In the very unlikely event that the United States defaults on its debt obligations, the country's economy would contract by 5 percent and stocks would fall by nearly a third, according to Credit Suisse.
While Andrew Garthwaite and the global strategy team at the Swiss bank see a 50-50 chance of a ratings downgrade of U.S. debt by the major ratings agencies, they remain confident such an outcome would not lead to disaster.
“We think there is a 50 percent chance of a ratings downgrade on U.S. sovereign debt.
This could happen even if the debt ceiling is raised,” Garthwaite, the head of global strategy at Credit Suisse, said in research note.
“We doubt it will have much effect," he continued. "Japan has a 1.1 percent yield and an AA- rating, many U.S. Treasury funds do not have credit-rating limitations and national bank regulators would probably keep risk weightings for U.S. sovereign debt at zero.”
If no budget deal is struck, but the U.S. does not default, Garthwaite predicts a bad time for stocks and the economy.
“As our economists point out, each month of no rise in the ceiling could easily take 0.5-1 percent off GDP.
In this case, equity markets would drop by 10-15 percent, prompting Congress to find a solution, and bond yields would fall to 2.75 percent.” If that proved to be the case, investors would in Garthwaite’s opinion need to get into defensive stocks and out of the dollar.
However, the worst case scenario is clearly an outright U.S. default. That is where things could get nasty, according to the Credit Suisse team.
“This is very unlikely, but if it occurs, GDP could fall 5 percent plus, and equities by 30 percent,” Garthwaite said.
In the event of such a disastrous outcome, Garthwaite predicts the only place to hide would be in cash-rich stocks.
“Worries about the U.S. public finances will likely bring investors to focus on ultra-safe equities: companies with [credit default swap] spreads below that of G7 sovereigns, yet offering dividend yields above government bond yields: Centrica, Sanofi, Novartis, Compass, Pfizer, Philip Morris, Merck.” With fiscal tightening in the cards no matter what the outcome of talks in Washington, Garthwaite is worried about the effect on growth, but not that worried.
“Our main concern is that, on IMF estimates, fiscal tightening in the U.S. will be equivalent to nearly 2.5 percent of GDP next year.” Garthwaite’s economics team predicts that most of that tightening estimated by the International Monetary Fund will not actually take place, and predicts only half a percent of GDP growth being lost as result.
© 2011 CNBC.com
Oregon Democratic Congressman David Wu, accused of an unwanted sexual encounter with a campaign donor's teenage daughter, said on Tuesday he will resign his seat to defend himself against "these very serious allegations."
The decision by Wu, 56, to step down came a day after he announced he would not seek an eighth term in office, as Nancy Pelosi, the top-ranking Democrat in the House of Representatives, referred the matter to the House Ethics Committee for investigation.
Wu becomes the latest in a long line of politicians from both parties to become caught up in sex scandals over the years, and the second House Democrat in little over a month to have his tenure cut short by such a controversy.
New York Representative Anthony Weiner resigned in June after he admitted lying about sending lewd photos of himself to women over the Internet.
Wu's conduct has been called into question previously. He acknowledged earlier this year he was undergoing psychiatric treatment after his staff complained of erratic behavior, including his e-mailing of a picture of himself dressed in a tiger costume.
Wu, the first Chinese-American elected to Congress, did not give a precise date for his resignation, saying only that he planned to step down "effective upon the resolution of the debt-ceiling crisis." Congress faces an early August deadline to pass legislation raising the nation's debt ceiling to avoid a U.S. default on its obligations.
While he made no explicit mention of the exact misconduct he is accused of, Wu said in his statement, "I cannot care for my family the way I wish while serving in Congress and fighting these very serious allegations."
SPECIAL ELECTION
Wu represents Oregon's heavily Democratic 1st Congressional District, which encompasses the western side of Portland, the state's largest city, as well as more rural areas in Oregon's northwestern corner.
The governor will call for a special election to fill Wu's seat for the remainder of his term.
Two other Democrats already had declared their intention to challenge Wu in next year's primary before the scandal broke -- state labor commissioner Brad Avakian and state lawmaker Brad Witt of Clatskanie, Oregon, northwest of Portland.
No Republicans have immediately announced plans to run. But Oregon Republican Party Chairman Allen Alley called the 1st District "absolutely a winnable Republican seat," citing what he described as a shift in the national political tone.
Although Democrats account for 42.4 percent of registered voters in the district, compared with 30.1 percent for Republicans, a sizable bloc, 27.5 percent, are registered as independent. In 2010, Wu's Republican challenger, Rob Cornilles, lost by 10 percentage points.
The latest allegations against Wu surfaced last week when the Portland Oregonian reported the daughter of a high school friend who contributed to Wu's campaign accused him of making an unwanted sexual advance around Thanksgiving of last year.
Details of the nature of the alleged encounter have not been disclosed. Wu has not denied the accusation and has acknowledged more than once the allegation was "serious."
The Oregonian newspaper said Wu's accuser, who has not been identified, was from Orange County, California, graduated from high school in 2010, and was 18 at the time of the incident.
Indian travel services firm Cox & Kings Ltd is in talks to acquire European holiday specialist, Holidaybreak Plc., in what can be the biggest overseas deal in the travel services industry.
Founded in 1973, Holidaybreak is based in Northwich (UK) and offers an extensive portfolio that includes camping brands like Eurocamp and Keycamp, an adventure holidays business (Explore) and the Hotel Breaks division.
According to Holidaybreak, the discussion may or may not lead to an offer at the price of 432.1 pence in cash per ordinary share. However, Holidaybreak's scrip shot up 12 per cent and was trading at 412 pence a share on the London Stock Exchange in early trading hours on Tuesday. At this price, the firm has a market capitalisation of £290 million ($475 million).
