Buffett predicts greater unemployment - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Buffett predicts greater unemployment 

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In this issue:
» The week that was
» Indian banks better than peers
» 25 years to reach previous high?
» ...and more!

Stories of paid leaves, pay cuts and job losses continue to pour in. The financial sector has been the worst hit. Citigroup has announced that it plans to cut 52,000 jobs in the coming year. That is twice the earlier layoff plan and 15% of its 352,000 strong workforce. Temasek, Singapore's state-owned investment company has announced a companywide pay cut. In fact, as per reports, financial job losses may double to 350,000 by 2009. Reductions on that scale would be equivalent to 20% of the global workforce at financial companies before the credit crisis began.

The IT sector is facing the heat too. Indian IT major Infosys has given its employees the option to take a 1-year break and pursue philanthropic activities. They will continue to receive 50% of their salaries. There are also reports that nearly 500,000 jobs might be lost in the Indian textile sector in the next 5 months.

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In an interview with Fox Business, Warren Buffett has commented on the unemployment situation. He says, "There are going to be more people unemployed...but I'm not worried about how we come out in the end. I mean, I'm not worried about five years from now. Five months from now, can be very painful...it will be considerably higher... it will not turn around by mid-year next year."

The mood across the global markets continues to be pretty sombre and indices oscillate wildly, alternating between despair and hope. Stock markets in the US edged lower with the Dow declining 5% during the week gone by.

Sensex, the Indian benchmark, ended in the red on 4 days. Although it bounced back on Friday, the decline for the week stood at 5%. The realty sector continued to take a severe beating with the sector index falling by as much as 18%.

The US auto industry has closely followed the US financial industry to the brink of failure. Hit by the biggest sales decline in nearly 25 years, GM has lost US$ 2.5 bn in the third quarter and if the current woes persist, the company might not be around by the time the year 2010 unfolds. Quite expectedly then, it is seeking a small slice of US$ 700 bn aid that the US government has passed on to the financial sector, to help it tide over the current crisis and enable it to come out with more fuel efficient and smaller cars.

Jack Welch, the former Chairman and CEO of General Electric, says that the US auto industry should not be bailed out. He believes that a bailout would only put the companies on a 'life support system', whereas a complete overhaul is the need of the hour. Bankruptcy proceedings will enable renegotiation with all the stakeholders and facilitate a meaningful structural change.

Crude oil declined by 9% during the week to US$ 49.9 a barrel. Gold prices moved in the opposite direction to end 9% higher at US$ 801 an ounce. Crude oil is now at 1/3rd of its all time peak of US$ 147 per barrel achieved in July 2008. While this brings much needed respite from inflationary pressures to countries like China and India, the producing countries are shell-shocked. They had planned huge public expenditure programs on the back of record prices for their bountiful crude oil reserves. The crash in the second half of the year is forcing them to take a second look at many of these programs.

US president elect Barack Obama has chosen his Treasury secretary. Timothy Geithner, who heads the Federal Reserve Bank of New York, will steer the world's largest economy in what has turned out to be its largest economic crisis since 1929. The Dow gave the decision a thumbs-up with a 6.5% surge on Friday.

Indian banks are dwarfed by their Chinese counterparts when it comes to balance sheet size. However, the same may not be a cause for indignity at a time when global banks with massive sizes have had to counter some of the most colossal problems. As per China Banking Regulatory Commission, Chinese banks' combined assets totaled US$ 8.7 trillion at the end of September 2008. The RBI data revealed that Indian banks had outstanding loans of US$ 510 bn (approx. Rs 25 trillion) at the same time. Moreover, as per the RBI, Indian banks have just US$ 1 bn of toxic western assets out of the total loan portfolio of US$ 510 bn.

25 years is a long-long time...especially if you are talking of the 25 years of 1929 to 1954. In this period, the Second World War started and ended killing 50 m worldwide, the first nuclear bomb was detonated as mankind developed the means to destroy itself, and Communist China was founded as a single territorial unit with a common administration. 25 years is certainly a long time for even long term investors. This is because it took these 25 years for the US stock markets to come back to their previous high of the pre-Great Depression levels - August 1929 to November 1954 to be exact.

And many are comparing the current financial turmoil with the Great Depression and the crisis period following it.

So is the current crisis a repeat of 1929? Are you, as an investor, staring at another 25 years to get your money back from stocks? We believe not really.

The 1929 stock market crisis was built on immense speculation in stocks. And banks were a key party to this mania. They (banks) aggressively expanded their loans given out to buy stocks. Investors could easily borrow up to 75% of the value of a stock purchase. In fact, by 1929, when the bubble reached its peak, almost 40% of US banks' loans were lent to buy stocks.

Auto majors like GM and Chrysler who are staring at bankruptcy now, were making tens of billions of dollars available to their employees as stock purchase loans. And as the Wall Street Journal reports, a company called Cities Service issued new shares, collected cash and used this to make loans for people to buy stocks. Such was the mania!

And when the bubble burst, the already weak banking system was crushed under its own weight. Over the next two years, almost 1,300 banks had closed. And since there was nothing like a Federal Deposit Insurance Corp. (which provides deposit insurance which currently guarantees the safety of deposits up to US$ 250,000 per depositor per bank), depositors lost everything.

During the depths of the depression, around 25% of US population was out of work. The Dow Jones Industrial Index had fallen almost 90%. The entire US banking system was shut for four days by presidential order.

Now you may wonder, aren't we facing a similar situation today? Banks are failing worldwide, markets are panicky and unemployment is rising.

Before arriving at any conclusions, it is important to understand the big differences between the crisis of today and the Great Depression and what would not make the latter repeat itself. The biggest difference is the massive intervention by the world's central banks. The US Fed, for instance, is now doing what it was intended to do when it was formed - not to prevent recessions, but to prevent the implosion of the financial system.

And they are trying to do just the same, by infusing liquidity in the system and by cutting interest rates to spur growth (the Fed has cut interest rates nine times since the credit crisis began in September 2007). The US$ 700 bn bailout bill and the fiscal stimulus measures that have been enacted this year, although controversial, also show that the US government is willing to intervene in the financial system to keep it afloat. Similar measures are being taken by policymakers across the world, including India.

Contrast this with what the Fed was doing post the crash of 1929 - it raised interest rates, thereby draining liquidity from the system, deciding that it was best to stamp out speculation. Although economists still debate the exact causes of the Great Depression, the Fed's moves are often considered one of the prime reasons the economy tumbled so hard.

Another difference between 1929's and today's crisis is that this time around banks made loans against houses, assets that should continue to have at least some value.

So, while we remain unsure as to where the stocks markets will head over the next few months, we believe that the wait to respite won't be 25 years ahead. Central banks' actions, though controversial at times, have raised some hopes.

Specifically for India, we believe that the economy is going through an absolutely critical point in its own transition, and see a lot of opportunity for companies across sectors like financial services, information technology, manufacturing, materials or energy.

India is a market, a story, a country and an economy domestic and international investors need to take seriously. The transformation in India has always been in fits and starts, meaning one step forward and one step back. But we now see more steps forward than we see steps backward and that encourages us a lot. And in the long run, the country is surely going to pull it off.

You as an investor need to stay the course. Live within your means. Reduce your debt. Keep saving...and investing. When the cycle turns, and it will, you will be glad you pulled the trigger.

04:45  Weekend investing mantra
"It's true, of course, that, in the long run, the scoreboard for investment decisions is market price. But prices will be determined by future earnings. In investing, just as in baseball, to put runs on the scoreboard one must watch the playing field, not the scoreboard." - Warren Buffett
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