The Importance of the Step Function

Stocks on Radar - GIC Housing Finance

The most important thing in life is freedom - particularly intellectual freedom. And in my quest for intellectual freedom, I think I have discovered some unusual things. Perhaps the most important of these is the step function.

I think human beings have an innate attraction for the linear function. So, we try to reduce everything to linearilites. Force =mass * acceleration, Price =EPS*P/E multiple etc. Over centuries, we have also become more comfortable with the cubic order equations. Where, however, we fail is the step function.

What I have observed, and this might be wrong, is that while systems often change state linearly, at some crucial times, systems jump from one state to another. This is most readily observed in stock markets. Markets might not adjust to something (say subprime) for months, and then in 2 days, there would be crash-and-burn and the system moves to another state. Weather systems also seem to follow a similar pattern - that is why climate scientists are worried that we might jump to a state of no-return in our fight against global warming.

Why is this important? Because, in stock markets, the point of maximum profits is the point of the step change. Simply extrapolating last 3 years revenue growth, margins and ROEs into the future is wrong and dangerous. And we might be more close to a step change in the global economic, political and social outlook than we have been in the last few years.

My personal life has definitely moved in step functions. Nothing will happen for years, and then suddenly, something will happen which will take into another state for the next few years.

Citi's 11% convertible bond placement with Abu Dhabi

I was wondering what forced Citi to place this $7.5 billion bond at such a high yield. After-all, Citi can raise high-yield debt at less than 9%. And this bond has a convertible option, so the yield should have been lesser.

Then I read this statement in Citi's press release - "The payment rate reflects market terms based on the conversion premium as well as Citi's current dividend yield." Citi's current dividend yield is 7%. So the yield on bond is 4%. Is this the correct way to think about it? Maybe yes. After-all, why will anyone buy a mandatorily converible bond if the bond yield is less than the current dividend yield. The investor would be better off simply buying the stock in the open market.

For Citi, this is better than selling stock at current depressed price of $30 (conversion price is $31.83 to $37.24). But it would have been better if they had stuck this deal when the stock was at $40 a month ago, when the full extent of their SIV troubles was already known. At that time they could have saved 2%-3% in interest cost, besides striking a higher conversion price.

Trip to Bhopal

I went to Bhopal last weekend to visit my sister. It is a really nice city, with some good tourist attractions. I would recommend anyone to go there for a weekend. As wikitravel doesn't do justice to Bhopal, I thought I will write a brief review here.

Places to see:

a) Bhimbetka - A World Heritage site in Bhopal !! I wasn't aware of this. It has some of the oldest cave paintings in India and in the world. So this is where one finds the earliest signs of human life in India. On some of the stone walls, there are a 10000 year old, a 5000 year old and a 2000 year old drawings, all side by side. The place is called Bhimbetka because according to legend, the Pandavas stayed here while in exile. There is a rock high above where Bhim is supposed to have sat (so Bhim + beth, i.e. sit in Hindi). Ask for Mr Rai as the guide - he is an old chap but his voice really rings out loud. http://en.wikipedia.org/wiki/Rock_Shelters_of_Bhimbetka

b) Bhojeshwar Temple in Bhojpur has the largest Shivling in India. Incidentally, Bhopal is named after Raja Bhoj (of Gangu teli fame).

c) Lakes - Many lakes in the city. Bada Taal is really huge. One can do kayaking/boating in "Bada taal", and then go to Cafe Coffee Day on the hill to drink coffee while having a nice view of the lake.

My sister took me to a couple of really good restaurants. I forget the name. Sorry!!

Stocks on radar

CNBC ran a 5 min clip on holding stocks trading at huge discount to assets. With the current run up in stock prices, one can argue that the stocks that these holding stocks own are expensive, rather than the holding companies being cheap. Still, it will be useful to have these on radar. TCI Finance, which owns Gati, could be interesting.

Mcdowell Holdings
Nagreeka Capital
TCI Finance
BNK Capital

Selling EWH and VBC Ferro Alloys

I sold the two speculative stocks that I had in my portfolio last week. EWH - the Hong Kong Index - was sold a mere 2 days after it was first purchased. I sold it at a loss of about 4% (at $23.10). As it was a speculative position and I was investing in an unknown, my stop loss was very low. I am happy that I got out soon as EWH has kept dropping - today it is at $21.14.

