'These are the real villains of the financial crisis'

Oct 11, 2010

In this issue:
» Why gold can still go up a great deal
» Good times coming to an end for commodity users
» Real estate riding high on the liquidity wave
» Lessons the US should take from Japan
» ...and more!!

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Imagine a stock with an intrinsic value of Rs 100 per share. The stock would indeed be more attractive when bought at Rs 40 than 60. However, there is a school of thought out there which believes that Rs 60 should be the right answer. Shocked? Well, the school further believes that it does not really matter if a company takes on too much debt. After all, debt and equity are the same.

Do you think the guys behind such foolish assumptions deserve any mention at all? Certainly not. But what if we tell you that they have gone on to receive the highest honour there is in the field of economics, The Nobel Prize. Yes, that's correct. In 1990, three gentlemen viz. Markowitz, Sharpe and Miller received the Nobel Prize in Economics for theories which had the above flawed assumptions and some more as their core. What more, the Nobel Prize also gave these guys such a reputation that some of the most reputed financial institutions in the world began using their theories indiscriminately.

Needless to say, sooner or later these theories ought to have met with disaster. And they frequently did. But the havoc that such theories created during the recent financial crisis made everyone sit up and take notice. So much so that these theories are now being very seriously questioned by experts the world over. Nassim Nicholas Taleb, author of the widely acclaimed 'The Black Swan' is one such man. 'I want to make the Nobel accountable', Taleb thundered in a recent interview. He has however not put the blame on the economists but has rather held the Nobel Prize committee as the main villains. He is of the view that no one would have taken these economists seriously had it not been for their Nobel prize. If you think that Taleb is indeed correct, let us know or post your comments on our Facebook page.

 Chart of the day
Today's chart of the day is perhaps another reason as to why despite going up continuously over the last decade, gold may still not be in a bubble territory. As the chart shows, gold and gold mining shares as a percentage of global assets were just a puny 0.8% in 2009. This compares with a range between 20%-30% during some of the years of the previous century. Even if gold was to achieve half of the historical levels, the surge in the price of yellow metal can only be imagined. Thus, if you haven't already made gold a part of your portfolio, it isn't very late to do it now.

Source: Casey's Daily Dispatch

We are not particularly adept at projecting the earnings estimates for the next quarter. Nor do we believe that the same serves the interest of long term investors. However, for those who have not yet been convinced about taking some profits off the table, here is some warning based on quarterly estimates. The dream run in terms of margins that commodity users have had so far may be nearing its end. Commodity prices are off their trough. And despite the benefit of lower input cost coupled with higher realizations, companies may see their earnings growth getting moderated soon. Select companies, however, may get the benefit of a turnaround in their overseas operations. Auto and textile sectors being the prime amongst them. However banks will have to remain cautious about asset quality while sustaining higher NIMs. While robust growth in earnings has been broad-based in the recent past, the same may not be seen for more than a couple of quarters. Hence, all the more reason for investors to ensure that they pay the price for sustainable earnings.

The global economic slowdown sent many investors flocking to US Treasuries. Especially in a scenario where 'safety' gained precedence over 'lucrativeness'. But now with more and more governments in the West steeped in debt, China's bonds are becoming almost safe as US Treasuries. This is because China's economy has been growing at a strong pace and has surpassed Japan to become the world's second-largest economy. The statistics also pile up heavily in favour of China. For instance, according to IMF, government debt in the dragon nation will amount to 22% of GDP this year, compared with 94% in the US, 85% in France and 82% in the UK. It also controls the world's biggest holdings of foreign-exchange reserves. This is about US$ 2.5 trillion, including at least US$ 846 bn of US Treasuries.

Having said that, China has its own set of problems. Property prices there have ballooned, raising fears of a bubble being formed. Growth is expected to slow down a bit. Plus, lack of transparency in the way China manages its economy is also an issue. Certainly, given the kind of debt that has been loaded onto US' balance sheet, safety of US Treasuries is being questioned. But one would still need more compelling reasons to justify that China's bonds are safer than that of the US.

Until recently, even the mention of realty stocks brought back some dreadful memories to investors. They were one of the best performing sectors in the run up to the January 2008 bull market. But have also been by far the worst performers since then. However, something seems to have changed off late. As per a DNA report, the real estate sector has seen 3 qualified institutional placements (QIPs) and an IPO successfully completed in less than a month. The recently closed Oberoi Realty IPO was oversubscribed 12 times. Another one is slated to open tomorrow.

The gushing liquidity in the markets seems to have finally begun affecting real estate stocks too. Investors seem to be betting on the fact that higher liquidity and fund raising will further enable realty companies to hold on to inventory at these high prices, reducing the chances of a correction in realty prices, thus in turn making realty stocks even more attractive. A self-fulfilling cycle where higher prices themselves provide the impetus for prices to move up even further.

In India, car sales volumes have been growing at spectacular rates in the past few months. Car manufacturers have witnessed record levels of sales. They are seeing long queues for their popular models. They are even able to raise prices without seeing a fall in volumes.

However, the question remains as to how long this would continue. Supply constraints on the spare part manufacturers may play spoil sport. While current orders and bookings indicate an excellent festive season sales, however, it may not translate into a healthy pipeline afterwards. The spare part manufacturers just do not have the capacity to deal with the order inflow. They may just meet the current demand but would need further ramping up to ensure the dream run continues into the months after the festive season.

