Wednesday, April 15, 2015

Making my life simple

Thought for the day
"I think fish is nice, but then I think that rain is wet, so who am I to judge?"
-          Douglas Adam (English, 1952-2001)
Word for the day
Argot (n)
The special vocabulary and idiom of a particular profession or social group.
(Source: Dictionary.com)
Malice towards none
MSY is groom's grandfather. LPY is bride's father. Their bonhomie and alliance is understandable.
What this guy Nitish is doing in the family affairs?

Making my life simple

The unconventional methods used by the global central bankers in their endeavor to stabilize global financial system since 2008, have definitely complicated the context of financial markets.
To a simpleton like me who:
(a)   does not understand the economics beyond its first lesson which says all economic decisions involve a trade off and price of things having economic value is determined by their demand and supply at that given point in time;
(b)   does not know how to play with data on Microsoft Excel Sheet;
(c)   likes to discover investment themes in streets, markets and fields; and
(d)   seriously believes that numbers invariably follow the good story
I find it tedious to comprehend how the movement in global currencies and bond yields could have material impact on my investment portfolio which is largely India centric.
But unfortunately, the current state of affair is that movements in global currencies and bond yields have become an important factor to analyze in construction and maintenance of an investment portfolio - regardless of country you live in and asset class you invest in. From precious metals to agro commodities, from real estate to bank deposits and from equities to bonds the prices and return on all asset classes across world is being impacted.
It is frustrating to note that the money in my savings bank account is also not spared. The commodity price disinflation caused by a fluctuating USD could impact the domestic inflation rate and thus the value of my savings also.
In order to simplify my life and avoid complications in investment process, I have made couple of assumptions, which incidentally are in agreement with the popular view.
With these assumption, I believe, I could live for another five years without attending economics or MS Excel classes.
1. USD shall continue to gain strength for next five years
I believe the demand of USD shall materially outstrip its supply in next five year, thus raising the price equilibrium of USD vs. most global currencies.
Simply put, the major source of supply of USD to the global economy are trade and investment.
Negative current account balance of US: when US economy imports more goods than it exports to the outside world, it bridges the gap by paying the difference in USD thus supplying USD to the world.
Negative budget balance of US government which is monetize by printing more USD. The USD so printed could be borrowed by the domestic investors and invested outside US to take advantage of the yield differential.
Quantitative easing (QE) program of US Federal Reserve: To provide monetary stimulus to the US economy US Federal Reserve may print USD and buy the outstanding debt of the government or private borrowers using newly minted USD. The USD so printed could be borrowed by the domestic investors and invested outside US to take advantage of the yield differential.
Similarly, in simpler terms, the major source of demand for USD could be listed as follows:
·         Governments: Since the USD is reserve currency for the world, a large number of governments/central bankers maintain a part of their reserves in USD to ensure adequate supply of currency to pay for imports and repayment of external debt.
·         Corporate borrowers: Corporates across the world borrow in USD given the wider acceptance and greater liquidity.
·         Global Investors: The global investors who invest in cross border assets need the common currency to make their investments.
·         Money launderers: Given the widest acceptance and easier access, USD is the preferred currency for illicit cross border trades & money laundering.
Considering that the traditional sources of USD supply are drying and demand for USD is likely to remain strong, it is a valid assumption that USD continue to gain strength in next few years, till the time the global market paradigm changes and an alternative reserve currency emerges.
(a)   The US current account deficit is shrinking and may even become positive in the following years given the lesser energy import and rising household savings rate.
(b)   US government budget is slated to attain equilibrium by 2018.
(c)   Fed has already winded up its QE program.
(d)   The USD reserves of foreign governments have bottomed out and beginning to rise.
(e)   The repayment cycle for USD borrowing made by global corporates and governments during easy money days of 2003-2012 will start in next few years - leading to higher demand for USD.
(f)    The US Federal Reserve may hike the policy rates from the current near Zero level in the near future. This shall definitely lead to higher demand for USD, as (a) the investors and arbitrageurs who have borrowed in USD to invest in higher yielding currencies may scramble to reverse the trade, and (b) USD assets may become relatively more attractive with higher yield.
(g)   The pressure on money launderers is rising across the world. Liquidation of physical assets to return the money to the country of origin may cause higher demand for USD.

To make my simple, therefore, I would factor in a strengthening USD over next five years in my investment assumptions for all constituents of my investment portfolio.

2. The cost of capital could only rise from here
As per various estimates, approximately one sixth of government bonds across the globe are yielding negative return to investors. Yer, investors are paying fees to own these bonds.



 
This sounds unsustainable to me. The condition therefore should normalize in next few years. Nonetheless, assumption that the cost of capital could fall further from the current level does not hold good to me.
Regardless of "abundance of liquidity" globally, the "risk capital" is shrinking fast. The liquidity created through numerous QE programs chases few basis point arbitrage opportunity through carry traders. It is seldom deployed in long gestation projects, especially in emerging markets.
I would therefore like to build in a rising cost of capital for domestic borrowers, notwithstanding the degree of slope seen on the domestic yield curves.
A large number of corporates have borrowed in USD in past five years. Presuming they have fully hedged their currency risk, the cost differential in INR and USD debt is close to 250bps.
Even if the domestic rates fall by 150-200bps over next three years, the cost of capital for these borrower will only rise if they are not able to roll over their current USD debt at current rates.
On the sidelines, cash hordes and dividend yields is more likely to comeback as an investment theme as compared to Cyclicals who are undercapitalized as present.


China’s First-Quarter GDP in Four Charts
China on Wednesday recorded its slowest growth rate since 2009, a time when the global economy was staggering beneath the effects of the financial crisis. First-quarter growth slowed to 7% on-year from 7.3% last quarter, a signal that the world’s second-biggest economy has little wiggle room to meet its annual growth target of about 7%.
Here’s a breakdown of China’s GDP in four charts:
China’s factories are hurting. Value-added industrial output, a measure of manufacturing production, has hit financial-crisis levels. Industrial production grew by 5.6% on-year in March, far short of economists’ expectations of 6.9%, amid weak global and domestic demand–a dynamic that has pressured prices.
Chinese shoppers aren’t buying. Retail-sales rose 10.2% in March. That’s slower than during the financial crisis.
Big spending is shrinking. First-quarter fixed-asset investment, which measures money put to big projects and factories, rose 13.5% on year, below economists’ expectations of 13.9%.

Trivia
In the post independence history of India there are many things that have been persistently gnawing the conscience of citizens and are in desperate need of closure.
The deaths of leaders like Netaji Subhash Chandra Bose, Lal Bahadur Shastri, Shyam Prasad Mukherjee, etc., transactions like Bofors, and events like partition, accession of Kashmir, emergency are few such things.
The points worth pondering are (a) how much disruption in normal life can we afford to attain this closure; and (b) whether the political establishment indeed intend to close these issues once for all and lose traditionally useful armory to fight the opposition!
Even more critical is to assess the cost and benefits of indicting Nehru for snooping on Netaji!

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