Sunday, March 29, 2020

Survival of Financial Capitalism

When I wrote my earlier article last week, the US Fed funds rate was 1% and I accurately predicted they are going to 0 sooner than we think. Even I didn't expect that to happen within the next 6 hours. The Fed jumped in and reduced the rates to zero in one go (Hasn't happened in history) and relaunched QE. Not only that - 1.5 trillion stimulus program and a daily 1 trillion repo. The stock market completely ignored this. In fact the fall in that week was the biggest fall for a week since 2008 - when the financial crisis was at its peak. It managed to recover more than 20% this week.

The COVID-19 pandemic is sweeping the world big-time. Human tragedy is beyond the definition of sadness. The threat from COVID-19 really looks like a lifetime event for many of us. Natural calamities like these are unavoidable as nature dictates them. Looking at the economical angle - it looks lot bleaker.We will focus on the economic aspects alone here.

The world economy was so vulnerable in the build up to this crisis, it just happened to be the coronavirus that exposed the underlying mal-investments of the last decade. 

The layoffs have started in the US. The initial job less claims was more than 3.2 million. The All time high of that number is 660,000. The million number - is unheard of in history. Once the pandemic fear recedes, these jobs will definitely return but not all of them would. That is the worry. The GDP is also set to contract because of the virus. There are dire predictions floating around like negative 24%. We just have to wait as it unfolds. Singapore initial estimates on first quarter GDP is a negative 10% which is little more than what was witnessed during the financial crisis of 08.

The world has seen this many times - public property being privatized and private property being nationalized. This happens when existing economic models get transitioned. Mikhail Gorbachev in 1984, privatized what were government managed industries for decades. Private player rushed to buy it. However It did not stop the collapse of the Soviet Union. It was just a transition from one form of economic model that was failing to an alternative model which is perceived to be "working". Bottom line - It is just a transition from one form of society to another form of society because of the obvious signs of lack of productivity in existing human labor. What is happening in the US today of nationalization of loss-making private entities, is no different from what Gorbachev did in 1984 for USSR except that it is exact reversal.

Many things were common
  1. Heavily indebted Federal government
  2. Decreased labor productivity - service sector industry focused economic model finally ran out of steam, proved by the fact that more women in labor force than men and a LOT of part-time jobs and not enough full time jobs
  3. Majority of the population with no savings
  4. Lack of confidence in government entities 
When the Soviet union failed economically in the 80s and 90s, it had a warhead of 10,000 nuclear arsenal. Always a proof that military might is not a replacement for mass labor productivity of the country.

The US government does not want the stock market to go down. It is well aware, if the stock market goes down, private companies would fail. With all the pension funds, global investment money into the US market - it will send all the fund values spiraling down. This will lead to mass exit of capital from the US market. Ben Bernanke very famously told during the 2008 economic crisis - the reason for ZIRP and QEs was to create the "wealth effect". When the markets go down in confidence and sells off - this wealth effect is lost causing a downward spiral.

The truth is no matter what they do, they cannot alter the trend of the market in anyway. If it goes higher - they can make it go little over., if it goes lower - they can slow it down. That is all they can do. Trend cannot be reversed.

The last thing that is holding the US economy together is the VALUE of the US dollar. The dollar index (DXY) is floating around the 100 mark. It was around the 95 handle just couple of weeks ago. The sell-off in the market has triggered a liquidation, and there is a natural need for the dollar as most financials are denominated in dollars. With the "Cash is King" mentality setting in, that money is going to look for alternative investments. If the US stock market continues to go down - the cash will not go there. With the Covid-19 situation getting worse by the day across the globe including the US, the cash is not going into risky assets. Eventually it needs to chase an investment - this could possibly be gold. When that ride happens - it would signal the demise of the dollar. When dollar loses confidence and goes to say the 70 handle (we were there in 2011 post financial crisis) - we are going to see a sea change in the movement of big money across the globe. With the currency risk not hedged by investment from Europe, Japan and Asian investment firms in the last decade there is going to be serious losses for them as their local currency gain value against the dollar. For example, Switzerland Sovereign fund is one of the top 10 investors in apple shares. Apple shares have tanked 25% in the last month. The fund has gone down by a quarter. If the dollar falls and the local currency (Swiss Francs) appreciates against dollar, the loss accelerates because of the currency exchange. With a stable or appreciating dollar the investment is better off and it is beneficial. But the fund cannot withstand a dollar depreciation scenario. Ideally huge investment funds, hedge their investment against currency risks, but the last decade of easy money policy has left them too complacent to follow it. When these loses happening, the global rush outside of the dollar will happen causing more problems for the US markets.

Even though the political establishments can blame the coronavirus for the current state., people who were aware of the bad economic policies of the past decade can easily see, that the virus is just a trigger. The Covid-19 situation will be gone 4-5 months from now. We are seeing Wuhan already returning to normal. As the virus situation recedes what is left is - the huge debt and the economy in its terminal state. The 1.2 Trillion stimulus programs will try to keep the economy afloat, but what happens if they don't work. Inflation will go beyond 3%. Once that is consistently higher, the existing bonds that yield less than 3% are going to be clobbered. Fed will buy it to create a market - but it won't work.

The rest of the world particularly the Asian economies will recover sooner as they are in a better place than the US.

