Successful encore

John Hussman’s weekly missive of April 28 is useful for the charts and information he presents on Price/Revenues of S&P 500 companies – average and median. Median Price/Revenue ratio is now above levels reached at the height of the stock market bubble of the year 2000.

One cannot get more unambiguous than this:

The central message to investors with unhedged equity positions and investment horizons shorter than about 7 years: Prospective returns have reached zero. The value you seek from selling in the future is already on the table today. The future is now. [Link]

This reminds me of what I read in an article last month – an interview of James Moniter of GMO in the Swiss newspaper, ‘Finanz und Wirtschaft’. This Q&A, like the one above, sums it all up rather too well:

James, are you able to find anything in today’s financial markets that still has an attractive valuation?
Nothing at all. When we look at the world today, what we see is a hideous opportunity set. And that’s a reflection of the central bank policies around the world. They drive the returns on all assets down to zero, pushing everybody out on the risk curve. So today, nothing is cheap anymore in absolute terms. There are pockets of relative attractiveness, but nothing is cheap or even at fair value. Everything is expensive. As an investor, you have to stick with the best of a bad bunch. [Link]

Central banks that are responsible for financial stability cannot feel proud of driving investor behaviour such as this:

Companies with low credit ratings learned a valuable lesson this week: investors will queue up to lend to them, and expect relatively little in return.

The midweek sale of €7.9bn of junk bonds by French telecoms and cable operator Numericable did more than break the record for a single sale of riskier debt: it revealed how financing for international companies with fragile balance sheets is conducted six years after the financial crisis.

Numericable, which has businesses in several countries, and parent group Altice offered a $21.8bn combination of loans and bonds in several maturities and two currencies, with yields on the bonds ranging from 4.875 to 6.25 per cent. The package was a hit, attracting $100bn in orders from investors spread over 700 accounts across the world. [Link]

Without creating meaningful jobs or incomes, the Federal Reserve has created an asset price bubble of epic proportions – more epic than before. US Household net worth went up by almost USD10.0trn last year because of gains in home prices and stock prices. The recovery in US house prices, since the crash of 2008-09, has been the fastest of all housing cycles. You can check it out yourself here. We all know the beneficiaries of this fastest and strongest recovery in asset prices. It is not the median American family.

The jobs created in the twelve months to March 2014 have mostly been in the low-wage and long hour categories. That has maintained the pattern since the ‘recovery’ began in 2009. This is what I wrote in my MINT column recently about the US economy’s ‘job creation’ record (or, the lack of it):

Five years after the interest rate was dropped to zero and after three rounds of QE, job creation in the US is confined mainly to low-paying sectors. In the 12 months to March, the US created around 2.24 million jobs. Jobs created in the services sectors were 2.04 million. Of these, 1.48 million jobs were created in retail trade (315,200), administrative and waste management services (423,600), education and health (334,000) and leisure and hospitality (406,000). Under leisure and hospitality, food services accounted for 323,000 jobs.

Despite claims of a much vaunted revival of US manufacturing, only 72,000 jobs were created in the sector in the last 12 months whereas 151,000 construction jobs have been created. No surprises then that, in the last 12 months, participation rate and the employment to population ratios for those who have completed high school or less have gone up whereas these two ratios have declined for those with a college or associate degree and a bachelor’s degree or more.

At the same time, with interest rates at rock-bottom levels, even the slightest increase in yields appears adequate to send borrowers into a tizzy and activity to contract. This risk too has been flagged before. As we flood the body with pain-killers and pain suppressants, its natural ability to withstand pain and stress withers and becomes utterly incapable of even the smallest increment in stress and pain. Economic systems are not exempt from this natural law. That is what we are witnessing now.

So, for the third time in less than two decades, asset prices have de-coupled from fundamentals. In the year 1999-00, it was not Fed inspired entirely. In 2007-08, it was a stock market and housing bubble, orchestrated by the Federal Reserve but other players had their roles to play too (such as SEC, the Federal government). This time around, the Federal Reserve has the lion’s share of the blame (or credit).

