How the banks turned around the corner ?

A picture is  better  than a thousand words.  Mark to Model, AIG payouts, tweaking your reporting period and all other scams conveyed below:

Banks turned around the corner

Treasury Bubble

One of the main axioms of investing is “Never bet against the FED”. However, “Ayn Rand” ideologue – Greenspan and Helicopter Ben have made betting against the Fed, a valid investment idea.

The treasury bubble is waiting to be burst. The so called “flight to safety” theme might actually be a “flight to disaster”. I will be analyzing the treasuries, in terms of risk premium.

Scenario-1: Economic Recovery with the hypothetical V -shaped recovery

Due to the massive amount of money being injected, the monetary base has expanded dramatically (refer graph). If Bernanke’s “green shoots” progresses into a V-shaped recovery, velocity of money multiplier will pick up since any recovery is dependent upon spending ( housing is beyond redemption) driven by more leverage ( The Fed and the treasury chose a quick and dirty fix; Hence, these factors drive recovery and spending rather than savings).

Monetary Base Expansion

Fed will need to increase the rates to combat the specter of inflation. The treasury yields need to incorporate the risk premium to account for inflation.

In my opinion, the current deflationary environment and economic worries crowded out the inflation risk premium due to the “Flight to Safety” argument.   GLD – Gold ETF has been steadily heading high over the last 3 months. JJC (Copper), JJA( Agri) and SLV have followed a similar pattern.

GOLD ETF - GLD

If the economy picks up, investors will abandon treasuries in favor of other asset classes , producing upward pressure on the yields.

Another interesting point is that if the Fed needs to increase rates to combat inflation (or the market demands a higher risk premium), the fragile “green shoots” road to recovery will be threatened. Will the Fed/Treasury be able to finance the recovery then?

Note that I have mentioned the risk premium due to the monetary base expansion alone here. The risk premium due to fiscal deficit and free for all money is covered in Scenario -2.

Scenario-2: Economic Recovery with the L -shaped recovery / Economy goes down in Flames.

Helicopter Ben might pump money to accelerate recovery. One or all of the following could occur:

1. Rising fiscal deficit not backed by Real GDP growth will undermine the US sovereign debt leading to a credit downgrade. Default/Migration risk premium needs to be accounted for.
2. Treasury auctions might fail. Investors might simply abandon sovereign debt in favor of GLD.
3. USD might lose its status as the world reserve currency (This is the only fact which helps Geithner and Bernanke to debase the USD and expand the monetary base.).Foreign economies might simply shift to another reserve currency. I do not buy the argument that there is no other perfect currency substitute. The seeds for dollar’s eminence as the reserve currency were sown only during 1940’s (Bretton Woods; Anchor Currency for gold was the dollar.). Before then, it was informally the GBP and Gold. If history has taught us anything, nothing is permanent. One might argue that the probability of this is remote. However, the probability has increased quite substantially in the last 2 years and the treasury yields need to incorporate this.

Will there be a flight to safety again ? I am skeptical. if so, it will be a classic case of ” fools rush in where angels fear to tread”.

General Theme:

In spite of the fed’s efforts to keep the yields low, the treasury yields need to

The treasury yields need to incorporate the risk premium due to the following factors:

1. Inflation
2. Fiscal Deficit
3. Credit Risk in terms of downgrade or apprehensions of not being to service the debt
4. Political Risk.

TBT (ProShares Ultrashort 20+year Treasury ETF) , GLD (Gold index) and commodities might be a good hedge against the factors mentioned above.

Disclaimer: Long GLD and TBT for quite some time now.

Future of Tech: Potential Stock Buys – I

Why I am still rooting for Amazon, NetFlix and Google in spite of their seemingly high P/E ?

