- How a Panicky Day Led the Fed to Act – WSJ
Freezing of Credit Drives Sudden Shift; Shoving to Make Trades
- Lessons of Past May Offer Clues To Market’s Fate – WSJ
- In Asia, It’s a World of Extremes – WSJ
China’s Insular Markets Defy Slump in Shares; Other Trends Pose Worry
- Asian Traders Brace For More Instability; Feng Shui Consultations – WSJ
- Crises Counsel – Fortune
Will the subprime lending meltdown and credit crunch send us into a financial free fall? We asked the sharpest minds in business to share their reactions to the downturn, and their insights on the road ahead.
Will the subprime lending meltdown and credit crunch send us into a financial free fall? We asked the sharpest minds in business to share their reactions to the downturn, and their insights on the road ahead.
The following is the selected writings of various investment leaders on current crisis covered by Fortune
- An entire article is avaialble here.
Marking to myth by Warren Buffett
Chairman and CEO, Berkshire Hathaway
Many institutions that publicly report precise market values for their holdings or CDOs and CMOs are in truth reporting fiction. They are marking to model rather than marking to market. The recent meltdown in much of the debt market, moreover, has transformed this process into marking to myth.
Because many of these institutions are highly leveraged, the difference between “model” and “market” could deliver a huge whack to shareholders’ equity. Indeed, for a few institutions, the difference in valuations is the difference between what purports to be robust health and insolvency. For these institutions, pinning down market values would not be difficult: They should simply sell 5% of all the large positions they hold. That kind of sale would establish a true value, though one still higher, no doubt, than would be realized for 100% of an oversized and illiquid holding.
In one way, I’m sympathetic to the institutional reluctance to face the music. I’d give a lot to mark my weight to “model” rather than to “market.”
Watch for buying opportunities by Bill Miller
Chairman and chief investment officer, Legg MasonCapital Management
These sorts of things are what’s known to the academics as “endogenous to the system”–that is to say, they’re normal. They happen usually every three to five years. So we had a freezing up of the market for corporate credit in the summer of ‘02. We had an equity bubble just before that. In ‘98 we had Long-Term Capital. In ‘94 we had a mortgage collapse like we’re having right now. In 1990 we had an S&L collapse. In ‘87 we had a stock market collapse. These things flow through the system, and they’re part of the system. I saw one quant quoted over the weekend saying, “Stuff that’s not supposed to happen once in 10,000 years happened three days in a row in August.” Well, I would think that you would learn in Quant 101 that the market is not what’s known as normally distributed. I’m not sure where he was when all these things happened every three or five years. I think these quant models are structurally flawed and tend to exacerbate this stuff.
But these events represent opportunities. When markets get locked up like this, it’s virtually always the case that you’ll have opportunities if you have liquidity. Instead of worrying how bad it’s going to get, I think people should be thinking about where the opportunities might be.
The NYSE financial index is probably the best barometer of what’s to come. The financials tend to be a very good indicator of where the market’s going. They tend to lead the market because they’re the lubrication for the economy. So I think the financial index will tell you if this thing is over, and so far it’s telling you it’s not over. It’s still falling. But just as financials lead on the downside, they will lead on the upside
The most dangerous words on Wall Street by Wilbur Ross
Chairman and CEO, WL Ross & Co
I recently overheard two men arguing about who was better off. One boasted about his new car, the other about a plasma TV and so on, until one proclaimed, “I am better off because I owe more than you are worth.” The second man conceded defeat. This anecdote summarizes the mortgage bubble. Americans spent more than they earned in 2005 and 2006 and borrowed the difference. The federal government did the same. Everyone secretly feared this was unsound but wanted immediate gratification, so there was applause for talking heads who said global liquidity would make these borrowings safe. Alan Greenspan went so far as to suggest that people take out adjustable-rate mortgages.
Liquidity, however, is not about physical cash; it is mainly a psychological state. Subprime problems have consumed only trivial amounts of global cash but already have burst bubbles by shocking lenders. Clever financial engineering effectively had convinced lenders to ignore risk, and not just in subprime. A major hedge fund participated in a loan to one of our companies, but sent no one to a due diligence meeting. So I called the senior partner to thank him and tell him about the non- attendance. He responded, “I know. For a $10 million commitment, it wasn’t worth going to a meeting.”
