It could not have been a better year for the investors as S&P500 has posted in excess of 20% return for the year with still one month left in 2009. What is an investor supposed to do? I think it is time to reassess the risk, consider blessed by the Market Gods, take some profit and stash it away in little more conservative asset class. That is the beauty of Modern Portfolio Theory and it will be quite timely to put that in practice right now.
Yes, in 2009, financial markets have come out of the crisis (at least for now...), economy has stopped its free-fall along with all types of markets, be it equity, credit markets, commodities, real estate, credit markets have unfroze and thawed well, credit is flowing smooth at least for the corporate markets, if not for individuals, government has started spending like crazy, so, what is to be afraid of. Well.. a lot. The direction U.S. government has taken is surely a short-term fix and ignored a sound long-term solution at the peril of our future financial health.
The end result is that the sick patient has sure gotten a good shot in the arm to start walking again, however, it has not been to a surgery room to free itself of its ailment completely. Only a lengthy surgery and long recovery time would have done the job. Without that, there is no sustainable and healthy recovery. It is more of a facade of a recovery.
Smart investment decision would be to clear some profit and wait for more opportune times.
Monday, November 30, 2009
Wednesday, September 30, 2009
Have We Reached the Economic Bottom Yet?
It appears that way at least. Does it mean that going forward, it will be an easy ride? Not by any stretch of an imagination. Although, what I am encouraged by is the resiliency of an American soul to rebound from such lows. This resiliency had been so typical for a consumer throughout the 1990s and 2000s that the U.S. consumer seemed insatiable. Businesses obviously had been through their typical highs and lows in terms of their capital spending. It was the U.S. consumer that kept the massive economic engine going. Well, that engine sputtered big time in 2006 through 2008 and now it is going in a more moderate or slow, but predictable fashion.
U.S. consumer has pulled its horns and gone into a hibernation for an indefinite period. That is how far as predictable as it can get. That is not changing anytime soon due to its heavy debt load. What has changed for the better over the last couple quarters is that the American consumers and businesses have steered clear of their extreme pessimism. That is no small feat. I have been really encouraged to see such a massive change in an American psyche. I, always being a contrarian, have been quite cynical about the over-optimism and over-pessimism that we have witnessed in the financial markets.
The year 2008 was certainly a pinnacle in that extreme pessimism just as 1999 and 2000 were the pinnacles of the extreme optimism. So, reverting back to the normalcy and ruling under the law of averages is always a highly desirable thing for folks like me. So, I welcome to more normal environment like this. The mainstream media has been calling this a "New Normal", but this is not a not a new normal. In a way, it is, if you compare to the "Old Normal", which was not normal. Otherwise, this is a real normal. Working hard and earning every penny that you truly deserve. That is a new normal so to speak.
U.S. consumer has pulled its horns and gone into a hibernation for an indefinite period. That is how far as predictable as it can get. That is not changing anytime soon due to its heavy debt load. What has changed for the better over the last couple quarters is that the American consumers and businesses have steered clear of their extreme pessimism. That is no small feat. I have been really encouraged to see such a massive change in an American psyche. I, always being a contrarian, have been quite cynical about the over-optimism and over-pessimism that we have witnessed in the financial markets.
The year 2008 was certainly a pinnacle in that extreme pessimism just as 1999 and 2000 were the pinnacles of the extreme optimism. So, reverting back to the normalcy and ruling under the law of averages is always a highly desirable thing for folks like me. So, I welcome to more normal environment like this. The mainstream media has been calling this a "New Normal", but this is not a not a new normal. In a way, it is, if you compare to the "Old Normal", which was not normal. Otherwise, this is a real normal. Working hard and earning every penny that you truly deserve. That is a new normal so to speak.
Friday, August 28, 2009
Visit to India, My Native Country
My Mother died on Aug 14, exactly two weeks ago from today, in India due to a heart attack at the age of 66. As a result, I boarded the flight on that day for my sojourn to India to have a glimpse at my beloved mother for one last time and to take care of the necessary rituals per our Hindu religion. I am in India for two weeks now and the feelings are nothing but nostalgic.
It has been little over twenty years since I have called the great United States my home. Yet, the motherland is a motherland. It has been nothing but the mixed feelings. Lots of good memories as well as lots of painful memories as life in India is not really easy, or at least, it was not not when I was growing up, for much of the middle class. I am really glad to see that India has come the long ways since I left the country. Over the years, I have visited India several times and every time, I have come to visit India, the progress I have seen is nothing short of impressive.
For example, the express highways, great many over bridges, number of airports and flights, suburban sprawling, growing wealth among all classes of people, emerging middle class, improving standard of living even for the most disadvantaged folks of the country are classic examples that India is really on the huge upswing since economic liberalization in early 1990s. Yet, a lot of work remains to be done and it will get there one day. That "one day" will whether materialize in 25 years or 50 years is a million dollar questions, nevertheless, it will get there, provided the current reforms continue.
China and India often possess a disproportionate share of the discussions and media coverage regarding their GDP growth and their growing presence in the world economy. One can see why such is the case, when you visit India. Though, India is behind China in creating unparalleled infrastructure as China had more than a decade of the leg up than India in economic liberalization, India can still learn a lot from China and other advanced countries regarding making the best of the investments.