You might find valuation along similar lines in other sites. My two cents worth of opinion ( I will update this post using financial ratios…)

Let’s take a look at Amazon, Netflix and Google:

All of them have highly radical models of serving customers.Everything over the internet! Makes it easy to optimize operations, reduce costs and transfer benefits to customers. These firms have disruptive operational models. The best part of it is they are  highly energy efficient. The energy factor would be a major player in the oncoming years. The world is and has been moving towards energy efficient models.  (Read the book: The Bottomless Well to delve deeply into what I mean.)

Netflix: Blockbuster model is dead. Netflix stands a lone chance against growing, infantile online video sites such as Hulu, YouTube, iTunes, et cetera. Even then, Netflix might lose in my opinion. Why ? The world is moving towards content at your fingertips ( say Apple iTV).  Netflix might survive for a period of time absorbing any adherents from the previous obsolete model before it becomes obsolete itself.  Direct Online Content over the Internet/TV is the future. However, Netflix is already providing the streaming high resolution video over the internet over XBox, BluRay and some other devices. We will have to see how effective their transition will be. But will they outdo their competition such as Hulu, Youtube, Amazon Unbox and others. I am skeptical.

( I was also informed by Zenmacro that Redbox might kill Netflix due to cheaper costs and speed of delivery content (pick up rather than a 1 day wait). I think both Redbox and Netflix will be killed by content delivery over the internet unless they transition to such services. )

Amazon: Amazon is an awesome e-Retailer who has constantly upped the game. Their revenues were impressive in spite of the Great Recession of 2008/09 and their outlook seems to be promising.

Why will traditional players falter against Amazon? They don’t make much of a difference unless offering massive discounts (or places like Costco). As an audiophile, trying to shop at places such as Best Buy/Circuit City was not very useful. Why? Useless staff who do not have answers beyond a certain basic capability.Outdated prices. At Best Buy, I saw the  price for a 400 DVD player unchanged for 3 years. At Amazon, the price dropped by 160$.  For basic stuff such as groceries and other stuff, Amazon might not participate for now leaving other players to rip each other.  Or Amazon might decide to do a WebVan ( w/o the bankruptcy. After all, this might be the right time. Some of the original ideas during the dot com bust might come to fruition now. They might have been ahead of their time then. Not so much now.).

Another factor is the Kindle. Despite its drawbacks, Kindle ( and its competitors) seem on the verge of bringing together various factors for the businessman, techno geeks and most of the world. If Amazon gets their act together and adds features such as email ( like the blackberry), blog reading/updates, twittering, internet browsing, compatibility with other formats and other additional features, we have a killer device (That was a long list). I would just buy the Kindle and throw my laptop/netbook into the hudson bay. Kindle has gotta  good headstart; We will have to wait and see how the game is being played. Another major source of revenue which will continue to grow is its digital media library consisting of streaming HD videos delivering to your computer, XBox player (and maybe Apple’s iTV) …Sounds like a competitor to iTunes. As Holmes would say, the Game is afoot, Watson.

A problem is that Amazon is a One Man’s Vision (Jeff Bezos).

Google:Apart from a world class search engine which will eventually turn into SKYNET and destroy the human world,  Why do I really care about Google ? Any other decade before this one, Google would have been a washout. Right now, Google is now in the right business areas in the right time. What do I mean ? I am talking about the cool gadgets they have , of course.

Let’s take the example of Google Documents. Though it has not caught on yet, the advent of Netbooks and devices such as the Kindle will lead to Google Documents (+ Calendar+ Gmail) replacing MS-Office easily. Lightweight, low memory footprint (both RAM and Storage ) and easily accessible , they will be the OFFICE package of choice. Though Google documents might find it difficult to replace MS Office in corporate environment, it will easily lead the pack in households/ students with these new fangled devices.  With the growing popularity of Cloud Computing, the corporate world might fold too. (We sold off our privacy and freedom of use to the devil long time back.). More ad revenue here and other space revenue possibly. Google might as well buy Garmin and start selling GPS devices…. I am clearly short MSFT. The next gen computers should not have much of an OS except to boot up and launch the internet. Everything happens online and is saved online. Microsoft has a better chance at hardware ( namely, the XBOX) than its current software except for programmers.