When subprime issues first surfaced this spring, many major institutions said they had none, but recent quarterly write-offs show they did. They weren’t lying; they just didn’t know what they had. Their embarrassment has brought risk control back into vogue. It was always silly to lend to weak credits at discounted interest rates, and without documenting income and balance sheets and without appraisals. No amount of model building should have enabled Wall Street to take $100 of such paper and alchemize it into securities sold for $103. Models inherently assume a future similar to the past and therefore they fail when multiple standard deviations occur. Subprime models also did not capture ever more lax credit standards nor that real estate might suffer severe and protracted price declines, again proving that the two most dangerous words in Wall Street vocabulary are “financial engineering.”
Now that we have identified the cause of the disease, how severe and how contagious is it? The present $200 billion of delinquencies will grow to $400 billion or $500 billion next year because $570 billion more low, teaser-rate mortgages will reset to market and consume more than 50% of the borrowers’ income. Therefore most of the loans will be foreclosed or restructured. Probably 1.5 million to two million families will lose their homes. Meanwhile, few lenders will put mortgages on the foreclosed houses, so the prices will plummet. Despite these tragedies, total losses will probably be less than 1% of household wealth and only 2% to 3% of one year’s GDP, so this is not Armageddon. However, even prime jumbo mortgages will be more expensive and more difficult to obtain.
Similar excesses occurred in corporate debt markets. Leveraged buyouts were financed with few or no restrictive covenants and with some borrowers able to “toggle,” or issue more bonds to pay interest in lieu of cash. The debt-to-cash-flow ratio hit record highs, and more than 60% of junk bonds issued are rated B or lower. Only 13% of high-yield issuance proceeds was for capital expenditures for expansion–87% went for sponsor dividends, stock buybacks, LBOs, or refinancings, none of which inherently advance credit worthiness. And this exotic lending paid only 2.5% to 3.0% more interest than Treasury bonds’ 5.5%. Therefore investors received only 8% or 8.5% interest on bonds that had a 25% probability of defaulting, the same ignoring of risk as in subprime.
The cause was also the same. Wall Street made $100 of these credits into tranches of securities that sold for $102 or more. Again we had securitization pseudo-alchemy creating fool’s gold. The weakest 5% or so of a $2 trillion universe of leveraged loans and high-yield bonds will crater. This is only 1% of GDP, but lending standards will tighten for a while, just as they did after the telecom bubble burst.
Because of this outlook, WL Ross portfolio companies raised $2 billion this year to eliminate outside financing needs. More recently, we provided a modest $50 million debtor-in-possession financing to American Home Mortgage, the tenth-largest subprime lender, as it entered bankruptcy. Ultimately, we will make a major move into mortgages, because lending to weak borrowers makes sense at premium rates with proper due diligence and appraisals. After Japan’s real estate bubble burst, we used a similar strategy to rehabilitate Kansai Sawayake Bank. It was earning 17% a year on equity after one year, almost twice the return typical of a Japanese bank
Market corrections are coming by Jim Rogers
Founder of the Rogers Raw MaterialsIndex
We’ve had the worst bubble in credit we’ve ever had in American history. As the bubble got bigger and bigger, it spread to emerging markets and leveraged buyouts and all sorts of things. And it hasn’t been cleaned out yet. I don’t think you can have a bubble like this and clean it out in six months or even a year. It has always taken longer.
Look at homebuilders, for instance. Historically, when an industry goes through a retrenchment like this, you have two or three big companies going bankrupt and most of the companies in the industry losing money for a year or two or three. Well, we haven’t gotten anywhere near that in the homebuilding business, so I think that bottom is a long way off. As far as the credit bubble, we have another several months, if not more, of mortgages that are going to reset and people who are going to find themselves with even higher monthly payments. There are many, many more losses to come, most of which we won’t know about for weeks or months.
