BACK TO THE MALLS

Kunal is an old friend from my first Banking organization. Talks a lot , thinks less and understands the least – he is someone I hate the most being with when I am alone , but then he is the only one to whom I can turn around whenever I am alone. Last week Hyderabad had only 3 working days, but surprisingly the malls were unexpectedly full to their capacity. Kunal with his shabby specs on his eyes glared at the crowd and asked a billion dollar (may be a trillion dollar) question – Is the recession gone?? The answer kept me awakened till 3 in the morning while I decided to pen down this reply.

Since sinking to a 12-year low of 676.53 on March 9, the Standard and Poor’s 500 Index had risen 24% — the best such short-term rally since 1933. But this isn’t 1933 and you shouldn’t trust the rally. Happy Days are NOT here again, at least not yet.

The 1933 rally came after a record-breaking decline. Real gross domestic product (GDP) fell by 25% during the Great Depression and the Dow Jones Industrial Index fell by almost 90%. What is less well known, however, is that valuations remained depressed for well over a decade after 1933. In 1949, when the Dow was selling at a price-to-earnings ratio (P/E) of just 7 times, it was cheaper in terms of earnings, net asset value, and GDP than it had been at its 1932 nadir.

This time around, the S&P 500 index fell 58% from its 2007 peak to its March 9 bottom at the superstitiously significant 666. Of course, 58% is nowhere near as much as 90%. To recover from a 58% drop the stock market must rise by 138%, but it must rise by 1,000% to recover from a 90% drop.

So it is not surprising that in spite of inflation and enormous economic growth, the Dow did not reach its 1929 level until 1954.

The other difference between 2009 and 1933 is that the 2008 stock market peak was both higher and more prolonged than it was in 1929, which was a mere blip by comparison.

Radio Corporation of America - 1929’s equivalent of Cisco Systems Inc. (CSCO) or Google Inc. (GOOG) - never got above 28 times earnings in that market, and the Dow spent less than three years within 50% of its peak value of 381.17, only passing 200 in December 1927, and finally falling below that level in August 1930.

In this market, the Dow was above 7,000 - within 50% of its 14,164 peak - continually from May 1997 until February 2009. Because the 2000s market was more overvalued for longer for a longer period of time, it has further to fall, even without a “Great Depression” economically.

Apart from the very largest banks, which gorged themselves on the most foolish and ill-designed products of the derivatives business, the banking system is suffering from a normal real estate downturn and is coping well with the high levels of loss that downturn has brought. With short-term interest rates well below long-term rates, banks’ ongoing lending business is currently exceptionally profitable.

The U.S. economy, as a whole, has stopped falling with ever-increasing velocity and may actually be beginning a lengthy “bottoming out” process. Had politicians avoided meddling with the monetary and fiscal systems of the globe, devoting trillions of dollars to bailouts and stimulus, the bottom we are approaching might well be somewhat deeper, but we could at least be sure that it was indeed the bottom, with recovery to follow.

In Asian countries such as Korea, Taiwan and Singapore, where stimulus has been modest, and in China where it has created only a modest budget deficit, the sharp recession caused by collapsing exports is already coming to an end. (China, however, has a major banking and real estate problem that could still cause trouble down the road.)

But in the United States, we can have no such assurance. Monetary policy, which was far too expansive in 1995-2008, reached expansiveness of extraordinary dimensions after last September’s crisis, with the monetary base doubling and broad money expanding at a rate of more than 15%. Fiscal policy has produced record peacetime deficits - deficits that are more than double the previous peacetime record. The Federal budget deficit in 2009 will be double the 2007 balance of payments deficit, which had previously been thought of as a critical and dangerous imbalance.

With imbalances of this size, there can be no assurance that a recessionary bottom will be followed by recovery, quite the opposite. Japan has now suffered near-recessionary conditions for almost two decades with a weak recovery in 2003-07. And that modest recovery is now being followed by a new recession as the Japanese government foolishly resorted to more wasteful public spending and debt.

Fiscal stimulus stimulates nothing in a country where public debt is already 160% of GDP; instead it increases uncertainty and crowds out risk-taking private capital.

The most likely scenario for the United States is a recession, or near-recession, that lasts for a decade with the economy unsuccessfully struggling against the twin problems of surging inflation and a budget deficit that crowds out private capital investment. Either real interest rates will be high to combat inflation or inflation will rage out of control.

In such an environment, the outlook for stocks is bleak. The high stock prices of 1996-2008 have gone, and they will not return. When the excessive monetary expansion began in the spring of 1995, the Dow was at 4,000. That is equivalent to a level of 7,800 today when you inflate it by the increase in nominal GDP since 1995.

However, 1995 was not a bear market low. It was far from it. The market had been rising for four years since its 1990 bottom and was almost 50% above its 1987 peak, just before the “Black Monday” crash.