I yearn to see India to be considered as one of the "developed nations". I just am not so sure whether that day will ever come due to the sheer size of its population and the baggage that it carries in the form of current systems in place. Even, if India is fortunate enough to see that day, it is highly unlikely that, I will ever see that day at least in my lifetime
It has been little over twenty years since I have called the great United States my home. Yet, the motherland is a motherland. It has been nothing but the mixed feelings. Lots of good memories as well as lots of painful memories as life in India is not really easy, or at least, it was not not when I was growing up, for much of the middle class. I am really glad to see that India has come the long ways since I left the country. Over the years, I have visited India several times and every time, I have come to visit India, the progress I have seen is nothing short of impressive.
For example, the express highways, great many over bridges, number of airports and flights, suburban sprawling, growing wealth among all classes of people, emerging middle class, improving standard of living even for the most disadvantaged folks of the country are classic examples that India is really on the huge upswing since economic liberalization in early 1990s. Yet, a lot of work remains to be done and it will get there one day. That "one day" will whether materialize in 25 years or 50 years is a million dollar questions, nevertheless, it will get there, provided the current reforms continue.
China and India often possess a disproportionate share of the discussions and media coverage regarding their GDP growth and their growing presence in the world economy. One can see why such is the case, when you visit India. Though, India is behind China in creating unparalleled infrastructure as China had more than a decade of the leg up than India in economic liberalization, India can still learn a lot from China and other advanced countries regarding making the best of the investments.
I yearn to see India to be considered as one of the "developed nations". I just am not so sure whether that day will ever come due to the sheer size of its population and the baggage that it carries in the form of current systems in place. Even, if India is fortunate enough to see that day, it is highly unlikely that, I will ever see that day at least in my lifetime
Tuesday, July 28, 2009
Real Dynamic Asset Allocation
While there has been a great deal of talk about the root causes of the housing debacle and how to avoid the repeats of such bubbles, regulatory fixes, etc., there has been a very little, if at all, a talk of investor's exposure to the equity asset class. A small minority of investors had little or no exposure to the equity asset class, however, most had a meaningful exposure to this risky asset class (with higher potential rewards) and they inadvertently took a big bath in last year's panic driven market meltdown.
According to a conventional school of thought, investor's asset base is divided between various asset classes such as stocks, bonds, cash, etc. depending on one's age and risk tolerance. More sophisticated asset allocation will utilize other asset classes such as real estate, commodities and hedge funds. More often than not, emphasis is not given at all to equity class valuations. That is where the dynamic asset allocation can come into play.
It has been real unfortunate that countless retirees or working population on the verge of retiring have had heavy exposure to the equity asset class in 2008 only to see almost one half of it to evaporate overnight. One cannot predict highly unlikely events like this with an uncanny ability or any consistency. Yes, housing bubble was witnessed by many and they predicted that it was destined to be popped some day. Yes, equity valuations were also quite reasonable or so we were told by all the equity strategists as they were hovering near or approaching their multi-decade average. Nevertheless, extremely small minority even predicted the equity class debacle that ensued following the housing bubble busting. What is one gotta do under such circumstances?
The only real solution I see is either to use the equity class quite sparingly or have a real dynamic asset allocation. There is no other way around it, if someone were to sidestep such catastrophes. The bottom line is it really is not worth it to have it otherwise. If you were to scale down equity exposure meaningfully, then, yes, the portfolio may not gain as it may otherwise, however, at the same time, you may be spared a pain of a lifetime as several families are witnessing at this moment. So, in other words, is that extra three to four percentage points in returns, at best, really worth it to have an outsized exposure to equities? To me, the answer is NO for the great majority of investors. Alternatively speaking, as some investment advisors exclusively focus on, wealth preservation is the key and not the asset growth.
Yes, most investment advisors do the asset allocation which is dynamic in the sense that the percentage of equity allocation among all other asset classes is determined based on the age and risk tolerance. Further more, there is an annual rebalancing done within the portfolio amongst various asset classes based on the set percentages or investment criterion.
However, the "real dynamic" asset allocation as I would like to call it is to add one more criterion to the allocation criterions. And that is the "Valuation" criterion. For example, a regular dynamic asset allocation may say that the investor at the age of 50, should have 50% exposure to the equities. However, there is no consideration or an emphasis given to the equity valuations at all. So, how about using a criterion such as at price to earnings (PE) ratio of 10 or less, one should have a full exposure at 50% (predetermined maximum level), however, rise in PE by each additional point will scale back equities exposure by 5%. That means, if the PE ratio is at 15, equity exposure is only 25% and when the PE ratio is at 20, one is completely out of equities.
This would have spared an investor tremendous amount of grief during the collapse of dotcom bubble as well as 2008 financial markets meltdown. No doubt one needs to stick to more consistent and uniform method to measure the PE ratio of an index such as S&P 500 or Wilshire 5000 Total Market Index . This type of risk management and "real dynamic" asset allocation adds a great deal of value to a conventional asset allocation.
Alternatively, one can always have an outsized exposure to the fixed income with only a minimal exposure to the equities on a permanent basis. As I mentioned earlier, is it really worth it to sacrifice life's worth of savings for few extra percentage points in return during those rare events? Is any meaningful exposure to even seemingly rare events really worth it?