Normally you have markets go down 10% or so every couple of years. We haven’t had a 10% correction in the stock market in nearly five years. I don’t know if this is the beginning of it, but we’ve got a lot of corrections coming. It wouldn’t surprise me to see a little bounce–say if a central bank cuts rates. But that will just lead to the markets falling further late this year or next year. It would be better for the market, it would be better for investors, and it would be better for the world if we went ahead and cleaned out the system. If they do cut rates in the U.S., it would be pure madness. Because the market’s down 7% or 8% from an all-time high? My gosh, what’s that going to say about the dollar? What’s that going to say to foreign creditors? What’s that going to say about inflation? The Federal Reserve was not founded to bail out Bear Stearns or a few hedge funds. It was founded to keep a stable currency and maintain its value.
I have been and continue to be short the investment banks and the commercial banks. If they bounce up, I’ll probably short more. I’m certainly not buying anything. The market’s only down 8%. I don’t consider that a buying opportunity. The things that I’m short, some people probably think are buying opportunities, but I don’t. I’ve been short the banks for close to a year, and for a while it was not fun. But I added to my positions, and now it’s a lot of fun.
More than 70 years ago, two Columbia professors named Benjamin Graham and David L. Dodd came up with a simple investing idea that remains more influential than perhaps any other. In the wake of the stock market crash in 1929, they urged investors to focus on hard facts — like a company’s past earnings and the value of its assets — rather than trying to guess what the future would bring. A company with strong profits and a relatively low stock price was probably undervalued, they said.
Their classic 1934 textbook, “Security Analysis,” became the bible for what is now known as value investing. Warren E. Buffett took Mr. Graham’s course at Columbia Business School in the 1950s and, after working briefly for Mr. Graham’s investment firm, set out on his own to put the theories into practice. Mr. Buffett’s billions are just one part of the professors’ giant legacy.
Yet somehow, one of their big ideas about how to analyze stock prices has been almost entirely forgotten. The idea essentially reminds investors to focus on long-term trends and not to get caught up in the moment. Unfortunately, when you apply it to today’s stock market, you get even more nervous about what’s going on.
Most Wall Street analysts, of course, say there is nothing to be worried about, at least not beyond the mortgage market. In an effort to calm investors after the recent volatility, analysts have been arguing that stocks are not very expensive right now. The basis for this argument is the standard measure of the market: the price-to-earnings ratio.
It sounds like just the sort of thing the professors would have loved. In its most common form, the ratio is equal to a company’s stock price divided by its earnings per share over the last 12 months. You can skip the math, though, and simply remember that a P/E ratio tells you how much a stock costs relative to a company’s performance. The higher the ratio, the more expensive the stock is — and the stronger the argument that it won’t do very well going forward.
Right now, the stocks in the Standard & Poor’s 500-stock index have an average P/E ratio of about 16.5, which by historical standards is quite normal. Since World War II, the average P/E ratio has been 16.1. During the bubbles of the 1920s and the 1990s, on the other hand, the ratio shot above 40. The core of Wall Street’s reassuring message, then, is that even if the mortgage mess leads to a full-blown credit squeeze, the damage will not last long because stocks don’t have far to fall.
To Mr. Graham and Mr. Dodd, the P/E ratio was indeed a crucial measure, but they would have had a problem with the way that the number is calculated today. Besides advising investors to focus on the past, the two men also cautioned against putting too much emphasis on the recent past. They realized that a few months, or even a year, of financial information could be deeply misleading. It could say more about what the economy happened to be doing at any one moment than about a company’s long-term prospects.
So they argued that P/E ratios should not be based on only one year’s worth of earnings. It is much better, they wrote in “Security Analysis,” to look at profits for “not less than five years, preferably seven or ten years.”
This advice has been largely lost to history. For one thing, collecting a decade’s worth of earnings data can be time consuming. It also seems a little strange to look so far into the past when your goal is to predict future returns.
But at least two economists have remembered the advice. For years, John Y. Campbell and Robert J. Shiller have been calculating long-term P/E ratios. When they were invited to a make a presentation to Alan Greenspan in 1996, they used the statistic to argue that stocks were badly overvalued. A few days later, Mr. Greenspan touched off a brief worldwide sell-off by wondering aloud whether “irrational exuberance” was infecting the markets. In 2000, not long before the market began its real swoon, Mr. Shiller published a book that used Mr. Greenspan’s phrase as its title.