Merely printing money for economic boom never works. If that was the case - every country in the world that can print its own money and can avoid economic set backs. US dollar being a global currency does not give the nation a right to print their way out. Money is just a medium of exchange for productive goods and productive labor. Without the underlying productive entity - the money itself is of no use. Sending $1200 check to all its citizens cannot work. At the peak of the financial crisis, Bush sent these stimulus checks. That did not stop the collapse of Lehman Brothers in September of 08 and the subsequent financial crisis. Similarly this check would also vanish in memory. Believe me - every country wants to send its citizen a check, but there is a small problem with that - no country can afford that.

US government is the biggest debtor in the history of this world. It's plan to bail out other smaller players would have worked in 2008., and will not work this time. The bottom might come out of the US dollar causing general currency issues. With all fiat money in play - all currencies of the world will lose confidence. We are going back to the gold standard.

Lenin very famously told - The best way to destroy the capitalist system is to debauch the currency. The capitalistic west will eventually realize that and it just might be too late. 

Sunday, March 15, 2020

The start of the end

In February all US stock market indexes were at an all time high. The time was right for President Trump to go to Congress for the State of the Union speech and declare victory over the economy. He would once again justify how awesome the economy is and why the prosperity of the people in the last three years of his Presidency was the best ever in US History. He glorified the rise of the stock market and took full credit for it. Little did he knew then, that the very market he glorified will tank into the bear market in record time. In fact, all indexes hit the bear market territory in the first two weeks of March. Market going to bear market was nothing new but the pace at which it got down from the peak into the bear market is unprecedented. The fear of Coronavirus (Covid-19) becoming a pandemic and dangerously spreading across the world swiftly, triggered the collapse of the markets.

As of today 15-March, We are seeing wide swings on daily trading swinging between + or - 4% on any day. In the process we have almost 10% down and up days within a week. The major indexes haven't seen this kind of swings unless you want to go back to the 1929 era of the great depression.

President Trump's reelection is almost 100% dependent on a good economy in build up to the elections in November. If the economy is in recession, it is almost certain that he will end up as one-term President. To avoid that - Trump would be ready to do extreme intermediate steps to postpone the crisis. The mere idea of payroll tax cut or a tax holiday is a direct reflection of that.

The US Federal reserve has kept the economy on cheap money post financial crisis of 2008, and it never managed to get back to normal interest rate in the last 12 years. They couldn't do it, because they were well aware doing that would cause a recession. Chairman Powell however did manage to get to 2.5% mark - almost half of historic average. Once the late rate rise was too much for the economy to manage, he had to pull it back to 1.5%. As stocks began to tank in the first week of March, the yield on the longer term treasuries began to tank. As the 10-year was dangling around the less than 1% mark, he really didn't have a choice but to make a unplanned 50 bps of emergency cut and bring the Fed funds rate to 1%. What scared chairman Powell the most was there were 7 days market freeze for the investment grade corporate bond. There were no buyers and hence no sellers. Within a week, the yield has further dropped down to 0.3% and back up to the 1% mark. The bond market is still pricing in a 50 bps points on the March 18th Fed meeting. They will cut it further I think. Sooner than we think, they are going back to zero percent. As stocks tanked the bond market crated with yields rising for non-government bonds. The spread looks lot scarier. The Fed has also promised to jump in to buy everything with its $1.5 Trillion QE program announced last week. The TARP in 2008 was $700 billion and it was very famously rejected by Congress initially. The bailout fund this week is almost double of that. This essentially is an admission that the problems are bigger than 2008. What is really interesting is - Can the Fed play its card this time. The last time it worked was because - Bernanke, the Fed Chairman then told Congress - the QE was not debt monetization but was TEMPORARY. But from past experience the QE programs always is repeating and every program dwarfs any previous programs in dollar value. The recent announcement of $1.5 Trillion QE programs is all previous QE program combined in dollar terms. They plan to bail out every industry possible. What needs to be observed is - the dollars don't make business viable but the productivity of the labor makes a business useful, viable and hence profitable.

President Trump is unleashing a "Bailout nation" in the guise of National Emergency because of the Covid-19 pandemic. The bond market went up in smoke last week. Trump really didn't have a choice. He had to come and put a floor to the fall. With fiat currency system in place, these government bond yields don't make sense. In fact these government papers trading at the lower yield is not an issue. The pressing issue is the opposite trade. The yield on the junk bonds are rising more than the fall in the US treasuries. That is the worrying part. The corporate bond market is so leveraged that it cannot handle rising rates. Corporate bonds that have junk status and have ratings just above junk are doomed to fail big time. With this trade "We will buy anything out there in the bond market" is the Fed's new rhetoric. They will go on to say, that it is temporary and they will sell it out during the good time. They couldn't do it fully last time, they will never be able to do it next time as well. Will the market buy it, is the $1.5Trillion question.

In the build up to the 2008 financial crisis - falling house prices was the pin that pricked the debt bubble. The bursting of the bubble exposed the over-leveraged debt market primarily mortgage debt. The mortgage debt market exploded initially in the subprime sector and then it spread to the entire mortgage market. The financial companies - that were part of the industry got burnt first like countrywide and then it spread to Fanie mae and Freddie mac - the quasi government enterprises., finally targeting the banking hierarchy from local & regional banks to international banks like Citi. This will solved by government bailouts to the financial sector.

The bailouts from the last great recession and the subsequent building up of national, corporate and household debt has created a far bigger crisis now than in 2008.

The plot that is playing now, is the Coronavirus is the pin that pricked the debt market, which is many fold bigger than what it was in 2008. First it would hit the easy targets and then finally the full scope of the economy. People ask that FANG stocks are doing ok, in spite of the big market correction. My answer to them is - first the soldiers get killed and then the generals. They are all highly leveraged and substantially over-valued. They will go down significantly as well.