At the indicative offer price of 432.1 pence a share, the deal will value Holidaybreak at £305 million ($500 million), according to VCCircle estimates.
"As part of its overall strategy for growth and expansion, the company does evaluate opportunities from time to time. In line with the company's growth strategy, it is in talks with Holidaybreak Plc., a company listed on the London Stock Exchange, which may or may not lead to an offer for shares in Holiday Plc. At this stage, there is no certainty that any offer will be made by the company or that any offer, if made, will be acceptable to the shareholders of Holidaybreak Plc.," Cox & Kings said on the proposed Holidaybreak deal.
On the Bombay Stock Exchange, the shares of Cox & Kings closed at Rs 197.8, down 2.25 per cent. This could be a reaction related to investor concerns of a large international acquisition and potential impact on the balance sheet.
In April this year, the company's board had said that it might raise up to Rs 1,500 crore through issue of shares/convertible instruments, besides raising the borrowing power of the firm from Rs 1,000 crore to Rs 1,500 crore.
The firm had also got the nod from FIPB, the nodal body monitoring foreign investment in India, to bring in FDI worth Rs 750 crore. It now plans to use the proceeds for acquisitions and new business launches, besides funding its current operations.
Mumbai-based Cox & Kings had recently teamed up with other shareholders of the privately held US-based travel management firm Radius, to pump in fresh capital in a multi-million dollar recapitalisation deal. The Indian company already held stake in Radius.
Cox & Kings is one of the world's oldest travel services brands, established in 1758. It is a premium brand which operates across 20 countries through its offices and through franchise sales shops.
One of the largest municipal bankruptcy of United States to be announced in near future as Jefferson County of Alabama State hired lawyers for possible bankruptcy filing as it is unable to pay its more than $3 billion debt for its sewer system.
The Jefferson County Commission approved resolutions Tuesday to hire prominent bankruptcy lawyers and to sell bonds later in case money is needed to emerge from bankruptcy.
Jefferson is Alabama's most populous county and seat of Birmingham. It's been trying for three years to avoid filing bankruptcy over debt payments it can no longer afford.
Two of the five commissioners say there's an 80 percent chance the county will file bankruptcy. The vote could come at a meeting scheduled for Thursday in Birmingham.
The commission president, David Carrington, says other possibilities include extending talks with creditors or accepting a settlement offer.
News Highlights - Week of 18 - 22 July 2011
Consumer price inflation in Malaysia accelerated to 3.5% year-on-year (y-o-y) in June, the highest level in 27 months, on the back of rising food and transportation prices. On a month-on-month (m-o-m) basis, consumer price inflation stood at 0.3% in June. In Hong Kong, China, the composite consumer price index rose 5.6% y-o-y in June, after climbing 5.2% in May, primarily driven by increasing food and housing rental prices.
* The Bank of Korea has restricted foreign exchange agencies' investments in foreign-currency-denominated bonds issued domestically by local enterprises for the purpose of Korean won financing, effective 25 July.
* Last week, Korea Housing Finance Corporation priced a USD500 million 5.5-year covered bond at a coupon rate of 3.50% and Samsung Securities issued a KRW300 billion 3-year bond at a coupon rate of 4.33%. In the Philippines, power conglomerate First Gen Corporation offered PHP10 billion worth of perpetual preferred shares last week with a dividend rate of 8% per annum. In Thailand, real estate developer Sansiri issued a THB1 billion 5-year bond carrying a coupon rate of 5.4%.
* In Singapore last week, water treatment company Hyflux issued a SGD100 million 5-year bond carrying a coupon rate of 3.5%; real estate developer Joynote issued a SGD180 million 5-year bond and a SGD320 million 7-year bond at coupon rates of 2.585% and 3.408%, respectively; and Singapore's Housing Development Board sold a SGD600 million 10-year bond at a coupon rate of 2.815%.
* The Export–Import Bank of China plans to issue CNY24 billion worth of bonds in two tranches. The China Three Gorges Project plans to issue a 3-year CNY5 billion medium-term note. In Indonesia, Medco Energi Internasional plans to auction USD50 million–USD100 million worth of bonds, while Permodalan Nasional Madani and Nippon Indosari Corpindo plan to sell IDR300 billion and IDR500 billion worth of bonds, respectively. Meanwhile, the Treasury Department of Thailand announced its plan to issue a THB3 billion securitized bond to finance property development projects.
* Japan recorded a trade surplus of JPY70.7 billion in June after posting a deficit of JPY855.8 billion in May. Singapore's non-oil domestic export growth eased to 1.1% y-o-y in June from 7.6% in May, due to lower shipments of electronic goods and declining sales of pharmaceutical products. The Philippines' balance of payments surplus soared to USD5 billion in 1H11 on the back of strong portfolio inflows and overseas Filipino remittances.
* Indonesia's car sales fell 0.3% y-o-y in June, while domestic motorcycle sales rose 0.8% y-o-y. In Thailand, total car sales decreased 0.4% y-o-y in June, following a 10.2% fall in May. In Japan, department store sales rose 0.3% y-o-y in June after registering a 2.4% decline in May.
* Government bond yields fell last week for most tenors in Indonesia, the Philippines and Thailand, while yields rose for all tenors in the People's Republic of China (PRC), the Republic of Korea, and Viet Nam and for most tenors in Malaysia. Yield movements were mixed in Hong Kong, China; and Singapore. Yield spreads between 2- and 10- year maturities widened in Hong Kong, China; Indonesia; Malaysia; Singapore; and Thailand, while spreads narrowed in most other emerging East Asian markets.
Read the full article at
Abstract:
Here are the ingredients in the plot: A problem everyone's aware of. If it isn't resolved, a shutdown with unspecified but possibly disastrous consequences. A deadline which seems indispensable, since in its absence it appears nothing would be done. And despite the presence of the oncoming freight train, movement toward a solution is deterred by highly entrenched positions. It's truly white-knuckle time, and if the progress toward a solution continues to lag, the things that must happen won't.
