Not a 'Prince'ly affair! - Views on News from Equitymaster

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Not a 'Prince'ly affair!

Nov 5, 2007

Citigroup, the largest financial institution in the world, has warned of another large subprime hit on its books, this time to the tune of US$ 11 bn (it earlier wrote-off US$ 3 bn in the first week of October 2007). And, as a consequence, its CEO, Charles Prince has announced his exit while taking complete responsibility for the said losses. Citigroup will take this write-off from its fourth quarter books. As a matter of fact, the total decline in the institution's subprime portfolio now stands at a huge US$ 55 bn (equals the 2006 GDP of Slovak Republic!). Prince's exit comes as a second for the Wall Street largest banks after the departure of Stanley O'Neal, the Chairman and CEO of Merrill Lynch.

So, is the worst behind us? Or even if it is ahead of us, rest assured that the US Federal Reserve would take care of that - by reducing interest rates further or by adding liquidity to the system! It did so on last Friday, when it injected US$ 41 bn to boost global liquidity and take some pressure off the credit markets.

The release of additional cash at specific rates to the banking system in not a new phenomenon and central banks resort to such tactics to deal with liquidity crises. However, what is really concerning is the way the contagion seems to be spreading across institutions and markets. The inflation in asset prices over the past 3-4 years has been largely a result of high levels of liquidity induced by cheap money globally. Now, with the leading central banks like the US Fed playing pied piper and infusing more of such cheap dollars into the system so as to maintain stability in the 'financial markets' is like adding fuel to fire. Investors need to understand that the sharp rise in stocks prices owing to an inflow of additional low cost global money shall further increase the levels of risks.

What do you do?
Mr. Bernanke might be thanking himself for the way he has sort of steered the global financial markets out of a probable recession by cutting the cost of short-term money. However, the fact that the markets now expect him to follow the last two cuts with a similar one in December shall make matters worse. It is these expectations that have led the rally in global stock markets over the past 2-3 months.

As for the Indian markets, with the passing of yet another round of strong quarterly results, participants shall be looking at the next trigger to take the markets further up from the current levels. While this might mean that stock prices might stay volatile, you, as a long-term investor, can take this market volatility as a way to build a long-term portfolio of solid companies with credible managements. It is imperative to make one's choice by way of doing own groundwork, following the same with conviction and discipline, and leaving aside greed and fear. That could be a good gift you can give yourself this Diwali. Happy investing!

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