According to a conventional school of thought, investor's asset base is divided between various asset classes such as stocks, bonds, cash, etc. depending on one's age and risk tolerance. More sophisticated asset allocation will utilize other asset classes such as real estate, commodities and hedge funds. More often than not, emphasis is not given at all to equity class valuations. That is where the dynamic asset allocation can come into play.
It has been real unfortunate that countless retirees or working population on the verge of retiring have had heavy exposure to the equity asset class in 2008 only to see almost one half of it to evaporate overnight. One cannot predict highly unlikely events like this with an uncanny ability or any consistency. Yes, housing bubble was witnessed by many and they predicted that it was destined to be popped some day. Yes, equity valuations were also quite reasonable or so we were told by all the equity strategists as they were hovering near or approaching their multi-decade average. Nevertheless, extremely small minority even predicted the equity class debacle that ensued following the housing bubble busting. What is one gotta do under such circumstances?
The only real solution I see is either to use the equity class quite sparingly or have a real dynamic asset allocation. There is no other way around it, if someone were to sidestep such catastrophes. The bottom line is it really is not worth it to have it otherwise. If you were to scale down equity exposure meaningfully, then, yes, the portfolio may not gain as it may otherwise, however, at the same time, you may be spared a pain of a lifetime as several families are witnessing at this moment. So, in other words, is that extra three to four percentage points in returns, at best, really worth it to have an outsized exposure to equities? To me, the answer is NO for the great majority of investors. Alternatively speaking, as some investment advisors exclusively focus on, wealth preservation is the key and not the asset growth.
Yes, most investment advisors do the asset allocation which is dynamic in the sense that the percentage of equity allocation among all other asset classes is determined based on the age and risk tolerance. Further more, there is an annual rebalancing done within the portfolio amongst various asset classes based on the set percentages or investment criterion.
However, the "real dynamic" asset allocation as I would like to call it is to add one more criterion to the allocation criterions. And that is the "Valuation" criterion. For example, a regular dynamic asset allocation may say that the investor at the age of 50, should have 50% exposure to the equities. However, there is no consideration or an emphasis given to the equity valuations at all. So, how about using a criterion such as at price to earnings (PE) ratio of 10 or less, one should have a full exposure at 50% (predetermined maximum level), however, rise in PE by each additional point will scale back equities exposure by 5%. That means, if the PE ratio is at 15, equity exposure is only 25% and when the PE ratio is at 20, one is completely out of equities.
This would have spared an investor tremendous amount of grief during the collapse of dotcom bubble as well as 2008 financial markets meltdown. No doubt one needs to stick to more consistent and uniform method to measure the PE ratio of an index such as S&P 500 or Wilshire 5000 Total Market Index . This type of risk management and "real dynamic" asset allocation adds a great deal of value to a conventional asset allocation.
Alternatively, one can always have an outsized exposure to the fixed income with only a minimal exposure to the equities on a permanent basis. As I mentioned earlier, is it really worth it to sacrifice life's worth of savings for few extra percentage points in return during those rare events? Is any meaningful exposure to even seemingly rare events really worth it?
Tuesday, June 30, 2009
Prime Example of the Sorry State of Nation's Infrastructure & Toll System
I landed in this great country just about twenty years ago on 4th of July, 1989. I am proud to make United States of America my new home since then and even prouder to be American citizen since 1995. One thing that continues to bother me for past few years is that I believe America is traversing towards a path of decline.
There is no better example than the Washington-New York I-95 corridor to illustrate the sorry state of our nation's infrastructure. I just traveled through the hodgepodge of I-95 that consists of New Jersey Turnpike, Delaware Turnpike and I-95 through these namesake states and a state of Maryland on my way from New Jersey to northern Virginia to visit a friend. As I had traveled through this corridor several times in my early years in United States, it brought back some good memories of my early life.
One thing that continues to baffle me is the short-sightedness or rather a lack of vision from the leaders of the current generations. It will be twenty years for me in the United States next weekend and unfortunately I just witnessed that during these twenty years, the most important corridor of our great country has seen no expansion at all. Washington-New York I-95 corridor connects the capital of the world's only superpower to the undisputed financial capital of the world, however, much of the stretch remains two to three lane highway where as only small parts of it are much more than that. It is really a pity for a country like United States that we do nothing in over twenty years to such a critical artery of our country when many emerging countries are rolling out new infrastructure projects like there is no tomorrow.
To make matters worse on this corridor or even a thing that is solely responsible for creating unforgiving congestion is a mere existence of a toll system. It just seems so backward. This is certainly a debatable matter due to issues such as costs and fairness. At a high level, is it really necessary to have such a toll system? It appears that only vision-lacking leaders can create or nurture such a system and selfish or unintelligent people can support such system. Are we really a country made of such people? There still are smart as well as fair ways to recoup the costs of building infrastructure (or even milk that infrastructure as many of our leaders like to) than simply clogging up major arteries by placing tolls at multiple places. Well, a human body takes food only from one place and not multiple places.
The prior generations had a vision to create such great interstate highway system in 1950s where as the later generations have done nothing but use it and abuse it with no respect to preserving and growing its legacy. Population grew meaningfully during the last 50 years, however, our infrastructure did not keep up with it at all. As a result, our nations' infrastructure appears overused and dilapidated, if not crumbling. United States receiving a "D" grade from American Society of Civil Engineers only confirms that fact.