A tangled web

John Hussman of Hussman Funds used to insist that much of the profit ‘recovery’ in the United States, post-crisis of 2008, was due to the suspension of mark-to-market accounting rules in 2009 (in April, I think). I was not sure if the suspension of rule FASB 157 has remained in force. But, this blog post confirms that FASB 157 suspension is alive and healthy. Banks are continuing to mark-to-model and we have no way of knowing how much of their profits is well earned and how much of it is not. In fact, it is worth studying – for a doctoral thesis – the impact of FASB157 suspension and QE on the US stock market’s meteoric rise (see the chart here on the rise of S&P 500 stock index).

Besides FASB157, there is also the absurd rule which allows banks to record as ‘income’, an erosion in the market value of their debt. So, a credit quality deterioration raises the bank’s reported income as the loss in the market value of the bond (par value of the bond – current market value) is allowed to be added to income. Unsurprisingly, this caused confusion and resulted in BofA to misreport its capital base. I am assuming no mala fide here.

Accounting rules, globally, are the biggest reminder of the complex world that we have created or the tangled web we weave when we first practice to deceive. Sir Walter Scott must have had accounting rules in mind, when he said that.

Thought and counter-thoughts

The thought:

Here is the link to the article by journalist Bharath Bhushan (BB) in ‘Business Standard’ on what he calls the ‘selfie’ campaign by Mr. Modi.


A campaign is not a basis to judge a person. So, if Modi is presenting a different picture of himself than he truly is and therefore, should be discounted, what should one do with the Congress and RG? Is what they are presenting a true picture of themselves? If so, is it engendering confidence?

Or, as per Mr. BB’s logic, should we elect them because the reality will not be so unpleasant? But, their historical reality of the last ten years is too much and too big to ignore.

This is what Mr. Bhushan is trying to convey:

One, BB is echoing many who have concluded that NM has effectively done a clever make-over and that the mask would be dropped once in office.

Second, Modi’s government actually colluded in the riots and yet managed to fool all of the investigators, the media, the court, despite having to confront a hostile central government, investigating agencies, the media and social activists?

Third, we are to ignore the character flaws and lies (major ones) of all those who spoke up against him – from Police officers (Shrikumar, Sanjay Bhatt, et al) to social activists (Medha,Teesta) to Congress politicians.

Fourth, we have to ignore the natural and most reasonable conjecture that a most pre-meditated and gruesome roasting alive of 50+ Hindu kar sevaks with women and children on board, would not provoke a spontaneous retaliation in a State charged with history of communalism.

Fifth, we have to believe that a person who was going to present his first State budget on that day was waiting for the Godhra incident to happen to let loose his worst communal instincts

Sixth, we are to ignore the fact that, going by actual numbers of deaths and the response, Modi government did far better than previous Congress governments in his own state and in the Centre, especially in 1984.

Seventh, we have to accept that the twelve years of post-2002 riots are a carefully staged drama of peace and quiet only to serve as a platform to unveil the true picture once he ascends the big throne.

Now, I have to confess two things:

One, I am not that omniscient as that of Mr. Bharat Bhushan and many of his ilk, to believe in all of the above collectively.

Two, I am not that conceited about my own intelligence and the lack of it in the rest of the Indian society  – such a chaotic, noisy, nosy and argumentative society – that it could be dumb enough to be fooled by one person so well for so long, in the face of a single-minded pursuit by his opponents.

I shall also express one confidence, one fear and one hope:

My confidence is that India has enough checks and balances that the fundamentalists and fanatics in the Hindu religion will remain where they are – in the fringes.

