The New Fad called QE

Wiki describes QE as monetary policy used by a central bank to stimulate an economy when standard monetary policy has become ineffective. A central bank implements quantitative easing by buying specified amounts of financial assets from commercial banks and other private institutions, thus raising the prices of those financial assets and lowering their yield, while simultaneously increasing the monetary base. This differs from the more usual policy of buying or selling short-term government bonds in order to keep interbank interest rates at a specified target value.

The process of printing and pumping money is not new and has been practised in the past especially during 1945 – 1971 i.e. post war economic upliftment, when most of the countries read US and European were devaluing their currencies to either become more competitive or to reduce their post war debt. This led to Germany going in hyperinflation and finally introducing a new currency in that period. Fast forward this to 2008 where US frantically printed money for monetary expansion to kickstart their troubled economy post crisis. With US Dollar being the dominant world currency and countries like China, Japan, India and other BRIC nations having massive trade with US the responsibility of the Federal reserve increases even further. With the global economy interconnected in more than one ways, a frantic printing of currency will push the inflation in economies other than the US. The recent example being the intervention by RBI to absorb the excess dollars hitting Indian shores and stop the INR appreciation. It’s a matter of time, when US interest rates rise and the hot money flows out, creating a demand for dollar and flooding the market with local currency, increasing bond yields and pushing up the inflation. Not all markets have the depth and capability to absorb the excess dollars, hence they adopt printing local currency to stop any appreciation albeit loss of local industry competitiveness. This creates a domino with all countries in order to remain competitive start printing currencies and hence debase their currencies. Sooner or later one of them, usually the one with least developed or least disciplined financial system crashes; creating hyperinflation and default on its debt, thereby again leading to choking of financial markets and crisis. So is QE good or bad and what is the rationale behind it?

Let’s start with basics of Economics i.e. the GDP or Gross Domestic Product. GDP comprises of 4 components C+I+G+(X-I).

C = Consumption in an economy

I = Investments by Private sector

G = Government spending

X = Exports; I = Imports; (X – I) = Net Exports

The components breaks up for US are: Consumption (~70%); Investment (~14%); Government Spending (~18%); Net Exports (~-2%)

Post the financial crisis of 2008, most of the financial engines were choked with loss of trust and none of the banks willing to lend. As a result, jobs were lost and consumption took a beating, leading to recessionary effect. In order to revive confidence and GDP, the Federal Reserve printed more money so as to increase consumption (this included a valiant effort to distribute Food stamp). However, due to non-availability of jobs and poor credit off take the consumption remained low and hence the effect on GDP was muted. When none of the efforts succeeded, the US government resorted to increase the GDP through Government spending. All of the above are based on the principle of multiplier effect i.e. for every 1 dollar spent by the government or given out as salaries there is a demand generated which is more than the dollar usually about 1.5 (±5-10%). However, the principal of multiplier was a Keynesian concept which worked well in 1945 – 1971 i.e. the post war era. However, this system in post economic crisis era of 2008 holds less significance, given the following reasons:

1)      In post war era of 1945, there was genuine need for liquidity, due to lower peg of Gold to Dollar (as currencies were pegged to Gold and hence due to low peg rate there was less liquidity in the system as compared to what was required) and the need for developing infrastructure post war. In 2008 and post crisis era, the liquidity was already there, however, the confidence of lending was missing. Hence, the trickle-down effect to the BoP was missing, therefore leading to less consumption.

2)      The Government sector in post 1945 era was a major employer as a percentage of total population, hence, the government spending led to kickstart of the local economy and worked well for the Multiplier. The money spent by the government went straight for consumption or investment in real estate by the personnel. Also, the money in the economy was being utilized by the businesses for investment to increase capacity as consumption grew. Post 2008 crisis, the private sector was by large the biggest employer and was not borrowing as they stacked in huge cash reserves and were is no need of more cash or loans. Part of the reason was the vicious circle created due to low consumption, leading to loss of investment requirement for the companies. Government sector employment fell from a high of 22.5m at the beginning of 2009 to 22m in 2013, whereas the private employment fell from 111m in 2009 to 107m in 2010 before recovering to 111m in 2013. The multiplier concept hence had a converse effect i.e. for every Dollar spent in the system the effect was less than 70 cents. Whoever got the dollar either stacked it away or invested some part outside the US. This was partly due to internationalization and interconnections of the world. With developing economies offering higher yields, the dollar found its way in those economies, thereby appreciating their currency and leading to the currency debasement domino as explained above. Else, due to the pressure of shareholder delight, most companies were off-shoring their production or cost lines to low cost destinations, thereby creating a positive multiplier in those countries as opposed to theirs.