Net net, with the gains in VWO last month and the loss in EWH this month, I made roughly 7% in a month and a half on 25K. Speculation can be rewarding.

I also sold VBC Ferro Alloys in India at Rs 365. I had purchased it at Rs 351. I can see why this stock should do well in the current power craze in Indian stock markets as the company owns 10%-15% odd in Konaseema Gas Power plant. At Rs 365, VBC Ferro is trading close to book value when power stocks in India are trading at 3x-4x book. Still I sold, as I think the noose is tighetining around speculators. US is going to flirt with a recession in 6 months if not earlier.

I own 3 stocks in my PA now:
a) Blue Dart - trading at 15x Dec08 P/E and growing at 30% yoy. Almost a monopoly in overnight courier business. While competition is hotting up with Gati starting services soon, the stock is cheap. Plus DHL (Blue Dart's majority owner) came out with its open offer last year at 550. Stock is now at 565. I plan to keep this forever.

b) Deccan Chronicle - While corporate governance is questionable, I love newspaper stocks. At 15x March08 P/E, it is cheaper than US newspaper companies. I plan to keep this forever.

c) Omaxe - Some money should be invested on speculation - this is my speculative stock these days.

The Party Continues - Buying EWH

Selling VWO last week looks like a wrong idea now. It is now at 116, while I sold it at 109.45. So, I have become even more speculative now. I have bought EWH - the Hong Kong Index ETF. It is up 55% in 2 months, and I am buying it at its lifetime high. So I now join the army of China lovers.

Why buy EWH? Few reasons:

• High likelihood that Fed cuts on Wednesday.
• Since Hong Kong Dollar is pegged to US dollar, Hong Kong will follow US monetary policy. i.e. rates in Hong Kong will go down, whether HK authorities want or not.
• Chinese Olympics next year - rally in China should continue till that time.
• If China allows its citizens to invest in HK, HK will boom as it has been for the last 2 months.

The Party is Over - for the time being

If India crashes today - post the SEBI proposal to reign in P-Notes - I think markets worldwide take a hit. Why? Because it is the BRICs which are supposed to save the world from US housing disaster. Anyways it is becoming difficult for the DOW and S&P500 to break into new highs. Credit concerns still exist - witness the creation of the master fund by Citi. IFN was down 8% in NYSE. Lets see if Sensex tanks by 1000+ points.

I sold VWO yesterday at 109.45 - 30 min before SEBI came out with the notification. Call it luck. I bought it at 100.50. 9% profit in a month is not bad - is it? Thats the party.

YHOO bet low expectations yesterday, Intel had a blowout quarter, while IBM was in line.. Will this offset the impact of Sensex's crash on the DOW.

This Friday is the 20th anniversary of Black October.

Is the party getting over?

It is becoming difficult for DOW to get to new highs. Plus Ericsson warned majorly today. Yahoo is reporting today, and if previous quarters are any guide it will be a mess. Tech has been outperformer in the last month (see Nasdaq). If tech takes a hit today, then we have a problem. Then oil is also touching $88.

Note that when I mention in the previous post that oil is going to $60, it is pure speculation. I am not an oil analyst and have no clue on inventories of oil etc. Speculating is a useful art that I am trying to learn.

Tata Power went up by 20% today. Look at the difference between the valuation of Reliance Energy and Tata Power now. One can argue that Tata Power can also set up a subsidiary like Reliance Energy is doing with Reliance Power and get the same crazy valuation. I am speculating on Tata Power tomorrow.

This is getting crazy by the day. $5 billion companies gain 20% on no news.

Sensex at 18000

I mentioned here a month ago that Sensex will cross 18000.(http://gaurav1.blogspot.com/2007/09/definition-of-inflation-and-deflation.html),

I had predicted here 2 months ago that oil is crossing 85 this time.(http://gaurav1.blogspot.com/2007/08/august-blues.html)

Oil is now falling to $60 by January. Why? Seasonality. Last year it fell to $50 in early January. Lets see if the pattern repeats itself.

Philosophy of Investing

What exactly is my philosophy of investing?