The irrational exuberance on steroids of the last decade finally seems to have started to end.

What to look for? What will confirm this? Looks at the weekly jobless claims numbers. It has to go beyond the 255K number. The jobs number for April and May are getting important. With the economic activity almost coming to a standstill on the fear of contracting the virus., that number should go up. If you seen the job reports numbers from the last 10 years, bulk of the jobs were created in the hospital and leisure sector of the economy. With this sector annihilated - there should be thousands and thousands of job losses. With US job market dominated by women workforce (non-labor intensive) that men, the jobs would disappear sooner.

Bailouts would work, if a part of the economy is struggling and the other part is doing good. With the entire stand-still happening, bailouts won't work. Open ended bailout commitment is a sign of weakness and not strength. Moreover the US government is the biggest debtor in the planet. It offering to bailout other smaller debtors just insults rational intelligence.

Sunday, February 23, 2020

Reality check 2020

The 30-year Treasury yield this week dropped to its all-time low of 1.89%. The Bond market is sounding alarm bells of a recession. Turns out investors are Ok to settle for 1.89% on their investment for the next 30 years. This is in-spite of the government annual inflation number being 2.3%. What this essentially means is - the investor who buys the 30-year and decides to hold it for next 30 years is guaranteed to lose money. In bonds the price and the yields move in opposite direction. So the lucrative offer is yields fall further and the price of the bonds surge more and then our investor can dump the 1.89% yielding Treasury to a new investor. One day or the other, you really run of fools. Because of government mandating banks to buy the long-term securities as investments - this forced buying creates a market. But with exploding US debt - again at historic highs, there is never short of these papers in future. US Government has already borrowed close to $23T and there is no sign from Washington DC that the spending is going to slow anytime soon. President Trump doesn't give any importance to national debt and so are the democratic nominees who will challenge him in November. We are in a phase historically where this is a complacent notion - Debts doesn't matter. Greece's debt didn't matter until they mattered. The debt market is a lender's market. Under consumption creates savings. Savings create lenders. Buyers would always be there. The existence of lenders is a pre-requisite for a debt market.

Banks buy Treasury as long term securities. They are mandated to do that. Without the mandatory rule to buy it, there is no natural want for it. Foreigners are also piling into the US treasuries. They are looking for yields outside their currencies. With interest rate either being zero or less, the 1.89% is more lucrative to say a Japanese investor or a European investor. Unlike before, these trading are happening without a hedge and poses a dangerous pattern. With their local currency (Yen or Euro) gaining against the Dollar will wipe out this thin wafer of < 2% interest and this essentially has become a necessary requisite for the boom to continue.

Switzerland Sovereign being amongst the top 10 investors in Apple is the same story but they choose the more risky route in Stocks.

The Fed has been buying short term securities from the overnight repo market. There are 2 things that are distinctly noticeable here. First, the Fed does not want to call these purchases QE. It continues to maintain a stand that these purchases do not amount to a QE program where they bought long-term bonds for $85B every month, Secondly they are unable to hide the balance sheet accumulation of nearly $500B since September of 2019. This is the same effect as the previous three QE programs except that the accumulation is without any upper limit. Any QE(n) program needs more money than QE(n-1) - this has always been the case. It is no different this time and hence it QE for sure. Banks like JP Morgan and Bank of NY Mellon - who have tremendous advantage being primary brokers benefit disproportionately from these overnight repos. They peddle money for the Fed basically, and it shouldn't be a surprise that JP Morgan reported its best ever profit during this time.

With all indexes - Dow, S&P and Nasdaq all hitting all time highs everyday, the stock market keeps going higher and higher. Just as trees do not grow to the sky., this will have to stop at some point.
Tesla stocks vaulting to $900 is the new mania around. It is the heavily shorted stock in American history. The excess flow of liquidity is chasing these speculative stocks. It has not only overtaken the market share of a car-major  like Volkswagen in a few trading days, but is in a striking distance from going ahead of Toyoto. Usually when bubbles are at its peak., we see mania companies going this way signaling its climax. Tesla story really looks one. The tech IPOs drying up is also notable after the weWork fiasco. From $90B valuation to being bailed out by its bigger investor just within few weeks. Even in 2000 bubble, the dotcoms failed first and the Nasdaq crashing was after a while. With Nasdaq about to hit the 10K mark - it looks it has ran out of steam.

The rise in price of gold this year is more than 8%. It is probably the best performing asset class of 2020. Gold has hit an all-time high against pretty much every currency except for the US dollar. An ounce of gold is at $1662 which is almost $300 less than its all time peak. The recent surge of gold may not be surprising for some people like me, but the surge of the DXY along with it to 100 is very interesting. Usually they trade opposite to each other because gold is traded in US dollars and they tend to go in opposite directions. One has to finally cave in. The Argument to gold is - if it can rise at this pace with the dollar getting strong., it should rise a lot faster on a sliding dollar which may happen soon. So looks gold finally is coming out as inflation hedge.

Coronavirus is still in its early stages and its impact may be longer and harder looks like. Car sales in China has plunged by 92% since the new year. This looks a pandemic that might have economic impact. As of now, even though it looks serious enough., to me I think, that market has used this reason to rectify an over-bought, genuine sell-off. Coronavirus looks very nastier than initially thought. It definitely can put China's economic order out of place temporarily and this obviously will have an impact on the rest of the world.