Today, the Graham-Dodd approach produces a very different picture from the one that Wall Street has been offering. Based on average profits over the last 10 years, the P/E ratio has been hovering around 27 recently. That’s higher than it has been at any other point over the last 130 years, save the great bubbles of the 1920s and the 1990s. The stock run-up of the 1990s was so big, in other words, that the market may still not have fully worked it off.
Now, this one statistic does not mean that a bear market is inevitable. But it does offer a good framework for thinking about stocks.
Over the last few years, corporate profits have soared. Economies around the world have been growing, new technologies have made companies more efficient and for a variety of reasons — globalization and automation chief among them — workers have not been able to demand big pay increases. In just three years, from 2003 to 2006, inflation-adjusted corporate profits jumped more than 30 percent, according to the Commerce Department. This profit boom has allowed standard, one-year P/E ratios to remain fairly low.
Going forward, one possibility is that the boom will continue. In this case, the Graham-Dodd P/E ratio doesn’t really matter. It is capturing a reality that no longer exists, and stocks could do well over the next few years.
The other possibility is that the boom will prove fleeting. Perhaps the recent productivity gains will peter out (as some measures suggest is already happening). Or perhaps the world’s major economies will slump in the next few years. If something along these lines happens, stocks may suddenly start to look very expensive.
In the long term, the stock market will almost certainly continue to be a good investment. But the next few years do seem to depend on a more rickety foundation than Wall Street’s soothing words suggest. Many investors are banking on the idea that the economy has entered a new era of rapid profit growth, and investments that depend on the words “new era” don’t usually do so well.
That makes for one more risk in a market that is relearning the meaning of the word.
Rakesh Jhunjhunwala’s meeting with students of IIT Mumbai
Published August 13, 2007 Rakesh Jhunjhunwala 1 Comment- Click here for the presentation file
- HT Mint newspaper has also given insights by Rakesh Jhunjhunwala here.
A champion broker, often termed as Warren Buffett of the Indian stock market, Jhunjhunwala had a full-to-the-brim auditorium spellbound as he traced how he made his fortune from a starting capital of Rs 5,000. His career path is stuff dreams are made of.
What earned him fame is his skill to pick under-valued stocks. Some of his renowned calls are Karur Vysya Bank, CRISIL and Bharat Electronics. There are, however, quite a few more. Talking about his company RARE (derived from the first two letters of his name and that of his wife Rekha) Enterprises, Jhunjhunwala says, “My company has only one client — my wife — so that I don’t need to handle others’ money.”
One of the biggest bulls of the Indian market, Jhunjhunwala believes in trading by the hunches. “If in doubt, listen to your heart,” is what he tells young investors. Extremely optimistic about India’s growth story, Jhunjhunwala shared with his audience some valuable insights about the Indian economy, future of Sensex.
Rakesh Jhunjhunwala’s secret to success
What paved the way to Jhunjhunwala’s success?
A democratic growth process rather than an imposed one and a biological evolution, pat comes the reply.
He owes a lot to resurrection of a dormant and vigorous entrepreneurial gene of India. “The country has rediscovered its confidence.”
There has been a strong improvement in India’s macroeconomic indicators, combined with a robust banking system.
Improvement has also been observed in India’s corporate performance, powered through productivity gains. Jhunjhunwala is convinced that on-going reforms would have a multiplier effect on India’s economy.
Jhunjhunwala’s investment strategies
Jhunjhunwala learnt investment strategies the hard way. And he was more than willing to share it with his audience. Here are a few gems from his book of learning
- Necessary for any investor is optimism.
- Be opportunistic but wait for the right moment
- Study the market thoroughly. Refer to history
- Maximise profits and minimise losses
- Invest in a business not a company
- Always have an independent opinion. Observe and read relevant information with an open mind
- Be happy with your gains but learn to accept losses with a smile
- Be prepared for challenges and risks
Gems from Jhunjhunwala
For beginners in the market, here are a few invaluable gems from Jhunjhunwala’s book:
- Whatever you can do or dream you can, begin it. Boldness has genius, power and magic in it.