Almost everyone who is a professional investor has a philosophy. Some swear by technical analysis, while many swear by fundamental analysis. Some are growth investors, others are value investors, and still others are momentum investors. What is intriguing is that the different classes of investors often do not see eye to eye. Technical analysts think fundamental analysts are bullshitting while fundamental analysts think technical analysis is a joke. Value investors think growth and momentum investors are gamblers. Growth investors argue value investors are Buffets wannabes who often get stuck in value traps.

Where am I?

I think something is true about all the approaches. However, at a particular point of time, one philosphy is more true than others. My philosophy is to figure out which philosophy is the truest of all at any point of time with respect to any particular security or the entire market.

My target is to have a 20% return each year with minimal risk. I do not define risk in terms of volatility of the portfolio. Rather, I define risk as the ratio of the number of days when I have negative returns versus number of days I have positive returns, weighted by the daily returns.

I dont care whether that 20% return comes from fundamental investing, momentum investing, technical charting, or what not. What I care is the following.

A) Will the security give me 20% annualized return.
B) Under which philosophy am I investing in the security.
C) If I am wrong, I should NOT switch to any other philosophy to justify my purchase.

How did I come up with 20% benchmark. Well, Buffet has compounded the book value of Berkshire Hathway at 21% over the last 40 years. If I do 20%, it is great.

When Price itself becomes the Biggest Variable

Normally, in economics, we try to argue for a particular price for an object based on supply-demand. But that is true only under normal cicumstances. In some situations though, price itself is the variable that impacts future prices. This is what people are doing when they are looking at charts and doing "momentum" investing.

And this is what might now happen in US housing. If home prices fall by 9% (at least the prices of new homes for sale has fallen by that in the report released yesterday, exisiting home sale price declines are much lower), why would anyone who has little equity in the home pay the full mortgage, whether employed or not? This would increase foreclosures, bring more houses on the market, further depress housing prices and accentuate the downward movement. I am sure Fed will be forced to intervene even more heavily than it already has (though I dont know when they will intervene). Though what they can do to move the 10yr bond (which determines mortgage rates) is open to speculation. Remember Fed controls the 3 month rate. The 10 yr rate is determined in the market, and with dollar depreciating on rate cuts, whether foreign investors will continue to invest in 10yr treasury bonds as Fed cuts more is an open question.

For stocks, momentum is often the best play. Look at Reliance in the last 2 months here in India. As Mr Steve Edney of Citadel had told me all those years ago, there are just two factors determing stock prices - earnings revisions and price momentum. But momentum cuts both ways, just like leverage.

So whats my portfolio now. 100% equities. I bought VWO heavily the day Fed cut rates by 50bp, which was 10 days ago. There is momentum in emerging markets. Dollar is weakening and commodities are going up which will benefit emerging markets. Plus 4th qtr is upon us - the best qtr for stock indices. The only risk is that next month is October - the deadliest month for markets (Oct 1929, Oct 1987, Oct 1998). It might be deadly this time if Fed doesnt cut. In India I bought ICICI, and it is already up 10%. Long live Momentum.

The Asymmetric Definitions of Inflation and Deflation

How can someone be short the markets when the central bank's definition of inflation excludes asset price inflation (as well as oil and food), but the definition of deflation includes asset price deflation? The Fed is concerned with a credit crunch impacting growth. A credit crunch will happen whenever asset prices decline. So the Fed is concerned with asset price declines. So they will always cut when asset prices fall. At the same time they won't do anything if asset prices rise, because it doesn't get included in calculation of core CPI. So one should always be long.

I was wrong. The bottom happened on August 16 - the day Fed cut the discount rate. I mentioned to Akshat that day that Indian markets are going to 18000, but never acted. Plus the tape kept telling and I kept ignoring. Lesson learnt - never bet against the Fed. Fed moves the markets.

The Fed Meets Tomorrow

And it will be something to see.

Japan is not raising interest rates anytime soon, contrary to what I thought 3 weeks ago. Their Prime Minister Mr. Abe has resigned and 2Q GDP growth came out -ve. So the yen carry trade is not unwinding anytime soon.

I need to figure out where to invest in Indian markets.