They are the two leading economies in the world. One of them is staring at sluggish economy for several years into the future. The other has already faced such a fate for several years in the past. We are talking about US and Japan. Japan has struggled with a flagging economy for years. To counteract it, it has recently gone for a economic stimulus package to the tune of US$ 61 bn. It includes measures to boost employment, help small and medium sized businesses, and support regional economies. Earlier, it had cut its key interest rate to virtually zero. It has also intervened in currency markets to weaken the yen. The point is, none of these stimulus measures are working for Japan anymore. A lesson, the US would do well to learn. Its economy is also in the doldrums. And sooner or later it will also realise that it cannot stimulate its way out of trouble. The best option is to grin and bear the pain. Let the market forces do their work.

Meanwhile, the benchmark indices faltered today after opening on a strong note. The BSE-Sensex was trading around 70 points higher at the time of writing, some distance off its day's highs. Reliance was helping the index stay firm. Most Asian markets closed firm today whereas Europe has also opened on a positive note.

 Today's investing mantra
"Determine value apart from price; progress apart from activity; wealth apart from size." - Charles Munger

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19 Responses to "'These are the real villains of the financial crisis'"


Oct 13, 2010

I admire both Taleb as well as the Nobel Committee.
I think the moot point is that the regulator's (Central banks & Govt. authorities) have not fully anticipated the effects of exotic financial products (mainly leverage) in the context of financial intelligence of the general public. Why couldn't/can't they attract the kind of talent/experts that eventually end up in the Financial world and use their expertise for their and their organisation's benefit. So, we end up with the core issues of greed and fear, for which there is straight forward solution. Ideally, there should be a global body for financial governance and a balance maintained between the top 50 financial institutions and such a body and Finance committee of top 10 economies by size in terms of the talent pool available. Easier said than done but earlier the better. Ofcourse, which country is represented and how many from each and what is a good talent pool (of financial experts and Industry heads) are questions only the presidents/prime ministers, Finance ministers and Industry heads can define. Should be definitely worth their time. Ofcourse, people with clean images should only be selected.

The said economic theory if used properly can certainly bring huge constructive benefits. A good analogy is the nuclear technology. By 2025, either the world will be able to satisfy its ever growing energy needs or will end blowing itself up. So, we dont blame the guy who invented the nuclear technolgy nor the guys who hand out awards to the well deserved innovators. The blame would be on the UN (& eventually the Central government authorities of the top economies) to not have put in regulatory controls to ensure its right usage.


Akash Sethia

Oct 12, 2010

This is ridiculous. Taleb is wrong and we sitting in judgement on the appropriateness of awards are worse.

Noble (for that matter any award) should not be given because the work done by someone is right or wrong, but for the fact that someone has done some sincere work and has generated some valid outcomes/learning.

If no one questions current wisdom new frontiers of knowledge would never be achieved. Often a judgement will/should go wrong. Thats why it is a judgement. Associating it with motives or even incompetence would be foolish. Nobel has had an exemplary record of choosing some of the best work done across fields, exceptions notwithstanding. Theu are very credible.

With the benefit of hindsight anyone can be called an expert. At least I do not expect such an approach from equitymaster.


Kaustubh Kulkarni

Oct 12, 2010

Indeed Taleb is absolutely right. I am a great admirer of Taleb. I would recommend everybody to read his book "Black Swan". It would change the way one looks at the world.



Oct 12, 2010

Yes I absolutely agree that had it not been for these so called intelligent people at least there would been a milder problem though it would not have eliminated the problem . I am a fan of Taleb who 10 years before 2007 said VAR and risk models used by banks are flawed and they will blow up some day and indeed they blew up . I hope those things dont happen in India


Dr. Atul Tiwari

Oct 12, 2010

Yes he is correct. A word fromnoble prise winner is certified sentance from god & if it is the same word for what he was awarded noble prise, is not justified but a sentance from god. After all all of our todays utensils are derived from principals of nobel award winners. Naturally- if they say any thing about economics, not only people will notice it but practise it, taking it as key to success. So yes- if some body fails, following there priciples, they should be accountable less...but acountable should be the members of Noble selection committee. I agree.



Oct 12, 2010

Gold assets as %-age:::::
The Chart gives some useful info; but could be misleading?
To make a better messaging chart, we need 5-age of allocation of other assets,also.
Why? In the ever changing world, asset allocation keeps changing! Some asset classes might not have existed at old times! (Gold was Old!)
Give 5-ages of ALL MAJOR ASSET CLASSES in the past 50 years; so that we get a better understanding, where is the money going??



Oct 12, 2010

Taleb is certainly right. This must be brought to the notice of the noble committee.



Oct 12, 2010


The prize brought the spot light on these guys.


Uma Krishnan

Oct 12, 2010

Taleb is absolutely right. Time and again Noble committee has blundered in recognising the right talent in the industry. From the very beginning it seems to be the case. When they did not award Noble Peace prize to Mahatma Gandhi, who till date remains the Symbol of peace, then of what use it is to give any weightage to their judgement. Noble prizes have lost their credibility for this one reason itself.


V C Tewari

Oct 11, 2010

If Noble prize was not awarded then no one would have given much thought to their advise. Noble should be questioned.

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