The excess money printed by Federal Reserve for kick-starting the economy though has produced better results than EU troubled austerity measures. However, the dollars are finding their way in high yielding economies and the inability of the dollar absorption capacity is either leading to local currency creation or inflation. In the short term due to political influences the local currency appreciation is welcomed by the hoi-polloi, for e.g. in India, the currency appreciation along with rock bottom oil price has reduced inflation (India imports 75% of its oil requirement). However, the Governor of the prime financial regulator (RBI) has issued statements that he would not intervene for bailing out any corporate who have taken non-hedged dollar exposures. The market is flooded with dollars which the government has to stem in order to protect its Net Exports and hence balance of payments. This could be done by further buying dollars and keeping the exchange rate in control. However, that is borrowing inflation from the US and once the demand for Dollar starts to increase or the Hot money flows out, the local currency would fall further and lead to excessive inflation. This phenomenon is being observed from China to Brazil. China, though has large dollar reserves to absorb any shocks, however, for smaller economies like Brazil, South Africa, this might prove detrimental. And with EU starting its bond buying programme or the QE the situation is about to get worse. Is it time for a Gold rally “AGAIN”?

Devil Investor

The Devil investor:

IBM, an employer of over 100,000 employees in India has decided to start handing over “Pink Slips”, hell a sophisticated term for sacking personnel. Even the top performers have been asked to leave. The reason in accordance to some news sources is that they were not able to achieve their earnings estimates and the analysts tracking the stocks questioned the same. Would I just beg to ask this question that basis analysts estimates (who in turn have no investment in the stock by the way) a company gets scared and starts firing its employees. I would love to ask the management who’s dearer to them the most, “the employee” who slogs for the company or “the analyst” who sits pretty on a computer of some fund and questions the basis of conducting business. The fund is no one’s friend and neither are the analysts, they will exit the stock and their investment if the estimates do not improve, and they exit even if it improves (at some point in time). And if IBM could not make good use of the employees they think are loading their employee costs, hence am sure it’s a very myopic view of obliging the analysts. This is essentially called denominator management, and the market reacts to it by giving thumbs up to the stock of by increasing the price in view of its increased profitability (read perceived short term). They do not understand that by firing personnel an atmosphere of fear is created like a sword hanging on the neck of rest of the lot, thereby leading to loss of productivity, which in term will lead to lower earnings and hence yet again loss of investor confidence. Also, add to it is the performing segment which is sometimes fired thereby leading to halt of growth prospects. It is a domino effect. Instead of firing the bottom-rung operational employees, questions should be raised on middle management on how can they not be made productive enough. Why the company cannot steer them in newer productive directions? After all for companies like IBM, employees are the underlying assets and cash or stock price is just a reaction to the employee productivity.

If the companies start reacting to analyst’s questions and miss their targets on and off, it’s a question on the capability of management of the company and not the lower rung employees, and more than often they are the ones who are in the firing line. The biggest reason being the proximity of the Middle managers to the authority. IBM’s road-map to 2015 was a target; in essence the management after conducting their due diligence and charting the course of IBM gave themselves a target. Hence, failure of the same should be their onus and responsibility and not of personnel executing their actions. Given, the accountability if the management is not able to steer the employees in a set direction, shouldn't they be held accountable. Also, giving in to the analysts and investor sentiments that are handful in number as compared to the employees (who are the assets) are they not being myopic. If they could not chart out a course (the management) in the given course how could they prove their worth by firing their own employees. Also, they are befriending their employees for money (read investors), who without blinking their eyes will move to other profitable avenues. If making EPS the epitome of success and protégé for success is the ultimate mantra, then long term objectives of the company including a potential attraction of talent will not be achieved.

The performers in the market will potentially give a skip to the company which in turn needs smart resources for them to achieve the desired growth. Also, credit worthiness of the employees takes a beating with banks. Banks as we know empanel companies basis their creditworthiness and dis-burses loans to its employees based on stability of jobs, pay-scale etc. etc. However, after this the employees might find harder to secure loans or land lease or perhaps higher interest rates being charged. This will lead to overall dis-satisfaction and hence loss of productivity in turn leading to a domino effect.

Instead at this point in time, companies should invest in employees and train them for roles which are the new direction and steer the organization to productive use. Firing the employees is like slashing your own wrists to bleed slowly and for whom; the investors, who as soon as the stock reaches a little higher will sell it off and probably go and buy a beer for themselves. To please an unknown one is befriending a native, this is sheer dis-respect and naivety on the part of management. 

Ek tha Tiger

Empty vessels make most noise. Still reeling or trying to execute the decision taken such as FDI in retail, FDI in aviation, etc. the government recently announced a plan asking banks to bail out Real estate developers. I cannot but contain my angst on this suggestion by the government.

Why should we use banks money to bail out in-efficient businessmen, who have overleveraged balance sheets and unsold inventory? How should we trust a business which is unwilling to play by market dynamics and is working on inflated prices without giving a valid proposition to the consumer? The following are the reasons for the same:

1.       Higher cost of financing

2.       Higher cost of acquisition

3.       Higher input costs

4.       Market cartelization

5.       Vested interests

6.       Lack of financial discipline

They should all take a lesson from the local vegetable vendor, who also knows that if by the end of a week or a day he has unsold stock they should lower the price and sell off to maintain the cycle of business and cash flow. Innovative accounting such as portraying advances on bookings as Equity too has not helped them in keeping up their cash flows.

