Monthly Archives: August 2011

Bernanke’s invisible stimulus

So what happened Thursday?

In a recap, the Federal Reserve Chairman Ben Bernanke said that the economy has not deterioated “enough” to need immediate additional stimulus. (Italics by the author). However he believes that if necessary, there could be more stimulus.

The inaction by the Feds is the invisible stimulus all the financial industry has been hoping for. The invisible stimulus is the lack of the increase in interest rates. With the decreased interest rates there is increased appetite for higher-risk assets, and possibly more return. However this is fueling another bubble by itself. Equities have been mispriced for the last two years, fueled mostly by speculation, and not the underlying business. Companies see great volatility in their stock price for an event that may have no connection to the stock. The low interest rates are a terrible incentive since it invites more “investors” ( I use this word loosely, since traders are not really investors) to enter the market and gamble away their money in the hopes of making a quick buck.

However if there is another “major” correction, which is quite possible within the next year (possibly 20% correction), then we will be seeing another round(s) of stimulus. The correction is derived based on the hypothesis that the stock market has reached  pre-2007 crisis level, however the earnings have been consistent or decreasing over the last three years. There is disconnect between the underlying stock and the business. Another assumption is that there is yet another housing bubble that is yet to take place due to high unemployment for the people in the middle trench for CDO’s, the guys who could previously afford the mortgages when they signed their contracts. The 2007 crisis was due to default on mortgages who could not afford their mortgages at all! Their sole reason for getting a property was to sell it back within six months, pocketing the difference, or they were suckered into the mortgage due to the temporary low rates. This next housing bubble is going to hit the whitecollar households where one of the person(s) in the household is unemployed and can barely afford the mortgages.

Once companies see their earnings decreasing (due to consistent high unemployment), they will be forced to layoff more people to save their stock prices, thus starting the vicious cycle where the economy is going to shed more jobs than it will create. (Do you remember the 18K jobs created in June vs expectation of 132K?)

 

Speculation: Virginia earthquake caused by fracking

The United States Geological Survey (USGS) officially addressed the issue of human activity may be causing some of the earthquakes around the globe. Incidentally, the earthquakes are not due to the use of dynamites or even a nuclear bomb, it is due to fracking. Per Wikipedia, fracking is:

“Hydraulic fracturing, often called fracking, fracing or hydrofracking, is the process of initiating and subsequently propagating a fracture in a rock layer, employing the pressure of a fluid as the source of energy. The fracturing, known as a frack job (or frac job), is done from a wellbore drilled into reservoir rock formations, in order to increase the extraction rates and ultimate recovery of oil and natural gas and coal seam gas.”

The USGS included the following statement on their website:

“Earthquakes induced by human activity have been documented in a few locations in the United States, Japan, and Canada. The cause was injection of fluids into deep wells for waste disposal and secondary recovery of oil, and the use of reservoirs for water supplies. Most of these earthquakes were minor. The largest and most widely known resulted from fluid injection at the Rocky Mountain Arsenal near Denver, Colorado. In 1967, an earthquake of magnitude 5.5 followed a series of smaller earthquakes. Injection had been discontinued at the site in the previous year once the link between the fluid injection and the earlier series of earthquakes was established. (Nicholson, Craig and Wesson, R.L., 1990, Earthquake Hazard Associated with Deep Well Injection–A Report to the U.S. Environmental Protection Agency: U.S. Geological Survey Bulletin 1951, 74 p.)”

This report establishes the fact that humans may have played a role in the 5.9 magnitude earthquake in the last week (August 23, 2011).   There are multiple reports and news articles on the use of fracking and its link to earthquake. As New York Times reported in February 2011 that the town of GUY (an hour from Arksansas) has seen increase in earthquakes since the arrival of the gas companies, and the start of fracking.

“Mr. DeTurck and many others described a boom followed by a quick, alarming shift, a sensation one man compared to watching the camera dive off a cliff in an Imax movie. Some say they have felt dozens, others only four or five, and still others say they have only heard them.

They do, however, have similar suspicions about the cause.

Several years ago, the gas companies arrived, part of a sort of rush in Arkansas to drill for gas in a geological formation called the Fayetteville shale.

Local landowners signed leases and royalty agreements with the companies on the promise of a few hundred dollars or more a month. Drilling sites started showing up in the fields, and the trucks began rumbling through day and night. Residents began to wonder whether all of this was such a good idea.

“They took advantage of people’s ignorance,” said Greg Hooten, the superintendent of the local water utility, who now worries about the effect of the drilling on the groundwater. Nonetheless, Mr. Hooten had signed an agreement for drilling on his property. “Who’s going to stop the gas and oil companies?” he asked.”

This topic needs more research. However we must ask ourselves if we are on the right trajectory.