It is very possible that the US fed might intervene and reduce rates citing Coronavirus. When that happens, we will all know that the Fed has not only economic cures but also medical cures. Let's wait and see on this. It is possible that the Fed may reduce rates and keep inflating the bubble. Whether investors will buy it this time also is a serious doubt.

The US market has not priced in anything yet, on a Bernie Sanders Presidency which increasing looks very possible. Republicans who think Sanders is the easiest democratic candidate to beat for Trump should be really cautious what they wish for. This is exactly what the democrats thought of Trump in 2016 and we all know what happen after that. Bernie has been a life long socialist. If he wins, it would be an admission that 29 years since the collapse of the Soviet Union in December of 1991, finally Socialism has made it to the shores of the United State of America. Bernie is not hiding the fact that he is a socialist. He has been a socialist all his life and is on record all his life saying He doesn't believe in capitalism and believes in cooperation instead. If Bernie's appeal resonates with ordinary US citizens and they vote for him, it should be admission of failing capitalism in the US. Unlike candidates who promise socialism and govern from the center., Bernie is very different I suspect. He will govern from the left. Any democratic system leads to a socialistic society eventually. This is because there are more employees who vote that employers. That is one reason, the US constitution notably doesn't have a word called democracy. It was founded as an republic. Somewhere in the last half-a-century, the democratic political system in the US has lead to socialistic leaders. 

An economic slowdown is long overdue in the US. Market is just looking for an excuse to sell. The excuses can be - Coronavirus impact in China and rest of the world, Dollar index sliding by 10-20% on sign of a US slow down, Opinion polls that indicate Trump losing Presidency in November of 2020, Earnings shock and bursting of the junk bond/corporate bond market. One of them might happen sooner than you think. There is no rule they don't happen all at the same time.

Tuesday, June 25, 2019

The Fed trap

The Fed stepped-in to assure the market this week by saying, it will do what it takes to support the present economic expansion. It looks pretty much a July cut is on the horizon and more likely more cuts this year and again next year. Markets exactly wanted to hear that, and started rallying. The S&P hit an all- time high the same day. What is different this time is, in the past - when the S&P and the broader indexes hit historic highs, the Fed would increase the interest rate to cool down the economy. On contrary - the Fed is promising to decrease it, to keep the economic expansion going. Ever expanding expansion of the economy ie., prolong current boom. Particularly with the way the world economy operates these days where there is constant boom and bust cycle - it is a given that the boom market will always lead to a proportional bust market. If we go with that theory - the longest ever bull market that we are in, should definitely create a longest bear market. The longest bear market can only be preceded by a crisis scenario.

The US stock market is roughly 140% of GDP. Historically, it has always been 30-60%. The great crash of 1987 - often referred to as black Monday, stocks crashed 20% on a single day. Even though the crash wiped out the share value by a fifth, it did not affect the real economy in a big way, because the stock market merely reflected less than 30% of GDP. After easy money for more than 10 years, we have an economy were asset prices are GDP. Financial assets are biggest chunk of it. Any stock market correction, is deemed to reflect an economic correction. The fed has the numbers and knows it. Fed Chairman Powell really got a first glimpse of the economic scare in the last quarter of 2018. There were no takers of the junk market bonds for 41 days, after the Fed insisted on its policy of auto-pilot. The economy was spilling over, with all indexes (dow, nasdaq, s&p and russel 2000) all going down 20% essentially starting the bear market. Once Powell raised the rates in December, it was the last rate hike of the cycle.

The last time, the Fed promised to cut interest rate (after a series of rate hikes) was in 2007. The funds rate at that time was little more than 5%. The Fed had the luxury of reducing the interest rate by 500 basis points to provide a boost to the economy - and still could not avoid a financial crisis in 2008. The Fed brought the interest rate to 0% in 2008. Even that wasn't sufficient to recover the economy from its historic slump. The Fed introduced QE not once but thrice in the next four years. What is interesting is - every QE-n was bigger that its QE-(n-1). From what has happened with those monetary experiments - we can clearly derive that with the current rate of 2.25-2.5% of Fed funds rate, the Fed doesn’t have enough room like last time. It only has just half the ammunition. Going to zero alone is not sufficient. QE has to come sooner rather than later. Also - the economy should have its head above water during this whole period. Any lapse in liquidity or promise to liquidity will choke the economy. It’s a really tricky spot to be in, for Fed chairman Powell. He just can't afford a mis-step. A slowdown will expose all the mal-investments of the last decade., fueled by the fed itself.

As I have already mentioned in my earlier blogs, Ben Bernanke and Janet Yellen are primarily responsible for having persisted with easy money policy for too long. When testifying to the Congress when introducing the US economy to QE., the then Fed chairman Ben Bernanke told the congress that he is not monetizing the debt. He told QE and ZIRP are temporary. Balance sheet accumulation is temporary. Also promised that as economy starts to recover, he will somehow wind down the 4 trillion debt and restore it to its pre-crisis levels. None of them are true. The Fed's balance sheet is just below 3.85 trillion and with fed about to reduce the interest rates, we can safely assume that the debt on fed's balance sheet is not going to go lower than that. Ben Bernanke initiated the mess, Janet Yellen continued with that mess, and it fell on Powell to do the clean-up act, which was way overdue and impossible. Just say the Fed doesn't raise interest rates in July as expected by the market - the stocks are going to plunge. In fact the market wants a 50 bps cut rather than the usual 25 bps. The market is holding a knife at the Fed's throat.