The end result is that we are paying a big price for it in form of a lack of "real" increase in our standard of living. It simply breaks my heart to travel on a same two-lane highway as it was twenty years ago between New York and Washington, a lifeblood of United States of America.
Much of the country still is heavily laden with two lane highways, often heavily congested now, which may have been an ideal solution over 50 years ago. However, is it not a high time to have some vision for the future of United States for the sake of our children and grandchildren as opposed to just be some users of the fruits of labor of past visionaries? At least, we owe that much to our forefathers to leave their legacy behind well intact.
There is no better example than the Washington-New York I-95 corridor to illustrate the sorry state of our nation's infrastructure. I just traveled through the hodgepodge of I-95 that consists of New Jersey Turnpike, Delaware Turnpike and I-95 through these namesake states and a state of Maryland on my way from New Jersey to northern Virginia to visit a friend. As I had traveled through this corridor several times in my early years in United States, it brought back some good memories of my early life.
One thing that continues to baffle me is the short-sightedness or rather a lack of vision from the leaders of the current generations. It will be twenty years for me in the United States next weekend and unfortunately I just witnessed that during these twenty years, the most important corridor of our great country has seen no expansion at all. Washington-New York I-95 corridor connects the capital of the world's only superpower to the undisputed financial capital of the world, however, much of the stretch remains two to three lane highway where as only small parts of it are much more than that. It is really a pity for a country like United States that we do nothing in over twenty years to such a critical artery of our country when many emerging countries are rolling out new infrastructure projects like there is no tomorrow.
To make matters worse on this corridor or even a thing that is solely responsible for creating unforgiving congestion is a mere existence of a toll system. It just seems so backward. This is certainly a debatable matter due to issues such as costs and fairness. At a high level, is it really necessary to have such a toll system? It appears that only vision-lacking leaders can create or nurture such a system and selfish or unintelligent people can support such system. Are we really a country made of such people? There still are smart as well as fair ways to recoup the costs of building infrastructure (or even milk that infrastructure as many of our leaders like to) than simply clogging up major arteries by placing tolls at multiple places. Well, a human body takes food only from one place and not multiple places.
The prior generations had a vision to create such great interstate highway system in 1950s where as the later generations have done nothing but use it and abuse it with no respect to preserving and growing its legacy. Population grew meaningfully during the last 50 years, however, our infrastructure did not keep up with it at all. As a result, our nations' infrastructure appears overused and dilapidated, if not crumbling. United States receiving a "D" grade from American Society of Civil Engineers only confirms that fact.
The end result is that we are paying a big price for it in form of a lack of "real" increase in our standard of living. It simply breaks my heart to travel on a same two-lane highway as it was twenty years ago between New York and Washington, a lifeblood of United States of America.
Much of the country still is heavily laden with two lane highways, often heavily congested now, which may have been an ideal solution over 50 years ago. However, is it not a high time to have some vision for the future of United States for the sake of our children and grandchildren as opposed to just be some users of the fruits of labor of past visionaries? At least, we owe that much to our forefathers to leave their legacy behind well intact.
Sunday, May 31, 2009
Deficits Deficits Deficits
U.S. Government under President George W. Bush's watch surely deserves the credit for forestalling a literal free fall in the financial markets (stock market as well as credit markets) during fall of 2008. No matter how imperfect measures they may have been deemed, $750 billion TARP program surely served its purpose. It reinstilled the confidence in the U.S. financial institutions as well as the financial markets, at least for the game to continue from a screeching halt.
Fast forward to spring and early summer of 2009. U.S. Government under the new regime of President Barack Obama is taking unprecedented steps of getting into ungodly amounts of deficits as far as the eyes can see. How can this all be justifiable? On the name of helping out the current dire situation, congress made the passage of$780 billion stimulus program. Who really needs all this stimuli? It seems like the government itself does.
So, where is the outrage among common people? Financial markets are already on the mend. Credit markets have been already thawed. They are not operating like a well-oiled machine due to obvious reasons of huge capital holes in the balance sheets of the financial institutions coupled with major economic weakness, though someone expecting them to operate like they did before the bust are having a wishful thinking. Those days are gone for ever. Credit is going to remain scarce for years to come...at least until the de-leveraging has run its course. There is no doubt about it. Stock markets are up significantly from their March 9 lows. So, clearly they have regained some lost footing. As a result, financial markets do not need any additional stimulus.
It appears that the trillion here or trillion there does not matter to the government anymore. It has planned annual deficit in the trillion dollar range for every year for next several years. A talk of trillion is so common these days that we can't even say that it amuses us. Who is going to pay for this? Ultimately, we all will, our children and grandchildren will.
The fact of U.S. being hailed as one of the best nations in the whole world, if not the best, may soon be the history. It was in the making for last three decades. What drove the country to this stage still continues; which is a disregard to a fiscal and monetary discipline. With the financial markets meltdown of 2008, we had a big hope that this may turn out to be a good inflection point for a better and brighter future. From there on, we could embark upon a journey with proper changes, that can lead us back into a solid financial footing. Now, it appears that the Government is squandering one of the biggest opportunities presented in generations. So, our hopes are dashed that the U.S. will regain its superpower status; instead it gradually will relinquish this crown to other nation(s) in the not so distant future.
