Next Innovation That Can Haunt Wall Street - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Next Innovation That Can Haunt Wall Street 

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In this issue:
» Wall Street's latest innovation: The thirty millisecond advantage
» Is the Asian stimulus working?
» Nandan Nilekani logs in to his new Identity
» Predicting the decline of great companies
» ...and more!!

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We don't have any problems with sophisticated computer models competing with humans when it comes to predicting events and their impact on prices in financial marketplaces. As the global financial crisis has shown, models can go horribly wrong, thus denting a big hole in the theory that state-of-the art computer programs have an edge over humans. However, as per a New York Times story, some institutions like Goldman Sachs may have found a way to circumvent this enormous shortcoming of mathematical models. Why try and predict the future when you can perceive the reality a millisecond ahead of others?

If you are one of those who were left scratching their heads over Goldman Sachs' quick return to profitability earlier this month, one of the reasons for the same has been found. Blame it on High-Frequency trading. Allow us to explain.

There seems to be some loophole in regulations that govern marketplaces like Nasdaq that allows some traders to see market orders slightly ahead for everyone else. Now, how about installing a superfast computer that in less than half a second not only sees the market orders but also crunches data so that the same shares could be bought in advance of the actual orders and sold to the same people at a higher price? Of course, the payout per deal could be small but when spread over thousand deals, it could run into millions of dollars, all virtually risk free. A research firm puts the estimates at US$ 21 bn per year.

Looks like good old fundamentals and long-term investing going for a toss? If history is any guide, this 'wonderful' innovation too will one day come back to haunt Wall Street.

01:10  Chart of the day
The common explanation for subsidising cooking fuels is that they have to be made affordable to the poor. But have a look at the price of Kerosene in our equally, if not more, poor neighborhood. The fuel is by far the cheapest in India. Is poverty really the explanation?

Perhaps 'democracy' provides a better answer. There seems to be an inverse correlation between Kerosene prices and the degree of democracy in the region. India, the most democratic nation in South Asia, has the highest subsidy and the lowest Kerosene price. The reverse could be said about Nepal and Pakistan.

Source: Petroleum Planning and Analysis Cell; *As per exchange rates on 2nd July,2009

Former co-chairman of Infosys, Nandan Nilekani begins his journey today as the chairman of the Unique Identification Authority of India (UIAI), and as the person at the helm of an ambitious project that holds tremendous value for every single person in the country. The first batch of these unique identification (UID) numbers will be issued in the next 12 to 18 months, with the nodal agency issuing only the numbers, and its partners like the oil ministry, oil marketing companies, passport offices and the finance ministry issuing the smart cards. The UID will use biometric authentication (like finger prints) to ensure people have a unique number, and thus help facilitate an organised and accurate national verification process. If all goes well, we believe this could mark the beginning of an important trend - of eminent people from the private sector entering public life in a big way.

If the financial meltdown was truly global in scale, it also brought out a unified response from governments and central bankers worldwide, including Asia. And there was a broad consensus on the solution to the crisis - economic stimulus. Now that a few months have passed since the stimulus packages were announced, it is perhaps time to look around to see if the results are starting to show.

The results in Asia at least seem to be positive. For example, as per government data released yesterday, India's core industrial sector i.e., crude oil, oil products, coal, electricity, cement and steel, has registered a growth of 4.8% YoY in the April-June quarter of this fiscal. This is as compared to 3.5% YoY growth that was recorded during the corresponding period last year.

Countries like South Korea are also doing well. As per Bloomberg, its economy in the last quarter grew at the fastest pace in almost six years. China and Singapore are also participating in a regional turnaround. In fact, the Asian Development Bank says that the East Asian economies (i.e., excluding Japan, South Asia and Central Asia) will rebound from the global economic crisis in a 'V-shaped' fashion.

It would seem that the stock markets have presaged this development as can be seen from the rise in the benchmark indices of India, China and South Korea since the start of this fiscal. Investors who kept their faith at a time when there was no cheer from economic data would be reaping rich rewards now. This opportunity was also available to long term investors in India.

