Brain Drain: A Tale of Two Centuries

Whenever we hear the term ‘Brain Drain’, we usually think in terms of migration of labor to developed economies. We associate it in terms of geographical movement of ‘brain’. However, equally important is the phenomenon of Brain Drain between industries, though it is much less talked about.

Automobile sector to IT sector
I remember receiving a chain mail long ago which compared the rate of innovation between the automobile industry and the IT industry. It went on to say that if the pace of innovation in automobile was as good as IT, then the current generation cars would be much better than what they are.

If automobile technology had improved at the same rate since 1960, a new car would cost less than an entry fee to the cinema hall, and we could drive through the length of our own country on less than a litre of petrol or diesel.

There was a huge shift in skilled labor from the automobile industry to the IT industry in the 1960s– and this led to the huge growth in technology over the past few decades. No other sector was able to match the rate of innovation, and companies came out with real surprises every now and then. However, now the IT industry finds itself in the shoes of automobile industry, and it too has been relegated to the ‘second choice’ employer status. Currently leading the pack are Goldman and the likes. And if we see the innovation across different sectors, we realize the impact of these changes.

IT sector to Finance sector
When I first learnt about the securitization business, I was dumbstruck. In the traditional model of banking, banks acted as the intermediaries between people with surplus cash, and people who needed cash. They used to take deposits from the public, and use the same to make loans. The sole purpose for the existence of banks was the match the source and need of funds – and they earned a margin for this. Also, they used to bear the counter-party risk in case of default, and the world largely was unaffected.
In the world of securitization, the banks sold-off these loans to institutions as well as public – in various forms (but lets not get into that). So, essentially, banks were accepting deposits as earlier, but not giving out loans in the same way. They used to give loans, but later sell them off to get the money which they further lent (and it went on and on). So, in the current scenario, banks weren’t matching those who had cash with those in need of it, but rather they redistributed everything. So, it was like a giant network where everything was connected to everything else. And banks were just acting as agents providing operational support to the whole system. In this system, everyone depended upon others, and if one link failed, the whole system would collapse. This was the ultimate dream for any bank – a vast ocean of people who lent money to each other, more directly than ever before – and these guys just controlled this massive spider web. In terms of IT sector, this is very close to the concept of Grid Computing. And whereas the concept is still in early stages in the IT industry, it has been done to death in the financial circles. And if the brain drain continues, very soon IT sector would also be left to the same fate as that of Automobile sector – and die a slow death. 

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Over the last few years, the financial industry has been the top choice for most of the fresh graduates and post-graduates. Hence, its no wonder that they have been miles ahead of other sectors in terms of innovation.

Market View: November 27, 2009

Something Is Not Right!

Markets were spooked by the Dubai storm, and bears finally had their long awaited wish. Everything was falling, and people rushed to buy protection. Nifty futures were back to trading in discount, and it seemed like bear market was back.

Nifty opened close to 5100 on the expiry day (26th day), and traded in a range for most part of the day. However, towards the end, it succumbed to the global pressures, and went into sharp fall. Thankfully US has a Thanksgiving and so it didn't add anything to the fall. And today as well the markets continued to fall amidst higher fears on the Dubai default (which seems unlikely, and a clear case of over-reaction currently. Unless...). Nifty touched 4820 levels, but recovered soon after HK closed, and went on to regain most of the fall. It finally closed at 4940 levels - quite a rally from its intra-day lows.

As I write this, Europe has re-bounded, and is trading in green. However, I think even if Dubai is averted, there are others waiting to explode. Its a liquidity rally, and nothing more than that - and NOT A RECOVERY RALLY. We are still groping in the dark about the way forward. Spain is struggling, Ireland is close to default, and now Dubai joins the list.
I would be surprised if this party continues for another year. I would be happy to buy Nifty 5000P December 2010 at current levels. Something doesn't seem to be right in this rally - and I don't know what.

Market View: November 6

Markets have been making a fool of bears for a long time now, and there was nothing new in its behavior over the past couple of weeks as well. Initially, it appeared that all the bulls have gone quiet taking a breather, and bears came out with their daggers. A week of fall in the markets, and we all thought ‘This is IT’ – a phrase which eventually got related to Michael Jackson more than the markets.

So, it wasn’t this time again, and the party continues. US has made it very clear that they aren’t going to raise the rates anytime sooner. Effectively, they would continue to write blank cheques, and the champagne would keep flowing.