Fast forward to spring and early summer of 2009. U.S. Government under the new regime of President Barack Obama is taking unprecedented steps of getting into ungodly amounts of deficits as far as the eyes can see. How can this all be justifiable? On the name of helping out the current dire situation, congress made the passage of$780 billion stimulus program. Who really needs all this stimuli? It seems like the government itself does.
So, where is the outrage among common people? Financial markets are already on the mend. Credit markets have been already thawed. They are not operating like a well-oiled machine due to obvious reasons of huge capital holes in the balance sheets of the financial institutions coupled with major economic weakness, though someone expecting them to operate like they did before the bust are having a wishful thinking. Those days are gone for ever. Credit is going to remain scarce for years to come...at least until the de-leveraging has run its course. There is no doubt about it. Stock markets are up significantly from their March 9 lows. So, clearly they have regained some lost footing. As a result, financial markets do not need any additional stimulus.
It appears that the trillion here or trillion there does not matter to the government anymore. It has planned annual deficit in the trillion dollar range for every year for next several years. A talk of trillion is so common these days that we can't even say that it amuses us. Who is going to pay for this? Ultimately, we all will, our children and grandchildren will.
The fact of U.S. being hailed as one of the best nations in the whole world, if not the best, may soon be the history. It was in the making for last three decades. What drove the country to this stage still continues; which is a disregard to a fiscal and monetary discipline. With the financial markets meltdown of 2008, we had a big hope that this may turn out to be a good inflection point for a better and brighter future. From there on, we could embark upon a journey with proper changes, that can lead us back into a solid financial footing. Now, it appears that the Government is squandering one of the biggest opportunities presented in generations. So, our hopes are dashed that the U.S. will regain its superpower status; instead it gradually will relinquish this crown to other nation(s) in the not so distant future.
Tuesday, April 28, 2009
Prozac Nation
What a difference. Between the fall of 2008 and spring of 2009. If it weren't for the Prozac nation, what would it be? Populace binged on everything: from stocks to housing to cheap loans (topped off with SUVs and iPods) during much of the 1990s and 2000s. At first glance, it appeared that the people were naive and led into believing that the "so called prosperity" was a real one and would last for ever. Now, we know that everyone was not so naive, many of them were complicit. Everyone found out that the "prosperity" was not so real. People also found out that it could not be achieved so fast without necessary discipline and sacrifices as they realized during this upheaval period and everyone hunkered down during this time period.
Most everyone on this planet earth had an awakening late last year and acted accordingly. Just too much. Just as the binging was too much, panic set in the marketplace was too much. We did not have to pay the price that we did. It did no one any good. Once we realize that mistakes were committed in the past, we make the corrective action. We should not make another mistake by overshooting in another direction. However, that is what exactly what happened by creating a free-fall in the securities market and finance sector which also created a second coming of the "Great Depression" talk. Now, folks have come around the full circle and now we see consumer confidence springing to well deserved levels from decade lows during last several months. Hence the analogy of a Prozac Nation, as it was dubbed at the height of tech mania in late 1999 and early 2000.
Certainly some preliminary signs are emerging for economic stability or at least a halt of precipitous decline. Housing market seems to be finding some kind of a footing. As the months go by, we hope to continue to see more and more of that. It is also an encouraging sign to see people become much more disciplined as it comes to spending. That is great for the longer term, however, no fun for the time being and certainly not for the economy. Now, only if our governments and the regulators have the fortitude to do the right thing to avoid such boom and bust scenarios.
Most everyone on this planet earth had an awakening late last year and acted accordingly. Just too much. Just as the binging was too much, panic set in the marketplace was too much. We did not have to pay the price that we did. It did no one any good. Once we realize that mistakes were committed in the past, we make the corrective action. We should not make another mistake by overshooting in another direction. However, that is what exactly what happened by creating a free-fall in the securities market and finance sector which also created a second coming of the "Great Depression" talk. Now, folks have come around the full circle and now we see consumer confidence springing to well deserved levels from decade lows during last several months. Hence the analogy of a Prozac Nation, as it was dubbed at the height of tech mania in late 1999 and early 2000.
Certainly some preliminary signs are emerging for economic stability or at least a halt of precipitous decline. Housing market seems to be finding some kind of a footing. As the months go by, we hope to continue to see more and more of that. It is also an encouraging sign to see people become much more disciplined as it comes to spending. That is great for the longer term, however, no fun for the time being and certainly not for the economy. Now, only if our governments and the regulators have the fortitude to do the right thing to avoid such boom and bust scenarios.
Saturday, April 11, 2009
Death of Wall Street
If the banking and finance sector had put the matter of "financial strength" ahead of "quick profits" in their corporate lives, this post would not have existed. It is beyond anyone's doubt that it is that myopia and greed that have brought the financial services industry to its knees and killed the Wall Street for good. It is a "human nature" as they say that is a culprit here.
As long as greed and naivete are there, there will be swindlers on this earth. The recent episode of 2007-2008 upheaval of financial services industry demonstrates the fact that in absence of a solid foundation, the industry is doomed to repeat its mistakes again, be it within one, two or three generation's time frame. As long as people (investors, financial institutions and enablers such as governments) are myopic and do not take a long term view of fixing its root problems, the bubbles, manias and subsequent busts are just going to keep re-occurring just in a different shape, form or size.