Why People Could Walk Away from their Homes even when Employed

I suddenly had a brilliant idea. Bulls on housing say that as long as people have jobs, they will keep paying their mortgages. But suppose the price of my own falls by, say 10%. Then, it might be better for me to walk away from the mortgage on that home, and buy the same home at 10% lesser price. My decision will depend on how much equity I have built into my previous home, as there will be penalties associated with walking away from my old mortgage. Plus, because of my now suspect credit history, my new mortgage might be at a higher interest rate. But, at a certain level of decline in the price of my old home, that could be a worthwhile tradeoff. So the rate of home price decline could be a more important variable than the rate of employment.

There is an entire category of people in the US who have very little equity in their homes today - they took option ARMs in the last 2 years. Why shouldn't they let their house go into foreclosure - whether they are prime or subprime, and whether are employed or not - when the ARMs reset in the next year or so?

In 1988 in Japan, people used to take 3-generation mortgages to pay off the loan on their house. Thereafter, real estate prices collapsed by 50% (or 30% or 80%, need to check on this). Why didn't people just walk away from their loans? Maybe they did. And banks became insolvent because of the NPAs. But because of the guarantee of the Japanese government, there were no failed banks. That is what maybe commentrators mean that Japanese just prolonged their agony by supporting their banks.

The Federal Reserve Policy - from here

That the Fed will cut on Sep 18 is a certainity - Fed doesn't like surprising markets. The question is - will Fed cut down all the way to 4.50 by the end of the year?

The Fed wants to balance growth and inflation. Growth is equivalent to reduction in unemployment.

Right now, the trouble in the real economy is in the housing market. Still, unemployment rate has remained low at 4.6%. At its August meeting, the Fed cut its outlook for growth for 2H by 25bps, without changing its inflation outlook, because of lower productivity gains (I predicted this correctly http://gaurav1.blogspot.com/2007/08/fed-meeting.html). What this implies is that if Fed cuts too much and ends up stimulating the economy, growth could be above trend and lead to unemployment rate remaining where it is (or decline). This could worsen inflation over time. Recall that after Sep 1998, Fed cut by 75 bps, and that was enough to start the tech bubble.

Has what happened last month increased the chances of higher unemployment going forward? That is the only reason Fed should cut substantially. I don't know the answer to that. Unless Fed is convinced that unemployment rate is headed to 5%, they shouldn't cut substantially.

What is happening in US is interesting. Is it possible that strong exports to a strong world economy offset weak domestic growth in US? Then you might continue to have strong employment.

Another issue is this - the current problem is in the asset backed commercial paper market, where investors don't trust assets underlying some of the conduits. Even if Fed cuts rates, these mortgage backed assets are not regaining investors confidence anytime soon, because of the suspect credibility of their ratings. It is very likely that more rating downgrades by S&P, Moodys are on the way - $120bn of subprime ARMs are being reset this qtr and next. So some other AAA CDOs are going to 0. Investors are already looking at the scenario and refusing to rollover the CP backing these securities. So the Fed could cut rates by 25 bps, and CP market could continue facing issues.

Am I wrong?

Am I wrong in being too bearish on the market? That markets have gone up in the last week after Fed cut its discount rate was expected. But is this crazy?

Markets are not stupid. Last year too in late July, markets started moving up after Ben Bernanke's testimony to the Congress, when the Israel-Palestine war was still on and oil was going crazy, and people were worried that Fed would raise interest rates again. Is it that even this year, a bottom has been set amidst the chaos, and markets are going up from here.

Why should one be bullish?

a) Fed will cut rates on Sep 18.
b) Global growth remains strong. This will be enough to offset any weakness in US housing.
c) US I-banks are well capitalized and they will be able to withstand the loan losses on the financing deals with PE players. All this deal financing issue is a temporary hiccup, and PE mergermania is soon going to be replaced by corporate mergermania and stock takeovers.

The most important question is - what will the Fed do? Will it cut or not? Lets consider the two scenarios:

Fed cuts: Considering that the 3 month T-bill is still yielding 4.5%, much below 5.25%, one can argue that credit conditions are still distressed, even though equity markets have moved up in the last week. So Fed should cut. (By Sep 18, this argument might not hold water. But lets assume Fed cuts). Markets rally on Sep 18.

However, BOJ also holds its next monetary policy meeting on Sep 18 and Sep 19. If markets stabilize by Sep 18 (and rally on Sep 18 because Fed cuts), BOJ will in all likelihood raise rates on Sep 19, after having decided not to raise it last week due to worsening global conditions.

