More trillion dollar losses coming - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

More trillion dollar losses coming 

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In this issue:
» With 'Sun', Oracle heats up competition to IBM
» Buffett's judgement on banks
» RBI nudges banks for rate cuts in monetary policy
» The power of brand 'Tata'
» ...and more!

While the risk of a second Great Depression could have been well and truly averted, we are far from seeing a bottom and major US financial institutions still have huge write-offs to make. This statement must have surely thrown cold water over the belief of investors who had started to think that a bull market rally has indeed begun. And there is all the more reason to get worried if it comes from a man who has perhaps done a better job than anybody in predicting the global financial crisis. Dr. Nouriel Roubini, who has earned the nickname 'Dr Doomsday' was speaking with a leading daily and the crux of his interaction has been summed up in the opening sentence of this paragraph.

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If one were go into details, on the positive earnings numbers of US banks, Dr. Roubini opined that although numbers are good, once you scratch the surface, the institutions look much weaker than they actually are as they have not provisioned enough for their losses. Secondly, the change in accounting policies is also helping them hide losses. But soon reality will catch up with them and looking at the overall macroeconomic scenario, he does not any reason as to why they will not make more write downs worth trillions of dollars. Dr Roubini also called the current stock market rally as a bear market sucker's rally simply because of the fact that the current recession is going to last much longer than the previous ones and the magnitude of the economic contraction is also going to be huge. It goes without saying that the Indian markets will not be decoupled from the repercussions of the pullback.

Where the Big Blue (IBM) failed, Oracle is about to succeed. We are talking about the latter's proposed takeover of Sun Microsystems for US$ 7.4 bn, or 14% higher than what IBM had originally bid at, and failed. However, as reported by DNA Money, the Oracle's rationale for acquiring Sun is different from IBM's. As the report states, "While IBM's play for Sun was seen as an attempt to have a stranglehold on the $85 billion global data centre business, particularly in the backdrop of the entry of Cisco Systems Inc. into the space, Oracle's pitch for the systems integrator makes sense from an altogether different perspective - its software."

While globally, the Oracle-Sun combination will bring it closer to the heels of IBM and Microsoft in terms of size, the impact in India is not seen to be big enough given the small proportion of the employee base of these companies working here.

In the last 18 months, global banks have eroded the maximum investor wealth than ever before. The legendary Warren Buffett thinks this is because the banks have done dumb things while running an otherwise smart business. The Oracle of Omaha who through his investment firm Berkshire Hathaway is one of the largest shareholders in one of best American banks Wells Fargo, has in an interview to CNN explained how banks have a simple business and can generate huge earning power. Equating that to the earning power of companies like Coca Cola, Buffett has explained that you cannot take away the potential in the growing customer base of a bank. As long as the spreads (difference between borrowing and lending rates) on assets are wide enough, the bank will have to do really dumb things to not make profits. Like lending on wafer think margins to grow their business or taking undue risks. Having said that, Buffett believes that returns on assets is the best yardstick to judge the earnings ability of a bank provided there is an intelligent review of the quality of earnings and the off-balance sheet items.

In its annual review of the monetary policy for 2008-09 released today, the central bank exercised its power to reduce the benchmark repo and reverse repo rates by 0.25% each and encouraged banks to augment their credit growth rates. Nevertheless, the RBI's half a dozen rate cut measures so far have not had the desired impact on the prime lending rates of several private sector and foreign banks. The PSU banks which were more proactive in responding to the RBI's cues largely outperformed their private sector and foreign peers in terms of incremental lending.

The central bank has, however, reiterated that while public investment can play a critical role in the short-term during a downturn, private investment has to increase as the recovery process sets in. A major macroeconomic challenge at this juncture is to support the drivers of aggregate demand to enable the economy return to its high growth trajectory. The RBI's rate cut move therefore stand well justified. Now, it is for the banks to act.

The most common refrain of CEOs these days is 'cost-cutting'. In the US, president Obama himself is setting the precedent. As per CNN Money, Obama has asked his cabinet to collectively cut US$ 100 m from their budgets. But the move is more symbolic than anything else. After all, the amount is only 0.003 % of the US budget or 0.006% of its budget deficit. But all such cuts would hardly make a dent in what is upending the country's chance at long-term fiscal balance - the rising costs of medicare and social security. It is believed that by 2030, the cost of medicare, social security and interest payments will consume all of US' tax revenues.

The great Indian middle class is now the focus of attention and for good reasons. Expected to touch 400 m people by FY10E, the middle income household earning be-tween Rs75, 000 and Rs5 lakh a year accounts for 61% of total urban income. While the metros continue to be the largest urban middle-class markets, tier II cites are fast catching up. Increase in the number of middle- and upper-income households has expanded the consumption, creating a strong pull factor to consume certain products and services. Not only FMCG companies (over 70% sales of FMCG products are made to middle class households), but also other consumption driven companies are eyeing this opportunity as this segment is expected to fuel growth in the long run. While Tata Motors launched the cheapest car Nano, Indian hotels have priced their Ginger Hotels below Rs 1,000 to attract these households. The real estate, malls and mobile companies have also lined up strategies to target this segment.

Image source: Livemint

A report by Brand Finance Plc., a UK based independent brand valuation consultant, has estimated that the top 500 global brands lost about 25% of their value in 2008 due to the global financial meltdown. But the 'Tata' brand held up relatively well against this, eroding by less than 16%. Tata is the only Indian brand in the top 100 of the rankings, and held the 51st position for 2009, up six places from its ranking for 2008. The consultant found the Tata brand to be worth US$ 9.9 bn and its 16% decline in value was moderate against the huge 40% to 60% slump in brand value of many iconic brands over the same period. For example, brand Citi recorded a 59% erosion in value, Dell 60%, Mercedes-Benz 48%, and AIG 62%. Mr. Gopalakrishnan, the executive director of Tata Sons said that the brand didn't take a hard hit in relative terms for various reasons, and that "The brand has been built on a platform of a century of ethical behaviour." We couldn't agree more! Incidentally, the year saw Wal-Mart emerge as the world's top-ranked brand, thus displacing Coca-Cola which held top spot last year.

Despite the RBI's favourable policy measures, the Indian benchmark BSE-Sensex joined the pack of losers in Asia and closed the day with losses of around 0.7%. The BSE Midcap and Smallcap indices shed 0.2% and 0.4% respectively. The European markets, meanwhile, have opened on a positive note.

04:55  Today's investing mantra
"Upon leaving the derivatives business, our feelings about the business mirrored a line in a country song: "I liked you better before I got to know you so wel" - Warren Buffett in 2008 Letter to Shareholders of Berkshire Hathaway
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