On the political side, President Trump cannot afford is allow the recession to set in. It affects his reelection campaign of 2020 and in general the scope of the economy. No one knows that better than President Trump. As candidate Trump in 2015 he told correctly that the whole economy is one big fat ugly bubble based on ZIRP and QE.  He promised to act on the rising US trade deficit with all its trading partners and is taking some action on it (which may or may not be right). Candidate Trump also acknowledged that the shrinking of the work force participation percentage which has dropped significantly since the financial crisis of 2008. The government released unemployment rate doesn't capture this variant and its published to be lower than what it actually is. Trump during his campaign repeated multiple times, that the real unemployment rate is lot higher than what is officially reported and he even says it is as high as 20% or more. He was so right on that and it resonated with the US electorate. After coming to office though, Trump began to endorse the very same bubble economy as economic prosperity and even took credit for doing it. In fact - He calls it the Best economy in the history of the United States. The numbers do not support it whatsoever.  Because he owned the boom, unfortunately he will have to own the bust too.

The 10-year treasury yield which is used as reference rate for many long-term bonds, notably the US mortgage rates is trading at 2%. The Bond market is right - they are predicting that a 2% interest on a 10-year bond is more lucrative than the annual percentage growth that is going to happen in the next decade. But what it doesn't price in - is the inflation effect. The inflation rate is hitting the 2% level already. It will most likely make its ascend north. The Fed has already indicated that the inflation effect is "transitory of 2%" - which translates to - the inflation is going beyond the 2% mark very soon. With that happening around the corner, there is absolutely no reason for the longer term securities to have a coupon rate of less than that. In general - the longer dated treasury's interest rate are heading higher. It started to happen in last quarter of 2018 and that is where the stock market panicked. Any interest rate hike on long term bonds directly affects the leverage on corporate borrowing. With rising interest rates - rolling over existing debt is not an option anymore and the earnings will have to go down.

The slowing US economy usually takes the dollar with it. The dollar index has broken key levels since the Fed's meeting and is drifting downwards. Gold on the other hand, is breaking the $1400 an ounce and marching higher. To retrace its historic high, it needs to go to $1930 an ounce. It is definitely going there. It has made the price of gold for Asian economies higher. For example, In Indian currency, with the current exchange rate tied to the dollar index, the price of gold has already hit a historic high of Rs. 3580/- for a gram of gold. If we project it proportionally, if the price of gold hits the $1930 dollar mark, the corresponding rupee price for a gram of gold is Rs. 5000/-. This is politically not acceptable and panic would set in for a gold-rush or mania in the Indian gold market. So the only way to avoid this is to allow the Indian Rupee to appreciate against the falling dollar. It is possible then that the price of Indian rupee can move from its current Rs. 70/- rupee mark to say something around Rs. 50/-. That would be logical. The other asset class that is responding better to a falling dollar is bitcoin. As it stands now, it is already over 11K. When bitcoin as an asset class loses confidence and investors are jumping out, the trade is going to the traditional safe haven asset like gold, which is only going to accelerate the price higher in dollar terms.

In the month of May, the US government spent more than any month in its history. The debt accumulated every month is astronomical and has no historical precinct. The debt accumulated in 2018 (budget deficit and unfunded liabilities) is more than the nominal GDP (GDP not adjusted to inflation). This means that, if hadn’t for the rise in national debt (zero borrowing),  US economic expansion would have recorded a negative growth for the year.

If it can go wrong, it will. When it does, it will do so in spectacular fashion: breathtaking collapses, ghastly whitewashes and complete annihilation of confidence. Even though it was always on the cards, it appears more imminent that ever before. As Peter Schiff rightly puts it - Having the economy on ZIRP and QE are addictive in nature. Even though it feels good, they cause more harm than good. Withdrawal symptoms after heavy addiction are always painful. A recession is the absolute cure. Re-introducing ZIRP and QE again to make it work, may not work anymore!

Sunday, May 12, 2019

Tech bubble 2.0 and the IPO Pins

I use the ride-hailing apps frequently. I pay them every time I close the meter. It is nominally priced and the driver also gets a significant profit too, for every ride. It is a win-win composition for both. It is very hard to imagine an awesome business idea like Uber cannot generate a profit so far in its multiple years of existence. It is also sad that a revenue generation model of ride-hailing apps, where every customer pays before getting off a ride - can be this screwed up. If you don't own any of the cars and any of the drivers - but just a mobile app that facilitate business between the demand and supply of a always waiting customer and a person with a car - Its just mediocre company performance. on any standards 

Before Uber hit the IPO this week, it was Lyft that hit the IPO market couple of months ago. It debut around the $78 mark and is now trading around $50 a share. Lyft lost $900 million dollars last year. The last earnings it reported after going public is yet another historic loss. Uber which wanted to hit the IPO with $120 billion valuation - started to see the week reception for Lyft and decided to rush to the market itself soon. The valuation went down every week and finally when the time came - it was $82 billion valuation. It was lot below the initial estimates. If they waited longer, the valuation of the company would go down even more and possibly the door would be shut completely even, if it decides to wait. Uber loses more money than lyft - they say its $900 million a quarter. Uber hit the IPO market at $45 and immediately traded down below $3. This really means the investor who bought it at the IPO were stung by public investors who got it for less. How Uber stocks performs needs to be watched.

When you buy a stock of the company, you are buying into the future revenue stream of the company. These new tech companies, in their IPO disclosure have explicitly mentioned that they may never be profitable. Pre-IPO investors have an exit strategy in the IPO usually. Founders and initial investors cash-in on the incoming public investors'  money. Why would anyone buy a share of a company that doesn't foresee a profit is beyond human rationalism. Only incentive is the demand for the share amongst the public - the belief that you can sell it to a bigger fool. As it turns-out - one day or the other, you run out of fools and then realize your were the last fool. 

