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Commentary

What Now?

Time for some rambling. Where are we today?

No man’s land
In terms of asset allocation we are in no-man’s land. That does not mean that it’s better for women. Though honestly, they have way more things to shop for than men, so they can allocate assets to “shopping” which most men, by which I mean the two guys I talked to recently, will find repulsive. Actually some women will too, and I won’t get all sexist here, so let me un-digress.

So we need to figure out where to invest. What do you invest in? Bank deposits? At 10% they aren’t going to make inflation. Equities? What, at a P/E of 19 when EPS growth is 10%?

Commodities? No, sorry, down cycle. Debt? Uhem, then what if the RBI keeps increasing rates, which it’s likely to do with inflation now at 12.44% and showing no signs of abatin? Then all debt loses value. Though honestly 90 day FMPs may make sense.

Given that there’s nothing else to invest in, perhaps Gold is the answer. But it just went below 800$. Still, I think it’s going to bounce – but that’s just speculative. The correct answer right now is – don’t do anything until the picture gets clearer.

And what’s happening in the good ole US of A?
Not all nice, I’m afraid. Homes are getting foreclosed like nobody’s business. That’s hurting new home sellers who have to compete with existing homes, and now a deluge of foreclosed homes. July is supposed to be the worst month – as predicted – with massive foreclosures from the resets [to higher interest rates] of a very large number of loans. This has caused the mortgage based securities of not just subprime owned homes but also those of the next level (Alt-A) to start getting the jitters. You have to read Tanta’s posts (One and Two) to understand the oncoming crisis.

Given that they trade and hold these securities, this means banks are, pardon my french, buggered. And not just Alt-A and Subprime. The recent investigation into ARS – Auction Rate Securities – shows that they missold them to investors as “safe”, and those investors lost money because these very banks ditched the auctions. The Fed has now forced literally all banks to make their investors “whole” – meaning they must cover losses. That’s ok, if the underlying securities that they buy back are sound. But there’s anothe problem.

Income problems
A large part of bond-street consists of municipal bonds and bonds by schools etc. Now how does a municipality earn money? By taxes, corporate and real estate and all that. Investment banks have lost so much money that New York isn’t likely to see any tax revenue from them over the next five years. California has so many foreclosures and tax losses that they’ve moved (or are moving) govt. employees to minimum wage until they find a solution. Some counties have declared bankruptcy and others are on the verge of doing so.

A small issue with this is that if any of these guys issued ARS and they get owned by banks, the banks are hosed further on their balance sheets.

Another thing though – most muni bonds are insured by monoline insurers like Ambac and MBIA. And S&P recently kept their rating up at AA. But if the municipalities and Alt-As and all that start going down, MBIA and Ambac are pretty much going to die, or so it seems.

And if they do, guess who is holding a piece of paper that supposedly insures them from defaults. Yes, the investment banks again. So that’s a little more on their plate. Heavy plate, that one.

Government Support
Of course the U.S. government isn’t going to let them go down. At least not that easily. So they will be protected, somehow, I don’t know how. But it is likely to mean a lot of flooding of dollar notes. Which is bad for the dollar in the long term. But against what currency? Euro? Sorry, but they are next.

Yen? Uhem – I used to think that until it’s out that Japanese banks have way too much U.S. credit exposure. No thanks.

Indian Rupee? Chinese Renminbi? UAE Dinar? Very likely, in my opinion. And that will cause the Great Indian and Chinese export stories to fall flat. BRIC will become BR.

Is it all hopeless?
Of course it is. Now turn off your browser and go back to work.

Just kidding.

I can’t see a way out unless there is a big set of failures in the U.S. And the more they try to save them, the more time it will take to unravel.

We in India are not isolated. We are going to feel it, and feel it very bad. We are not decoupled or delinked in any reasonable way. When the world falls down, we aren’t going to be a bastion of excellence, standing in the corner holding the world economy steady. (which is 60x our economy, by the way) If we added India and China, the total GDP is still less than 10% of world GDP, and around 15% of that is exports.

Still, the hope is that this stuff will play itself out in a couple years. There’s not much chance of it taking any lesser time, but it could stretch substantially longer depending on how much all our governments are willing to run their printing presses. What I do not want is a 15-20 year cycle of bad news, denial, support, complacency, audacity, shock, horror, more bad news, denial…you get the drift.

Till then I shall continue on my trip of finding good investment strategies that don’t need to make any sense – the automated trading system bits – and the short-only stuff. And also finally get to read Pyramid, Lords and Ladies and Thief of Time. Terry Pratchett rocks.

P.S. This is a post written purely as a note. Thats why there is no effort to explain much. Lemme see how, with link-posts later.

  • Anonymous says:

    >After reading your post, feel like why do i waste time investing when everything is going to go in drain

  • Rajiv says:

    >Hi Deepak, ” whats your take on guys who say Worst has already been discounted by the markets? so we dont see too much of a downside “

  • Deepak Shenoy says:

    >Rajiv: Do you really believe that? With a P/E of 19 and when EPS growth for a number of companies is still negative?

  • Raghuram says:

    >This is definitely a very incisive scenario that you have built. Wonder from a currency perspective would that mean it would be better to be rupee long, since the domestic economy still has a consumption capacity. From a stock perspective I would then prefer import intensive industries. what do you say?