With all the talks of rates hike marginalized, I go back to my bullish stance, and think that the round for correction is over. Now, we are back to listening to the Rally Monkey chants. Last year, there was no year end rally, but this time around, there may be one.


Food for Thought: Markets for the last couple of years (from when I have started observing) haven’t changed their trend in the months of November and December. In 2007, the party continued late into the night, and the music stopped early in January. Similarly, in 2008, the markets continued to fall down, and only recovered in March. So, in both the years, November and December just continued the overall annual trend of the market. And think it would be same this time around. If not a sharp rise, we shouldn’t end lower than the current levels.

Automobiles Sector Basics: 101

Market Movers

This is not amongst the largest sector in the Index (~3% weight), and is affected by news flow.

1. Monthly numbers: Vehicle sales numbers are declared on 1st of every month
2. Interest Rates: Lower interest rates mean higher sales for the industry - as loans would be cheaper
3. Capacity Addition/Suspension: Affects the supply and competition in the industry
4. Economy: Related to economic growth as well, over the medium term

 

Reading the Statements

1. Auto-stocks are most sensitive to EBITDA margins (as volumes are known beforehand).
2. Primary costs are Raw Material expenses - 70-75% of net sales

 

Long Term Concerns/Factors

1. GDP Growth
2. Loan Growth - and interest rates
3. Tax Cuts - Income tax cuts would boost auto sales
4. Demographic - long term growth potential

 

Industry Structure

1. Two wheelers is highly consolidated industry with top 3 players (Hero Honda, Bajaj, and TVS) accounting for 80% market share.

2. Cars are also very much a consolidated markets, but there is a threat of increased competition going forward.

Banking Sector Basics

Overall Picture
Banks have very high linkage to the overall macroeconomic environment, and have very standard practices across the globe (can be compared with global peers on different ratios). This being a very important sector, is very tightly controlled and highly regulated.
One key unique feature of the industry is that here equal emphasis is given to the balance sheet (along with Income statements).
 
Asset Liability Mix
The asset side of the balance sheet mainly consists of Loans and Advances (~60%) and Investments (~27%). Most of these investments are into G-Secs (meeting the SLR requirements), and very little investments in other assets.
On the liabilities front, bulk of it is from the customer deposits (~75%).
 
Competition
More than 75% of the loans are from Public sector banks, with SBI group alone having a 25% share. Private banks have only 25% of the market now, but are growing rapidly.
 
Market
India has amongst the lowest Loan/Deposit ratio in the world. And total loans are still ~50% of the GDP. Also, consumer loans are just 10% of the GDP, so there is a tremendous opportunity for growth.
A large chunk of household savings flow to Bank Deposits - more than 50%. Good opportunities in Wealth Management, and Insurance - private banks are well positioned to capitalize on these.
Historical growth rate has been high at 12-20%, and this seems sustainable for another decade. Penetration level has improved considerably, though still much below global standards. NPLs have continued to drift down.
 
Financial Services Opportunities
1. Brokerages
2. Wealth Management
3. Life Insurance
 
Key factors affecting Stocks

• Loan Growth: Slowing down recently, from 30%+ levels in 2007 to ~17-18% now.
• Earnings: Major contributors are Growth and Portfolio Gains (in falling rates scenario)
• Interest Rates: Meaningful -ve correlation between stock prices and interest rates. However, key is the distinguish whether low rates are due to liquidity (positive for economy) or lack of loan demand (negative).
• Asset Quality: This factor is quite passive, and is talked about only in cases of sharp asset deterioration

Stock Futures Basics

Advantages of Stock Futures

1. Leverage
2. Lower Transaction Costs
3. Hedging/Shorting

Market Participants

1. Cash volumes are mainly generated by Long Only funds, DII and Retail participants. The volume in retail is fairly stable over time, compared with futures volume.

2. In Stock Futures, major participants are retail speculators and hedge funds – looking for high leverage.

3. Index Futures are mainly used for hedging purposes by institutional players – long only funds.

OI Information
Stock Futures OI largely are a function of speculative activities in the market. In periods of heavy bullishness (2007-end), there was huge OI build-up in the stock futures (and not much in Index Futures). However, that corrected after the crash, and came back to normal levels. Index Futures OI do not fluctuate too much as hedging requirements do not wildly fluctuate.
 