As long as the government has no political will to ditch the myopia and take the strong medicine in terms of regulatory reforms to create sound and sensible regulations and its unforgiving implementation, financial services history littered with these blemishes will continue to repeat itself again. Government may not have an ability to eliminate such catastrophes, however, it does have a power to lay a strong foundation and a framework that ensures that such calamities are lot less frequent and lot less smaller in size.
Is it just ironic or is it by design that rich and famous who plan conservatively never get in trouble, yet rich and famous who do not execute well end up loosing much of their wealth? If it can happen to rich, why not to a general populace? It is not the "profit" that matters ultimately, it is the "strength" that matters in a long run. My heart aches a lot to see my beloved (and so near and dear to my heart) industry getting killed by a handful of myopic folks.
As long as greed and naivete are there, there will be swindlers on this earth. The recent episode of 2007-2008 upheaval of financial services industry demonstrates the fact that in absence of a solid foundation, the industry is doomed to repeat its mistakes again, be it within one, two or three generation's time frame. As long as people (investors, financial institutions and enablers such as governments) are myopic and do not take a long term view of fixing its root problems, the bubbles, manias and subsequent busts are just going to keep re-occurring just in a different shape, form or size.
As long as the government has no political will to ditch the myopia and take the strong medicine in terms of regulatory reforms to create sound and sensible regulations and its unforgiving implementation, financial services history littered with these blemishes will continue to repeat itself again. Government may not have an ability to eliminate such catastrophes, however, it does have a power to lay a strong foundation and a framework that ensures that such calamities are lot less frequent and lot less smaller in size.
Is it just ironic or is it by design that rich and famous who plan conservatively never get in trouble, yet rich and famous who do not execute well end up loosing much of their wealth? If it can happen to rich, why not to a general populace? It is not the "profit" that matters ultimately, it is the "strength" that matters in a long run. My heart aches a lot to see my beloved (and so near and dear to my heart) industry getting killed by a handful of myopic folks.
Tuesday, March 31, 2009
Power of Option Writing
"Options are risky." That is one of the most common phrase you may hear among investors, if you talk about options . It is absolutely true...that is only if you "buy" them. There is a flip side to this. Options can be the greatest tool out there at your disposal for the safety of your portfolio and consistency of its returns; if you "sell" the options. Here is how it works.
By definition, buying an option gives you a right to buy a particular security at a predetermined price for a specific period of time, just as the word "option" implies. However, there is a price to pay for this option. This is precisely why they are risky. There are two types of options: calls and puts. A call option gives you a right to buy and a put option gives you a right to sell at the predetermined prices. This in turn makes a call option akin to a lottery ticket and put option an insurance policy in the layman's terms.
Since, one has to pay for a lottery ticket and an insurance policy, they may become worthless in absence of hitting a lottery or a need for filing an insurance claim. All they did is that they served their purpose; which is to allow you to play a lottery (for call option) and allow to buy a peace of mind (for put option). Obviously, there is a cost associated with either of these two. That is the worst case scenario. One may recover part, if not all, of their original investment depending on the magnitude of the move of a particular security.
So, how about if you do the opposite? One can sell a call or a put option and collect the premium, instead. The key here is to "not pay" a premium, but instead "collect" a premium. This allows you to become a lottery agent or an insurance company. As you know, the lottery agent, be it a state government or a store owner selling a lottery ticket are the ones making money on a consistent basis, not the lottery buyers. Similarly, insurance companies are the ones that make money selling insurance. Buyers of an insurance policy have nothing but the cost of protection and protection of value in case of a disaster.
Investor keeping the above concept in the mind can devise an investment strategy that can give them relatively steady and consistent performance as opposed to leaving investment returns to the vagaries of Mr. Market. In terms of specifics, a covered call strategy has been an age-old and a proven strategy that has delivered relatively consistent, thought not magnificent, returns. A cash secured put writing strategy can be utilized in a similar manner as well. That allows an investors to utilize not only one side of a coin, but both sides of a coin.
In order to improve returns, more sophisticated approach can be employed in a portfolio via a combination of covered and uncovered positions to exploit the world of options even further. However, risk management is the key here. Under no circumstances, the risk should be higher than the market as a whole. The portfolio risk must not exceed the risk of an overall market. If it exceeds, potential returns are higher, however, at the same time, risk of loss is greater, too.
By definition, buying an option gives you a right to buy a particular security at a predetermined price for a specific period of time, just as the word "option" implies. However, there is a price to pay for this option. This is precisely why they are risky. There are two types of options: calls and puts. A call option gives you a right to buy and a put option gives you a right to sell at the predetermined prices. This in turn makes a call option akin to a lottery ticket and put option an insurance policy in the layman's terms.
Since, one has to pay for a lottery ticket and an insurance policy, they may become worthless in absence of hitting a lottery or a need for filing an insurance claim. All they did is that they served their purpose; which is to allow you to play a lottery (for call option) and allow to buy a peace of mind (for put option). Obviously, there is a cost associated with either of these two. That is the worst case scenario. One may recover part, if not all, of their original investment depending on the magnitude of the move of a particular security.
