We are in recession and what to do now ?

Recently, I posted an answer to the question of a blogger:


QUESTION

We are in recession and what to do now ?

The subprime wipeout alone, says history's best paid fund manager John Paulson, will last the next two and a half years. Even Merrill Lynch says Wall Street is "in denial" about a U.S. recession -- because recession has already arrived. "According to our analysis," one of the firm's most recent reports says, "this isn't even a forecast any more but is a present day reality."

Goldman Sachs agrees. And other big-time analysts are lining up to say the same. We're 'undoubtedly in a recession," says famous investor Jim Rogers. And Nouriel Roubini, the economist who called the housing bust, calls today the "tipping point" for U.S. consumers.

"The effects will be ugly," Roubini just told CBS Marketwatch "Expect the great recession of 2007 to be much nastier, deeper and more protracted than the 2001 recession." Even AT&T says they've had to cut record numbers of phone and broadband accounts because customers can't meet their bills.

What will be the impact on Indian / Chinese stock markets will more funds drive them up ?


ANSWER

As with most other downturns, this one has been induced by people buying “stories” ignoring caution and commonsense.

Let’s looks at some of the bubbles to get a perspective:

In March 2000, the NASDAQ hit 5,049, followed by a sell-off. The market plunged downward, reaching its bottom of 1,114 on October 9, 2002. People bought stocks with a belief that a “new economy” had emerged in which technology ensured that recessions were a thing of the past and productivity gains would continue at levels that formerly had seemed unattainable.

In 1989, the Nikkei hit its all time high of 38,916, and then slid downward for more than a decade, reaching its bottom of 12,698 in 2001. After a decade of deflation and banking reform, the Nikkei hit a five-year high in January 2006, about 33 percent of its peak value.

However, asset bubbles are not a recent phenomenon, nor are they limited to stock markets. The Dutch Tulip bubble of the 17th century was one of the most dramatic examples. As the price of tulip bulbs increased, speculators began buying the bulbs from sailors and selling them to the wealthy. It is estimated that a bulb at the peak of the bubble sold for $34,584 in today’s dollars. Eventually, some investors began to liquidate their interests in tulips, supply increased dramatically, and during a six week period in 1636, tulip prices fell by 90 percent. To limit the chaos that followed, the government nullified all tulip contracts and declared tulip speculation a form of gambling. Tulip prices never recovered after the bubble burst, and today rare tulip bulbs sell for $0.30 to $0.40 apiece

Recent bubbles have been induced by “reckless” action from the US Fed. This is called the “Fed Put” - the Fed trying to rescue careless investors and traders by cutting interest rates. This action has created one bubble after the other – Nasdaq, Sub Prime, and the next could be emerging market equities and industrial commodities.

People have definitely bought into the “decoupling theory” and the “TINA – There is no alternative” theory, pumping money into India, China, Gold, Oil – you name it !!! US Dollar has been reaching new lows, creating problems for exporters (into the US), but providing better gains for investors in assets denominated in currencies other than the USD.

What will happen in future ? There are a few golden rules which probably will not be violated this time too
a) During a downturn, money flows into the home market
b) If there is a recession in the US, no country can fully decouple itself and maintain its growth rate
c) Reckless rate cuts will only stoke inflation rather providing a real impetus to growth (China is currently witnessing inflation of over 6% and the authorities have committed themselves to fight it through a tight monetary policy). Despite the heavy fall in short term interest rates in the US, the long term interest rates have refused to budge, indicating bullishness on inflation trends.

How do you position yourself ?

a) Act like a hedge fund; have a long-and short strategy. Immediately switch out of stocks that are dependent on discretionary consumer spending in the US. You can buy into emerging market equities on dips, but buy into those stocks which have lower export component and are fairly valued. Don’t buy stocks whose valuations are can be justified only by a great growth story.
b) If you play commodities, play agri-commodities – the switch from food to fuel is unlikely reverse in a hurry and will help maintain an upward bias on prices.
c) If you are currency trader, short the dollar and the pound and go long on the Chinese Yuan. The Chinese government is not answerable to its people and will not mind paying the cost of holding a huge forex reserve (the reserve is already worth about $1.6 trillion – over 50% of its GDP). The government is in NO mood to let the currency seek its natural level and China's trade surplus is not going to disappear in a hurry.

If the inter-connectedness of the global economy and the consequent complexity creates anxiety in you, Welcome to the Club !!!