- Do something you love
- The means are as important as the end
- Aspire, but never envy
- Be paranoid of success — never take it for granted. Realise success can be temporary and transient
- Build a fighting spirit — take the bad with the good
- When you see a horizon, it seems so distant. When you reach that horizon, you will realize how many more horizons are within reach
5 things you need to be successful
“Patience may be tested, but conviction will be rewarded,” he asserted. He appealed to the budding investors to go by what George Soros said: ‘It’s not important whether you are right or wrong, it more important how much you lose when you are wrong and how much money you make when you are right.’
To be successful in investing, five things are critical. There has to be:
- an attractive, addressable, external opportunity;
- a sustainable competitive advantage;
- scalability and operating leverage; and
- a qualified and integral management
- Last but not least, it is of vital importance what one buys and at what price.
‘India has everything’
- Efficient capital allocation
- Sustained earnings expansion driven by growth and productivity
- 8 per cent+ real GDP growth + 4%+ Inflation = 12%+ Nominal GDP growth
- Corporates to grow faster than unorganised sector
- Operating and financial Leverage to kick-in
- Corporate earnings to grow at 18%+
- Favourable framework for equity investing
- Rising savings, yet low equity ownership — significant potential
- Corporate governance
- Transparency
- Effective regulation
- Electronic trading
- Dematerialisation
- Tax paradise for equity investing under the STT regime
‘Be realistic’
He said enormous wealth was created over the last five years because opportunities in India have grown manifold.
Admitting that gains were going to be moderate in future unlike the manifold rise over the last few years, he advised investors to be realistic in their expectations.
Text courtesy: RARE Enterprises –><!–
44-day-old baby Akshithaa is India’s youngest PAN card holder. –><!– Photographs: Sreeram Selvaraj –> <!–
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‘The market is always right’
“Blindly following stock picks by big investors is not a wise thing to do,” he warns investors. “I don’t think the government is necessarily interested in hurting growth. The government is interested in growth with controlled inflation.”
“The market,” he says, “is always right. Markets cannot be taught, they have to be learnt.”
“We must have an attitude where we must balance fear and greed,” was the hot tip by one of India’s most high-profile investor.
Why growth will continue
According to him, growth enablers (such as favourable demographics, higher base of skilled people and education base), liberalisation catalysts (such as competition), fall in interest rates, multiplier effect (on account of reforms), structural changes in quality of corporate earnings and micro trends (such as change in mindset of companies who are aspiring to become global) are likely to drive India’s growth story to a higher level.
Crisis gives best buying opportunities: Rakesh Jhunjhunwala
Published August 13, 2007 1 Leave a CommentAce investor and partner of Rare Enterprises, Rakesh Jhunjhunwala, also called ‘The Warren Buffet of India” is still bullish on the Indian markets and sees Sensex touching 25,000 level by 2012. However, he is of the opinion that world equity markets are bound to get shaken in the wake of ongoing subprime mortgage issue and the next few months will be tough for them.
Addressing Finance Continuum, 2007 at SJMSOM, IIT Mumbai, he said that crisis gives best buying opportunities. Subprime issue has hit the global markets severely and there has been a negative sentiment for past two weeks across the globe. He also feels that Indian markets will be less affected than the global markets including Asian markets.
Jhunjhunwala further added that fundamentals are still strong and Indian markets have all the ingredients to sustain the growth.
Expressing his views on overseas investment, he said that Indian markets have still to offer a lot. Jhunjhunwala has plans to explore overseas markets after 2012 and also wants to build up organizations.
Talking on house-hold savings and its importance on equity markets, he predicts that by 2012, over USD 57 billion from house-hold savings will be invested in the equity market. If his prediction comes true then Indian markets will not face liquidity crunch issues. Currently, house-hold savings investment in equity market is around USD 12 bn.
Additional Reading
- The Economic Times has covered this news here: India’s equity returns can be delayed, but not denied
- An another note on his visit is available here.