Newspapers are dead; Their ad revenues is shrinking and their revenue model through ads and subscriptions is shrinking; Citizen Blogs are becoming ever popular. Of course, Google is way ahead with Blogspot and Google Reader.  Google is well poised to tap the revenue growth in these new arenas, which will become the future. Btw, regarding privacy issues, none is suspicious of a firm which touts ” No Evil” ,fights the US govt over privacy rights and capitulates to the Chinese govt (oh, they are commies after all).

Conclusion:

IMHO, any company which conforms to this disruptive model combining energy efficiency,  internet based delivery model, operational advantage, s/w conforming to this new era of hardware, might be a WINNER.  Now, you have the idea, do your own research and go stock picking. ( Remember to read the disclaimer….).

This article also points out whats my thoughts of future technoological trends:

1. Smaller  multipurpose devices – PDA like devices doing everything a laptop does,
2. Energy efficient delivery models,
3. Content/Information delivery @ your fingertips,
4. Centralized computing…..

I will update this post with an analysis of fundamental ratios.

April 2009 Trades

bought SKF (ultra short financial ETF) and SDS (Ultra short S&P 500) ETF on 3rd April, 2009.

Mark to Market vs Mark to Model

The quick fix, apparently, now is to ease the Mark to Market rules.
Why do I think this is wrong ?

Mark to Model or using subjective argument to value these assets is not right. Agreed that these assets are illiquid and it is difficult to value these assets. Leaving the banks to value these assets based upon models which have led to these situation is dumb.

There are NO MARKET OBSERVABLE parameters for these models. Nobody trades default correlation!!!You are violating the fundamental rule of modeling i.e you need market completeness.

In the absence of such market observable parameters, each of these firms will simply fix the value they want on these assets, calibrate the model to these values and obtain the parameters.  Not to mention quantitative mumbo jumbo talking about valuation in hypothetical worlds which cannot(and won’t) exist in reality.

Maybe we should start changing criminal law! Prosecution arguments will be done by the alleged suspects themselves. Bernie Madoff  & Stanford will be in the Bahamas dancing to calypso tunes.

Why are these assets illiquid ? Let’s say,The market is willing to buy these assets for 0.25$ on the dollar, the banks wish to sell them for 0.65$ on the dollar. The banks do not wish to sell at these prices which will result in huge losses on the balance sheet. So they keep holding on to these assets. Why ? They can lobby hard to change the rules and of course, when the s*** hits the roof, the FED might buy these assets at much better prices than the market is willing to buy them.  Taxpayers will offer a better deal.

That’s the reason for illiquidity! Ask these banks to start selling these assets at the low prices, viola, you get liquidity on these assets!

Is Mark to Market better in these circumstances ?

Given my views on Rational investor theory & Efficient Markets hypothesis, you might question me why the markets are correct in spite of illiquidity. I would rather have an idiotic democracy than an efficient aristocracy.

Mathematical Weapon of Mass Destruction – Average

Imho, a mathematical concept conjured up by mankind for something else and used most destructively is Averaging ( Call it mean, or whatever.).

Why so? Because every mathematician out there believes averaging removes noise and converges to the unknown right value.
And nowhere is it more destructively used than in the field of finance and economics.

Averaging in Efficient Market hypothesis:

If million people participate in the markets, their views intersect and the market price is the right one. Their views average out. Balderdash!

If Copernicus or Galileo had thought similarly, we would still be believing the Geo-centric theory. And you can kiss the Apollo missions goodbye.

I believe firmly in Nietzsche’s quote:

“Insanity in individuals is something rare – but in groups, parties, nations and epochs, it is the rule”

Pricing:

Average out all prices in all the states and that has to be the right value.

Another common viewpoint:

If you have few points of market data, do not worry. Average them out. Removes noise. Do you need correlation on 5 points of data, average the correlation structure. It will magically converge to the right one. Why ? Oh. Because no one knows the right value, this has to be the right value.