Microsoft, Google and Facebook - other biggies went into the IPO market when they were profitable. However Amazon did not disclose a profit even after six years after going public. All these new tech companies planning its life as publicly traded entities - want their luck to work out similar to Amazon. They may not be as lucky. 

This is tech bubble 2.0

Paul Krugman, Nobel Laureate and Keynesian economist who has been strong advocate of Barack Obama's easy money economic policy and the Fed's approach with ZIRP and QEs after the 2008 financial crisis even admits there is a tech-bubble in silicon valley. The last time it happened in the late 90s, we all know it didn't end well. Investors lost money investing in new dotcom companies, that not only did not have profits, but did not even have sales. Many companies who went to IPOs lost all their money eventually and went out of business.

The recent tech-boom in the industry promises to be no different. We have the same set of companies coming to the IPO market with tall promises for the future but never made a profit in the company's lifetime so far. Pintrest IPO debuted this week. The company has been around for ten years. Never once, it made a profit. Talking about PINS (its stock ticker) - that breaks bubbles, it could very well be one.

If well-known companies like Uber, Lyft can fail miserably in their IPO debut, what is the motivation for other tech-startups that came into existence in the last few years? What is the mind set of the investors who are already behind those ventures? If I was an investor who has invested in multiple start-ups and see productive business model companies like Uber hit the dust in the IPO market - I will be really scared. I would like to exit my current investments and book my returns before things come biting. When all the investors rush to the exit - the whole start-up mania would starve for the funds. One thing we know very well in bust times is - when it goes bad, it goes horribly bad for everyone. If these highly hyped IPOs fail, it might act as a trigger for a genuinely anticipated slow-down that is already long overdue.

The bursting of the tech bubble will definitely be contagious. It will make the other asset bubbles burst including the housing, bonds (both sovereign and corporate). The corporate bubble in particular is almost 3 times what subprime was in 2008. A recession or slow-down would put the US economy into a long period of economic darkness. Trump and the Fed will do everything they possibly can, to avoid it until the markets hit a point - where whatever they do isn't relevant anymore. At the point, the public would know that the reality has finally set-in to the markets. 

Tuesday, March 26, 2019

NaMo - Wrong person in the wrong party

India would be performing socially, politically, economically and humanely far better without the current set of rulers.

Generally in the recent years, India as a country is so divided. The credit goes to the current government of India. In this fast changing world of Social media, sensation is the new child on the block. A person who can sensationalize certain political happenings grab attention of the people. They gain publicity out of the act. In the ever competitive world of political leaders - every one is trying weird things which they might not do at the personal front.

Mahatma Gandhi very famously told - India lives in its villages. Even seventy years after Independence, it is very toweringly true. Instead of making a difference on the ground in villages - the ruling establishments are taming the people through the media. With every passing day - there is huge one-page Ads on every newspaper highlighting the so called achievements of Narendra Modi. On the ground here - nothing has changed. The political class has only become more crooked and selfish. Publicity as a policy strategy is bad. Ideal way - the schemes and programs of the government percolate enough into the lives of people and there is a natural inclination of masses. This appreciation leads to accumulation of votes during elections. It has reached a point where controlling all sections of the media and constantly propagating a narrative will get them votes. Whether to see if it works remains to be seen in this election.

The political topics that are being discussed in the so called mainstream media is mostly about trivial items. Real issues like lack of infrastructure (electricity, water, roads) and corruption still being daily problems for common man., they do not get prominently debated and solutions sought.  In fact lynching a man for beef-eating or attacking a Kashmiri shop owner in streets of UP is the news of the day. It is a law and order issue. Both the state and the central government are responsible to save the lives of all its citizens. No one can disagree with it. But the twist is - the people who are responsible to deal with this - would comply with the crime. First they speak for it or tacitly support it. A prominent person from the ruling party would pass unjustifiable (often not legal) opinions on them. This creates a sensation and division of the society. There is this new set of population that rebels against the mainstream thought and take a relative radical stand. This fuels discussion on social media and in live television for the day. The rulers get some publicity for their deviance from established norm. New comers to politics tend to navigate this way to make an accent on the political ladder in their party. Ideally people in saffron dresses need to be liked upon and trustable by every other living life. But nowadays, you see people in saffron behaving violently and having a sharp tongue particularly against people of other faith and vulnerable sections of the society.

Not a single day goes by, with the PM Narendra Modi blaming the previous Congress governments for everything that is bad in the country. He even blames Nehru. It is ok, if you do that for a year or two when you have a full majority government. If you do it in your 5th year - you are just being non-performing.The performance of the government is not up to the mark in general. The publicity is to cover them all. If there is real performance - there wouldn't be a real need for publicity. The ruling establishment believes they could manipulate the signals and get away, without underlying actions.

Narendra Modi as PM will be remembered for a long time for demonetization - making 85% of high denomination currency notes invalid overnight. The justification provided for that was to eliminate black money and punish the corrupt hoarders. At that time - it sounded logical and timely. Later on - it would turn out that most of the printed money where returned back to the RBI and it didn't make a big impact. To be clear - it was a bold step and the intention cannot be questioned. I believe it was done with right intentions. Where it miserably failed was - not being able to capitalize on that. The PM should have stick to lower denominations only. Now we have more 2000 rupee note in the market which didn't exist before the demonetization. There is more currency in circulation now than prior to demonetization. It would have been awesome chance to restrict the ATM withdrawal to 10K only. (No one stops you from going to a bank and withdrawing anything more than that). This would have put severe restrictions on cash operations. The big failure of demonetization by the BJP government - was not allowing that "crisis" to benefit the people in the "subsequent years".