My fear is not that Mr. Bharat Bhushan and others would be proven right but would prove to be too wrong – that, once in office, Mr. Modi would swing too far to the Left as to become acceptable to Delhi-based pseudo and English-speaking intellectuals. I fear that, in the process, he would pursue meaningless gestures of appeasement to minorities, go soft on cross-border terrorism, ignore the nefarious agenda of foreign nations and forces and still end up being unpopular.

My hope is that Mr. Modi will restore secularism in its truest sense – a government that does not take sides between religions.

Shallowness list

(1) In the NYT Economix blog, Simon Johnson and his co-author try to downplay the global repercussions of a slowdown in China growth and China’s shadow banking malaise:

So if China avoids a Lehman crisis but does face a serious growth slowdown, how worried should Europe and the United States be for their own economic growth? The answer is, not much at all.

China is still only a small fraction of the world economy. World G.D.P., calculated by the International Monetary Fund, was $73.5 trillion at the end of 2013, while China’s G.D.P. was about $9 trillion, or 12 percent of the total. The United States at $16.7 trillion and the European Union at $17 trillion are each nearly double the size of China (using market prices and actual exchange rates).

China’s main link with the rest of the world is through trade. According to the latest available data from the World Trade Organization, for 2012, China’s merchandise imports accounted for nearly 10 percent of the world’s imports. Exports to China in 2013were $1.95 trillion.

Surprising coming from someone who has studied the role an reach of the financial sector and its linkages.

I am surprised that he is not taking into account linkages within Chinese economy (cascading effects) and also international financial linkages. If China shadow banking implodes, will international financial institutions remain unaffected? Haven’t they lent to China banks, shadow banks and Chinese corporations? If deposits made into non-banking sector for higher yield go bad (are not repaid), what about the ripple effect on real estate values? What happens to carry-trade deposits and hence, the Yuan exchange rate? If Yuan tumbles, will it not create its own ripple effects?

Then, there will be second round effects from the RoW back to China.  Further, given that the US stock market is trading at bubbly levels and given that corporate bonds trading are at exorbitant levels, we do not know if a sharp slowdown in China economy would not trigger a collapse in corporate profits, then in US stocks and then the ripple effects coming back to haunt Asian and China stocks, credit and economies.

How sure can we be about our knowledge of China shadow banking? Do we know how big it is? What about (local and international) exposure through derivatives?

[Andrew Smithers has written a good piece on China in FT]

(2) Swaminathan Aiyar has written a piece on why Ukraine should have had nuclear warheads. I have no problem with his change of heart on nuclear deterrence. I welcome it. But, his reading of the situation in Ukraine seems woefully off the mark. He sees Russia as the trouble-maker. I doubt if that is the case.

(3) Ms. Renu Kohli had written a piece on the ‘Hindu rate of growth’. She has every right to suggest that India would find it difficult to break out of its current state of low growth, irrespective of who comes to office. That is her prerogative. But, there is no need to call it the ‘Hindu’ rate of growth. It is devoid of meaning. It is laziness.

A shrill campaign for financial liberalisation

Mr. Percy Mistry’s latest column is at it again: His unabashed and open campaign for financial liberalisation (as though it is the only and the most important instrument for India’s economic salvation) is both impressive and disturbing for its single-mindedness.Sample the following sentences:

artificially restricting the entry and expansion of foreign banks that India so desperately needs…and dramatically expand the entry of foreign banks to meet India’s vastly expanded foreign capital needs for the next 20-30 years.

Really? How desperate and why?

It is clear that all of India’s exchanges need to be internationalised and become part of global exchange networks that must eventually allow 24-hour trading of all scrip and be expanded to include the trading of all debt securities and exchange traded derivatives as well.

There you go. 24-hour trading will restore India’s industrial production and investment and capital formation. That is the missing ingredient. A 24-hour second-hand car market will boost auto production, of course.

That requires the Indian political system and government not to be obsessed by who owns what or by the supposed need of the state to own everything or most things in finance or other parts of the economy.