A Visionary's Dream - Now a Reality

Disclosure: I work for the Tata Group and hence you should take my comments with a pinch of salt.
Disclaimer: These are my personal views and do not necessarily reflect the views of my organisation.

Tata Motors has unveiled its "People' Car". Some eminent personalities of the automobile industry have been ridiculing the idea that such a car can be produced at a price tag of Rs. 1 lakh ($2500), but they would have been surprised, if not shocked today.

A visionary's dream has become reality, with the help of hunderds of ambitious, talented, and dedicated engineers and managers. The small car is an engineering marvel and has been aptly named the Nano.

I disagree with the views of the so-called environmentalists opposing the car. Their only concern is the price tag. They are not able to digest the fact that millions of people will now be able to afford a car that until now only the affluent section of the Indian society could afford. The people's car has silenced its critics by meeting or exceeding all the legal and regulatory requirements on safety and emissions. The so-called environmentalists now have absolutely no moral standing to speak against this car.

I think this a great moment in the history of the Indian (and global) automobile industry. Come, cherish this moment at http://tatapeoplescar.com/tatamotors/

The Climate Change Conundrum

Yvo de Boer, Executive Secretary, UNFCC, at an OPEC seminar, says "OPEC part of the solution to climate change, not part of the problem" (source: UNFCC website). He might have actually committed a faux pas by making a statement like this. The world's largest cartel's greed sees no end and oil at $100 per barrel is just a matter of time. Higher the price of oil, higher will be the investment in "Green Technologies". Did Yvo de Boer mean OPEC's greed helps the cause of reversing climate change ?
What about a new slogan for green initiatives - "Opec's Envy, IPCC's Pride", on the lines of Onida's tagline ('Neighbor's Envy, Owner's Pride').

The IPCC report released yesterday points to some ominous signs. Not only does the report suggest that humankind is the cause of global warming, but also states that the results of inaction could be devastating.

United Nations Climate Change conference will be held in Indonesia during the first two weeks of December. Policymakers will begin to discuss a global climate change treaty that will replace the Kyoto protocol, expiring in 2012. Can they persuade the US and Australia to finally commit to reducing emissions ? And what about India and China ? Though the per capita emissions of these countries is far lower than the developed nations, there will be increasing pressure on them to commit to capping the overall emissions.

Meanwhile, climate change has become a big business and this lobby could induce a change in the stance of of politicians who believe that climate change action could hurt the economy. Policymakers are looking at near-term concerns, but one cannot miss the point that only those nations that are endowed with fossil fuels have to worry in the long run, unless they act decisively to invest their spoils (accrued through the high price of oil) in taking stakes in companies that own 'green technologies'.

Bangalore - the new home to IBM's Chief HR Officer ??

The Economist carries an interesting article:
Hungry Tiger, Dancing Elephant - How India is changing IBM's world

The article analyzes how IBM is changing its business strategy to take advantage of the talent-pool available in India. India is fast becoming the country that houses the maximum number of IBM employees. IBM's business in India is growing @ 40% to 50%. IBM has realized that to compete with top-tier Indian companies it needs to leverage the global service delivery model (pioneered by Tata Consultancy Services - India's largest IT services company) - the model comprising of onsite, offshore and nearshore business development centres.

People who have worked at some point in time in the Indian software industry would know that TCS has a much better and robust business model when compared to the other top-tier companies. Its clientile, focus on innovation and creation of knowledge assets, best-in-class processes, and a deep talent pool have placed it in a strong position to leverage the opportunites that globalization creates, without eroding its short-term competitiveness.

IBM's chief procurement officer John Paterson moved office to China. (Read http://av.blogspot.com/2007/04/offshoring-corner-office.html)

I would not be surprised if within the next couple of years, IBM's Chief HR Officer moves office to Bangalore...

Private Equity Boom - How long will it last ??

MUST READ
An amazing article (in the CFO magazine dated 1st Apr, 2007) on the private equity (PE) boom
http://www.cfo.com/article.cfm/8909971/1/c_8910395?f=home_magazine

Refer to my comments posted on this blog on March 30th
http://av.blogspot.com/2007/03/fallout-of-ballooning-asset-bubble.html

Making Mumbai an International Financial Centre

A high-powered expert committee has come out with a report on how Mumbai can join the league of New York and London in the export of International Financial Services.

A summary of the report:
http://finmin.nic.in/press_room/2007/gist_of_report.pdf

It is a well-known fact that India has the basic ingredients for Mumbai to emerge as a world-class IFC. Technologically advanced stock exchanges, intellectual capital, a growing domestic economy, and its strong and independent institutions (market regulation, democracy, judiciary, and the press).