So, how about if you do the opposite? One can sell a call or a put option and collect the premium, instead. The key here is to "not pay" a premium, but instead "collect" a premium. This allows you to become a lottery agent or an insurance company. As you know, the lottery agent, be it a state government or a store owner selling a lottery ticket are the ones making money on a consistent basis, not the lottery buyers. Similarly, insurance companies are the ones that make money selling insurance. Buyers of an insurance policy have nothing but the cost of protection and protection of value in case of a disaster.
Investor keeping the above concept in the mind can devise an investment strategy that can give them relatively steady and consistent performance as opposed to leaving investment returns to the vagaries of Mr. Market. In terms of specifics, a covered call strategy has been an age-old and a proven strategy that has delivered relatively consistent, thought not magnificent, returns. A cash secured put writing strategy can be utilized in a similar manner as well. That allows an investors to utilize not only one side of a coin, but both sides of a coin.
In order to improve returns, more sophisticated approach can be employed in a portfolio via a combination of covered and uncovered positions to exploit the world of options even further. However, risk management is the key here. Under no circumstances, the risk should be higher than the market as a whole. The portfolio risk must not exceed the risk of an overall market. If it exceeds, potential returns are higher, however, at the same time, risk of loss is greater, too.
Saturday, February 28, 2009
Effects of Banks Not Lending
One thing we have a hard time understanding is that if someone gets in a major accident and is hurt severely, then do we expect him or her to start running in a matter of a short time. Depending on an injury, it may be days or months or even years before someone can resume his or her prior routine. Certain accident even cripple the person permanently. That person is going to take time to recuperate; first walk and then run. So is the case with the banking sector. Against that backdrop, why everyone is complaining that the banks are not lending? Of course, they cannot lend…at least not the way they used to. We need to get real about it. We need to get used to it...for now.
Why is there such a rush to lend? Because they lent too much earlier is the reason why we are in such a big mess in the first place. Why not give them a time to work its way out of this mess? What is wrong with those people complaining about banks? Mainstream media is making a same mistake again by hammering on this message now just as they were promoting housing mania earlier this decade and affect people’s psyche in a wrong manner. Our mainstream media needs to demonstrate more prudence and intelligence.
Our complaint is that those people and businesses really need the loan are not getting any. There can only be two reasons needing a loan. One is for a “Renewal” purpose due to maturity of an existing loan. The other reason is for a “Growth” purpose, be it a new construction or acquisition for a business person or a new housing loan for individuals.
To us, only the first reason – “Renewal” is critical enough, because, if the maturing loan does not get renewed then it can send even a healthy business into a default. Now, that is not good to push healthy businesses or individuals into default for no fault of their own. That is a plain and simple failure of a financial system and a tragic one at that. In that case, we propose that those maturing debts be renewed automatically for one year due to government's mandate. Then we revisit that issue a year later. Hopefully, banks will be somewhat healthier and we would not need to worry about that situation again.
As for the second reason – “Growth”, what is the worst thing that can happen? No new "deals". That is all. It is only natural that the recession occurs after such a big financial meltdown. In that case, we are going to have to compromise with the growth aspects of our economy. Once we turn healthy, we are sure going to grow again. We need not worry too much about the growth at this point in time, at least.
Bottom line is that as long as the maturing debts get renewed, there is no other ill-effect on the economy other than a lack of growth. What so wrong with that picture?
Why is there such a rush to lend? Because they lent too much earlier is the reason why we are in such a big mess in the first place. Why not give them a time to work its way out of this mess? What is wrong with those people complaining about banks? Mainstream media is making a same mistake again by hammering on this message now just as they were promoting housing mania earlier this decade and affect people’s psyche in a wrong manner. Our mainstream media needs to demonstrate more prudence and intelligence.
Our complaint is that those people and businesses really need the loan are not getting any. There can only be two reasons needing a loan. One is for a “Renewal” purpose due to maturity of an existing loan. The other reason is for a “Growth” purpose, be it a new construction or acquisition for a business person or a new housing loan for individuals.
To us, only the first reason – “Renewal” is critical enough, because, if the maturing loan does not get renewed then it can send even a healthy business into a default. Now, that is not good to push healthy businesses or individuals into default for no fault of their own. That is a plain and simple failure of a financial system and a tragic one at that. In that case, we propose that those maturing debts be renewed automatically for one year due to government's mandate. Then we revisit that issue a year later. Hopefully, banks will be somewhat healthier and we would not need to worry about that situation again.
As for the second reason – “Growth”, what is the worst thing that can happen? No new "deals". That is all. It is only natural that the recession occurs after such a big financial meltdown. In that case, we are going to have to compromise with the growth aspects of our economy. Once we turn healthy, we are sure going to grow again. We need not worry too much about the growth at this point in time, at least.
Bottom line is that as long as the maturing debts get renewed, there is no other ill-effect on the economy other than a lack of growth. What so wrong with that picture?
Monday, January 26, 2009
Importance of Asset Allocation & Alternative Assets
In the investment world, 90% of the returns are determined by the asset allocation and remaining 10% returns are determined by the security selection. There are five major asset classes outside of cash: stocks, bonds, real estate, commodities and alternative assets. These asset classes can further be broken down into various subcategories such as domestic versus international (stocks and bonds both), growth versus value (stocks), large cap, mid cap and small cap (stocks), government, corporate and high yield (bonds), etc.