This is clever. Suddenly, he ropes in the rest of the non-financial economy into the argument so that any resistance to his argument can be branded antediluvian. Ownership of the non-financial economy and financial economy are two different things. Second, even if one argues for private sector banks and the end of government dominance in banking (I have argued so in a recent MINT piece, given State-directed lending, poor commercial culture that it breeds and the moral hazard it creates), it is not the same as foreign ownership.

If the upcoming general election is to be as seminal in changing India’s politics as wise psephologists attest, it will prove to be a damp squib if it does not precipitate transformation and liberalisation of India’s economy and financial system.

Again, there is a deliberate conflation of liberalisation of the economy and the financial system. With warts and caveats, one can be in favour of the former and yet, be very wary of the latter. In the case of the former (the economy), the burden of proof is on the anti-liberaliser.

In the case of the latter (financial system), the burden of proof is on the liberaliser, given regulatory capture, given subsidies that TBTF banks still enjoy (see chapter 3 of the latest Global Financial Stability Report of the IMF, April 2014) and given the pervasive rigging in financial markets – from stocks to commodities to precious metals to bonds to asset-backed securities.

(p.s: Ms. Ila Patnaik has been appointed principal economic advisor in the Finance Ministry. She will hold this job for three years. For a government that is just a few weeks away from being voted out of office, making this appointment is rather a strange thing to do. I am unable to see it as a routine appointment).

Learning Social Science

Learning social science is (or at least ought to be) radically different to learning how to walk. Whereas walking is best learnt mechanically, social theory is best imparted by critical thinking (accompanied of course with large doses of rigorous training). In social theory the two are parasitic on each other; rigour without critical thinking leads to bad theory while critical thinking without rigour reduces to blind moralism. The trick is to find a decent balance between the two. [Link]

I like the highlighted portion very much.

[An afterthought: are the many critics of Modi suffering from the malady of critical thinking without rigour?]

A new paradigm for chutzpah

A gentleman by name Nikhil Inamdar chose to write an Op.-Ed in Business Standard summarising the summary version (published in Economic & Political Weekly) of this article.

UPA performance history has not been written by detractors. It has been written by its own disastrous policy-making. With a job creation record of 0.1% per annum and that too thanks to vigorous jobs growth in ( the construction sector (12% per annum), an inflation record of 63% in five years (Dec. 2008 to Dec. 2013) and a bankrupt government-owned banking sector, UPA wrote its own epitaph. Detractors were spared their sweat.

In the meantime, my friend sent me the link to another article that Shankar Sharma and Devina Mehra have written for NDTV Profit.

These lines caught my attention:

India, under the UPA II, has resisted the grandstanding temptation to show short term debt-fuelled, economic growth by spending its way out of trouble (the way GDP is calculated, the more you spend, even wastefully, the faster you grow! This is absurd, but true). [Link]

I am impressed that some one actually could write like this and wrote like this too because this is the polar opposite of what UPA did. Economic growth in UPA I and II is a case of debt-fuelled growth – government debt, domestic debt to the private sector and private sector external debt. The weights varied. It was domestic private debt mostly in UPA I and it was external debt and public debt mostly in UPA II although all three were resorted to in both UPA I and II. I

What India had under UPA was not economic growth but debt-fuelled binge. That is why India is still grappling with the hangover of stagflation.

If UPA could not arrest the growth slowdown in 2012-14, it was not because they exercised exemplary restraint. They had run out of scope to borrow and spend. Credit rating would have plummeted and the rupee and Indian assets would have followed suit with greater vigour.

This article will go down as another classic example of chutzpah (the standard one is that of a defendant pleading to be freed because he was now an orphan, after having shot his parents dead).

Nitin’s mantra

I think Nitin (the prime and co-founder of Takshashila Institution with me and others) has been emphasizing restoring economic growth as an all-important policy and national priority. His latest Op.-Ed. in Business Standard is consistent with that.