 

Alpha

 

A Dot on the Map, Until the Earth Started Shaking – NYT

The Degree of Market efficiency / inefficiency

THE DEGREE OF MARKET EFFICIECNY/  INEFFICIENCY

A Look at Academic and Professional Research

by Hassan Adil

Abstract

 

There is abundant amount of research done on the efficiency of the markets. However, the academics and professionals have yet to come to a conclusion about the degree of efficiency.  This study will contribute to the understanding of the efficient market hypothesis, as first proposed by Fama. Later the paper will discuss the weak form, semi-strong, and briefly, the strong form of the market efficiency. This paper will synthesize academic research spanning from the 1960’s to 2010 regarding market efficiency. Finally this still will also provide a conclusion regarding the degree of the market efficiency after weighing and discussing the research conducted so far about the efficiency of the markets.

For the full text, continue to the article.

Continue reading

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War in the horizon?

Before we start on this topic, you must read the full article by Stratfor (a leading geopolitical economic, political intelligence agency).

The article hints that there may be another conflict or “war” on the horizon between Israel and Palestinians (Hamas).  The trigger could possibly be the vote on the Palestinian statehood which is due to take place in September. Also the fact that the neighbouring countries, such as Syria and Egypt are going through internal strife, which is creating great political and economic instability in the region.

The main trigger in Palestine would be the divide between the Palestinian people, the two political groups; Fatah and Hamas. Fatah is favoured by the western governments due to its secular ideas, whereas Hamas uses religion (Islam) to lure people into its agendas, and has become the dominant political force in the recent years. It will be in the interest of both of the political parties to force their agendas and form the government if the Palestinian statehood formalizes. “Whoever controls the state, defines what Palestinians are” sums it up very well.

Historically, Egypt has played an active role in the politics of the Middle East, and it was one of the first nations to announce truce with Israel. If the radical movements begin in the region, it will be difficult for Egypt to not intervene in the region, given that majority of the Egyptians do not see Egypt’s relations with Israel favourably. And we may have another major conflict in the region that will spread from intra-country to inter country.

Now this is where the twist happens. The global political situation is not looking any rosy either. China came out last month to scold the U.S as “addicted to debt”, and Russia called U.S as a “parasite”, and the ongoing Euro debt crisis, with Germany the lone soldier trying to calm everything down. We are seeing governments playing the blame game, consequently increasing tensions between the already stiff relations.

Per the analysis by Todd Harrison (Marketwatch), the “% decline in the S&P before the September 11 attack is precisely is the same as what we have witnessed in the last three months”. And I could not agree more.  The concern for a terrorist attack is more tangible than ever before and if that were to happen, we would see the global economies “tank”, and with that we will see a worsening recession, even depression. This may force another war.

I have come to similar conclusions myself over the last six months. The financial and social situation right now much resembles the pre-world war I and world war II scenarios (minus the trigger points).  The economy was battered before World War II. I remember reading about the wars during my high school years and looking at the pictures of people, battered and exhausted, waiting in line to get food and water, since they did not have enough money to survive. The situation is similar in the U.S, however the idea is not main stream yet. (It took the market almost 6 months to figure out that there was a possibility for the U.S to default on its sovereign debt, it will take even longer for the market to realize the increasing social problems in the U.S). There are 45.7 million people in the U.S that currently (May 2011) rely on food stamps. For comparison purposes, the numbers increased by a whopping 4.9 million from compared with May 2010, and increase of 1.105 million people from April 2011. This represents almost 14.5% of the total population succumbing to equivalent of soup kitchens of pre-world war times.

Do you see a trend?

 

Resources:

Israeli-Arab Crisis Approaching (Startfor)

Is the market forecasting war? (Marketwatch)

Food research and action centre (FRAC)

 

RIM’s next play – dividends?

Research in Motion (RIM.TO) has had a tremendous run in the cellphone market with its Blackberry devices. The company was once revolutionary when it came to communication and security of its network, however the competition is heating up for RIM, especially with the recent acquisition of Google Inc. (GOOG) acquisition of Motorolla (manufacturer of “cool” handsets). Now Google has officially entered the ring of cell phones, and RIM is going to face an uphill battle worse than before as the company is going to have to fight off both Google AND Apple Inc. (APPL). Before Motorollas acquisition, Google was only selling its software on the different cell phones, now it will control the handset and the software, which makes it a stiff competition, especially in the emerging markets, where RIM needs to push to get more subscribers.

So what is the next play for RIM? Should it issue dividends? RIM has reached maturity, and finding it difficult to grow and compete. Unless, the company finds valuable investments, then it will be better off for the shareholders to receive some cash, especially since the stock has decreased by more than 50% within the last year ($26.28), a tremendous blow for a stock that traded at $148 in 2008. The company has yet to come up with marketable phones, and it is lagging behind in innovation. The only thing that is keeping its subscriber base is, well, BBM. I said it. This is the only value-added service for RIM customers. Wait when Google lets its users use a BBM-like software, then the demise will be complete.