The key to successful investing is the asset allocation and one cannot emphasize enough on its importance to provide relatively steady returns. It is basically about creating an all-weather portfolio. It is designed in such a way that some of the parts of the portfolio out-perform while other parts under-perform. As a result, the overall portfolio provides steady and respectable returns for any given year with minimal amount of standard deviation. The key here is to minimize this standard deviation in returns of a portfolio.
It is a well accepted doctrine in the investment world that says one should have 10% to 20% of their assets in the alternative asset class including real estate and commodities categories aside from usual stocks, bonds and cash. One of the brightest investment minds, Mohamed El-Erian, even suggests putting one third of the portfolio in this asset class. In today's uncertain investment environment, one needs to take a hard look at the overall asset allocation and investments that can be a bastion or a source of visibility, stability and consistency.
The alternative asset class (also known as hedge funds or private funds) strives to provide absolute returns, i.e. positive returns, regardless of market's performance. Further, this alternative asset class is generally meant for high net-worth or ultra-wealthy investors only and it has gotten it's more than fair share of fame as well as blame. The alternative asset class is essentially a pay-for-performance industry, where fund managers can make good or even obscene amount of money (Richard Gere uses a phrase "obscene amount of money" in a film "Pretty Woman".)
Smart and talented money managers capable of delivering as well as me-too types of managers flock to this industry as they are highly motivated by its generous incentive structure. For example, a hedge fund manager, John Paulson (no not that Paulson), amid this world falling apart, made billions for him and his investors during 2007-2008 period.
The key to successful investing is the asset allocation and one cannot emphasize enough on its importance to provide relatively steady returns. It is basically about creating an all-weather portfolio. It is designed in such a way that some of the parts of the portfolio out-perform while other parts under-perform. As a result, the overall portfolio provides steady and respectable returns for any given year with minimal amount of standard deviation. The key here is to minimize this standard deviation in returns of a portfolio.
It is a well accepted doctrine in the investment world that says one should have 10% to 20% of their assets in the alternative asset class including real estate and commodities categories aside from usual stocks, bonds and cash. One of the brightest investment minds, Mohamed El-Erian, even suggests putting one third of the portfolio in this asset class. In today's uncertain investment environment, one needs to take a hard look at the overall asset allocation and investments that can be a bastion or a source of visibility, stability and consistency.
The alternative asset class (also known as hedge funds or private funds) strives to provide absolute returns, i.e. positive returns, regardless of market's performance. Further, this alternative asset class is generally meant for high net-worth or ultra-wealthy investors only and it has gotten it's more than fair share of fame as well as blame. The alternative asset class is essentially a pay-for-performance industry, where fund managers can make good or even obscene amount of money (Richard Gere uses a phrase "obscene amount of money" in a film "Pretty Woman".)
Smart and talented money managers capable of delivering as well as me-too types of managers flock to this industry as they are highly motivated by its generous incentive structure. For example, a hedge fund manager, John Paulson (no not that Paulson), amid this world falling apart, made billions for him and his investors during 2007-2008 period.
Tuesday, January 13, 2009
Equity Market for Next 10 Years
One question on everyone’s mind is how the equities are going to perform for the next 10 years. We just had a “lost decade” ending into 2008. It is only fair to wonder about how it would do going forward. As a matter of fact, just today, my friend’s wife asked me, should she keep everything in cash or continue doing dollar cost averaging as she is quite concerned about the stock market. While historically, equity markets have delivered returns in high single digits including dividends over the last century, there is no certainty that every decade is going to deliver that kind of an average return. Some decades such as 80s and 90s did dramatically well, where as there have been two instances in last century where the stock markets barely budged for 25 years period. That is right; 25 years period.
What juncture are we at now? There are two things near certain. We probably would not see the unprecedented despair and a massacre that we saw in last few months of 2008 again, regardless of how much economy gets bad or how much government, for their fair share, screws things up. That was a wholesale treatment, an obvious shutdown or a freeze-up of credit markets and equity markets in a free-fall, literally. That is unlikely to repeat; extremely small chance of that happening again. Does it mean that going forward is a smooth ride? Not even by a long shot. It will continue to stay rough and may very well get even more painful, however, it is going to be a slow motion movie as opposed to the shock treatment to a mental patient.
The other thing is the next decade seems to bring little more hope than the last one. I am not surprised to see a lost decade that we just had as I did envision that in 2000-2002 time period like many other bears. Had you asked me a question back then, I would have easily said that it does not bring a lot of hope. I am also not surprised by the magnitude of it. While I was one of the minorities to see the train wreck coming, what I have been surprised along with several others who even foresaw this coming is the velocity of that train. A sheer intensity of the storm that gasped everything is what surprised everyone. I in fact imagined a slow motion movie unraveling the ugliness of all of the excesses of the past 25 years.
Next decade could be a continuation of the last decade, however, I doubt it, given the fact that the valuations, though not super-cheap, are below historical average. The downside risk still remains at further 30% due to dire effects of de-leveraging and broken balance sheets of all constituents: households, businesses and governments. Whether the protracted downturn materializes in one, three or five years is anyone’s guess. A lot is going to depend on the actions of U.S. Government and Federal Reserve. While I am optimistic in their actions, unfortunately, I do not have a lot of hope there. This means that we may be in it for a rough ride. However, chances of hitting high single digit returns during the next 10 years are better than 50-50.
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