This is a slightly modified version of what I wrote to him in a private email:

(1) Your mantra to the Symbiosis students is good to drive home the importance of economic growth.

But, just a few caveats and some more point to add, the next time:

(a) Growth is like happiness. The more you chase it directly, the more you are likely to get the wrong kind of growth just as the wrong kind of happiness. We chased it and we got it but it was debt fuelled construction boom. In fact, beyond a point, China’s growth is a similar story.

The US is chasing growth through leverage too.

(b) So, one does not chase economic growth but one prepares the soil for a gdod harvest. The good harvest is a natural consequence of the soil preparation and many other inputs (right quantity and quality of water, fertilisers, tilling, etc.)

That is, Enable growth. Public and the government can and should do what they can, to enable growth that can be maintained for a reasonable length of time without creating other imbalances that undermine and undercut growth for a long period of time.

(c) if you are speaking to students, you can tell them what they, as citizens, can do to ‘enable growth’ – they can start by respecting traffic rules and avoiding defecation and urination on the street.

So, an even more dramatic corollary to your foreign policy theory is that India’s America policy, China policy and Pakistan Policy are these:

(i) Do not jump red light.
(ii) Do not urinate or defecate in public

[I forgot to add lane discipline]

Yes, these things do result in a different set of national pride, discipline, self-belief and confidence that add up to economic growth surely, over time. I am not even counting the tangible public health and public safety multipliers.

(d) So, your growth mantra is very likely – even if you do not mean it – to be interpreted as ‘growth at all costs‘.

Therefore, to avoid that, the right slogan is ‘growth with awareness of costs‘.

(2) To raise the potential to 8%, India will take at least half a decade, assuming that it does all the right things.

Right now, after ten years of UPA, India does not have the capacity to grow at 8%.

Fighting the Fed

The first headline I saw this morning on (that is the site from where I begin my morning explorations) was a link to Raghuram Rajan’s speech at Brookings on Thursday. I did not proceed further. I opened the link. Read the speech and I found it explosive.

I will be very interested to know how the US handles his visa after he hangs up his boots in RBI 🙂

As I was reading, I annotated his speech with my comments and highlights. A thought struck me to convert it into a proper Op.-Ed. with his remarks followed by my comments. MINT was only too happy to oblige.

The piece with my annotations and highlights is attached. Here is the URL to my piece in MINT.

Looks like the machinery of the West swung into action, closing ranks:

(1) FT correctly called it an explosive speech. Interesting that FT reports that Bernanke said that he would take Raghuram to task for his remarks! I think he must have meant that literally and otherwise. Raghu has torn into QE and mocked the Fed’s defence of QE.

(2) Reuters reported that there was a cool reception to his speech. Chicago Federal Reserve Chairman is reported to have said that low inflation was a problem globally. Is it? He does not seem to be aware of this short paper by two economists at the FRB Minneapolis, published in January 2004. Except in the Great Depression of 1929-32, there has been no link between deflation and depression. So, why bother about deflation so much as to build up enormous costs, distortions and dislocations locally and globally?

Unrig the game

It is not so much any more that the public does not trust their brokers. They do not trust the markets, the exchanges, or the regulators either. And why should they, given our showing in the past few years? To the public the financial markets may increasingly seem like a casino, except that the casino is more transparent and simpler to understand. I did not see the forces of fragmentation and the opportunity for people to use technology to keep to the letter but avoid the spirit of the rules — creating the current crisis.

The financial markets of at least the world’s developed countries are at a turning point. Technology, market structure and new products have evolved more quickly than our capacity to understand or control them. The result has been a series of crises over the past few years that have caused many investors to lose confidence or to think that the whole system is a rigged game.

Some remarks from the speech by Thomas Peterffy, Chairman & CEO of the Interactive Brokers Group delivered before the 2010 General Assembly of the World Federation of Exchanges, on October 11, 2010. Full speech here. [ht: Zerohedge]