I'm not talking about the nearly concluded drama at the National Football League, where failure to reach a labor settlement for just a few more days would have caused significant changes in the schedule for the coming year, upsetting the flow of wealth to owners and players and depriving fans of the game they love. I'm talking about the down-to-the-wire battle over the U.S. debt ceiling. I've decided to devote a memo to the debt issue and its significance. I especially hope it'll be helpful to our non-U.S. clients, for whom the lack of progress to date must be absolutely incomprehensible.
Interestingly, the immediate debt crisis is somewhat artificial. It is occasioned now only because of our debt ceiling, which currently limits the net debt of the United States to $14.29 trillion. Such ceilings are far from the norm worldwide. Many other nations seem to function no worse without them.
But the U.S. has the historical accident of a ceiling, and we must deal with it. Because the limitation is set in terms of absolute dollars and not indexed for inflation or growth,we would run into it every few years even if our debt only grew apace with the economy. "In fact, it's been raised nearly 100 times over the
decades." (Financial Times, July 16) But thanks to the especially rapid growth of our debt relative to GDP in recent years –exacerbated by the Afghan and Iraq wars and the financial crisis – the ceiling has the potential to provide some real excitement every once in a while.
For much of the last century, as public equity markets have grown, the choice for owners of private businesses that had growth potential was a simple one. Stay private, with limited access to equity capital or go public? In making the decision, the owner weighed the pluses and minuses of a public offering. On the plus side, liquidity increases and you have access to far more capital, generally at a lower cost, since the investors buying your equity tend to be more diversified (and thus willing to overlook a portion of the risk in your company). On the minus side, you risk loss of control (if not right away, but at some point in time in the future; remember the cautionary tale of Steve Jobs and Steve Wozniak being forced out of Apple in the 1980s) and you also have far more stringent corporate governance rules (think Sarbanes-Oxley) and information disclosure requirements. The venture capital market eased the transition, by allowing small firms that were not ready to go public to raise equity from private investors, albeit at a higher cost than they would pay in public markets
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That giant whooshing, and humming, sound you hear are all the printers at the basement of Marriner Eccles getting refills and start the warm up process. Because according to the Fed Charles Plosser the Federal Reserve is actively preparing for the possibility that the United States could default. Which can only mean one thing: an immediate paradrop of millions of $100 bricks to every man woman and child in the US since as we all know by know Tim Geithner has repeatedly confirmed the Treasury has absolutely no default plans. None.
Per Reuters:
Philadelphia Federal Reserve Bank President Charles Plosser said the Fed has for the past few months been working closely with Treasury, ironing out what to do if the world's biggest economy runs out of cash on August 2.
"We are in contingency planning mode," Plosser told Reuters in an interview at the regional central bank's headquarters in Philadelphia. "We are all engaged … It's a very active process."
Plosser said his "gut feeling" was that President Barack Obama and Congress will come to an agreement to increase the Treasury's borrowing authority in time to avert a default on government obligations.
And in addition to the warming up, the Fed is also engaging in the following:
The Fed effectively acts as the Treasury's bank — it clears the government's checks to everyone from social security recipients to government workers.
"We are developing processes and procedures by which the Treasury communicates to us what we are going to do," Plosser said, adding that the task was manageable. "How the Fed is going to go about clearing government checks. Which ones are going to be good? Which ones are not going to be good?"
"There are a lot of people working on what we would do and how we would do it," he said.
Plosser added that there are difficult questions that the Fed itself had to grapple with.
The Fed lends to banks at the discount window against good collateral. But what happens if U.S. Treasuries no longer fit that bill?
"Do we treat them as if they didn't default, in which case we would be saying we are pretending it never happened? Or do we treat them as if they defaulted and don't lend against them?" Plosser said. "Those are more policy questions."s at the basement of Marriner Eccles getting refills and start the warm up process.
We urge the secretary of tax evasion to take a hint or two from his "Treasury Bank" brethren and start contemplating a Plan B since we now stand less than 48 hours away from D-Hour and there is still no consensus.
News Highlights - Week of 4 - 8 July 2011
The People's Republic of China (PRC) raised its policy rates to curb inflation for the third time this year—by 25 basis points (bps) each—to 3.5% for the 1-year deposit rate and 6.56% for the 1-year lending rate, effective 7 July. Meanwhile, Bank Negara Malaysia kept its policy rate at 3.0% but hiked its statutory reserve requirement ratio by 100 bps to 4.0%, effective 16 July. Viet Nam slashed its repurchase rate by 100 bps to 14.0% effective 4 July, after a series of rate hikes earlier this year.
* PRC's consumer price inflation accelerated to 6.4% year-on-year (y-o-y) in June – the highest recorded – on the back of rising food prices. Consumer price inflation in the Philippines surged to 4.6% y-o-y in June, the highest level in 26 months, driven by price increases in water, electricity, gas and oil, food products, and education fees. In the Republic of Korea, growth in producer price inflation was constant at 6.2% y-o-y in both May and June.
* Net foreign investments in the Republic of Korea's local currency (LCY) bonds stood at KRW2.2 trillion in June, as net bond purchases for the month widened to KRW8.5 trillion, which eclipsed maturity redemptions of KRW6.4 trillion. However, net foreign investment in Korean LCY bonds was down in June from KRW2.6 trillion in May.
* Thailand's Public Debt Management Office has approved five foreign banks to issue THB-denominated bonds up until 31 December. First Gulf Joint Stock Company plans to issue its debut bond worth THB6 billion, while Credit Agricole Corporate and Investment Bank, ING Bank, and Export–Import Bank of Korea were granted permission to issue THB10 billion each. Meanwhile, Lloyds TSB Bank was given approval to issue bonds up to a total of THB6 billion.