Thus, even if the economy had the growth prospects of 1995, a level of 7,800 on the Dow would be a reasonable expectation, not for a bear market low but for an equilibrium value. If you then take into account the markedly worse expectations for the U.S. economy resulting from excessive fiscal and monetary stimulus, 7,800 is too high.

Take the 1949 P/E multiple of 7, and apply it to a recovering earnings level of say $60 on the Standard and Poor’s 500, and you get an S&P of 420 – equivalent to a Dow of around 4,000.

The market is no longer hugely overvalued with the Dow at 8,000, but any rally will be temporary, and we can expect an eventual low well below the 6,547 the Dow reached last month.

I WISH..........

I wish to Be the sunshine that brightens your day;

I wish to be the moonlight in your sweet dreams;
I wish to be joy and your smile;
I wish to be the fulfilment to lift you up to destiny;
I wish to be your goals so you can achieve all;
I wish to be your mind so you can think no problems;
I wish to be your world and let you own me;
I wish to be your blood that strengthens your muscles;
I wish to be the heartbeat that keeps you alive;
I wish to be the nourishment you need to survive;
I wish to be the voice that talks On your behalf;
I wish to be your arms to hand everything you need;
I wish to be your dreams come true.
I wish to be the lips that caress your skin;
I wish to be the veins singing in streams of your blood;
I wish to be the wonder that shines within.
I wish to be the pillow that cushions your head;
I wish to be the mattress that softens your bed;
I wish to be the touch that strokes your desire;
I wish to be the flame that ignites your fire.
I wish to be the passion that melts you;
I wish to be the loyalty that sets you apart.
I wish to be your darling and keep you happier forever;
I wish to be the love that will always remain.
I wish to be the treasure that makes you fly;

I wish to be everything you need, want and desire;

I wish to be the portion that makes you whole;

I wish to be the poem in your heart.

Dedicated to you my love...................

The Strange World of Derivatives

A violent meeting

I was shown into the conference room. A small room with a round table carved out of wood, walls white washed with rough textures, I was asked to be seated for a while, the thickly padded leather chairs were comfortable. It was, I feared, going to be a long meeting.

The boss walked in with a deceived look on his face followed by the so called treasury manager Mr. S. He knew nothing about treasury except for its spelling in english, though he boasted of being a Chartered accountant and had an earlier stint in a broking firm that actively traded on futures and options on stock exchange, always felt that he knew the whole derivative business inside out. A lot of painstaking efforts in explaining him that derivatives in currencies is a different ball game altogather, several times, went in vain.

" what the F*** has happened? I was told that nothing could go wrong and now my firm has a Negative MTM ( Mark to market - loss/profit if the deal was to be unwound at that particular point of time) of 2.7 million and you are here for a margin of another 1.2 million, I need to know why am I being whipped" screamed the boss. The boss (Mr.R) was a man in his late thirties, about 5 feet 8 inches tall and had a fair complextion with a medium personality. He was the man behind an IT firm which did software development for clients in US and UK. Generally very soft spoken, but now he had every reason to be furious.

I had to speak, " I think it would be helpful to go over the chronology of the transaction," I began. It took me over 10 minutes to explain the whole deal in detail after which the debate began. In order to save myself from being blamed, I started off in a very assertive tone " all the possible options to hedge the firm's flows were explained detailing the pros and cons for each one of them," " thats fine , but tell me how did this whole thing go wrong?" beamed Mr. R, " you are locked on the sell side at 40.04 and the rupee today is at 40.94 after paying a year's forward premium, hence you have an obligation to deliver at 40.04 when the market is at 40.94 - an opportunity loss, an unexpected depreciation in rupee being the major cause sir" I said. " So?? I am going to deliver, and it bloody makes no sense in you asking me another 1.2 million when u already hold 2.7 million of my money as deposit against this trade," It took me great courage to explain him the whole concept of MTM and the risk that bank carried for holding the firm's position. " you think I am going to F*** off without delivering?? are you questioning the credibility of my company???" he barked at me. After great deal of explaination and blame taking business, I could successfully convince Mr.R that it was purely a call of the company ( rather Mr. S) to get into a forward, heedlessly putting at stake the entire revenue stream of the frim for an year and that we had suggested plain vanilla at all the meets prior to the closure of the deal, and now it was not the bank's call to collect money, but an RBI directive.

Derivatives - WMD

On the face of it, derivatives are to hedge one's risk on a particular asset. the word 'hedge' is to be taken in its pure sense - to protect / to reduce the risk, more often we find companies 'gambling' thier chances with luck, having thier revenues at stake - thats one side of it, which I am ok with ( I am, afterall, a banker!!), the other dangerous side is the one I am currently living with, firms have no idea what derivatives are for, they get sold to what the bankers/brokers/consultants say, only to be blamed later that every thing was executed at the sole discretion of the firm. The case mentioned above has a little exception though, to thank my stars, the so called treasury manager who lived with a conception that he mastered the art, made my job safe and easy to fool him and make money.