Lets take a look at above factors.

Higher cost of financing: This particular factor takes the cake as the cost of financing is not giving any respite and the stock prices of all companies related to interest costs (be it borrowing by businesses and borrowing by consumer who buys these products viz. Real estate, automobiles, etc.) are on a roller-coaster ride. The ever bullish psyche of the real estate industry and the banking (after all they are humans) let them run amok and flush the sector with excessive funds with banks running after developers to take their money. This led to two things:

a.       Value of assets rose significantly

b.      Attracted many a fraudulent players who were not fit to operate

Lot of people made a lot of money, the wise ones stepped aside and the over-enthusiasts, invested in more assets in far-flung places. However, the fundamental factor on which this sector thrives was lost, the User and not the investor was missing. Slowly the first shake-out happened, and the weaker links in the game started breaking away. The over-leveraged factor and unsold and incomplete projects started rising, fraud stories started erupting and a number of companies closed their shutters. The heavy-weights who were able to sell their inventories survived either due to good relations with banks or there comes a time when the creditor has to give in the demands of borrowers to safeguard their money. The ever increasing prices of inventory (developed or launched projects) made in un-affordable for User and hence was supported by investors for some time. However, every investor needs returns, and when their interest depleted with vanishing returns, the funds dried up. At this point, it should have been logical to lower the price and let the market correct, and here lies the missing link.

Higher input costs:

This is the double whammy, with ever increasing input costs and raw material costs due to overall inflation in the economy, this sector got burdened with higher development costs. Hence, putting further pressure on margins.

Also, with MNREGA coming in the labour became a scarce resource and had a better bargaining power, thereby again leading to higher costs at the hands of developers. However, the parallel economy (black money) must have kept the market upbeat and the development has still continued despite drying up of bank funding.

There is difference between cash and per sq. Feet space. There came a time when the latter was considered cash, but unsold space is a cost (interest + Opportunity) and should be cleared to maintain cash flow.

Higher cost of acquisition:

With governments mobilizing land acquisition act for vote banks, the bargaining power of farmers grew. And like the retrospective tax on Vodafone, many developers had to not only pay up farmers for the land already acquired and save their investments. Also, their future investments and plans basis which they has cleared funding became unviable, thereby again hindering their cash flows.

Also, many a small developers who were the followers and not the entrants always entered the markets late on rosy projections and had to cough up higher prices and work on lower margins, thereby further tightening their situation. When the projects became unviable, they shut their shops and ran away with the investors money or are waiting for a bail out

Cartel formation:

The price in an area is beneficial for the other and an unsaid cartel has been formed in many areas. Also, the ever inquisitive nature of buyers is keeping the hope alive. For instance in Gurgaon any good development cannot be found at the buying price of less than INR 8,000 – INR 12000 per sq feet. This is preposterous as an average selling price of a normal 1500 sq. Feet apartment would be about INR 13mn. – INR 18mn. Leveraging about 85% of the price of the apartment comes to about INR 0.12 mn. per month for 20 years. Only a working professional(s) or a DINK couple with a combined salary of more than INR 0.3mn per month will be willing to invest or move in. Else an investor will be willing to invest with a view of rosy return in future. This seems a little unreasonable for the very fact that even 60% of the total available units will be able to find “users” for their developments.

Hence, comes in the question about the lowering of prices to adjust to market reality. Given the fact that is not happening, these apartments are being rented out as that is more affordable for the user. This gives the owner a return of about 2.5% per annum, which in no way is anything to rave about. Hence, it becomes more affordable to rent out rather than own a house.

However, working on ever enthusiastic attitude of rising real estate prices, this leads to a systemic risk and hence leads to creation of cartels so as to not sell below a particular price and safeguard the interests of few on the cost of many.

Vested interests:

It is not un-common to find vested interests that do not have any association to the business whatsoever but their commandment does not let the developed lower the prices. It is as similar to having a non-executive investor in the company with a majority stake who though does have any knowledge of the business but wishes for the best returns as comparable to an e-commerce industry these days. These vested interests invest or park their surplus (not necessarily on the books income) and are looking for returns till they do not need the money. These interests too discourage the developers to offload the inventory due to the returns expected by these ghost investors and the higher costs as mentioned above

No Financial discipline:

This is in inherent nature and not a followed diktat. More money in this sector saw instead of better products, fancy cars, customized holidays, designer clothing and designer homes for the owners entering the houses of the developers. Anticipation of income has seen kins of these businesses driving the fanciest of cars and splurging like there’s no tomorrow.