* The PRC's exports grew 17.9% y-o-y in June, from 19.4% in May while import growth slowed to 19.3% y-o-y in June, from 28.4% in May. Trade surplus grew to a 7-month high in June at USD22.3 billion. Malaysia's export growth eased to 5.4% y-o-y and imports rose 5.6 % in May. In the first 5 months of the year, total exports increased 6.2% y-o-y to MYR279.2 billion and total imports rose 10.3% to MYR228.0 billion. As a result, Malaysia's trade surplus in January–May stood at MYR51.3 billion.
* Last week, Shanghai International Port issued CNH3 billion of 5-year callable bonds to yield 5.05%. Indonesia's Bank Sumut sold IDR600 billion of 5-year bonds with a coupon of 10.125% and IDR400 billion of 7-year subordinated bonds with a coupon of 11.35%. Korea Hydro and Nuclear Power Co. sold USD500 million of 10-year bonds. Korea Gas priced a JPY30 billon samurai bond. Korea Land & Housing Corp. issued KRW250 billion of 3.5-year bonds at a coupon of 4.27%. Hyundai Merchant Marine raised KRW240 billion from the sale of 5-year bonds at a 5.8% coupon. Thailand issued THB40 billion of 10-year inflation-linked bonds at a coupon of 1.2%. Asian Property Development issued THB1.5 billion of 3.5-year senior notes that carry a step-up coupon of 4.5% in the third year and 5.8% in the fourth year.
* Government bond yields fell last week for all tenors in Indonesia and for most tenors in the PRC, the Philippines, Singapore and Viet Nam. Yields rose for all tenors in Hong Kong, China and for most tenors in the Republic of Korea, Malaysia and Thailand. Yield spreads between 2- and 10- maturities widened in the PRC; Hong Kong, China; the Philippines; Thailand; and Viet Nam, while spreads narrowed in the rest of East Asian markets.
In recent times, many companies have resorted to inflating their numbers in keeping with their reputations or to meet investor expectations. What started as a trickle is now a full-fledged practice. Fortunately, equity analysts have been quick to sift through annual reports and flag instances of creative accounting. Here are some of the more common fudges in corporate India's accounting standards.
Foreign exchange gains/losses
You can have a long-term debt in a foreign denominated currency, or on the asset side of the balance sheet, you can have an overseas investment exposure. Both situations can lead to notional gains or losses. Until recently, there was no uniform standard for recognising profits and losses in various situations in the profit-and-loss account.
Besides, the corporates that routinely use forex hedges (forwards and derivatives) to manage forex risks pose an additional problem of how to recognise the realised and unrealised gains and losses on these exposures. While some strict (and welcome) changes have been made in terms of accounting standards, there are still fears on hidden/undeclared forex losses of many listed companies.
FCCBs: Interest and redemption premium
For many years now, companies have raised money in foreign currencies via convertible bonds. Typically, these bonds carry a very low coupon rate such as 0% or 1% and are redeemable at a huge premium, so that the yield-to-maturity value for the bond holder works out to 6-7%. The company hopes that the redemption premium will never be incurred by it since the bond holder will opt for conversion to shares.
Meanwhile, in the stock market, conversion is often not sought since the conversion price is lower than the prevailing CMP (current market price). In such cases, the redemption premium paid is routed 'below the line' (by charging it to share premium account, instead of reporting it in the profit-and-loss account ).
While this is the prescribed practice, it's unfair that such a charge on borrowed funds should not be reported in the profit-and-loss account uniformly across the life of the bonds. Even if the bond conversion to shares takes place, the discount to CMP implies that such issuances should be expensed like stock options.
Advances and investments
One of the most important determinants of shareholder value creation is capital allocation, that is, how a company reinvests the cash it generates. Redeployment in productive assets, such as plant and machinery, especially if the incremental business can be executed at a similar or better profitability, can quickly lead to multi-bagger stock performance as profits compound. Obviously, such opportunities are not uniformly available across all businesses. Many companies routinely divert the cash surplus from a profitable business to a cash guzzler, only to kill their own shareholder value.
Typically, such (mis)allocations of capital can be found by scanning the investment schedule in their balance sheets. Since investors have figured this out, the more creative companies often resort to making unjustifiable advances to group entities, which show up in the loans and advances schedule under the broader category of 'current assets'. There is nothing remotely current about such assets, since they are invariably share capital advance money or apparently short-term loans given to (often undeserving) parties, who enjoy the benefits of such funds for extended periods of time.
Acceptances
A simple word like this in the current liabilities schedule can send shivers down the spine of investors, especially if a bloating is visible. Acceptances are short-term liabilities that the company accepts and promises to pay such claimants in the future. The danger is that these liabilities might extend beyond the normal scope of trade payables incurred in the normal course of business.
For example, a short-term loan availed of to retire long-term debt can theoretically fall under acceptances. This helps the balance sheet in many ways. Firstly, long-term debt is understated as a result of diverting the liability to the current liabilities head rather than the debt head. Hence, the total capital employed (net worth plus debt) in the balance sheet effectively falls and artificially improves return ratios such as RoCE or RoA.
Secondly, the increase in current liabilities reduces the net working capital (CA-CL), which improves the apparent cash flow from operations. Again, this is artificial, since in a few days after the balance sheet date, the company will probably resort to switching the acceptances with proper long-term debt.
Thirdly, under-reporting of debt has the effect of boosting fair market capitalisation, and hence, fair value per share, wherever analysts attempt to estimate fair EV (market cap plus debt) as a multiple of EBIDTA. All other factors remaining constant, the effect of under-reported debt will be to boost fair market cap. Hence, the target price of the stock (calculated by a less-than-diligent analyst) would rise with no sane rationale.