The current government prides itself in calling Narendra Modi, a powerful Prime minister. If this was really the case - the GST would have been just a one tier structure say 8-10%, leaving all complexities out. A right move would have been to have a "NO GST" and "With GST of 10%" - that's it. Trying to have multiple tiers and adding few/removing few over these years was a reflection of poor implementations. A clean, simple procedure would have definitely helped in the roll out, and the PM could not even enforce that. With global oil prices being down for almost all the five years, the government coffers were very lavish to take bold financial measures. The public perception has changed from the "Government has no money" to "Government has all the money" and just couldn't do anything meaningful.

The PM should also be pinned down for the failure to change the system significantly on any domain that relates to common man. That is why they are not able to say - the next five years would be as glorious as the last five years. None of what they did has not affected the common man positively and more importantly significantly. A bold PM would have automated the grievance address system on Law and Order in the country by now. India would have a 911-equivalent phone number to call anything that is related to Law and Order / Police calls. Those would have made enormous difference to ordinary people's life. With almost everyone having access to a cell phone, all would have felt - they are just one phone call away to safety in case of a threat or an emergency.

The current government has been seriously undermining various institutions in the country like the RBI, Judiciary, CBI - the investigative agency and Election commission. The RBI governor resigned before his term could end because of too much political pressure from the PMO and its appointment of its own people as members of the board. The recent fight between the top brass of the CBI was pretty wide open. It is obvious the PMO put their people in the investigative agency and used them to target political opponents. There is always a CBI raid on the opposition, and some sensation news related to it. CBI raids on relatives of EPS, the Tamil Nadu CM was done just before the no confidence motion in parliament against the Central Government. They also clearly manipulate the Judiciary and how the cases come for hearing. When Jayalalitha was the Chief Minister of the state, the pending case against her in Supreme Court, for which she was initially convicted by a lower court and exonerated in high court (with some mathematical mistakes in calculation) did not see the light when she was in power or when she was seriously ill in the Apollo hospital. After her Death, O.Paneerselvam was made the CM and when he revolted against the inner circles of the party - Sasikala and her family. Sasikala was projected to be the CM herself and MLAs were moved to Koovathur resort for them to get the numbers in the floor of the assembly. The Central government then from nowhere woke up, took the case for hearing right away and convicted her before she could prove her number in the assembly. Their puppet state Governor was involved in delaying the process and played obediently in favor of the central government and against democratic rules of the state. It was pretty evident they control when the judicial case against the opponents are brought and used as political tool. Unfortunately the way judiciary operates in this country is like that.

The BJP government has been tacitly controlling the election commission to suit their agenda. When in school, we were all taught the by-election to constituencies happen within 6 months of either the MLA/MP is dead or suspended from operating as a representative of the people. In our state in Tamil Nadu,  in the last 3 years, we have seen multiple seats that are lying vacant without a elected member for more than 6 months. Just imagine about the people who are in those constituencies. Without a member representing them, it creates lot of ground difficulties. Election Commission not ordering by-elections in vacant constituency is a big crime because it is their only job. The only reason they do that was in favor of the state and central governments. The people of Tamil Nadu should have realized this already.

These kind of institutional management for political gains are always done by ruling parties. But never in the history of our country it has been done to this scale.

One thing that is both funny and makes me angry is - The court this week pronounced a verdict on a by-election in Tirupurankundram assembly constituency in Tamil Nadu. The verdict was - the election of the ruling MLA from that constituency has been declared invalid. This is because of Jayalalithaa's thumb impression was used instead of her signature in approving the party candidate who eventually won. And that thumb  impression was found to be not valid. The sad truth is - Jayalalithaa is dead already and the MLA is also dead. Its basically a classic case of "Operation Success but Patient Dead". It is sadly Judiciary succeeded and Democracy failed. What Angers me about this joke is - The Joke is on us, the people.

Making the institutions play for their tune has gone one step further. Now the BJP wants everyone to think they alone are synonymous with the military - if you are against them, then you are against the military. This is wicked thing. This is what happens when crooks are running the country.
The recent Pulwama attack - where an Indian Citizen became a suicide bomber to kill our own military personal is something really everyone in our country should think about. Blaming it 100% on Pakistan is propaganda and not intelligence. This is unlike the Mumbai attacks where everyone came from Pakistan. It was imported terror. We don't have control over it. But in this case, if one of our own citizen gets radicalized and bombs our army men - we need to find our why would this happen and make steps so that its not repeated. If training and explosives came from across the border in Pakistan - it really means - our border is porous. Make steps to tighten that. We have enough home work on our side to do on top of blaming Pakistan. The ruling party conveniently capitalized on the tragedy and it made it worse by surgical strike misadventure to convey to the people of India, their strong character. In the end, gave an opportunity to the Pakistan PM to become a noble statesman.

What is upsetting, lately the military is being used as a propaganda tool for their own political agenda.