A financial discipline is most necessary while conducting any business. Cash flows should be utilized towards bringing efficiency in the business rather than adding cars to the fleet. Lack of this has dwindled many developers into bankruptcy and reeling under pressure. Also, this business has transformed into show business, with the success being measured by the fleet of cars and the labels one wears. A Sales manager of a real estate (infrastructure they call it now) I met recently speaks in Millions and drives a fancy car, but a little probe  left me bewildered that his income is levered about 70%. A fancy car and a designer lable helps him in selling at a higher price. This is what I call the Iceland effect, where its just the money in the economy playing a role and no one knows how to value the asset. It is speculation and not efficient buying and selling which is driving the industry. And once speculation takes the charge, its always best for retail investors or users to stay put till the market corrects.

Also, there is no mechanism to hedge the risks against such kind of markets in India.

Most of the points mentioned above are common for other sectors reeling under the pressure, however, that does not mean that we will keep bailing out everyone. What steps were taken for the recent airline which almost has shut down (however not so delayed) should be kept in mind and the market should be allowed to take its call. Else, the NPA's will rise and tax payers money will be lost.

Banks however, should consider the risk of losing the money in one scenario atleast as they are lending to the developers to build and on the other side financing the borrowers and investors to buy at an inflated rate.  The unsold inventory is piling up as the investor is not attracted at the returns anymore and the User finds it too expensive. Hence, It should be left to the markets to decide who shuts the shops or corrects the price rather than “bail – out” the developers so they can carry the farce and create another bubble.

Seems all the hard work and reforms (read good reforms) are being let go off by the government. And I am but forced to draw an analogy with the recent hit movie by showman of Bollywood “Ek Tha Tiger” and the recent spate of disappearing tigers in India. The same is the state of reforms which are disappearing and are being replaced by these “suggestions” by the government.

Fables of E-Commerce

After the Facebook fallout and a nearly disastrous IPO (the trading price as and when I write this is about $33.10), I am but not amazed at the E-Commerce revolution in India. From services like 24 hours alcohol and beverages supply to Shoes and fashion clothing at “unbelievable” discounts is something which I can’t digest. This unprecedented growth followed by mindless stake buys by the biggest names in the PE industry is giving shape to a new story. Though I agree that the big brother push (PE’s, Bankers and policies) is required to germinate a solid foundation for any industry, however, the economics are astounding and make me wonder how the firms are surviving.

My approach is based on following platform of ideas:

1)     The customer acquisition (fabrication)

2)     Big Discounts – myth or a short-lived opportunity

3)      Huge money being pumped (again the FB story wherein an asset is being tossed after a good story at a fat price on someone else’s balance sheet)

I will focus on the Fashion/ Clothing/ Households products etc. in this blog. Though I know the potential for services is huge, however, the big push is in the E-tailing industry and this blog essentially focuses on perils of the same.

Lets start by focusing on why will I buy a particular brand?

a.      It gels with my persona

b.     It augments my persona

c.     It is value for money (again to augment my persona)

d.     I trust the brand

The value offered by a brand is exactly the price is comes for, this I learnt from a renowned professor during my one off interaction at a seminar. And I kind of stick to this story, i.e. the price I pay at the start of a season is always high due to the exclusivity offered. As the season progresses, the value of the product or a style always diminishes and finally goes on a discount, unless it becomes like a Tote from Gucci or the signature LV bag. The economics works like this, a brand always tries to unlock its investment and at least 50% of the target return in the first few weeks of a season of say 4 months. Post this; whatever the stock left is either bundled with the new marketing campaign or sold off slowly at a discount starting from 10% or more, again depending upon the brand strength. Eventually when the product or SKU reaches the clearance stage, it is the eccentric sizes/ colors/defected pieces which are left on the shelf.  However, a brand which sells at a discount from Day 1 or tries to sell eventually becomes a discounted brand, it not only loses its sheen for the false volumes it generates, but also dies out with time. For e.g. Cantabil, Reebok and numerous others opened up factory outlets and were on sale 12 months a year in the recent past. A brand usually goes on sale to either clear out its inventory or unlock the value to generate cash in order to meet its expenses. We did witness that most of the brands went up on sale last year during slowdown, in order to meet their expense and debt obligation and also to give some momentum to its products off the shelf.

The E-commerce revolution in India, as they say is on the customer acquisition spree, thereby luring the customer with mindless discounts. I know websites where the high end brands are being offered at more than 50% discounts in addition to the margins the websites selling them are making, thereby further reducing the cost of procurement. The following are the circumstances which can make this happen:

1)      These brands are not original – However, these websites guarantee the authenticity of the brands and will be tangled in litigation issues if they are doing so and sooner or later someone will notice.

2)      There are export product lots which do not meet company’s specifications and are auctioned or sold off to clear the inventory (If this is the case then the products mentioned on the websites should clearly mention Export surplus)

3)      The discounts are coming out of the company’s budgets to promote their website and acquire more and more customers. However, the basic premise of any such e-commerce portal is the range and the ease of purchase. These services can easily be replicated and the basic premise is built on a discount price platform. Therefore, once the website stops offering discounts, the customers will move elsewhere.