As the Indian accounting standards are set to approach global standards of checking fraudulent practices, especially with the IFRS (International Financial Reporting Standards) convergence, some of these malpractices will hopefully end. Moreover, Sebi needs to lay down strict laws to combat this menace.
Even the Indian accountants and analysts will have to continue to set the bar high for accounting standards in such a way that corporates find it increasingly difficult to get away with a less-than-fair disclosures of numbers to investors.
Michael Mauboussin, the Chief Investment Strategist for the well known fund manager Legg Mason, provides some interesting insights into the reasons why most investors perform poorly over time, and what are the key skills to develop for successful investing. He has written several books and is an adjunct professor of finance at Columbia University. He was interviewed recently by WealthTrack and I have summarised below the key points:
-While more hard work leads to better results in most spheres of life – it doesn't necessarily do so in the investment world where investors do too much and typically end up buying high and selling low. Often, sitting tight and not doing anything is the best course of action.
-Surveys of a variety of investor groups (including institutions) have shown that they typically hire managers who have recently outperformed and fire managers who have underperformed – and that they would have been better off over the following two year period if they had stayed with the underperforming managers.
-Investors suffer from a "recency bias" and their returns have lagged returns on mutual funds as they chase the hot funds of the day. The key is to find an asset which is unloved and cheap and then hold it (which is different from just buy and hold).
-Most activities in life lie somewhere along the continuum of pure skill, no luck and pure skill, no luck. Investing falls more towards the luck end of the spectrum, and that is why it is so hard to beat the market as everyone is working really hard at it and their skills sort of cancel out.
-It is therefore important to have longer time periods to assess managers (and strategies) as it is only then that their skills will be apparent. In the short term it tends to be noisy and luck plays a key role.
-Really good performances (or outcomes in other aspects of life) are usually a result of skills with lots of good luck – and luck tends to be transitory and mean reverting.
-There are three important skills to develop as an investor: 1) an analytical edge – which, firstly, requires the ability to analyse the difference between the price of an asset and its fundamentals, and, secondly, to position a portfolio appropriately by provide higher weightings to the good ideas , 2) behavioural - to avoid the traps and biases we are all prone to – i.e. over confidence and be overly swayed by market sentiments which tempts us to buy high and sell low, 3) institutional barriers – to avoid being with the pack.
-The well known value investor Seth Klarman of Baupost Group said it best: "Value investing is at its core the marriage of a contrarian streak with a calculator" implying that when everyone loves or dislikes something, take out your calculator and try to spot the discrepancy between the price and its fundamentals.
-The capital accumulation rate of a stock, which is determined by its price, is what matters to an investor. Dividend paying strategies only work if you assume that the dividends are fully reinvested with no taxes. For example, a sock worth $100 which pays a dividend of $3 is then worth $97 , and will be worth $100 only if you reinvest the full dividend.
-The market is currently attractively valued with the S&P500 estimated p/e for 2012 at around 12 versus a historical average of 15/16 – implying a yield of 8.3% which provides an excess return over treasuries of about 5%.
-US corporate balance sheets are healthy, and in particular the large multinationals are trading at attractive valuations and provide an attractive investment opportunity.
Thought provoking insights from Mauboussin and while we would all like to attribute our success to a superior set of skills – it is more often likely to be a result of luck! This is also the point made of Nassim Taleb in his book "Fooled by Randomness". Does this mean we give up working on our skill s? – of course not! – as he notes, luck is mean reverting, so developing your skill set and being prepared to take advantage of a favourable change in fortune would be an appropriate strategy. His observation on dividends is also instructive – dividend paying stocks have done well over long periods because the have also exhibited solid earnings growth, but the assumption underlying this thesis is that the dividends are reinvested and not spent! And on his final (and in my view) most important point, "be a contrarian with a calculator" – Greece and Tepco bonds anyone?!
With the abysmal job growth number released this Friday, the debate between austerity and further fiscal spending is likely to intensify in the weeks and months ahead. Talks of starting an infrastructure bank are an opening salvo from Obama – expect an acrimonious debate and more market volatility ahead. For those who continue to believe in the merits of fiscal austerity I would suggest listening to this 50 minutes lecture by Professor Paul Krugman delivered recently at Cambridge University to celebrate the 75th anniversary of the General Theory. To borrow an apt Sanskrit prayer from the Vedas: "tamaso maa jyotirgamaya" – "lead us from darkness to light"!
The timing on the earlier pronouncement that rating agencies may have found religion could not have been better. Not even an hour later, here comes Moody's with a blockbuster which may put China's "White Knight" status, at least as ar as Europe is concerned, in grave danger. In a report just released, the rating agency not only warns that China's debt problem is "bigger than stated" (i.e., China is hiding a ton of ugly stuff off the books), but goes ahead to quantify it: "Of the RMB 10.7 trillion (about $1.6 trillion) of local government debt examined by the Chinese audit agency, RMB 8.5 trillion ($1.3 trillion) was funded by banks. However, Moody's has identified another potential RMB 3.5 trillion ($540 billion) of such loans that the Chinese auditors did not discuss in their report….we find that the Chinese audit agency could be understating banks' exposures to local governments by as much as RMB 3.5 trillion." Naturally, the implication is that this is an absolutely willing "omission" (thank you central planning), which means that of China's $5.8 trillion GDP (or whatever imaginary number the Polit Bureau is happy with throwing around for mass consumption), $540 billion is debt that is "unaccounted for", most likely due to being, well, bad. That would be equivalent to saying that $1.4 trillion of US corporate debt is delinquent. And lest anything is lost in translation, Moody's drives the steak through the Dragon's heart: "Since these loans to local governments are not covered by the NAO report, this means they are not considered by the audit agency as real claims on local governments. This indicates that these loans are most likely poorly documented and may pose the greatest risk of delinquency." So let's get this straight: a country which has 10% of its GDP in the form of bad debt, is somehow expected to be credible enough to buy not only Greek debt, but the EURUSD each and every day? Mmmmk. In the meantime, Dagong downgrades the US to junk status in 5, 4, 3…
Full Moody's release:
"Moody's Investors Service says that the potential scale of the problem loans at Chinese banks may be closer to its stress case than its base case, according to an assessment that the rating agency conducted following the release of new data by China's National Audit Office (NAO).