The dollar-yen carry trade will get whipsawed on both sides. If Fed cuts and BOJ raises rates, the interest differential between USD and Yen has narrowed by 50bps - a very significant amount. The risk to unwinding dollar-yen carry trades is indeed high then.

Fed doesnt cut: Considering that Fed futures are pricing in a 100% probability of a rate cut, markets will surely dive if Fed doesn't cut.

Considering Fed doesn't like to surprise markets, I think a Fed cut is certain, simply because Fed futures are pricing in 100%. It will not help Fed's credibility if they say we are not cutting, markets seize up again, and they end up again lowering the discount rate or the Fed funds rate.
But one can also argue Fed won't cut. Things have only improved since they cut the discount rate. So then why should they cut the Fed funds rate? It is very tricky this time.

But whatever they do, I think there is a high likelihood that markets get whipsawed on Sep 18 and Sep 19.

Over the next 1 year, I think the US housing market will take its toll. This is US housing - the biggest category of US aggregate wealth. It will have lost 10% of its value by next year. Why will this deflation not spread to other asset classes? With a lot of mortgage bankers in bankruptcy now, the fight for market share has gone down => crazy mortgages are gone. Plus rates just went up in August - the impact of which is going to come after a few months. I dont think a 25 or 50 bps cut by the Fed will save housing from here. The Fed needs to cut steeply if it has to save housing. But that will risk inflation and declining dollar.

Maybe I am wrong and it will all turn out to be fine. After all, the people at Fed have spent their lives with this stuff, while I have been reading this only in the last 3 years. Lets see how this evolves.

From Excess Liquidity to Credit Crunch.. Gone in 2 weeks

The last week I was on vacation in France and Switzerland. I found a nice castle to get married in France next year, of which I have forgotten the name. I will post the link as soon as I remember.

A lot of drama happened in the markets when I was away, especially last week. Please read WSJ to get more details. And the Fed cut its bank lending rate by 50bps on Friday, because of which all the markets are up today.

A lot of pain of recent days has been on the quant funds. Some of them seem to have become even for the year (esp. AQR, Renaissance) after the jump in the last 2 days. They have all been delevering for sure. But overall in the long run, quant funds will make money, unless they are so overleveraged that they go under when markets make 5 std deviation moves against them. Goldman will make money on the $2billion it put in its quant fund for sure.

I think the next issues would be these -

(a) Are all the hedge funds and money market fund blowups over? It is the money market fund blowups (which were holding AAA rated sub-prime paper) that has shaken investors, who are now questioning the very credibility of AAA rating. And if investors ask higher returns to hold the AAA paper, it implies credit spreads have widened. All this credit crunch is more of a ratings credibility issue than anything else.

(b) What happens to the $300 bn+ LBO financing coming up in the next few months? In some cases, offers will be revised down, like with Home Depot supply chain sale. In others, PE and I-banks will take a hit.

(c) What are the quarterly results for I-banks? Note that some of them operate on Aug-end quarter, and almost half of the quarter would have virtually no I-banking/debt market activity. The big question would be - how did the prop trading desks of the banks do? This is where the Mogans and Goldmans of the world have been minting money over the years. Were their traders smart to make money even this time?

(d) And the most important of all - will the Fed really cut rates on or before Sep 18. And how much will it cut? The Fed has not cut rates on Friday - it has lowered the rates at which banks can borrow directly from it (which is now 50bps higher than its fed funds rates, in normal times nobody borrows from the Fed as it is considered a sign of weak credit). So homeowners are still squeezed in US - their rates are determined by the Fed Funds rates.

(e) If the Fed has to cut a lot to stabilize the markets, dollar would depreciate sharply because capital will flow out of a low interest bearing currency. Or it could appreciate if investors seek safety of US treasuries. Or it can remain stable because both these effects offset. And how does this impact other currencies (Yen, Euro) - I have no idea. This could turn into a currency crises, or it may not. Note that Australian Dollar and NZ currency had their biggest declines last week as investors unwound carry trades.

I still think that there will be a lot of volatility in the markets, and a better time to invest would come probably next month. As somebody said, people have lost more money catching the first 5% move than they made in next 95% move. I will wait and not invest in the first 5%.