Derivatives if understood properly can be a boon to the guy buying them, else its a disaster for the entire company eventually leading to death. The guys buying and selling these financial weapons must be masters in reading the market and its moves, and at the same time act very witty when required, more importantly they must be leveraged enough to escape when the markets turn against them. Every morning, I get up only to realize the gruesome cruelty with which I sell structures to clients and sometimes push them into trading which they, hardly, are aware of. Thats my job and thats what I am paid for........

Derivatives or trading comes into picture when a firm has cross currency exposures, liability in other currencies and domestic loans in their portfolios. Firms generally use derivatives as an instrument to protect their exposures to foreign currencies, to reduce the interest rates on domestic and international liabilities. However, there is a catch to it, nothing in this world comes at free of cost, the firm either diversifies its risk to something else or pays a cost upfront to stay safe. The greed with which most managers think, does not allow them to pay upfront premiums, instead, put thier head into something that they hardly know, on the name of diversification.

Donald rumsfeld once quoted "As we know, there are known knowns. There are things we know we know. We also know there are known unknowns. That is to say we know there are some things we do not know. But there are also unknown unknowns, the ones we don't know we don't know."

- The world of derivatives is full of known unknowns and unknown unknowns.

I still remember the days of my MBA at college, we had a subject by name Risk Management (cant help my self but laugh the moment I read this word, for the sheer exploitation that bankers/brokers/consultants use this word to make millions). I used to ponder over all these concepts like options, fowards, swaps....I mean, why the F*** would some take a loan in rupee at 10% and then swap it to Japanese Yen for a 9% arbitrage when you can F****** borrow in yen directly, which fool would dare to sell an option which is like crocheting a rope to hang yourself, all by yourself. I felt all these concepts are sheer nonsense, only If I had known then, that I would be making smart money selling the same nonsense for all my life!!!

Trading........

Trading is straightforward, you just need to buy at a cheaper price than you sell. If you expect the price to go up, you buy it; then you sell it when it has gone up and you are sure that it is not going to go up any more; you bank the profits. If you want to be fancier, then you use derivatives: you use a forward to gain leverage; you buy a call option to limit your risk to the premium paid if the price doesn't go up. you can sell a put option and bank the premium; if the price goes up then the option won't be exercised and you get to keep the premium; if the price goes down, then you leave the country. (you leave the country because the guy to whom you sold, would come to you with a bazooka in his hand forcing you to buy at the agreed price which is galaxies away from the market price.)

Epilogue

After coming up with proofs of all the conformations and underlyings signed and submitted by the firm ( done by Mr. S, which he had no powers of doing so), Mr.R had no choice but to cancel the deal ( otherwise he would have to sell himself along with the company to pay for any further loss) and take a loss of 4 million ( which he thought was better than keeping the trade alive, paying margin money to keep the MTM low) and kick Mr. S out of the firm for his reckless pretentious behaviour. All Mr.S aimed at, was a smart bonus for protecting the revenue streams of the firm and that too at no cost. Greed paid!!!!

Depression???

'A condition of general emotional dejection and withdrawl' this is what the dictionary defines it as. well, going by this definition I am not depressed afterall. what then is to be pondered about is the term to be coined to my current disposition. One thing for sure is that I am not happy, I feel life is no longer a mirthful experience, there is a sense of utter desolation that I feel in life. Is it because I no longer find happiness in things I do?? is it because I feel I underperform or is it becuase I have set such high standards for myself that I am not able to live up to them????

whatever the reasons might be, the end is same...there is something missing, something that I need to add into life to make it more happening. To be frank its all about dejection. Dejection that I am not standing upto what I want to be and do.

Discipline

I just wish I didnt know this word, I wish this word never had a place in the dictionary, the very word makes u feel far from life, counterproductive and dysfunctional. If not for this word, I would have been happy with myelf, content with what I am doing and the way I am doing it.

Ambitious

This is the word (world) I'd love to live in, the world that I want to be the king of. The world that I feel have a birthright to rule. Without this trait in me, I'd rather prefer to be lifeless.

Success

Here's the whole problem, A conglomeration of both the above mentioned traits with a little of luck added is the reciepe of success. something that I am expected to possess. after a lot of dissection and dissolution, I come to the conclusion that I need to be more disciplined and a little less ambitious. The whole problem starts with the fact that I aim high, work low and feel sad about the gap between the former and the latter.

Time management is the most easiest to talk about and the most diffcult (next to impossible) thing to implement. I often find my self midway of a task only to realize that I have spent too much time on what I shouldnt have, and then only to feel miserably guilty for doing so.

Self motivation is the mantra, something has been tried and tested with me. time and again, I could successfully confront challenges in life because I was motivated by my own soul, and so the time has come for my soul to do the same, time has come for my mind to push itself to the edge to deliver, perform and conquer.

I am sure and I realize that none of what is written above is conclusive and makes sense...hope to write something sensible next time.