When considering the apparent absence of a clear master plan to deal with this issue, Moody's also views the credit outlook for the Chinese banking system as potentially turning to negative.
"We assume that the majority of loans to local governments are of good quality, but based on our assessment of the loan classifications and risk characteristics, as provided by the NAO and other Chinese agencies, we conclude that the banks' exposure to local government borrowers is greater than we anticipated," says Yvonne Zhang, a Moody's Vice President and one of the authors of the report.
Of the RMB 10.7 trillion (about $1.6 trillion) of local government debt examined by the Chinese audit agency, RMB 8.5 trillion ($1.3 trillion) was funded by banks. However, Moody's has identified another potential RMB 3.5 trillion ($540 billion) of such loans that the Chinese auditors did not discuss in their report.
"When cross-examining the findings by the June 27 NAO report — in conjunction with reports from Chinese banking regulators — we find that the Chinese audit agency could be understating banks' exposures to local governments by as much as RMB 3.5 trillion," says Zhang.
"Since these loans to local governments are not covered by the NAO report, this means they are not considered by the audit agency as real claims on local governments. This indicates that these loans are most likely poorly documented and may pose the greatest risk of delinquency," the analyst adds.
Moody's report estimates that the Chinese banking system's economic non-performing loans could reach between 8% and 12% of total loans, compared to 5% to 8% in the rating agency's base case, and 10% to 18% in its stress case.
In the report, the rating agency examines various scenarios as to how banks could tackle problem loans, including some where the government provides assistance, but Moody's generally expects the Chinese authorities to implement gradual discipline.
Paul Krugman has written a fascinating review of a recent book : "Age of Greed: The triumph of Finance and the decline of America, 1970 to the present" by Jeff Maddrick. The book is a "deeply disturbing tale of hypocrisy, corruption and greed" and recounts, through a series of vignettes, how America came to be dominated by Wall Street and its culture of "greed is good" (the book is definitely on my ever expanding reading list!). To summarise:
-The recent crisis is the latest in a series of repeating cycles of "financial overreach, taxpayer bailout and subsequent Wall Street ingratitude". The busts only get bigger as it seems the lessons of past crises are not learnt.
-The US emerged from the Great Depression with a tightly regulated financial system which kept banking safe and boring for about 40 years.
-This began to change in the 1970s and 1980s as the political mood turned against "big government" largely as a result of the stagflation of the 1970s – which was not a result of "big government" but had its roots in temporary events like the oil price shock and disappointing crop yields which got magnified through wage-price indexation.
-Constant policy shifts under Nixon, Ford and Carter led to public disillusionment with government and proved to be a fertile ground for the antigovernment messages of Milton Friedman and Ronald Reagan.
-Reagan convinced a credulous public that the " government had become the principal obstacle to their personal fulfilment" and made excessive greed and individualism acceptable, and even lauded, in the American psyche.
-While Friedman made important contributions to the economic field, he often shoehorned real-life data to fit his views and made "overly simple assertions of free market claims". He erroneously believed that free markets were a solution to virtually every problem and even held the government responsible for the Great Depression (contrary to what the data says).
-Reagan and Friedman fanned the culture of "greedism– that unchecked self-interest furthers the common good".
-Walter Wriston, who ran Citibank from the 1960s until the 1980s, "lived a free market charade" arguing against the bailouts of Chyrsler (1978) and Continental Illinois (1984) while having his own bank saved by the government multiple times (sounds familiar?)
-Wriston was responsible for the first major step in banking deregulation with the introduction of negotiable CDs in 1961 which did away with the legal limits on deposits.
-Wriston also a played prominent role in the Latin American lending crisis of the 1980s and made the famous quote "Countries don't go bust" (which ranks with the Chuck Prince quote on "keep dancing until the music stops" as an all-time great!).
-The Latin American lending crisis has much in common with the sub-prime crisis decades later – i.e. a notion that all debtor nations (or nation-wide house prices) could not simultaneously have a funding problem (or suffer from precipitous price drops).
-US and European banks were bailed-out by the government with a programme heralded as aid to debtor nations but was in reality a bailout of the banks as the loans were made to the debtor nations to allow them to repay the banks, at the cost of imposing harsh austerity measures on the debtor nations which resulted in a "lost decade" for Latin America (sounds familiar?).
-Following the Latin American crisis was the savings and loan crisis of the early nineties, which had a greater direct cost to taxpayers than even the current crisis, and which was dealt with by further dismantling regulations left over from the Depression era.
-Then came the last two great bubbles – the technology bubble of the 1990s and the recent housing bubble, where Wall Street corruption played a crucial role and involved a colourful cast of characters: Sandy Weill, Jack Grubman (Solomon tech analyst), Frank Quattrone (Morgan Stanley tech banker), Ken Lay (Enron), Angelo Mozilo (Countrywide), Jimmy Caine (Bear Stearns) , Dick Fuld (Lehman), Stan O'Neal (Merrill Lynch) and Chuck Prince (Citibank).
-Sandy Weill was single-handedly responsible for dismantling the Glass-Steagal Act by proposing the merger between Solomon Smith Barney and Citibank, and actually getting the law changed to retroactively approve the merger.