However, the report cites inadequate liquidity in the debt, currency, and related derivatives markets as a major hindrance. The debt for the recent large M&A deals announced by Indian companies were raised abroad. Apart from foreign debt being cheaper, the Indian market does not have the liquidity to manage such deal sizes.

The Reserve Bank of India is uncomfortable with speculative positions on currency. It allows taking positions only for hedging balance sheet exposure. The committee has recommended full capital convertibility (removal of all restrictions on currency transactions).

The report also urges the government to act to bring Mumbai upto world standards in urban infrastructure and governance, so that it attracts immigrants from all over the world.

In a lighter vein, if Mumbai does indeed become an IFC, inbound immigration service could become a great money spinner sooner than later.

Buffett's Annual Letter to Shareholders

Every year Warren Buffett, the world’s most legendary (and richest) investor, makes his annual letter to shareholders public. As always, the 2007 letter is a good read (its labeled “2006″ because its a report about last year).

As always, this year, his thoughts range quite widely. A few parts caught my attention:
His company increased in value by $ 16.9 billion in 2006 - the biggest single year value gain in corporate history (or so they think). Berkshire-Hathaway owns more than 60 companies, including insurance, clothing, furniture, jewelry and candy companies, restaurants, natural gas and corporate jet firms .

He has announced his retirement, but still don’t have a successor for him. But he is not handing over to children, nor ducking the decision. That would be to risk, in his own words, “decay… accompanied by my delusional thinking that I am reaching new heights of managerial brilliance”.
“Our most important business, insurance, benefited from a large dose of luck: Mother Nature, bless her heart, went on vacation. After hammering us with hurricanes in 2004 and 2005 — storms that caused us to lose a bundle on super-cat insurance — she just vanished. Last year, the red ink from this activity turned black, very black.”

Buffett expresses regret at the passing of traditional climate patterns, and had similar sentiments for the glory days of the newspaper industry (another big industry for Berkshire-Hathaway), where he thinks that “eroding fundamentals will overwhelm managerial brilliance”. Even if “non-economic buyers” emerge for newspapers “the ‘psychic’ value of possessing one will wane”.

Buffett does not expect that upcoming disclosure rules will put a stop to “astronomical” executive compensation, often unrelated to performance. That will “only occur if the largest institutional shareholders - it would only take a few - demand a fresh look at the whole system”.

Offshoring the Corner Office ???

The link below leads you to an excellent article. It explains how Globalization is creating a shift in the country from which senior management operates

http://www.cfo.com/article.cfm/8834573?f=related

Though the article discusses the phenomenon of senior management team operating in different locations to capitalize on business opportunites, the idea of moving decision making jobs to low-cost locations is increasingly debated in mainstream media.

George David, Chairman of United Technologies, a Fortune 50 company, had earned $88 million in compensation in 2005. He had jokingly suggested outsourcing his own job to India.

The advent of KPO as a business model has increasingly made analytics based decision making "outsourceable". Technology has reduced distance. Travel has become faster and easier.

In such a scenario, it may not be long before boards demand outsourcing management jobs to the country with a vast pool of high quality managers - India.

Fallout of the ballooning asset bubble....

Global M&A topped 1 trillion USD in the first three months of this year (Jan '07 to Mar '07) reports Financial Times.

This is 15% higher than same period last year. What is causing such a frentic activity ? The surge of liquidity in the last two years, has been blamed for most of the excesses.

Is this a bubble that is likely to burst and have far reaching consequences on the economy ???

How do bubbles get created in the first place ? Bubbles are created when the fundamentals of an underlying asset are ignored and purchasing decisions are based on just one factor - "is someone likely to buy from me at higher price later?"

The newspaper DNA reported about Mumbai's first real estate bubble
http://www.dnaindia.com/report.asp?NewsID=1082931

The $1000 billion worth of deals would have been financed primarily through LBO funds and a sizeable portion of it would have involved private equity players. The modus operandi - borrow money cheap, buy out, show short term improvement in operations, sell out. But what is strange is that players like Blackstone are raising money by taking their company public rather than selling their investments - "same phenomenon of expecting to sell assets at a higher price eventually?"

Let us hope that there is no sudden panic which would cause manic deleveraging. Otherwise it would lead to severe pain in the world's financial system.

How do you protect yourself ? If you are holding on to a risky asset, it is time you diversified or managed the risk by buying some form of insurance.