- Another blog covers this topic here.
Source: WEB’s Speeches & Writings
But he is not just a man with a large heart and a matching wallet. Also known as The Sage of Omaha, he is also full of wisdom and wit.
Here are some of his gems of advice for investors who look at the stock market to make a fortune, culled from various publications, his speeches and writings:
• ‘Never invest in a business you cannot understand.’
• ‘Always invest for the long term.’
• ‘Remember that the stock market is manic-depressive.’
• ‘Buy a business, don’t rent stocks.’
• ‘Price is what you pay. Value is what you get.’
• ‘Stop trying to predict the direction of the stock market, the economy, interest rates, or elections.’
• ‘I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.’
• ‘Wall Street is the only place that people ride to in a Rolls-Royce to get advice from those who take the subway.’
• ‘Buy companies with strong histories of profitability and with a dominant business franchise.’
• ‘It is optimism that is the enemy of the rational buyer.’
• ‘As far as you are concerned, the stock market does not exist. Ignore it.’
• ‘The ability to say ‘no’ is a tremendous advantage for an investor.’
• ‘If you’re doing something you love, you’re more likely to put your all into it, and that generally equates to making money.’
• ‘My idea of a group decision is to look in the mirror.’
• ‘Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.’
• ‘The smarter the journalists are, the better off society is.’
• ‘Success in investing doesn’t correlate with IQ once you’re above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.’
• ‘Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.’
• ‘You’re neither right nor wrong because other people agree with you. You’re right because your facts are right and your reasoning is right – that’s the only thing that makes you right. And if your facts and reasoning are right, you don’t have to worry about anybody else.’
• ‘There seems to be some perverse human characteristic that likes to make easy things difficult.’
• ‘In the short run, the market is a voting machine but in the long run it is a weighing machine.’
• ‘It’s only when the tide goes out that you learn who’s been swimming naked.’
• ‘Somebody once said that in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if they don’t have the first, the other two will kill you. You think about it; it’s true. If you hire somebody without the first, you really want them to be dumb and lazy.’
• ‘There are three kinds of people in the world: those who can count, and those who can’t.’
• ‘It takes 20 years to build a reputation and five minutes to lose it.’
• ‘The first rule is not to lose. The second rule is not to forget the first rule.’
• ‘Wide diversification is only required when investors do not understand what they are doing.’
• ‘Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.’
• ‘We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.’
• ‘Our favourite holding period is forever.’
• ‘If past history was all there was to the game, the richest people would be librarians.’
• ‘Why not invest your assets in the companies you really like? As Mae West said, ‘Too much of a good thing can be wonderful.”
• ‘Your premium brand had better be delivering something special, or it’s not going to get the business.’
• ‘You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.’
• ‘We do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own assets.’
• ‘Accounting consequences do not influence our operating or capital-allocation decisions. When acquisition costs are similar, we much prefer to purchase $2 of earnings that is not reportable by us under standard accounting principles than to purchase $1 of earnings that is reportable.’
• ‘Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.’
• ‘The critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price.’
• ‘Risk can be greatly reduced by concentrating on only a few holdings.’
• ‘Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell.’
• ‘Lethargy, bordering on sloth should remain the cornerstone of an investment style.’
• ‘An investor should act as though he had a lifetime decision card with just twenty punches on it.’
• ‘An investor needs to do very few things right as long as he or she avoids big mistakes.’
• ‘Turnarounds’ seldom turn.’
• ‘The advice ‘you never go broke taking a profit’ is foolish.’
• ‘It is more important to say ‘no’ to an opportunity, than to say ‘yes.’
• ‘It is not necessary to do extraordinary things to get extraordinary results.’
• ‘An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.’
• ‘It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.’
• ‘In the business world, the rearview mirror is always clearer than the windshield.’
• ‘A public-opinion poll is no substitute for thought.’
• ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
• ‘The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective.’
• ‘Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.’
• ‘The investor of today does not profit from yesterday’s growth.’
• ‘Of the billionaires I have known, money just brings out the basic traits in them. If they were jerks before they had money, they are simply jerks with a billion dollars.’
• ‘I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.’