One can provide a counter point mathematically to every one of these points. Fortunately, we do not live in mathematically perfect hypothetical world.

Folks, read this aloud:

Averaging of noise does not remove noise. IT IS NOISE.

My trades: Feb/Mar 2009

I am quite bearish on the market. My temporary bottom for the mkt is at around S&P to hit 500!!

My trades include:

JPM Apr 2009 -$12.5 puts – bought them at around 1 st week of feb and sold them at around 110+% return last week.

MET Apr 2009 – $5 puts – bought them last week; Under water due to mkt rally. Why Metlife ? Because they used to sell variable annuities big time. Selling Variable annuities is like selling  exotic PUT options to everyone out there. Insurance firms are short Delta, short Gamma. They are required to hedge these losses and in these mkts, they bleed.

JPM Apr 7.5$ – Bought these puts last week; Underwater now.Risk Magazine’s Credit derivatives house of the year 2009. Netting their assets at par because they have bought protection from AIG and AIG is backed by the Govt!! Not to mention the Bear Stearns  and WaMu acquisitions!

QQQQ OTM puts Apr – Expect TECH sector to get hit more. I dont think valuations for TECH has accounted for this yet. Bought them in first week of FEB 2009.

SATYAM – The Hard Truth@ 20 Rs INR

Lets take a look at the scandals involving Satyam, one of India’s outsourcing companies

1. World Bank scandal involving data security and spy ware.
2. Inflated revenues, cash position and operating margins by the founder- chairman,   Ramalinga Raju.

World Bank scandal is quite a problem. However, this could have been overcome. World bank is not exactly spotless with its own share of corruption. A look at the World Bank – Siemens scandal could prove this. World on the street allegedly being : bribing = projects at world bank.

The more serious issue is the Ramalinga Raju confession.

The more I read this, more skeptical I am about his statement.
I find it ludicrous to believe that one man could have cheated so much on his own on this scale. The letter by Raju was his finishing touch to the scam.

1. The CFO had to know about the financial statements,
2. COO needs to know about the operating margins,
3. The division heads(Vertical such as Banking,….) had to have some sense (if not, concrete) of the  operating margins within their group and the revenues within their group and their relative positioning  compared to other divisions. Their bonuses depend upon this, remember.
4. The finance team should have had a inkling about this.
5. The auditors.. (Lets forget the auditors for the moment).

And this is just the tip of the iceberg.

I also find it ludicrous that 3% operating margins were the real value and bank balances of Rs 5000+Cr( around USD 1 Bn) could be faked completely. I can understand a 15-20% operating margin being faked to 30%. If true figures were so low, the division heads,even project managers could have spotted this fake figure 30% number.

My bet is that Raju and his family invested deeply in real estate (Maytas) and other businesses using Satyam money with the complete assent of the ones I mentioned above. The investments should have turned sour in this
current turmoil and hence, the aborted attempt to negotiate a deal with Maytas at a overblown valuation (USD 1.3 BN – Am assuming at least a 80-90% overvaluation covering the cash). Maytas also won the metro project for Hyderabad amidst great controversy with no prior experience. This should have gone as bribes to most politicians in AP/Central govt.(The
Rajus are a politically connected family). I find the numbers matching the Maytas valuation with that of “lost” money to be too close for mere coincidence.

This is all money which will be recovered (or at least should be) from the Rajus. I can understand a partial fudging of numbers. Not a complete 100% on this scale. Given India’s judicial track record, investors can kiss this money good bye.

What now?  Given the Indian govt’s involvement, India’s socialist heritage, “Job-Security” expectations of Indian people and populist policies of every Indian party, I anticipate that the new board negotiating a M&A deal with interested parties with the  Govt backing any liabilities. Brand Satyam is dead. I find a fallout of at least 30-40% clients (at a best case) with newer clients harder to find especially amongst financial, insurance and healthcare sectors, where data security is paramount. Also, billing rates need to be lowered to retain clients hitting against an ever increasing remuneration for IT employees (atleast after this economic turmoil). And also, perish any thought of attracting job security focused Indian graduates. Satyam is dead! Long live Satyam!!