4)      The brands are selling off the products to clear out their inventory. In this situation the brand in question is either a sub standard discounted brand or has a nincompoop manager who though generating volumes is moving towards the black hole of discounted brand. This will not be sustainable in the long run, as the lower rung brand which offers less exclusivity and will be low on margins will cease to exist or the high margin brands with continuous discounts will lose its sheen. In either case, the traffic of customers will lose owing to less exclusive brands being offered and bread and butter will be less exclusive low margin products being offered on discounts, which is neither profitable and will commoditize its business soon . Eitherways, again there will be another change of hands for equity to continue the mindless bargains or there will be corners cut in terms of products being offered, thereby yet again making the model unsustainable.

There is a free hand given by the stakeholders and management to acquire as many customers and add to the bottom-line, while adjusting the profits. These stakes will eventually be offloaded to some other PE, Bank or listed, thereby de-risking own portfolio and offloading on someone else’s books. People argue with the case of Amazon, however, Amazon offered discount on books by bridging the gap between the publishers and readers, thereby biting away the margins in between.  There were no exclusive publisher stores and its different story with brands. Though Amazon expanded to other categories as well, however, the core offering is reflected on margins made on books.

Fashion and clothing is a different ball game altogether. There is plethora of businesses and websites, which have closed their shops or lowered their offerings substantially, like The Private sales, Fetise, etc. Once the cash runs out or the money from stake sale or equity of owners dries up, a company should and will have to focus on bottom-line or atleast EBITDA. Else, the money thrown in will go in a bottom-less pit, with cash being pumped in through reselling of stake until someone realizes it is a loss making proposition. The same happened with Facebook and Real estate bubbles, wherein an underlying asset is being tossed from one balance sheet to other, not because of value addition but just because the interest rates are low and there is excess money being pumped in the economy.  With the slowdown in the Indian economy, growing penetration of Internet and online banking, over leveraged balance sheets of conventional companies and huge cash piles of unutilized cash has prompted a flurry in this sector (e-commerce). Everyone wants a piece of the pie and after the news of Instagram being sold off at $1bn, thinking theirs might be the next big revolution.

However, the financial model is not so easy as it seems to be. The Cash on deliver model (or COD as they call it), which is another convenience factor, is indeed a twin edged sword.

1)      It not only leads to a lag in collection and cost in terms of keeping a tab on collection, but also adds to the pressure of cost of inventory. This is due to the reason that, as opposed to the start of e-commerce business wherein the products were delivered only when a certain number of sales were achieved by the seller, the websites are purchasing the inventory and storing it in the warehouse, thereby further increasing the costs and reducing the margins.

2)      For e.g. A product worth INR 5000 is sold on a COD model and the margin on the product is 15% i.e. INR 750(to make it simplified, let us assume there is no cost of logistics). The collection agency will take a minimum of 15 – 30 days to transfer the money from the date of sale. If everything goes normal and the product is satisfactory, the margin is reduced by INR 42.5, 46, 50 and 53; given interest rates are 12%, 13%, 14% or 15% respectively.

3)      Add to the above the cost of rent of warehouse, labour, electricity, water, etc. and the margins are pressurized further.  

4)      The cost of discounts as added, not by the bargaining power, but though marketing budgets may also be another deterring factor to the fundamental business sense.
T
T   Things were different when the sites were procuring their merchandize based on number of orders from their clients, however, with setting up of infrastructure to expand, more and more costs are being added, while competition is further squeezing the margins.  

A sustained business model cannot be built on discounts offered. Websites have to steer clear of being as only discount driven sites to offering exclusive products. There is no ‘Points of differentiation’ being offered by these neo-sites apart from convenience, which also have inherent flaws in terms of wrong products being shipped (these are initial hiccups though and can be overcome in the long terms with better backend integration). However, still I would wait and see how sustainable and scalable the model is after a couple of years to eventually believe in the e-commerce story. Till then, enjoy the mindless discounts at the expense of others while I do the same. 

Darling of Investors OR Greed of few

Whether it is successful or not is yet to be seen, however, the $16bn. IPO of Facebook ($18.4bn, if the underwriters exercise their IPO option at the listing price) will set example of many more similar entrepreneurial ventures monetizing their creations. Whether sales of $3.8bn, last year justifies this price or not is yet to be formalized. The model around which the story is doing rounds is the Advertising sales (well wasn’t this the model that Mr. Zuckerberg loathed while creating this asset.)

Whether this is just the lack of companies to invest in and monetize by the hungry investment bankers and the PE industry or whether ‘someone’ saw ‘some’ intrinsic business value based on an excellent business model is yet to be seen.