Going into unchartered territories

The ECB and Fed injected liquidity into the markets today. ECB allowed european banks to borrow close to 100 billion euros. Reason was that liquidity pressures developed in the call money market, and call rates moved up significantly higher - above the European fund rate. This is almost like a run on a bank. This happened because BNP Paribas lost money in 3 of its money market funds today due to AAA rated subprime blowup. Is my money in Vanguard money market accounts safe??

With this, I think we enter unchartered territories. Risk spreads are not going back to last months levels in a lifetime. I don't know where markets are headed in the next 2 months. But they won't be where anyone expects them to be. This is going to be the best learning experience that I have so far had. Will the Fed cut? How deep will the turmoil be? Will it impact economic growth?

Fed Meeting

It was exactly a year ago that Fed stopped raising rates. And perhaps this meeting is as crucial as that one for the outlook of markets over next few months. For, at both times, markets were pretty rocky just prior to the meeting.

Some people expect the Fed to change its language to signal risks of inflation and growth are now evenly balanced, vs inflation being a primary worry of the Fed till last meeting. After all, housing has been much worse than expected.

Question is: what level of growth is the Fed comfortable with? Recent revisions to historical data suggest productivity growth in last 3 years was slower than earlier reported. If productivity growth is lower, then the economy's growth potential is also lower. So while 2H growth outlook has come down following housing decline, this might now fit with the new reduced growth potential of economy.So the risks could still be towards inflation. But a few data points on productivity don't make a trend.

I am sure Fed will not move to neutral simply because of recent market volatility. While troubling, it is hardly a systemic threat. True some lenders and funds have blown up, but it is not the job of Fed to prevent every small $500 million blowup. True credit markets are seized up, but this is not LTCM with 6 sigma credit spreads. Credit spreads right now are more in line with historical averages. They are wider compared to where they should be because of low bankruptcy rate today.But they are not in unchartered territory.

A true test of whether risks are really dispersed enough globally would be to not intervene in the market and see how it plays out. One should also recall that Fed tightened in summer of 2000 when internet bubble burst, and didn't intervene till fall 2000. I vaguely recall Greenspan saying somewhere that we should let hypothetical bubbles build and if real, clean up the bubble after it has burst, rather than preventing a hypothetical bubble forming in the first place, as it might not be a bubble. If Fed signals it will be cutting rates, it would have let a bubble build and prevented it from a hypothetical bursting.For all the hue and cry of the last 2 weeks, Dow is off just 5% off its peak.

Why India Should Raise Capital Gains Taxes?

I think I found the perfect answer to two problems facing India.

a) Widening disparity between rich and poor
b) Currency appreciation because of huge capital inflows

Simple. The government should increase long-term capital gains taxes from the stupidly low 0%. Which country in the world has these kind of taxes? Manmohan Singh complaints that CEOs are making 5 crore in salary. They have made much more through stock appreciation. True stock markets will take a hit, and true that capital will flow out suddenly. But I think a 10%-15% capital gains tax is justifiable and can be justified to investors. It is better than the capital controls that RBI hinted to in its credit policy and which would really hurt investor sentiment towards India.

If Democrats seize power in next year's Presidential elections, expect a tax hike in US too. I also figured out the debate over taxes that PE pays. Currently they pay capital gains taxes (15%) on the gains they make by buying and selling companies. Some people are now arguing that since it is the job of PE guys to buy and sell companies, the gains should be considered as income and taxed at income tax rate (35%), rather than capital gains tax rate. I am in the camp of higher tax rates to lower income disparities. I think government is a better circulator of wealth than PE guys through their charities (the argument being made by PE guys as to why they shouldn't be taxed highly). The assumption, of course, that I am making here is that a equal society is better than an unequal one.

August Blues

So finally, we have entered the period of volatility that I had been expecting since March. Considering that S&P is up 3% for the year while I have made 2.5% in my bank account (in dollars), cash hasn't been that bad.

But still, the major markets of the world are only 5% off their peaks. That's a very minor correction, considering that we have been up 30% since last july, from the day of Bernanke's testimony in congress in 2006, and the end of Israeli-Palestine conflict.

Yesterday, the Dow rallied by about 250 points in the last 20 min of trading, after having been down as much as 100 points. Clearly, this kind of volatility is unsettling.