Unless the board & govt are incompetent, I expect the M&A deal to be the
best option.

Why M&A?

1. All said and done, Satyam’s BI unit is one of the best out there. Data warehousing and mining capabilites are better than the big 4 (INFY, Wipro, CTS and TCS).
2. Frankly, Satyam’s human resource pool,imho, are much more well groomed than the big 4. (I used to work in one of the big 4 and have interacted with associates amongst all of them.).
3. Satyam has a niche capability in the Automobile vertical.

4. For small firms such as L&T Infotech or foreign firms such as CapGemini/IBM, who are vehemently trying to increase their scale of operations in India. But this needs Govt backing. Interestingly, L&T Infotech has a 4% stake in Satyam through its parent, L&T.However, it has denied any plans to buyout Satyam due to the Raju scandal.

5. Existing PE investors are not going to burn their investments w/o making any attempt to restructure.

Why the Govt might help?

1. Election Year. The Congress govt at the center and at A.P (HQ of Satyam) need to do something urgently unless they want to commit harakiri. (However, the Congress party is known to do much worse.). 53,000 employees, their families, friends (India is incredibly connected in terms of people esp ppl when they are fired. A politician makes a scam and gets away with 5Bn$, nobody cares. One clerk is fired, entire state would vote
against the party.) voting against the Congress and its allies all over South India (which proved to be its saving grace last elections), the IT Stronghold, should have the govt doing something immediate.
2. There is no way these employees would be absorbed by the market soon, given the economic conditions and the reputation of Sathyam. Unemployment means huge hue and cry and lost votes. It is  every Indian’s nightmare to head back to the 70’s and 80’s with unemployment rampant.

3. In the long run, this would just exacerbate the current economic condition.

W/o the govt backing, I see very limited attempts at a takeover or merger unless undertaken by a US/ influential European firm who is cash rich (given this liquidity crunch) and can settle any potential liabilities.

Is Satyam a good buy at 20+INR per share  given that any analysis of  book value would be incorrect due to fudged numbers?

I would say “Yes”. however, this investment would be highly volatile and is not for the fainthearted and not definitely for pension funds. If your concern is about preserving capital, go somewhere else.

Risk Neutral Pricing and Girsanov’s Theorem: A commentary

This article is a commentary on Girsanov’s theorem.

Click on the link below to read the article:

A Commentary on Girsanov’s Theorem

It is ,by no means, exhaustive and I have not finished it completely.

Any errors reported would be greatly appreciated as would be any feedback.

I need to publish some companion articles to lead upto this article. Will work on this when I have time.

Why God(????) is a quant ?

People assume that god (0r the Google super network which eventually becomes god) would just go ahead and create something just like…

If you really carefully observe nature, astrophysics, everything seems to be self sustaining systems which have ingrained slow-moving dynamics which affect every part of the entire system. For eg: Prithvi(Earth) with its environment/ecological balances. How small changes affect the balance and the adaptation of the system to this change? The system also builds up a response slowly to remove any threats. Interaction between various lifeforms to co-exist and eventually, to survive. The systems are all encompassing and also microcosmic. Going by folklore, intervention to nudge human populace in a specific direction. Would he intervene too much or would he let the mkts (human populace) play itself out and introduce small nudges which with high probability could affect the course of human advance. In his Foundation series, Azimov explains this very well on how Hari Seldon slowly modifies the advance of the Galactic empire. Too much intervention would be interfering with free will.

Apparently, Einstein’s ” God does not play dice with the universe” does not hold water (imho), as  Heisenberg’s uncertainity principle proved to be.

Are Quants gods? No. I mentioned that Gods were quants (probably super duper quants). but i never did indicate the other way was correct. ( btw, I believe in polytheism compared to monotheism).