The total money supply of USD is set to cross $9 trn., and the US economy has slowed down considerably since 2008, with its GDP growth and job market just barely justifying the money or fiscal stimulus being pumped in or was pumped in. There is no manufacturing or infrastructure growth which will justify the amount of money being pumped in. The consumption pattern has shown a declining rate, the government is hell bent on keeping the interest rates at its lowest till atleast 2014 so as to kickstart the biggest consumer economy in the world. This, they hope will kickstart the investment climate and grease the wheels of the economy so that it starts moving again. However, job growth data is not sending any positive signals and the business climate remains uncertain owing to Euro crisis. Grexit (Greece Exit) is all but inevitable. Austerity measures are not helping either the economy of the politics of any country. Spain is soon slipping down (the fresh issue of bonds last Thursday is proof enough of falling investor confidence).

The point of the above ‘Gyaan’ is just to highlight the fact that given the circumstances, the investor climate and the business climate is not conducive for any business to flourish, leave alone expand. And to be honest every banker (this particular profession is off late getting enough bad publicity like the lawyers always dread) needs a company which is a darling of investors, so that they can churn out as much fees as possible. ‘Facebook is just the right answer’. In one of the books by Michael Lewis, I read that during the famous crisis post the ‘Honeymoon’ era of growth i.e. early 2000’s till 2007, Iceland, which was essentially a fisherman’s economy and had no experience whatsoever in Investment banking soon started acquiring Banks and Football clubs. This was fuelled by the cheap money supplied due to their credit rating enhanced by the European union, which led to excessive real estate boom. As neither had they had access to such kind of money, nor they had the experience of handling such money, they started transferring the same assets at inflated price on each other’s balance sheet. So imagine an asset (say land) having underlying value to INR 100, being sold for INR 120, then the same being floated around with a story and little value addition at INR 140, and so on. The value of the asset is increasing due to the increase in money supply in the economy and not because its creating any value.

Now compare this scenario to the IPO in question, there is no set emphatic and innovative structure of revenue which the company has to offer apart from advertising (which essentially was uncool for facebook to start with). Once, just to please their investors, the company throws the towel for advertisement, it might cheese off its users. However, that is still a big question mark. Also, other similar IPO’s in the past like Groupon are reeling under pressure and are trading lower than their IPO level prices (Is this a cautionary note). However, Facebook is clearly a different value proposition and first of its kind to hit the bourses, so it remains to be seen what will be its plight (pun intended)

So, is it creative PR and false stories and bankers and PE managers who don’t want to miss the bus who artificially inflated its price tag? There is immense pressure on the financial industry to perform, as most the fund managers have barely made any returns on their portflio’s since the last crisis. So was this a herd following (carefully crafted) to ‘create’ an asset with no underlying revenue model. A 107 times is trailing 12-month earnings and about 26 times its revenue in 12 –month as on March 31. This is no joke, no one gets that kind of valuation. Apple inc. with a super-cool product line which is a hit amongst the hoi - polloi and oozes the oomph factor amongst consumers and investors alike has a valuation at about 4.5 times its revenues and a PE ratio of about 12.93. It might not be an accurate comparison; however, we are speaking of valuation unheard of (or maybe heard off during the dotcom bust). But are we trying to ignore the signals of 2000 – 2001. Fine, it has a user base of 900mn users, but ‘how’ do they monetize it. 

I want to compare Facebook to Central park (which is also a social networking platform), where approximate users every year are about 38mn. This is immense, but how do you monetize Central park visitors. Yes, the park is maintained through probably government funds, donations and park fees, etc. however, once you start advertising all over the park and charge customers, imagine you’re spoiling the beauty of it.

Probably Facebook should be nationalized and be maintained out of government funds pooled in by various governments depending on their country user base, as definitely its become a massive force which is beneficial in more ways I can think of. In the past mass movements like aggregation or start of revolution in Libya and other North African and Middle east countries started though Facebook, following which governments of various countries have stopped Facebook access, due to the danger it poses on creating a domino effect. However, in all the above cases the reason has been more socialist than capitalist. The opening day did not offer any respite, the opening day could not break the $40 mark, when the IPO price was $38. Fine the signals were wrong, Spain is under pressure, there are talks of Grexit. However, if the investors saw such a strong underlying intrinsic value in FB (as they famously address it) why did not it show on its opening day price levels? It seems like everyone has their eyes shut to the fact that because no one knows what lies in the FB story, so it must be good, as everyone’s buying it.

However, one fact that cannot be ignored is that this kind of money will open up doors to innovation in the social media and ecommerce space. We will see more innovative offerings in future, however, if this company fails to charm its investors, the reverse domino effect might start and before anyone knows the stock will be dumped and moved on upon. That will again lead to a logjam and another set of bust which swarmed the world markets in 2000 – 2001. There should be caution and only the slightest hints and consumers and investors will flee to the next best alternative.