Source: Yahoo Finance

If identifying the next great company can make you a fortune, predicting the decline of already great companies can probably save you one. But how can one make the prediction? The balance sheet can give some clues. However, it only captures the past and does not look into the future, because of which you can be easily fooled. Thankfully, events like entry and exit of key employees, slippage in new products, and subtle shifts in the tone of press releases, advertisements and executive speeches also provide clues.

And then there can be the faintest whiff of decay. Take for instance, Microsoft. It has reported its worst fiscal since it went public in 1986. The company's revenue and full-year sales of flagship Windows software have dropped for the first time ever. Many blame it on the decay within the company due to lack of innovation and subsequently failed product launches. In contrast, competitors like Apple and Google have continued to innovate in spite of their size.

There is a lesson here for the large Indian IT companies. They face the risk of becoming conservative and thereby killing the spirit of innovation. This view is shared by many insiders. Mr. S Ramadorai, the CEO of TCS, has recently said that the large Indian IT companies are unsustainable in the current form - as complex organizations made of horizontals, verticals etc. They will sooner or later give way to smaller, nimbler entities grouped around service offerings. From an investing standpoint, it may be noted that Philip Fisher, the doyen of 'growth' investing, placed a huge emphasis on R&D and innovation while picking technology stocks.

At the time of writing, stocks in India were trading on a positive note with buying activity being witnessed in the stocks from the auto and metal space. The BSE-Sensex was trading higher by around 125 points (0.8%). Other Asian markets were also trading in the green, with China (1.3%), Singapore (1.8%) and Japan (1.6%) leading the pack of gainers. Stocks in Europe have opened on a firm note.

04:55  Today's investing mantra
"Bad news is an investor's best friend. It lets you buy a slice of America's future at a marked-down price." - Warren Buffett
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4 Responses to "Next Innovation That Can Haunt Wall Street"

K.G. Rao

Jul 31, 2009

This is about the UIA headed by Mr. Nilekani. EqM has not commented on the project per se, only on Mr Nilekani heading it. No doubt he is a sincere, talented, hardworking technocrat with an impeccable record of delivering the goods and of unimpeachable integrity. He should not have touched this project with a barge pole.

There is already a controversy with Sri Nilakeni saying that cards will be issued to all residents,not only citizens. As in the USA, where the social security number is an important identity, and despite 99 % literacy identity theft is occurring, in India this will no doubt happen much more extensively. There are also no clear indications of the purpose to which these cards will be put, and it is possible the the whole exercise will be another major GOI flop. Let me explain why.

I foresee the following events.
1.Innumerable foreign jaunts for the hordes of IAS officers who will finally execute the project.
2.Posh offices,liveried flunkies and red lighted siren sounding automobiles for the officers,memsahibs and baba-baby log.
3."Kannada Pride" being wounded and "Maratha Manoos" up in arms because of the cards being in English. Finally an outcry for cards in all regional languages.
4.At least 20 % of cards being bogus,issued to dead/non existent/yet-to-be-born people.
5.Huge profits for the contractors who will undertake the project.
6.Vested interests(wolves in sheep's clothing)putting obstacles at every turn on the specious plea that they are protecting the privacy of the individual, which is a very real fear but will be protected only selectively.
7.Huge cost and time overruns.
8.Data being sold by the Babus/ Private sector employees to Telemarketing companies.

We have yet to see a single GOI ID project, for any purpose, being executed with efficiency. The voters ID
cards are a joke, if one considers the numerous errors and gaffes reported. The issue of these, to a limited part of the population, has still not been effective enough for it to be a mandatory requirement for voting.

I am sure readers must be having their own horror stories about voter ID, ration cards and driving licences-in fact, any document issued by the Government, the actual work being outsourced to cheapest tender incompetence. Will it all be a waste of money! I sincerely hope not, but we need to keep our fingers crossed.



Jul 24, 2009

Chart of the Day is interesting. Providing an affordable price level for basic commodities is not merely a function of democracy but it also makes economic sense that we are investing in HR for sustaining a healthy labour force to sustain economic growth in future.



Jul 24, 2009

I think "High-Frequency trading" is pure exploitation of a loophole in the system and milking money. GS is always good in doing that.



Jul 24, 2009

Informative,short and sweet,easily digested,PLAIN SPEAKING-even a lay man like me can follow.

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