Why do leaders always fail to see the coming crisis?

May 12, 2011

In this issue:
» What does Jim Rogers think of silver now?
» Another spectrum fee bounty for the Government
» US will be on gold standard in five years, feels Steve Forbes
» Clients wary of high debt as well as cash with IT companies
» ...and more!

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In his little book Hedgehogging, Barton Biggs, market veteran and the world's top strategist during his times had some interesting anecdotes to share. He mentioned how his employer Morgan Stanley heavily promoted tech and growth stocks way back in 2000 just as the tech bubble was bursting. This is not all. The firm made an exact opposite mistake a few years later in 2003 when it shut down its Asian Equity fund just as mother of all rallies in Asian equities was about to start!

Now, Morgan Stanley is no ordinary firm. It is one of the biggest names in the field of finance and hence, for it to make such basic errors and that too in quick succession is indeed perplexing. But wait, we think we know why these gaffes were committed by the Wall Street giant. You see, people who made business decisions at Morgan Stanley were certainly not investors. They were businesspeople and were given the task of maximising the company's short term profitability. And this is where the whole script starts to go wrong we believe. While business is all about earning maximum possible profits in the near term, investing is a completely different ball game altogether. The latter requires a long-term approach. It requires a tendency to be contrarian and be alone in the crowd. Most businessmen on the other hand take a short term approach. They insist on sticking with what is popular and that which is doing well. Thus, it can now be clearly seen that business executives at Morgan Stanley, on account of their business orientation, ended up taking decisions that were detrimental to long term investment success. Hence, they ended up paying the price for it.

Of course, Morgan Stanley is not alone. There is a whole litany of companies and CEOs who are so obsessed with maximising near term profits that they fail to grasp the big picture. The subprime crisis is another perfect example of this. A lot of successful long term investors did indeed see the coming crisis and even warned about it. But as usual, the warning fell on deaf ears of shrewd, short term profit minded business leaders. To make matters worse, even regulators failed to see the crisis coming. A very important lesson for investors here we believe. They should never take the statements and decisions of leaders at face value. Doing some due diligence of their own would come in quite handy in the long run.

Do you think leaders fail to see the coming crisis? Share your views with us or comment on our facebook page.

 Chart of the day
When it comes to demand for a whole host of commodities out there, China of course is the big elephant in the room. There is no reason why the precious metal gold should be any different. There is, however, one small difference though. While China has already made its impact felt in most commodities, it is yet to do so in gold. As today's chart of the day shows, gold jewelry consumption in China on a per capita basis is amongst the lowest in the world. However, with a fast rising middle class, things could well be different a few years from now. And gold bugs cannot help but rub their hands in glee on the kind of impact this demand surge will have on gold prices. Add to this the Indian demand and it becomes clear that gold mania is here to stay.

Source: World Gold Council

After raking in a bounty of approximately Rs 1 trillion during the last year by auctioning 3G and wireless broadband spectrum, Department of Telecom (DoT) is planning another round of auction this year. Government expects to rake in Rs 800 bn through the proposed auctions which are expected to begin in three months time. This would certainly mean another windfall gain for the exchequer.

However, what remains to be seen is how enthusiastic the telecom operators are for the upcoming bidding process this time around. Last time due to aggressive bidding, spectrum prices in some of the circles went to irrational levels. So much so, that spectrum which is considered to be a "crown jewel" for telecom companies ultimately became a "winners curse". And the situation this time around could be no different.

Currently, the bid capacity of most telecom companies is minimal thanks to the stretched balance sheets resulting from the initial bidding which concluded last year. However, spectrum is a feedstock for telecom companies and no company can do without it. Thus, companies with inadequate/insufficient spectrum would be eager to have a go. However, only time can tell whether the price they paid would be equivalent to the value they expect from it.

Steve Forbes, the publisher of the famed Forbes Magazine has made a startling prediction. According to him, there is a fair likelihood that the US will return to the gold standard within five years. This seems the only way to correct the fiscal and monetary imbalances, the dire consequences of which the US economy is facing now.

What would a return to the gold standard mean? One obvious effect of this would be stabilisation of the dollar by deterring excess fiscal spending and reckless money printing. If the gold standard hadn't been abandoned, the dollar would not only have been stronger but also less volatile. In fact, the housing bubble which was a precursor to the financial crisis was largely pumped up by the US Fed's loose monetary policy. A gold standard would make it difficult for governments to borrow too heavily, a reality that exists now.

Though a return to the gold standard may seem implausible given the Fed's current slant, the chorus in support of a gold-backed currency is gaining momentum. We believe the gold standard will be the perfect cure for many of the current financial maladies plaguing the global economy.

