World Economy in Recession

I recently started working in an Investment Bank. And over the last one year, have had the opportunity to witness an event that may well describe our age. The credit-crisis have changed the shape of the world, and if not the Great Depression, this is at least comparable to the 9/11 attacks on the US.

Here are my learning from this recession:

1. Recession doesn't end very early, whatever be everyone's prediction about the state of the world markets, it does last for some time, sometimes for years. It may take us another 12 months to get to the end of the current one.

2. During recession, there are common themes which would always make money. One should be long the defensive sectors like FMCG, Pharmaceuticals, and be short the leveraged sectors like Real Estate, Banking, etc. Cash is king in these times, and sectors/companies with lower Debt/Equity ratios tend to outperform the rest.

3. At the onset of recession, rates usually move up - mostly caused by high levels of inflation. As recession deepens, central banks come into the picture, and start cutting rates. It might be a good idea to wait for rates to go up to 12-13% and then put some money into debt paper.

4. Oil and Gold perform very well during recessionary periods. One of the prime reason is flight to quality - these are commodities, and not paper certificates. Another reason is their link to inflation. Higher the inflation, higher the commodity prices. Hence, inevitably, most of the recessions are marked by rise in price of commodities.

5. Financial Sector is amongst the worst performers in a bad economy. The higher interest rates lead to de-leveraging, and lesser credit in the system. All this has negative effect of the banking system.

6. Big Caps always outperform the Small Caps, primarily because of the flight to quality syndrome. Another reason could be that during tightened credit conditions, small companies find it harder to raise debt, and their costs of funding soars higher.

7. Futures trade at lower premium (and even discounts) during Bear markets. This is simply due to huge shorting in index and stock futures by speculators as well as portfolio managers.

Tape Reading

Tape reading is a technique of reading the price action of the stocks, and infer something about the market activity in that name. In earlier days, expert traders used this to track strong buy or sell orders in a particular stock.

These days, the technique has become a little complicated, with millions of people having access to the trading terminals, and different software programs generating automated responses to certain events. However, as always, any astute trader can still devise his ways and means of reading the tape - which now may include in addition to price information on volume, open interest, put-call ratio and futures' basis.

I like this concept, and will try to get my hands on some literature on the subject.

First Trade

In the last post I had mentioned about my first trade, and the losses I made in it. As it turned out, those were just paper losses, and I actually got to close the trade at a profit.

Whatever, in the end, I just got out capturing a panic-moment in the market when the stock went down from -4% to -7% in a few minutes. The best thing about the current market is that everyone is scared, and it takes only a few moments for a stock to fall down. The best policy during these volatile market should be to capture the intra-day volatility.

Still, the lesson is learnt from the trade. Next time, would be a little more careful before shorting a stock. It was a lucky escape for me, and I would be doing more home work from now onwards.

First Trading Lessons

As I write this, there is a major turmoil developing in the world markets. Bear Sterns is already down the dump, being almost acquired by JPMC for as little as USD 240 MM. Lehman has had a bumpy ride on the last two days. Yesterday, it was down by more than 40% at one point in time, and today, its up by 35% on the back of positive returns.

Anyways, as people debate over the future of the financial firms, and these wall street barons, I have put on my first real trade. I am short on ABCD stock and have hedged that by being long on the index. ABCD was down yesterday, and I had made a small profit yesterday. However, today, it went up and up, and I have more than 4% loss for the day. I would wind up this position at 5% loss.

First learning from the trading:

1. Never short a stock which is backed by a strong promoter having large holdings. The promoter can stand at a price, and even when the whole market is falling, the stock may just stand at one price.