Important Indicators

1. Basis: Sign of pressure from longs or shorts
2. Open Interest: Amount of interest in the underlying
3. Price Change: Direction of the momentum in the underlying

Have to see these indicators together to make sense of the activities of the market participants – for example, when basis is strong, and OI is rising, a price rise indicates long side speculative activities.
 
Index Arbitrage
Nifty futures usually trade at a discount to the fair value (as it is used as a hedging instrument by the long only guys), and as a result, arbitrageurs put up positions in Long Nifty Futures and Short Stock (or SSF).
A large chunk of this position is sticky, in line with the fact that a large chunk of short Nifty (hedge) is also sticky. However, not all arbitrage players have access to the full 50 stocks at all times, and hence they usually have to short a few SSF also in the stock basket. Hence, some of the stock futures also trade at a discount due to this factor (mostly those whose inventory is not readily available). Most of the under-owned stocks trade at discounts (only Nifty stocks).
 
Futures Rolls
At expiry, investors have the following options:

1. Unwind
2. Expire
3. Rollover
4. Convert to Spot (buy/sell spot in VWAP)

Considerations during the expiry

1. Basis: If the futures have been trading in premium over the month, then there would pressure from the long side – rolls also might happen at a premium (the premium in near month would move to next month close to expiry)
2. Market Trend: A rising market would imply futures in premium – and hence rolls also might happen at a premium
3. OI with Price Action: A rising OI with price increase would also mean more and more pressure on the long side, and higher roll premiums.
4. Historical Rollover Ratio: The proportion of futures positions getting rolled every expiry also gives a good indication of the remaining interest in the counter.

Exit Point

Why do all the trading literature concentrate so much on entering a trade? The successful exit strategy is as important as entry. And that would many a times make the difference between a profitable trade and an unprofitable one.

More on this later, when I finish some of the Technical Analysis books that I have got.

Market View: October 23

Nifty Movements: Nifty lost some of its gains this week, and ended the week a shade below the mark of 5000. However, the market was quite strong, and despite the bad news from the RIL front, managed to close flat on today. Think the market would continue to hold over the short term, and may end the year at a high. Usually, markets do have a tendency of rallying close to the year ends, and if that happens, we may be in for another 10-15% up move from here.
 
Stocks: Telecom stocks have been very weak recently, and they continued to be under-performers. Real Estate also faced sell-off for a couple of days. However, the big under-performer has been RIL – marred in controversy and court battle, and then the Hardy pullout. IT companies surprisingly have held out well in spite of a stronger outlook on INR, though going forward we may see some weakness there. Another sector to watch out for could be the metals, with bad news expected from China.
 

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Next Week Views: The main risk remains the Chinese markets, and if the news coming out of there about the overheated economy and inflation concerns indeed is true, then we may see weak markets. However, there is not much bad news coming out of West at the moment, and if the results continue to surprise, the markets may even accommodate modest bad news from China.
I think we are standing at some sort of an inflection point – there are people who believe markets would reach new highs, and there are people who believe we are in the middle of a ‘W’. And the rational from both the sides seems to make sense. May be, this is the way markets are designed to be – capturing all the present information, and standing well in balance. I haven’t seen a bull-run from a trading floor before, so am not sure how they appear. Were there equal number of skeptics way back in the bull markets of 2003-2007 as well?

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Food for Thought: How do you think the consumption patterns would change in the next 10 years? What would be the next generation consume more, and what they would consume less? I think all the things traditional would be consumed less and less (in value terms adjusted for inflation). And people would consume more and more technology. Just like there has been a great shift in ‘Telecom’ consumption over the last decade, I think people would consume some technology a lot more than what they are consuming now. If I have to put a bet on different industries, this is how I would think:

1. IT wouldn’t remain an industry servicing large brick-mortar corporation. As more and more things start happening online, more and more IT services would be consumed by all organizations. And I would think there would be a drastic shift in the IT-related expenditure for all firms.
2. Telecom would continue its march, and might develop into the biggest industry. Most of the telecom companies would offer all sort of communication services – Television, Media, Broadband, and Telecommunications (they have already started). I think the opportunity here is huge, and we have just hit the tip of the ice-berg. The usage for the communications would increase greatly, and if somehow they manage to replace the credit cards as payment options, then it would be unprecedented. And I see nothing that a credit card offers which a mobile phone can’t do better.
3. Media/Entertainment: This is another industry which I would think would grow. Currently media is not being priced correctly, and most of time people make bundled payments (when paying for all the channels). With selective view-based pricing, and more and more cities coming under the multiplex chain, media revenues make take a quantum leap sometime in the next few years (with multiplexes opening just in the metros, the revenues from movies leapt from 10-20 Cr average to 50-60 Cr average).