Money or no Money

The market movement perfectly correlates with the oscillation of swings in the park, the factors causing this effect are sometimes the Greece crisis to now the Italy crisis, the US Job figures to Indian IIP data which the government also does not know how to measure. The seems the market has lost its immunity from any kind of cold. Be it Mr. Anna, Kingfisher Airlines default or Greece catching cold, our markets do react. Now here's a trivia, according to some journals I subscribe to, Indian Corporates are sitting on a cool pile of cash i.e. about $96 billion. The PSU's alone are sitting at about$40 billion worth of cash. Everyone has their purse tightened, crying out loud that the interest rates are high, and not spending a penny on investment. Agreed the investment climate of the country is not conducive and infrastructure growth can be compared to tight rope walking, however, retail investor is yet again the only one sitting and wondering that where is his money going. The cost of maintaining lifestyle is going up (need I explain this one - Petrol prices, Vegetable prices, Consumer goods, Loans, Clothes, etc.), however, the benefits of my investments are not going great guns.
If he/she keeps it in the savings account 'it' de-grows (though the freedom of savings bank rate is the step in the right direction, but unless one earns more than 11-12% I don't think there'll be any relief. One the other hand the cost of maintaining a normal house is increasing owing to Inflation.
One cannot dare to step in the market, because once the market crosses 18K mark we think oh darn I missed the bus and once it comes back below 17k within the next week one wonders, should I invest right now or it still will fall further.
This is the same situation as to how much is too much and how little is too little.

Any prudence would aim towards the PPF which rightly is the need of the hour, however, we're not certain that the rates will stay above 8.5% for a long time (as these are linked to government bonds), NCD's or Bond Offerings are a good option but they lack liquidity and any retail investor would not step in this territory.
These are times I would compare to situation of Wall Street in 1974, when everyone knew that the economy is going great guns, however, the market was crashing due to extraneous factors and not due to the fact that the domestic economy was in shambles.
If I take a look at most of the Blue chips, they are trading at a HUGE discount of what they were 52 weeks back, but still I don't want to invest because am afraid what lies ahead. DO we really believe that the biggest bank or the biggest IT company would go belly up.
The panic is widespread because of speculation and people who have their jobs in line unless they show hourly profits (probably exaggerating). It is what a great investor said staying ahead of the herd, but you still are the herd aren't you.
The GDP had been revised to a little above 7% now and the fiscal deficit is pegged at 5.5% for this year (if we are lucky). Do we really think its because of events happening in India, not really. These events are all external, Dollar appreciation (again because of my most hated uncle Mr. Speculator) - thus making my Oil import bill denting in my Dollar receipts and increasing the Current account deficit (this in the wake of dwindling exports due to slowdown in West is not good news). Revenue from taxes has slowed, my Non tax revenue growth given the market condition and the government is not able to divest. Lets stay here for a minute, and I am thankful the market conditions are not right for any stake sales, as I will be looking towards financing my deficits and Operating expenditure through sale of assets (In form of stakes in PSU's). The Airwaves auction has not taken place as the government is not able to decide and no one is willing to form a policy as the wounds from 2G scams loom over their heads (This is probably attributed to internal political events which will come to near equilibrium in near future, they HAVE to form a consensus and get the parliament moving sans dividing any states and towards policy reforms or both parties can be sure to be kicked out in the next election).
Greece and Italy have their own set of problems, which they will eventually solve, there is no way Germany and France will use their Tax Payers money to bail anyone out anymore beyond a certain level. The government has to cut its budgets and deficits, the austerity has to set in, and harshly but truly the generation of today will have to repay for sins of few. The whims and fancies of a few who tried to create a coalition of states thereby upgrading their credit worthiness is the same as giving an 18 year old of today an unlimited credit card and setting him/her free at Harrods.
The USD stands at above Rs. 51 levels and has to and will come down in effect in future as this is where growth is, India has done a better job than many Emerging economies in atleast trying to go for Inclusive growth (I know the Urban rural and poor rich divide, however, it is still a lot better than what China has achieved) Rural economy is booming, Eastern India is growing at a good pace and more importantly agriculture supply and not production is an issue.
Which now brings us to the question of what should the retail investor do at this point in time, I can list out many companies on which if I start investing 5-10k a month over the next one year, I am sure I'll make a cool return (I refrain from any forecasts or figures as I think a few points here and there will not matter). But more important than that is a fact that look for Blue Chips, they are trading at yummy values as of now. Be patient, look for what returns if you'd be invested for about 3-5 years and not the next 3-5 hours. The compounding effect at a rate of just 12% p.a. for the next 5 years which any good Blue chip will give is a staggering 76% (and these are rough estimates). So, be cautious but be prudent, Blue chips other than Financial markets-which will be dented by high interest rates in the short run, are a decent buy.