The company is sitting on 7.448 billion of current assets,  as of Feb 26, 2011, and 1.791 billion of cash. You may find that it is a lot of cash, however for tech companies it is vital to have this much cushion available for acquistions (if they do come their way). If the company pays out dividend, then it will be eroding its power for acquisitions and future growth, and the company’s stock will nose dive.

Instead the company should focus not on the short-term, but the long-term return on investment. The company should increase its funding in research and development for cutting edge technology. It should consider strengthening its bonds with another software giant (a good candidate will be Microsoft) to fight off the threat of Andriod and IPhone. I expect that the merger of the two companies would be a disaster, as it is with most companies that are acquired by Microsoft, it is just how it is. RIM needs leverage, and it must get it through strategic partnership, and no one would be a better partner than Microsoft, who is also suffering due to Apple’s and Google’s success.

 

I can write more about the topic, however its time to sleep.

 

Alpha

 

Gold – a bear’s best friend

If you have been following Gold for the last three months, you must be astonished by the total return received on the yellow metal, a whopping 109% (annualized return). The yellow metal increased in value by 27.4%.  So the question is, what is the reason for the increase in gold prices?

You

Or the investor sentiment. However there is much more that needs to be said about the topic.

Historically, whenever the price of gold goes up, the world sees an increase in the supply of gold. The supply is from Southeast Asia, notably Pakistan, India, Sri Lanka and Bangladesh, where families have been converting excess savings into gold for the last hundreds of years. Traditionally brides are gifted gold jewellery by her parents when she is married, so there is always an ample supply of gold laying around. Whenever the price used to go up, the increase in supply would temporarily dampen the price increase.

Well that is the old gold. The new gold rush is due to the fear of Fiat currency, and notably the prestigious U.S dollar decreasing in value. Investors seek refuge from inflation and growth fears that have been plaguing the Euro and the U.S. As of now, we know that the Euro might as well call it quits. Germany and France are cornered and they do not have a way to get Eruo debt in control. Their only gameplay is more austerity measures on the Euro countries, and devaluing the Euro, which is taking place unsystematic by the market  (unsystematic is a nice way to say, brutally).

Two months ago when the markets were in the fear of Euro, they rushed towards the U.S, because the U.S will always be the safe heaven. Just like the Greeks, the Romans, the Arabs, Chinese empire, and the British empire, the U.S. will always have its cool and be able to repay its debt. (Can you tell if I am being sarcastic enough?) However the market just realized, oh, this is not true any more. There is real growth problems in the U.S. But the bigger problem is the political restlessness that has gripped the U.S, where the politicians bicker and fight about measly decrease in deficits and threaten to default the country. The market will punish U.S for a long time.

As they say it in the olden times; Reputation is like fine china, takes hardwork to keep it in shape, and it only takes one mistake to break it into a million pieces.

I am bearish on the U.S economy, the U.S political system and worst, the U.S social system. As a disclosure, I am long Gold, and will be for the forseeable future.

 

Alpha

Todays sell off – when will we recover?

There is an interesting graphic from JPMorgan funds that I would like to share; it tells how long it takes for the market to recover from its losses.

However, we can never be certain. This market turbulence indicates that the investors need to get into a safe position, rebalance the portfolio for some cash, and decrease equities (unless you have a strong stomach to handle the fluctuations).

I expect that the market may stabalize momentarily, however it still is heading for at least 10% correction (optmistic view).

Here we go:

Time it takes for a bear market to recover

 

Alpha

Market efficiency and relevance of finance taught at universities

There are a few topics that I remember discussing as a student with my professors in Finance class, however most of the time we would discuss the efficiency of the markets, the CAPM model, the risk-free asset and how the last 40 years have changed so much, much thanks to Fama and his breakthrough research paper on the Efficiency of Markets (refer to the attached pdf on a paper re: the above topic).

In my Masters thesis paper I got the opportunity to really discuss the efficiency of the markets, as mentioned by Fama. However, looking back it seems that the efficiency of the market is not always true. It may be true during certain instances, for example during the boom years, however it is certainly not true when there is a financial crisis. The logic is simple; if the market was really efficient, and it readily absorbed all of the information, and came to a valid AND true conclusion regarding the price of a particular security, then there would be no bubbles.  Certainly we know that is not true.

Welcome to the real world, dear Finance Students.

Theory: What you learn at school may not be applicable in real life.

Lemma: Having more degrees does not make you more knowledge and/or expert in your field.

Corollary:  You just wasted 4 years of life, or more.

 

Welcome to layman’s finance.

Alpha