-Abdication of regulatory oversight has been behind these cycles of financial overreach, crisis, bailout and lessons unlearnt. The centrepiece of this saga has been Alan Greenspan whose refusal to rein in the housing bubble, despite repeated warnings about an impending catastrophe, ranks highest in the list of ignominious acts. Greenspan, like Friedman and Reagan, firmly believed in "greedism" as an ethos.
-Why did this all happen? There are likely to be deeper forces at work than just a series of contingent event starting with the stagflation of the 1970s and roles played by the characters involved. The role of money in politics? A white backlash against the civil rights movement which transformed American politics? – a topic for another book.
-Despite the claims of some academics (primarily in business schools), the vast amount of capital channelled through Wall Street has not improved America's productive capacity by "efficiently allocating capital to its best use" and has in fact diminished its productive capacity through financial chicanery, massive bonus payouts and creating asset bubbles.
-The main lesson from these cycles , that unregulated greed, especially in the financial sector, is counterproductive for a nation's prosperity is still sadly unlearnt and we are still being told that "greed is good".
A remarkable narrative and a scathing criticism of the "greed is good" ethos which prevails today as a detriment against social and economical progress. A backlash against this culture is inevitable, and as noted by the socio-economist Neil Howe in book 'The Fourth Turning" the process is well underway. The pendulum swung to one extreme over the last few decades, ushering a radical shift in ideologies and beliefs in its wake, and will eventually swing to the other extreme and bring its own set of ideologies and beliefs. That is just how life and nature works-for better or for worse!
It was an eventful week in financial markets, with Greece voting in an austerity package which is likely to be followed by a EU vote this Sunday in favour of a funding package which would allow Greece breathing space until 2015. While the bonds are up in prices, they continue to provide an attractive yield and potential for further price appreciation as this issue gradually recedes into the background. As noted above, Latin America endured a decade of austerity to dig itself out of the hole and there is no reason that Greece, and other peripherals, cannot endure several more years of austerity to improve their balance sheets.
Select EM stock markets like Greater China, India, Brazil and Russia continue to provide an attractive entry level to add to the core EM assets position as the focus of these governments shifts from containing inflation to stimulating growth in the second half of the year. However, housing bubbles in some of these countries is likely to be contained as the backlash against unaffordable housing gains traction. I witnessed an unprecedented event in Hong Kong last night, with a late night silent sit-in by 218,000 people in central Hong Kong (which totally disrupted traffic and brought out scores of police vans!) protesting against government policies and unaffordable property prices. While HK/China property prices are unlikely to undergo a steep correction in the next few years (with China's change of regime taking place in 2012), they are likely to depreciate in real terms until a Renminbi revaluation (combined with a HK$ repeg) event takes place. The main beneficiary of this policy of containing housing prices is likely to be the stock market, which will benefit from the diversion of liquidity flows.
As a follow-up to last week's missive on the case for further fiscal spending as made by Larry Summers (which provoked some heated responses from readers!), I was pleasantly surprised to read Bill Gross of Pimco making a similar case. Bill Gross is a bond manager, and fiscal spending in anathema to bond investors and Wall Street bankers as it usually implies increasing interest rates which typically has an adverse affect on a variety of asset prices. Mr. Gross also highlighted the dire state of projected long-term finances of the US in a previous newsletter, so it is interesting to understand where he is coming from as he argues for more fiscal spending now and to focus on the long-term debt issue at a later stage. To summarise:
-The 2012 elections will be "fought on the battlefield of job creation". A 9.1% unemployment rate, which almost doubles if you include part-time and discouraged workers, does not create a well disposed electorate.
-Over the last 10 years, only 1.8 million jobs have been created while the workforce has grown by over 15 million. America's focus on services and hi tech sectors, and neglect of its manufacturing sector, has severely constrained its ability to create jobs.
-Over the past several decades, America's excessive reliance on financial assets to create wealth (and jobs) at the cost of an erosion of its manufacturing base, has finally led to a situation where the U.S. is "untrained, underinvested and overindebted" compared to its major competitors.
-Both the Democrats and Republicans have no credible plan on increasing employment – but both make claims that balancing the budget will, mystifyingly, create 20 million jobs over the next 10 years.
-Fiscal prudence is a long-term requirement for a stable and steady economy, but if implemented too quickly could be a death-blow to a still fragile economy.
-The roots of this false notion of fiscal conservatism equating to economic and job growth lie in the theories of David Ricardo developed in the early 19th century - which belong to the trash bin of theories aimed at academics rather than practical reality.
-Solutions to address the jobs issue should include long-term elements like education and skill-based training geared towards the "middle" than "hitech" , and more emphasis on science and math relative to the liberal arts. (He also makes some interesting observations on the state of college education in the US and questions whether it is worth the time and cost).
-The government needs to take the lead role in job creation – the private sector cannot take up this crucial role in the short-term as long as it is much cheaper to produce overseas with access to much labour.
-An infrastructure bank to fund reconstruction projects would be a productive use of deficit funds and a "true investment in our future".
-As the late economist and expert on financial crises Hyman Minsky noted so presciently years ago – "Big Government, should become the employer of last resort in a crisis, offering a job to anyone who wants one" .
An insightful piece which focuses on what will be the key issue as we move into 2012 – the lack of job growth in the US. With the economy growing at less than 3%, job creation will continue to be a challenge and will increase pressure on the Obama administration to provide more/continued stimulus – both on the fiscal and monetary front. The government should temporarily play a bigger role in the economy now to boost employment and growth, which would actually lay the groundwork for reducing fiscal imbalances in later years. As Professor Krugman has noted repeatedly in his columns- the US is in a zero-interest rate liquidity trap and conventional policies and frameworks to address issues like jobs and economic growth are unlikely to work– so now is not the time to "pay homage to some long defunct economist"!