A Contrarian View:

US raised its debt ceiling to an extent of $2.4 trillion, thereby saving its face of not defaulting on its payments and hence affecting its sovereign rating from AAA to a notch below that. However, has it actually helped? After the bail out of banks and flushing of economies with more and more money, little has been achieved albeit more asset price speculation (Gold Prices hitting $1672 an ounce or INR 24,211 per 10 gms and Swiss Franc and Yen also touching new highs). The US job data has not shown any signs of improvements and the opposition in the US wants equal fiscal deficit cuts for the third tranche of the current raised debt ceiling i.e. $1.5 trillion to control the deficit and lesser burden on future generations to come.
Like my articles earlier, my question still remains, shying away from cutting costs and removing layers and layers of sloth and free lunches will eventually lead to default.
In the midst of all this, India has been tainted with a plethora of corruption scandals from Telecom 2G (I have lost count of how many scandals are involved), Common Wealth Games scandal, the Satyam scam and the current Iron Ore scam at Bellary. Now, the total of these scams do run in Hundreds of Billions of Dollars, however, it has done something which I think is a blessing in disguise, however, not without its economic ramifications (Inflation being the most gruesome one). It has slowed down the process of decision making or clearing of projects within the political departments. No one is willing to sign the dotted line of the fear that who knows what legal and political implication he/she might have to dodge.
My contrarian view is that this has done good as well as bad to the Indian economy. My views again will go back to the World War 1 era, when US economy went through unprecedented growth because of cheap money flowing emanating from the European region especially Britain and Germany. This was followed by the Great Depression, wherein more than 9000 banks in the US had failed and depositors has lost their money (it was not insured, FDIC came into picture much after this). This situation arose as cheap money floating around the world was looking for returns and since US was the only healthy economy post war, the money poured in, thereby increasing the capacities of industries (Auto Industry essentially) and speculation on asset prices predominantly real estate and stocks. The economy inflated and fell on its feet thereby wiping out large amount of investor money and confidence.

Compare this to the situation prevailing today, though the tools and measure available are much more sophisticated than it was in World War 1 era (it was still pegged at Gold back then), still any economy could be destroyed by the cheap money looking for returns (LIBOR today stands at 0.42%). The South East asian crisis was one example and so to a certain extent is China today. The interest rates are rising and the real estate and stock markets are in trouble. The capacities created are going underutilized and world is putting pressure on China to revalue its currency, which China has managed to keep under control artificially. The labor rates are rising and companies are mechanizing their factories to control costs (Chinese manufacturers have planned to use 1 million Robots against 300,000 as of today is near future). They are the largest holders of US debt (Above $1 trillion) and will go to any extent to support US so as to not let their debt lose its value.
India on the other hand did benefit from the cheap money available in the market, the stock markets which slumped post 2008, has recovered to above 18K (BSE) and 5.4K (NSE) mark. However, it has not breached the 200 Moving Day Averages, a sign that the Bull phase is still not in sight and a sign that investors are not confident enough. The inflation is at an all time high and the RBI has increased the interest rates for the 11th time since the past 1 year and the Repo rate (rates at which banks borrow from RBI) to 8% and Reverse Repo (the rate at which RBI borrows from Banks) at 7%. This is to contain inflation rate which still looms at 8%+ in the current scenario. Though many may question that it’s more of supply side inflation (i.e. when the product in produced but cannot be supplied due to lack of infrastructure), however, the capacity is not being created to absorb the flow of money. Yes, this is a vicious circle wherein the Policy decision making will lead to capacity creation and the policy inactivity is leading to lack of capacity creation, be it retail or infrastructure. The stock markets are leashed and range bound due to the fact that FII’s are not confident in the development of policy plaguing retail and infrastructure sector. The Energy sector, which is considered as the backbone of any economy is plagued by overcapacity as many a power plants are lying idle due to lack of coal linkages, which again is plagued by policy and environmental approvals and loss due to transmission. This again is putting pressure on books of not only Power companies, but Banks that have funded the projects due to uncertainty of recovery.

Had the government been a little efficient in approving the policies and laws governing investments, we would though have grown at probably more than 9% (probably much higher than that), however, the growth fuelled by easy access to cheap money would have led to spiraling of Real estate and Stocks more than creating capacity/value.
The capacities would have been created which would hold little significance in today’s world. As can be compared to China which is more exported oriented than India and was serving a mature consumer and economy. Its capacities today are lying idle due to slowing consumer demand in the US. In case of India, Money would or would not have trickled down to the lowest level.
The corrosive decision making of the government has led to low cost innovations to satisfy the investor appetite which is being shattered time and time again by political babu’s. Be it the current telecom price wars, the digital revolution in making, the Nano project, etc. Had the government been efficient, these low cost innovations would have come much later and only after the first phase of consolidation. The cheap credit availability would have fuelled the demand for products not needed by the hoi-polloi and hence would have inflated the balance sheets of banks. We would have gone through an era of consumerism plagued by debt and a burden on future generations to come.

The cheap or Hot money flowing around the world is nothing but a time bomb, which though available, will bring nothing but debt laden consumerism and burden on future generations without creating REAL capacities.