domestic demand. Also RIL’s has commenced gas production from KG basin, which will save India almost $9 Billion per year. This should help fiscal deficit and reduce dependency of the international crude oil prices.

What should investors do?

All the points mentioned above will drive the SENSEX EPS numbers and smart money will start coming in. I would not suggest taking aggressive bets in the market right now, but fundamentals have started improving and I suggest a SIP would be a good approach to the market from here on. After all it’s not possible to predict the bottom of the market.

Long term investing

Image via Wikipedia

Since I started investing the one thing that crossed me highest number of times is advice to invest for "Long term". Though in all the articles I read the definition of long term was not very clear or was at east not consistent. So even today when some one talks about long term I get confuse .

though there are two things I have observed about long term investing.

1) If you press "ctrl F" and type Warren Buffet and then enter the chances are very high that you will find a match. it can be an advertisement of a book teaching you long term investment or some excerpts from some of his old interviews or an example on how he has made money

2) It reminds me of a story I read in 5th standard about five blind men touching an elephant, they all try to picture the elephant depending on what part they touched. the story holds true for long term investing as well. The term assumes different meaning depending on who is using it. I have met investors for whom long term was any thing more then a week to some one who says I never want to sell a stock.
what is more interesting is the answer changes depending on whether you are asking the question in a bear market or a bull market. for example in last one year, long term has changed,from about 6 months to 5 years.

also for most of the mortals it is impossible to predict the markets top and bottom, this include most of the people managing big money also. I say this because of the kind of smart money comes in the market just before the doom. Private equity funds collected for investing in real estate companies and in real estate were the highest just before the sub prime happened. Now private equity players are some of the smartest people in investing world. Still remains as vulnerable to markets. The same happened in 2000 when a lot of venture capitalists invested tons of money in anything that ended with ".com".

I am sure investing for long term is not the panacea for making good returns, there are "n" number of examples of this. Century Textile was a one time market darling (with most of other textile companies), which is way below its life time high and has seen two market reallies since then without the price moving closer to it's peak. Also some of the IT companies are miles away from their life time high they made in 1999- 2000, and I have my own doubts about the real estate companies going back to prices they were being quoted in 2007 (I am not saying that all of them will not come back but few of them will definitely perish, even if the company does well there is no guarantee the price will at least in the short term).

At the same time the other side of the story is of companies like Wipro, when the IPO hit the market it was not really received very well by the market, same happened with Infosys, IPO remained unsubscribe. If you discount all the bonuses, split and dividend the opening price was .89 Rupees. now it is about 270. this is a compound interest of about 38%. some other companies like Reliance, Infosys, ITC, HLL have given fantastic returns, the only catch is; When did you buy it and are you still holding on to then.

OK now it looks very simple, Identify the winners and get rid of losers, but then how many investors have done it in lat so many years. let me ask you a few questions.

how many investors have identified the industries whose time is over before the crash?

Did they sell HLL three years back? Or sold Infosys or Wipro around it’s peak saying it’s expensive? (At a PE of more then 500 companies should be considered expensive)
Got out of the market in 1992, 2000, 2007 because it was expensive?

How many would have agreed that Indian market was expensive in 2007? (Indian market had a PE of 25 whereas China was quoting at around 45 so Indian markets were cheap relative to Chinese markets)

How many of us are going to be proved wrong who thinks reality stocks will recover, or who do not think they will recover, or which stocks will/ not recover.

These are million dollar questions and one can loose millions if he get them wrong. Unfortunately no one knows the answers of these questions. You may claim to know but no one can guarantee. And just because you proved right does not mean you were correct. You can be just plain lucky, also just because you proved wrong does not mean you were wrong, you can be plain unlucky.

This is like reading a book on success. I am sure a lot of you would have read books on success. Those are mostly written by people who were successful. The author looks back and says I did following things that made me successful. I bet if you do all what he has mentioned, you can still remain unsuccessful. needless to say you may not do any of them and can still be successful.

Unfortunately many people start investing not because they think they can make money but because their neighbor is making a lot of money. This problem (getting influenced by neighbor) is not limited to retail investor but the biggest of the fund managers also fall prey of it (remember the number of real estate funds which were launched last year). It’s like saying my neighbor’s fever was cure by medicine “A” so I also start taking it. I just double the quantity and I still don’t have fever.

I do not want to get into preaching on what is correct and what is not. I am sure there is enough material available, and one can spend his entire life reading. Most of us who invest are smart enough to know what is correct for us.