The Fed meets next week. If they as much mention that they are aware of the turmoil in the credit markets, markets will rally in anticipation of a rate cut. What would be best is markets keep oscillating around current levels for next week, Fed again says that inflation is still a concern, and markets correct after that.

Then after 15 Aug, we enter hurricane season. I wouldn't be surprised if oil jumps to 85 this time. At least one hurricane always goes by Gulf of Mexico. If that were to happen, markets will shake, on concerns of declining consumer spending.

And finally, BOJ meets on 22 Aug. After the defeat of the ruling party in recent elections, I am not sure how they are thinking and whether they will raise rates. But if they do, that would be the really big headwind facing the markets.

I am convinced markets will end up 10% for the year. I am also convinced that a better entry point will occur in mid september.

A perfect short - if it ever gets listed.

The last few months have nothing been short of hectic. Hopefully I will be able to post more regularly now.

So here is where I stand today. I have 10% of the money in the two stocks I own - American Tower and Idearc. Idearc is up nicely, up about 35%, besides its 5% dividend yield. AMT is flat. Besides this, 40% of my money is in Vanguard S&P and Global fund, which has been a good strategy. 50% is in cash, which has been a bad choice, considering that I relocated to India and dollar depreciated in the last few months.

Should I change my asset allocation? Problem is - if I cash out of my Vanguard funds, I will pay short-term capital gains tax. At the same time, the market has gone up in a straight line since last September, except for a brief pause in February. While there is no point fighting the tape, at some point something unexpected is bound to occur. But can I really invest for the unexpected?

What are interesting stocks going forward? It will be difficult to follow the US markets now that my focus is in India. So this blog would become more focused on Indian stocks from now.

Here, it seems I have found the perfect short. It is called NHPC - National HydroElectric Power Corporation. It is currently owned by the government, and has filed for its IPO. If and when that IPO happens, one should go long it to make a quick buck. Over the long run though, this company is a Ponzi scheme.

The company's ROI is less than 5%, and it appears to have always been below 5%. The company survives on generous equity infusions by the government each year. What it means is that the company will keep diluting its equityholders each year after becoming public to fund any of the projects it talks so enthusiastically in its IPO. The government of India has really sent taxpayer's money down the drain with this company.

I am sure the IPO will zoom the first day of trading as happened with PFC. At that time, it would be a very good short for the long run.

The Markets - Last Few Months and Going Forward

Since September 2006, markets have gone in just one direction - up - except for a brief pause in Feb. The Dow has now risen in 11 out of the last 12 days, and is now threatening the 13000 mark. I moved half of my portfolio into cash after the markets crashed in February. That in hindsight was not right. Dow and S&P are up 4% now for the year. However, I have moved the other half into cash this last week. Why am I bearish on the market?

There are two reasons for this. First is seasonality. Traditionally, markets are weak between May and September. Almost all the stock market gains over the last 100 years have come between the months of October and March. Second is - this April reminds me of last April. All assets are going up at the same time. Commodities are going up, gold is back above $700, even prices of agriculture commodities are increasing rapidly. There seems to be a general bullishness.

Currently, the earnings season is underway and companies are most likely to beat the 3.3% in operating profit growth forecasted by Wall Street by a wide margin. Once the earnings season is over in the first week of May, markets are again going to start focusing on economic news. That is when things might get a bit tough.

But for the year, I think markets will be up quite handsomely. This is the third year in the US presidential cycle, when markets are up something like 90% of the time. Dont ask me the reason - maybe the President tries to boost the economy to get reelected. But that is a historical fact over the last 100 years.

I sold Motorla in Jaunary at $18 - after they blew up another quarter. What I learned is this - product cycles in tech can be very volatile. Motorola went from beating analyst estimates widely to missing analyst estimates widely in a few months. Just one of their products - Razr - was accounting for the majority of their operating profits. When it fell, they couldn't use it any further to subsidize lower margin products to capture market share.

I also sold DRC at $25 - now the stock is at $32. Lesson I learned - be patient with a good stock. Net net, I lost $100 on the two stocks (Motorola and DRC), but Smith Barney brokerage took another $140 in brokerage commisions to hand me a loss of $240. Good that I am leaving Citi and escaping their clutches. Now I can trade more freely.