Rally Monkey: Still Playing At a Market Near You

Nothing describes the current markets better than the Rally Monkey music. This one has to be played out loud in the office during the market hours (you will need to turn ON the sound on this page).

Disclaimer: The webpage actually has nothing to do with the markets, but all the investors indeed dance to similar tunes :)

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The markets have been correcting for the past few sessions, and daggers are out on the sustainability of the rally. A growing number of people believe that the markets have run up too high, and are long overdue for a correction. Well, I’m not completely bearish even now, and think there are still a couple of legs to the rally. I might be wrong here, and might have to eat my words pretty soon (for October isn’t over yet), but I would still stick to the long view.

Oil is back at $80 levels, Gold is trading at record highs, EUR has gone back to 1.50 levels and Equities are almost at their early or mid-2007 valuations. But China is still 50% down from its peak. The country best placed to avert the crisis, inspite of all the steroid-led growth stories, hasn’t seen too much of a recovery. And even though it makes sense (as China’s growth is led by export to US), I don’t think US would remain with 10% unemployment numbers for a long time. And hence, there is a strong case of rise in Chinese stocks, adding another leg to the global rally.

The underlying rational for all my bullish thoughts is the assumption that US isn’t going to have a lost decade. Japan’s case was different – Yen wasn’t the world’s reserve currency. Here, US is the master of the world – and any holes in its economy would be plugged by Qatar or Singapore or anyone else. There is a strong queue waiting to bailout US, for its the safest asset in the world. And as US comes out of the crisis, the whole world would follow, sooner or later.

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Food for thought: I got an answer to my long puzzling puzzle of why markets tend to go up more often that not. Money Supply growth is quite large compared with the World population growth, and hence, with each passing day, world is getting richer and richer. And there are only two avenues to use this money – consumption or investment. Inflation measures the rise in consumption demand, and rising markets measure the rise in investment demand. And since the marginal propensity to consume goes down as income increases, the rise in investment demand increases more than the inflation. And hence, the world markets are in perpetual bull runs.

Market View – October 5

Oktoberfest has started in Germany, but the Oktobercrash is nowhere in sight. And with each passing day, I’m getting more and more pessimistic about the possibility of it (rather than sounding optimistic, I have tried to use a double negative here).

1. To start with, I don’t see too many companies posting very bad results. Most of the times before the crash happens, the results are really bad (like in 2008) – which though not the final trigger, but atleast contribute to the weak markets. This time around, with the lower expectations, results won’t be ‘exceptionally’ bad for most of the companies. Hence, one of the crucial requirements of a crash is missing.

2. Another factor which shoots down a possibility of a big crash is the fact that rarely have the markets crashed in two consecutive Octobers. Historically, we have had crashes separated by a decade or so (atleast in near history, with 1987 crash, followed by 1997 Asian crisis, and 2007 credit crisis). So, it might be too much to expect a crash in 2009. I would rather put my money on a 2017 crash here :).

3. Last year, there was a great uncertainty in the markets – job markets as well as asset markets. No one seemed to have any clue as to how many banks would go under, or who’s next, or whether one would be left with any jobs at the end of the year or not. There was panic everywhere, and people had put on hold all their investment plans – manifested in the falling property prices, no IPOs, decelerating loan growth, etc. Somehow, this time around, that fear is missing. Property prices have risen by 20-40% in Mumbai, people are no more ‘too’ concerned about their job prospects, and all the asset classes are booming. Somehow, the fear factor seems to be gone.

4. Relentless FII buying in India is in fact making me believe that we may be in for a big rally soon (even from these levels). FIIs have bought stocks worth USD 12-13 Billion this year, and this is inspite of the initial selling in the months of Jan and Feb. To put figure into perspective, in 2007, FII had bought stocks worth USD 17 billion, and in 2008, they sold worth USD 13 Billion. So, the buying this year is almost on a record scale, and won’t be surprised if the locals start jumping in anytime now. Post-diwali, I think there would be a queue of people trying to get into the markets, and that might take it another 10-20% from here.

So, I would stick with my year end estimate of 20,000 on the Sensex. This might sound ridiculous, but then, 2009 as a year has been exactly that.