The armed forces of India belong to the country. They represent the people of the country and not its current rulers. The democratic government merely have an impact on them when in power. They tend to give a perception that if you support the Army, then you support the ruling party is absurd. What is amazing is the current BJP government is pretty successful in propagating this idea so far. When emotions run high, the ploy may work. When reality catches up, people will figure out the difference. In the US, when the Iraq war happened and George Bush was President - They tried to do a similar propaganda where, if you hated the war, then you are against the troops. This made a big impact in mobilization of the people in support of the war for multiple years and also played a bigger role in his re-election to his second term as President. Only after the endless war effort and losing multiple US military personal, did the people of the country realize - war and support for military are unrelated. When the common good is lost - the trust is lost as well. Never before in our country was this kind of campaign done. The military was and is supreme entity in India - people valued it. It is just a armed group to save this country for people's common good - mostly dominated by poor sons of our soil.  Using them as political weapon to segregate society and impose political ideological is mischievous. It is possible - they might go to war to prolong their political ideology and continue with their ruling power. 

The way they have been operating so far, giving another five years to Narendra Modi, Amit Shah and its gang - is very scary. They don't even seem to be "Good People". 

Sunday, March 24, 2019

The E- Commerce CRAP

The Indian government has stepped in more to regulate the ecommerce Industry. They are formulating procedures that would trim the ecommerce business. The intention they say is to protect the brick and mortar stores spread all over the country. However the whole thing is absurd.

This is one classic example of how the government usually behaves with complete lack of common sense. First they allowed foreign companies to run ecommerce ventures in the country. With more than a billion consumers and a improving middle-class, foreign and local investors have poured in tonnes of money as investment. With a high-inbound of cash into the business, the firm just doesn't know where to spend the money on. Because its all online - there is not even stores/parking expenses. All they need is warehouses and shipment centers. With competition also increasingly growing and with the intention of market dominance, these ecommerce firms use investor's money to offer irrational discounts on the products they sell in their platforms. So a product that has a cost price of Rs. 70/- and a selling price of Rs. 80/- in a outside shop, is being sold for say Rs. 50/- Who pays for the difference - its the investors money.

Every ecommerce firm tries to replicate Amazon.

Amazon has been a leader in the ecommerce space globally. With unlimited investor money looking for returns, mainly sourced from low-cost borrowing rates in developed countries - it became a ideal target. Business of Amazon has been expanding for a decade now exponentially and it is always considered the phoenix bird of the dotcom boom-bust era. The way the business model works - Amazon has reported loses every quarter for most of its lifetime. The shareholders did not gain much from their investment because of the lack of profit. All earnings were re-invested to grow the business. Jeff Bezos mindset is that, grow the business wide and high, the company will eventually be profitable. In late 2015/2016 is where Amazon reported a significant quarterly profit in a quarter since their inception. As soon this happened, investors started piling into the stocks and the share has risen from low double-digits to over $2000/- since then. Recently it has corrected to somewhere around 1500 bugs. On the business side, their ecommerce business has never yielded a significant profit in spite of their long life-span in the business. The reason is this - they do not sell the products for a "profit" in their platform. They sell a lot for a loss. The loss is compensated by the new investor money.

Internally within Amazon, these products are called C.R.A.P - acronym for "Cannot Realize A Profit".

To maintain the market dominance and rival the competitors in number of purchases/revenue, not a single day goes by without a strikingly discount-sale, that no other for-profit business would do. They would ship a 30-40 pound heavy dog-food bag to your house every week that costs $40. They would sell TVs to your house, the price would be lot less than what you would find in the nearest store and on top of that, they offer the shipping to be free. On top of that, if the TV is broken en-route, they would send a replacement. The cost the consumer pays is way less than all these that make it happen.

Consumer is god damn-happy he is getting the best deal and also it is all being door delivered. He saves on the effort and cost that takes him to go to the nearest store and do a pick-up himself. They deliver to the remotest of remote part of the country. All the consumer has to do - is stand-up from his sofa and open the door when Amazon delivery guy knocks in your door. This is absolutely good thing for the consumer. No question about that.

However for Amazon and its investors its a horrible deal.

What is amazing and mind-blowing, is the ecommerce firms are able to do this for so long and making Amazon's Jeff Bezos the richest person in the world.

One sad truth - Amazon has amazingly proved that such an illogical business model can work and prosper. Any company that does this will fail. Amazon will definitely fail as well.

The latest entry to this kind of business model is swiggy and Zomato. It is very hard to miss them on the Indian city streets these days. They have hired thousands of people who deliver food to customers who order using their mobile app. The prices are significantly low - sometimes its obvious it doesn't even add up for the expense on the food and the cost it takes to deliver it to the customer. Rs. 15/- breakfast for early users is common. For comparison - this same breakfast would cost at least Rs 50/- on the floor of the restaurant. These companies also lavishly shower money on their delivery boys. Apparently they earn more than Rs. 25,000/- a month. They operate like Amazon actually - first they offer unrealistic discount to get more people on the platform, buyout the competition, take a leader role in the industry - and it so turns up - they end up never raising prices to actual cost prices. They very well know as well its customers that customers will only be in the platform only until the discounts last. In a real-price structure the business would cease to exist. Once the prices are nominal or above nominal, the customers have no incentive to stick to the platform - either they would walk to restaurants themselves or would start cooking at home, which is lot cheaper. The biggest loser in this game when it gets over finally, is unfortunately the delivery boys. They have been delivering food for years. There is nothing to show for. They didn't acquire any skills or knowledge. Finally they don't have the lavish income too.

What is very amazing about Amazon, Swiggy, Zomato kind of companies is how long they survive? A early failure is good thing. They can be good ordinary companies that are serving customers well. They can't be these extra-ordinary companies which drives competition out.