Jim Rogers is no novice to commodities and investments. He describes that the recent commodity crash as nothing unusual. Corrections happen all the time in markets, he says. And he is convinced that the prices of scarce commodities like oil and precious metals will continue to be on an upward trend for a number of years to come. Well, we hope that investors find his words reassuring. Over the past week silver dropped 25% in value in its biggest correction since the 1980s. The metal was hit by a successive margin increases implemented by the commodity exchanges that nearly doubled trading costs. This was mainly done to curb speculation in the silver prices, which rose nearly 27% since April 2011. Oil prices also fell over 13%. But, now that silver prices have retreated, Rogers continues to remain optimistic. He wants to buy more silver. But one thing he wants to short is US Treasury bonds. He expects that the end of the Fed's quantitative easing (QE) program will pressure government bonds. With a large majority of investors bearish on US bonds, it still looks like commodities may still be the best long term bet.

'Too much of anything can be bad'. This seems to be the case for the Indian IT (Information Technology) companies. Customers like investors have started questioning companies that have excess cash or excess debt as the case maybe. Companies like iGate have come under the scanner for holding huge amounts of debt. The company has nearly US$ 700 m of debt related to its acquisition of Patni Computer Systems. Customers are carrying out a much more intense financial due diligence of the company to ensure that nothing goes wrong with the company, which would hamper their own business interests.

Infosys has come under the scanner for its huge pile of cash of US$ 3.8 bn. Clients have become skeptical of the company's cash balance as well as high operating margins and are demanding lower billing rates. The alternative for Infosys is to either utilize this cash for new acquisitions or develop niche capabilities so that they can support their pricing. Or to yield to customer pressure and lower billing rates, which would hurt the company's profitability. In any case, holding too much cash without deploying it for furthering business growth or holding too much debt is bad for any company. And even Infosys is no exception to the rule as it is realizing thanks to its customers.

Meanwhile, after starting the day on a flat note, indices in the Indian stock market have plunged deep into the red. Sensex was trading lower by 200 points at the time of writing. ICICI Bank and HDFC were seen losing the most amongst blue chips. Almost all Asian indices also closed in the red today and Europe too has opened on a negative note.

 Today's investing mantra
"To me, it's obvious that the winner has to bet very selectively. It's been obvious to me since very early in life. I don't know why it's not obvious to very many other people." - Charlie Munger

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6 Responses to "Why do leaders always fail to see the coming crisis?"

Daniel Menezes

May 15, 2011

Because, they're leaders no more!



May 13, 2011

I still can't understand what is infy doing



May 12, 2011

They must be knowing about the comming crisis or at least they know that sonething is amiss. They are more bothered about the short term because their pay packets & bonuses & allowances & what not, are due next
month. They know that in the long term they would probably be dead. It makes no sense to get a
fat pay cheque after death.


R S Chakravarti

May 12, 2011

Large corporations didn't get where they are by thinking only in the short term. Why is Morgan Stanley different, according to you? There is something wrong with your analysis.


Anupam garg

May 12, 2011

wht on earth do u think of investors? we havn't done a ph.d in stcok analysis & no, we ain't super smart & instinctive like Mr. buffett. If tht were the case, thr wld not hav been any need 4 top leaders, or even website like urs

I remember the time of the crisis. I got the hunch tht all was not well & started inquiring. I pleaded to a few to b cautious, shouted at few for being so stupid to still invest & cried out loud as i felt tht the world had decided to cheat me.

& at the end of it all, i did feel cheated. i was kept under a well built illusion. Not only the leaders failed miserably, the much trustworthy regulators didn't do anything. In fact, they turned out to b major culprits. m surprised tht the investor community didn't go completely mad.

So what shld i do now? turn my back at every person on earth & say, 'sorry i can't trust u'...i can't, i must invest. Its not me who needs to learn, its the leaders & regulators who still don't feel any shame or any guilt in what they did with my trust. & tht's coz they weren't brought 2 justice. the only guilt the investor community shld hav is tht he didn't do anything to punish them. But rational investor knows tht david vs goliath is only a myth.

But then agn, the leaders shld know now tht testing investor's patience anymore wld b absolutely stupid on their part coz bad experience is a school tht only fools keep going to, & i ain't no fool.

The contrasting examples presented in ur take on IT industry is interesting. Both firms hav highly different fundamentals. But one must understand tht both hav to respond to their family of shareholders & creditors. While the cash rich may not face much heat by changing its stand, the debt ridden will hav hard time answering its family's questions on the logic of its decision...especially tht of the acquisition, no matter how synergetic it may prove.


vaibhav joshi

May 12, 2011

Today's Wrap up is best.

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