Friday, June 27, 2008

Exit Blue Dart

Got out of Blue Dart yesterday - it is cheap on numbers (14x-16x fwd PE). But air frieght business when oil prices are soaring is dicey. Plus, believe it or not, Parliament might actually pass a bill making it mandatory that packages < 500gm only get shipped by India Post. At least there was a 7% type gain.

PSU banks - I am down 40% on Union bank and 5% on Bank of baroda (have held it for 3 years). I will wait for the quarterly numbers before I sell. On the ground, economy is still solid and growing and NPAs are low, so any hit is 6 months away. They have already been hammered so much.

Looks like the Nifty call options are going to expire worthless. The Fed trade didnt work, it actually went the other way.

Oil Price Speculation

There is a fairly large number of people who believe that blaming the oil price rise on speculators is wrong. It is purely supply-demand mismatch etc etc. These include people like Krugman, Ftalphaville, etc.

Surprisingly, these are the same people who believe it was speculators playing on no-down payment loans in a low interest rate scenario who caused real estate prices to go up earlier this decade. Why then isnt it possible that speculators playing on 6% margin in a low interest rate scenario (as it exists today) are behind this sudden crude oil spike?

To the question as to what could have been done to prevent the mortgage boom, their answer is - more regulation by the Fed. But, they are aghast if Congress talks of more regulation of the oil futures market.

It is bizarre. People believe Greenspan failed in not detecting and defusing the real estate bubble in time, but they are in arms if Congress tries to do something on oil. They want oil "markets" to work. Greenspan let mortgage markets work - the outcome is here.

Monday, June 23, 2008

Buying Aban at 3300, and the Fed trade

Today I bought some more of Aban at 3300. Also I had bought Nifty July 5000 call options on Friday. With the kind of inflation (11%) that is there in India and the chances of a policy error high, it is not right to be a bull on India. But then, nothing ever goes down in a straight line. These are all trading positions with a fair chance of losing capital.

The most significant event of this week is the Fed Reserve meeting. Bond yields had risen sharply in the last three weeks on anti-inflation rhetoric from the Fed earlier this month. They have eased a bit in the last week as Fed suddenly turned soft again. WSJ rightly says that Bernanke is squandering his most valuable commodity - his credibility. It will be interesting to see the post-meeting statement, and how it deals with inflation.

Can the Federal Reserve trade work again? Remember Jan 22 and March 18, when markets were falling before Fed met, only to reverse course later. Yes there are no more interest rate cuts coming. But the Fed's statement carries a lot of power. No harm betting that it will stabilize the currently falling equity markets.

Tuesday, June 17, 2008

Fighting Inflation in India

A favorite topic of WSJ and FT and other personal finance websites these days is - what is the best investment in these times of inflation for retail investors?

My take on somebody investing in India is:

It is not bonds - anyway one can't buy any
It is not stocks - contrary to what everyone else says
It is not real estate - this is a global real estate bust and it is reaching India - so wait for 4 years.
It is cash

Yes, one will earn less than inflation today on cash. One year down the line though, when bonds are cheaper and so are stocks and so is real estate, that same cash can be deployed into other assets which have fallen much harder. Think about relative valuation between assets one year down the road, rather than value of an asset against inflation.

That bonds will fall as inflation rises - that is clear.

That stocks will fall as inflation rises - that goes against conventional wisdom which says stocks return 10% + every year over long periods. That is incorrect. Anyone who invested in US in 2000 has earned 0% over last 8 years. The starting point is important.

And today, the starting point for investing in equities to protect against inflation is not right. Corporate ROEs are at all time highs - inflation will hit margins and lead to downwards earnings revisions, and stocks will find it very hard to go up in such an environment. Besides, if bond yields rise because of inflation (as they have in India and around the world over the past 1 month), the economy gets its third shock of the year.

First shock - subprime and credit crunch
Second shock - oil prices
Third shock - rising inflation and bond yields

A one year FD in India is yielding 9.5%. Why take the risk? Sit in cash and do nothing. As they say, when to hold it and when to fold it is important in poker. This is the time to fold and not to hold.

Tuesday, June 10, 2008

Restarting Aban Loyd, taking stock of portfolio

I restarted the position in Aban Loyd at 3580. If the stock falls to 3200, then I will purchase more. At that price, it starts trading at an appropriate discount to Transocean. The biggest risk is that when this company publishes its consolidated results in its annual report, investors won't like it and will run away. Investors have no clue of the earnings of its Singapore sub which has 70% of the assets. It is a risky stock.

I had bought Indiabulls securities at 132. Now it is at 92. Down 30% in 2 months, 25% with dividend. I was quite bullish 2 months ago and brokerages are the highest beta stocks, so I bought it. The biggest risk to the bull thesis was oil prices, so I had also bought Aban Loyd (which I sold later). This effectively became a hedged transaction.

I like the brokerage business model - from peak-to-peak, brokers are the biggest beneficiaries of capitalism and the societal push to make pricing transparent for a lot of goods. But can some of the Indian brokers get blown away if a downturn happens? Very likely. One needs to find the best one to back.

Another stock to keep on radar is ICI. It seems like some of the big institutional owners push this stock up as the qtr end approaches to window dress their NAVs. If it doesn't happen, one incurs unnecessary trading costs. Risk of losing money at 500 is low because company keeps buying stock at 525.

I have lost a lot of money (down 20% in 2 months) on US financials. But as it is my "value" pick, I want to stick to it for five years and see whether one can really make money by buying when the hour is the darkest. So far, I have always invested in the easy-to-see or cheap on valuation stories. This is the first deep value (or deeply stupid) investment. If I don't make money, I will have such hallowed names like TPG (WaMu), Warbug Pincus (MBIA), Temasek (Merrill) and other SWFs in my company. The misery of others lessens one's own misery :)

This is a historical year in the history of the world. Possibly the first black president in the White House. Oil at 135. The return of inflation. Bear Sterns in smoke. A bloodied Wall Street. At least the most significant year since 2001 (9/11). 2003-07 seems so boring in retrospect.

Portfolio allocation now is 30% stocks, 20% bonds, 50% cash.

Thursday, June 05, 2008

What is Moral Hazard?

Excellent speech by Richmond Fed President Jeffrey Lacker is here, where he discusses the Bear Sterns bailout and moral hazard.

Moral hazard is the central problem that the financial safety net necessarily brings with it. And this problem exists even if central bank lending ensures that the resolution of a problem institution leaves its shareholders with nothing. Market discipline on risk-taking by financial firms comes more from the cost of debt finance than from equity holders (given the limited liability nature of equity). So it is the potential consequences of central bank lending for creditors that raises moral hazard concerns by reducing the cost of debt and potentially leading to greater leverage than would otherwise be chosen.

In the Bear Sterns bailout, it is the equity holders that got hit - they got only $10 for a company whose book value was presumably north of $50. It was the debt holders who were the winners. They would have lost big had Bear Sterns gone into bankruptcy, now they have been made whole by the Fed. So, the risk of lending to an I-bank has gone down following the Bear Sterns precedent.