The secret behind Warren Buffett's optimism

Feb 5, 2009

In this issue:
» Fortune digs out a chart from history
» Why Ford was out of its mind and Tata Motors' wasn't
» US financial industry to be tightly regulated
» Nasscom predicts lower IT growth
» ...and more!

Fortune, one of US' leading business magazine, has just published a chart. It depicts the relationship between the total market value of US stocks and the country's GNP (gross national product) over a period of time, starting from as back as 1924. What is so special about the chart you would say? Well, in late January it reached a point, which according to Warren Buffett, one of the most successful investors walking the planet today, signals a very good time to buy stocks.

Buffett believes that if the percentage relationship between market value of US stocks and its GNP falls between 70% and 80%, then buying stocks is likely to work out very well for investors. In late January, the percentage had touched the 75% mark, thus pointing towards high odds of attractive returns in stock market based on Buffett's metric.

Source: Fortune

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It should be noted that in the aftermath of the event that sowed the seeds of the last bull-run, the ratio stood at 133%. This could be an indication that an even bigger bull run is staring us in the face. For all the things that Buffett is known for, we are quite sure that none of those things pertain to taking broad market based calls. He has done it very sparingly indeed, although the success ratio has been higher than even the most adept economists can boast of.

His last call had come only a few months ago when he wrote an op-ed for the New York Times stating that stocks have begun looking attractive and if they continue to fall further, he will move to 100% equities in his personal portfolio.

The Tatas have received a fair amount of flak in recent times for their acquisitions binge at quite a few group companies. None more so than Tata Motors. The company's leveraged buyout of JLR (Jaguar-Land Rover), which with the benefit of hindsight can now be thought of as ill-timed, has caused enormous heartburn for shareholders. The wealth destruction in the past one year alone has been in the region of US$ 5 bn with the company losing as much as 82% of its market cap from its 52-week high. Not a good sight indeed. Recently though, the deal has received an endorsement from the most unlikely of quarters. It is from a man that has given value creation a whole new name - EVA, or economic value added.

Joel Stern, co founder of Stern Stewart and Co., the firm that has devised the value measuring metric, spoke to one of India's leading business dailies on a wide variety of things. And when the topic of JLR acquisition came up, he had the following to say, "The Tatas' timing wasn't great. But there's always tomorrow. As long, as they have enough equity to carry through into two-three years from now then the Tata-JLR deal would be fine. Plus it was a distressed price. He paid almost nothing for it."

Mr. Stern even went to add that while someone in Ford (the erstwhile owner of JLR) had lost his mind, Tatas have turned out to be smart. Words that will no doubt give the men running the beleaguered company a huge shot in the arm.

Barack Obama's stimulus package of US$ 819 bn may have received the thumbs up, but the House of Representatives voting to require that the public works projects financed by this package use only American iron and steel is sure to raise controversies. In fact, keeping this in mind, Obama has announced his intention of removing the 'Buy American' restrictions cautious of not wanting to breach any international trade agreements.

Not to be deterred, foreign firms themselves are strengthening their presence in the US and hiring staff from there. These firms are also lining up to be doled out a slice of the stimulus pie. In the longer interests of the US, it does not make sense for the country to resort to protectionist measures which besides sparking trade wars does also not bode well given that the financial crisis has nearly engulfed many countries across continents.

In fact, at a time when the unemployment rate in the US has surged to 7.2%, if foreign firms are expanding operations in the US and hiring people from there, so much the better for the country.

After nearly three decades of de-regulation, a wide spectrum of financial services in the US would once again be brought under strict legislations. These would not just control the unregulated bodies but also make the executives responsible for their decisions. The purpose is to craft a framework of financial regulations influenced by the lessons learnt from the current crisis. A welcome move indeed!

Down and out they may be, but come year end and US banks will once again start considering big ticket deals with debt component as high as 50%. This is a prediction that has been made by private equity giant Carlyle's founder, Rubenstein. In fact, even in the current environment, he does not feel that lack of deals in the private equity space is because of credit crunch. He is of the belief that asset prices are the problem and not the lack of leverage. "Why pay 50 cents on the dollar when one can pay 30 cents on the dollar in a few month's time", Rubenstein explains his stand.

The pinch that Indian IT companies is facing, has come out clear in their representative's voice as well. Nasscom, or National Association of Software and Services Companies, has lowered its guidance for growth of Indian IT services in FY09. The representative body now estimates that India's IT and BPO export revenue would grow by only 16 to 17% during the current fiscal, lower than its earlier estimates of a 21 to 24% growth. This downgrade comes on the back of global economic turmoil and tighter IT spends - two key factors that have also been mentioned by managements of Indian IT companies. Nasscom has also lowered its FY10 guidance. The US$ 60 bn Indian IT and BPO exports target that it had estimated for FY10 has now been pushed to FY11.

Outsourcing has always been a sensitive topic in developed countries. Now with the economic crisis resulting in a rash of job cuts, the voices against outsourcing have become even more shrill, especially in companies like Microsoft and IBM that recently announced layoffs. It may be noted that hi-tech industries in the US have cut nearly 187,000 jobs in 2008. In fact, according to the US Labor Department, 3.6 m additional people have become unemployed since recession began in December 2007. While there are those like Alliance IBM, the union of technology workers at IBM who lead campaigns against outsourcing, most managements believe that it is inevitable given that it delivers cost benefits to customers.

Most Asian indices had another red letter day today with the Indian benchmark, BSE-Sensex amongst the worst hit, losing a little over 1%. The selling seems to have been sparked off by concerns over the deepening global recession. All the major European indices are also trading in the red currently. Weakness was also witnessed in the US markets yesterday as both the key benchmark viz. Dow and the Nasdaq edged lower on the back of weak earnings from some prominent US corporates.

Crude oil in the meanwhile, traded little changed from its previous closing as OPEC production cut impact canceled out higher inventory reports in the US and weak demand.

 Today's investing mantra
"I spend about 15 minutes a year on economic analysis. The way you lose money in the stock market is to start off with an economic picture. I also spend 15 minutes a year on where the stock market is going." - Peter Lynch

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