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Commentary

“We’re Coming Down, To The Ground”

The US markets are down 5% as we speak, and the drama is getting worse. The S&P downgraded Freddie Mac and Fannie Mae – which is obvious because they can’t hold a higher rating than the government that guarantees them. That has caused a flurry of activity in the markets, particularly in banks. Why?

Because no one knows the impact. When you provided Freddie/Fannie bonds as collateral on a contract, their AAA rating ensured you needed to provide say $10 worth. But much of the lingo in contracts has been standardized to demand increased collateral when ratings fall. We don’t know if that applies to AA+ (which the US is now) versus AAA. We don’t know what changes. Since many of these contracts are off regulatory limits (hint, people) no one knows the real amount of damage it can cause.

My wild guess is: not much. If there are collateral requirements those can be bilaterally settled away. Plus, the other two rating agencies still give a AAA. So while this is an unknown, and perhaps creates a little bit of panic, there isn’t enough reason for two 5% down days in the US. No, this is definitely something else.

Well, what else?

Japan has just decided to flood the market with 50 trillion yen- that’s $640 bn, nearly as much as TARP – to bring down the Dollar-Yen ratio from its recent levels of 76+. But even a flood of 4.5 trillion yen – that’s about $58 billion – in the last week got it up to  80, and then, most of that was erased as it went back to 77.67.

In Europe, there is still turmoil, as Spanish and Greek debt is being bought by the truckload by the ECB. (The “Eurobazooka”) Yet, the problems remain, and it seems the Euribor (the euro equiv of the Libor, the interbank overnight rate) froze over the weekend, which means banks aren’t willing to lend to each other.  Greece has banned short selling. Germany is worried about inflation, Spain and Italy about survival, Greece has more or less given up, Ireland is probably in schadenfreude mode and Britain is cloudy with spots of sunshine and bland food. Obviously, time to panic.

In the US, Bank of America – a fairly large bank that swallowed Merrill – is now in trouble, down to $6.70 or 18% down, and nearly half of its value in May. A large bank like that will not go easy – and already people are preparing obituaries and writing death-notes. AIG has today announced that it will sue Bank of America for $10 billion for misrepresenting mortgages that it took losses on.

And then, the world has gone to hell. There is no hope in the US – housing prices, which drove much of the GDP growth of the noughties, are scraping the bottom of the barrel. Europe is in such a mess. Japan is, in famous economist lingo, a bug waiting for a windshield. China is busy cutting off its nose to spite its face. India has so many knickers in twists that you feel like giving them marks for ingenuity.

Who cares about all this? What about my portfolio?

Short answer: Respect your stop losses. If you want to buy, buy with a stop loss in mind. If you don’t know what you want to do, don’t do anything. Make your decision based on your analysis; too much money has been lost on the advice of people who thought they knew best for someone else. Stocks are built to behave like this. If you think they will survive, buy them. If you think there’s more downside, sell.

What do I think? There’s more downside. Much more for broad markets. I am not short – a strategy I regret. My biggest portfolio element, by a factor of 5, is Gold, which I continue to buy. The next is stocks like SmartLink and Piramal Healthcare and Opto Circuits. I will probably buy more of them. I am buying selectively, but slowly. But I read markets every day. From breakfast. Plus, I have no qualms losing money. So none of this might apply to you.

Bonus

Okay so my son likes Wall*E a lot. He loves the music on the credits – so much that he imagines a guitar in his hand and strums away. Well, I found the lyrics today: A Peter Gabriel number, Down to Earth.

Cool parts, that I see apply to us now:

Did you think that your feet had been bound 
By what gravity brings to the ground?
Did you feel you were tricked
By the future you picked?
Well, come on down

All those rules don’t apply
When you’re high in the sky
So, come on down Come on down.

  • Jagadees says:

    I understand taking shelter in cash-rich companies like piramal health & smartlink and gold in the current market mayhem. But what is the story behind optocircuits??
    Regards
    Jagadees

    • Opto makes stents for clogged hearts. I think there are going to be a lot of clogged hearts 🙂 No, seriously, I like their biz model.

      • Ramu says:

        Situation is fast changing in that area…people are fast becoming aware of nutritional deficiencies in regular diets and so called low-fat diets. My guess is, its still 50-50 that stent use will see rapid rise in the next decade or so.

  • Rudra Chowdhury says:

    Hi Deepak,
    Regarding Opto Circuits, I last bought around 230 levels in Feb. Post Cardiac Sciences acquisition there has been margin dilution where OPM fell by almost ~600 bps and NPM has fallen too by the same levels ( 22% in Jun ’11 vs 28% in Jun ’10) and interest outgo has doubled over the same period.
    One key takeaway is their re-entry into the Japanese markets, through Cardiac Science’s flagship Powerheart AED (automated external defibrillator), which is the 2nd biggest market for AEDs.

  • kazaan says:

    B-D I like your son’s taste in music! He’s clearly got scope! But don’t get him an actual guitar till he is 13. And he has heard a lot of Jimi Hendrix ! LOL
    And yes, I like Opto Circuit too! I am always exited by consolidations near historical highs. FWIW, Once it get above 310 on the move that’s just building, and holds a new life high, I’m looking at 400+.
    Good work Deepak!