I had noted the opportunity in purchasing Greece debt a few weeks ago, with short-term yields now over 30% and 5 year yields approaching 20% the opportunity continues to be attractive. The manager John Hussman made an interesting observation in his recent newsletter, that current market yields are implying a 100% chance of Greek default by mid-2013. This presents an attractive short-term investment (but risky!) opportunity as market sentiment possibly shifts over the next month or so– it is very unlikely that Greece will be allowed to default now as the contagion effects on the European financial system would make Lehman 2008 seem like a walk in the park! The long dated bonds (due 2037) are trading in the early 40s and likely present the best price appreciation potential.
What is Mauritius treaty?
The Indo-Mauritius tax treaty, signed in 1983, spares investors based in Mauritius from paying capital gains tax on the sale of shares of Indian companies. The treaty made it clear that capital gains from sale of shares by residents in Mauritius does not tax capital gains, the tax rate is zero.
Why does India want to re-work the pact?
The official reason is that India wants to curb treaty shopping, a practise in which residents of a third country take advantage of a beneficial tax treaty between two countries to lower their tax liability. However, the fact that Mauritius has no domestic companies or financial investors capable of investing larger sums in India is well known to the government. The real reason is that India is confident that investors will come directly even if they have to pay tax.
What does the Indian governement want?
It wants to tax foreign investors at the same rate as domestic ones. Currently, the long-term-defined as more than one year - capital gains tax for equity is zero while it is 10% for shares held for less than a year.
What about Mauritius?
Mauritius has resisted re-working the treaty with India. But the global regulatory environment towards so-called tax havens has hardened. As a result, Mauritius has agreed to resume a dialogue with India through a joint working group, comprising officials from both countries. The JWG had broken down in 2008 after six rounds of talks. The treaty can be reworked only if Mauritius agrees to do so and that will be long haul.
How far will Mauritius budge?
It may agree to re-work the pact on information exchange to end banking secrecy and provide information to India's tax authorities and to agencies like CBI or ED even if such information is not of domestic interest to Mauritius. However, Mauritius would resist forgoing the beneficail tax treatment on capital gains. India wants to ensure that shell companies in Mauritius don't enjoy tax benefits.But most companies registered in the Island nation have done so only to invest in India. Thus, Mauritius may never agree.
What is India's other option?
India will introduce a new direct taxes code in April 2012 that will give authorities the power to lift the corporate veil and look at the substance of a deal. But if an entity being probed is located in Mauritius, then the authorities there have to agree.
How soon can the tax pact be re-worked?
Surely not in 2011. First, Mauritius has to agree to re-work the treaty and this can happen only after rounds of JWG talks. Secondly, after Mauritius agrees, it would take at least a year to re-work the treaty.
Is the treaty all about revenues and taxes?
No. With China's strategic 'string of pearls' approach, India needs Mauritius to counter the threat of losing its foothold in the blue waters.
Buoyant gay couples cheered by supporters began marrying Sunday in Manhattan on the landmark day that New York became the sixth and largest state to recognize same-sex weddings.
On Sunday, New York became the sixth and largest state to recognize same-sex weddings.
New York City officials expected to host hundreds of same-sex weddings Sunday and about 100 couples waited in line on a sweltering morning in Manhattan for the chance to exchange vows at the city clerk's office.
Some people waiting to wed clutched bouquets and wore tuxedos or wedding dresses before they were ushered in the clerk's office for a license and a ceremony in one of the building's simple chapels. Among the first couples to say "I do" were Daniel Hernandez, 53, and Nevin Cohen, 48, Manhattan residents who met in 1998.
"Long time waiting, right?" deputy clerk Alisa Fuentes asked the couple, who smiled and nodded.
The two men, wearing matching navy blue sport jackets, kissed as a group of four friends clapped and news photographers' cameras snapped.
New York's adoption of legal same-sex marriage is viewed as a pivotal moment in the national gay rights movement and was expected to galvanize supporters and opponents alike. The state joined Connecticut, Iowa, Massachusetts, New Hampshire and Vermont, along with Washington, D.C., when it voted last month to legalize gay marriage.
Protest rallies were planned around the state Sunday afternoon.
Clerks in New York City and about a dozen other cities statewide opened their doors Sunday to cater to same-sex couples. In New York City, judges waived a mandatory 24-hour waiting period that allowed couples to exchange vows moments after receiving their licenses.
Initially, New York City officials had projected that about 2,500 couples might show up at the city clerk's offices hoping to get married on Sunday, but by the time a 48-hour lottery had drawn to a close on Thursday, 823 couples had signed up -- 59 more than the city had planned to accommodate. The city will perform ceremonies for all 823.
The first couples got married at the stroke of midnight Sunday in every corner of the state, from Niagara Falls to the capital in Albany to Long Island.
Gay-rights activists Kitty Lambert and Cheryle Rudd were legally married the very first moment they could be during a midnight ceremony at Niagara Falls.
With a rainbow-lit Niagara Falls as a backdrop, Lambert, 54, and Rudd, 53, were among the first gay couples to tie the knot with the blessing of the state. Lambert and Rudd, who have 12 grandchildren between them, have been together for more than a decade and had long been fighting for the right to marry.
The couple, both from Buffalo, smiled broadly as they exchanged traditional marriage vows, promising to love and cherish each other in sickness and in health. A crowd of several hundred people cheered as they were pronounced married and shared their first kiss.
"What an incredible night this was," said Lambert, who wore an electric blue satin gown with a sequined train for the midnight ceremony and carried a bouquet of blue hydrangeas. "This was an amazing night. Everything was absolutely perfect."
In Albany, Mayor Jerry Jennings performed marriages at 12:01 a.m. Sunday in the Common Council's chambers.