• ‘I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.’
• ‘I always knew I was going to be rich. I don’t think I ever doubted it for a minute.’
• ‘We enjoy the process far more than the proceeds.’
• ‘You do things when the opportunities come along. I’ve had periods in my life when I’ve had a bundle of ideas come along, and I’ve had long dry spells. If I get an idea next week, I’ll do something. If not, I won’t do a damn thing.’
• ‘I buy expensive suits. They just look cheap on me.’
• ‘Let blockheads read what blockheads wrote.’
• ‘I do not like debt and do not like to invest in companies that have too much debt, particularly long-term debt. With long-term debt, increases in interest rates can drastically affect company profits and make future cash flows less predictable.’
• ‘My grandfather would sell me Wrigley’s chewing gum and I would go door to door around my neighbourhood selling it. He also sold me a Coca-Cola for a quarter and I would sell it for a nickel each in the neighbourhood, so I made a small profit. I was always trying to do something like this.’
• ‘A public-opinion poll is no substitute for thought.’
His most famous principle was, “Invest in what you know”. His other stock-picking principles include, “Do your research and set reasonable expectations”, “Know the fundamentals”, “Invest for the long-run’.
Some investment nuggets from him:
“Investing without research is like playing stud poker and never looking at the cards.”
“Everyone has the brainpower to follow the stock market. If you made it through fifth-grade math, you can do it.”
“Bargains are the holy grail of the true stock picker. The fact the 10 to 30 per cent of our net worth is lost in a market sell-off is of little consequence. We see the latest correction not as a disaster but as an opportunity to acqu ire more shares at low prices. This is how great fortunes are made over time.”
“Things are never clear on Wall Street, or when they are, then it’s too late to profit from them. The scientific mind that needs to know all the data will be thwarted here.”
“You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in the markets.”
“… We’re forcing people to do the wrong things. They look at what’s hot. They spend so much time trying to figure out if the market is going up. That’s so unimportant. It’s about earnings. They need to follow the earnings.”
“If you spend more than 13 minutes analysing economic and market forecasts, you’ve wasted 10 minutes.”
“It is the rare investor who doesn’t secretly harbour the conviction that he or she has a knack for divining stock prices or gold prices or interest rates. In spite of the fact that most of us have been proven wrong again and again, it’s uncanny how often people feel most strongly that stocks are going to go up or the economy is going to improve just when the opposite occurs.”
“When it comes to predicting the market, the important skill here is not listening, it’s snoring. The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as lo ng as the fundamental story of the company hasn’t changed.”
“Absent a lot of surprises, stocks are relatively predictable over 10-20 years. As to whether they’re going to be higher or lower in two or three years, you might as well flip a coin to decide.”
Yes, Radha, the bust in USA will hit us in India.
In May 2006 when the BSE-30 Index declined by 17% in eight sessions, we wrote about the bubble in the Middle East markets – Markets Do Fall and said, “Better economic and GDP growth is not an assurance to a perpetually booming stock market”.
The link between financial markets in the US and Indian stock markets
Today, as the Indian markets get lashed by something called sub-prime mortgage, we are being asked to remain calm and cool as there is no linkage between what happens to the financial markets in the US and to the Indian stock market.
Well, that is a partial truth and, in effect, a partial lie.
Stock markets are influenced by 2 factors:
1) how much do companies earn, and
2) how much are people willing to pay for those earnings.
The earnings power of a company is a function of the business of the company, its management, and the overall growth rate in the economy in which it operates. There is little change here in our view and we should safely assume that India’s GDP will grow at a 6% to 6.5% per annum rate for the next few years. (Many more optimistic people have a higher GDP growth rate for India at 8% plus but we don’t subscribe to that view as yet.)
Understanding liquidity & sub-prime debt
How much people are willing to pay for those earnings is a function of what economists call “liquidity” and though there is no clear definition of what “liquidity” is, one can assume that it is how much money is sloshing in the system. Imagine you are at a bar and everyone is feeling a little good from the various other liquids that the bar tender has to offer for a price, of course. Then the bar tender says, “Hey, folks, how about I cut the price of the drinks by 50% – anyone want some more?”
You bet! The crowds get bigger and people feel even more elated. With all those drinks available on the cheap, they lose their sense of judgment. Human nature is anyways tuned to drift into flirtations. With a few more drinks, the drifting becomes a reality. The poor bloke standing next to you in this bar – a total stranger – suddenly feels like a friend. You begin chatting. By the end of the fifth glass, the poor fellow who works as a waiter in some corner restaurant in some obscure town in USA now looks like a promising young man who could one day start his own restaurant, build his own mall, and maybe have a chain of restaurants. So you lend him money to buy a house. He is actually what the credit rating agencies would call a “sub-prime credit risk”. But, because that bar tender gave you all those free drinks, in your eyes he becomes a good risk and better still, you turn to the other drunk next to you and re-sell the loan you made to this sub-prime fellow for a profit. And why do you sell the loan for a profit? Because the guy you sell it to (a European, Japanese, Middle Eastern, whoever) is more drunk than you because the bar tender in his country also gives him free drinks. And he cannot assess the risk profile of that sub-prime American any better than you can. So all the drunks are happy. And you use that profit to make another loan to another poor sub-prime fellow and so on and so forth……
Since 2003 all the drunks are having a good time, lending and buying and selling sub-prime loans to each other.
All the sub-prime folks who got this silly money in 2003, 2004, and 2005 from the folks at the bar thought they were rich and started buying big houses and big cars and spent money which was not earned, but borrowed.
The bar tender is serving the drinks because he needs to make sure everyone feels good. There may be an election around the corner. Or if he serves his drinks quick and fast, some big bank group may come in and hire him as a consultant or make him a chairman of a global financial conglomerate riding this tide of global liquidity.
So the central banks were the bar tenders, doling out drinks and money as if their printing presses had to print, and print and print. Rather than being the men in grey suits with grumpy faces worried about the fate of the financial world, they became the stars on TV channels and the toast of conventions: their suits were grey but they were talking about this perfect world and this goldilocks, fairy tale.
And that fairy tale found its way to India and the rest of the emerging markets. From being the poor countries with corrupt governments and inept governments that have consistently failed to look after the needs of their people, these countries got a new name: BRIC. They became the darlings of the drunks. Yes, while there have been significant improvements in many countries – including India – the perception of the depth or the sustainability of these improvements were exaggerated when the drunks at the bar came calling.
India has seen nearly US$ 50 billion of foreign inflows – of which US$ 40 billion have come in since 2003. Yes, the Indian companies and the Indian stock markets did deserve a lot of that but the assessment of risk has been, in my opinion, absent.
The sub-prime fall out
The sub-prime blow has so far seen some US$ 2 billion of losses from funds that have been closed down. There is maybe another US$ 50 to 100 billion of losses that may yet be exposed, according to people who track this industry. While US$ 100 billion is nothing in a world where the market cap of stocks is US$ 30 trillion (300 times the potential losses) and where bonds worth maybe US$ 100 trillion float around, the bar tenders are now serving less of that booze. The drunks are getting more sober. They now see that sub-prime person as someone who may be lucky to keep his job in a restaurant as opposed to their previous assumption (over the rim of their liquor glass) that they were lucky to stumble on the founder of the next new big restaurant chain in USA. And they will price that loan accordingly.
And they will see the investment opportunities in the emerging markets with a little better understanding of risk. Don’t get me wrong: the fundamentals for India are fantastic, and money will flow in to India over the next decade. Sensible, risk-assesses money. But for now, the silly money will go out. The P-Note folks will vacate and that will cause the Indian market to suffer.
India has, via its P-Note policy, linked itself to silly money. We enjoyed the ride for the past 4 years, now we will feel a bit of pain.
Keep your money ready to invest. Stay disciplined, never be carried away, politely tell the bartenders to keep their extra, free drinks. And you will profit: steadily but surely.
Ajit Dayal is Director, Quantum Advisors Private Limited. Ajit is the founder of Quantum Asset Management Company Pvt. Ltd. and also Quantum Information Services Pvt. Ltd., which owns Equitymaster & Personalfn.
