GalaTime

• Bloomberg: Bill Miller Not Dead Yet as Value Funds Bury Quants

Investors using so-called quantitative momentum strategies — which speculate that the worst stocks in the past 12 months will continue to decline — have become this year’s biggest losers after banks and companies that rely on consumer spending surged. Quant momentum techniques may have lost 27 percent this month in the U.S., the most since at least 1993.

While momentum investors have suffered in 2009, last year’s worst performers, Miller’s Legg Mason Value Trust and Harry Lange of the Fidelity Magellan Fund, are making comebacks with bets on technology companies. Both lost more client money than 98 percent of their rivals in 2008 by clinging to or doubling down on shares of financials. Now, Miller is outperforming 68 percent of his peers with a 1.2 percent gain in 2009 after boosting his stake in Hopkinton, Massachusetts-based EMC Corp. in the fourth quarter.

• WSJ: Why Capital Structure Matters

With financial institutions weakened by the recession, public and private markets began displacing banks as the source of most corporate financing. Bonds rallied strongly in 1975-76, providing underpinning for the stock market, which rose 75%. Some high-yield funds achieved unleveraged, two-year rates of return approaching 100%.

Just as in the 1974 recession, investment-grade companies have started to reliquify. Once that happens, the market begins to open for lower-rated bonds. Thus BB- and B-rated corporations are now raising capital through new issues of equity, debt and convertibles. This cyclical process today appears to be where it was in early 1975, when balance sheets began to improve and corporations with strong capital structures started acquiring others.

• Hussman Funds: Trading Volume Separates Bull Markets from Bear Rallies

If March 6th proves to be the bottom of the market, Anatomy of the Bear author Russell Napier can put off his next edition for awhile because the most recent bear market won’t qualify as a great bottom. That’s because even though the market’s decline since 2007 has been one of the largest on record, it didn’t bring the market to truly great values. In his analysis of the stock market bottoms of 1921, 1932, 1949, and 1982 Mr. Napier chose to use two measures to gauge the valuation of the market. One was Robert Shiller’s PE ratio based on trailing earnings. As I noted in Market Valuations During U.S. Recessions , this ratio has fallen to the mid-single digits during periods of extreme undervalution. It’s currently 15. The second valuation tool Mr. Napier used was the q-ratio, a measure of market valuation relative to the replacement cost of assets. Deep undervaluation for this measure tends to be when market prices are roughly 35 percent of replacement costs. According to the most recent data the q ratio is about twice that.

An important observation that Mr. Napier makes in his studies of the most damaging bear markets is that even if the initial move off of the bottom is lacking volume, once a new higher level is reached, the market should begin to attract buying interest. In each of the bottoms he studied, volume expanded noticeably after the intial rally. This idea also holds up for the majority of bear-market bottoms. In the graph below the axes are the same as the graph immediately above. The vertical axis shows the percent change in the S&P 500 while the horizontal axis shows the percent change in volume. But this time the period is 6 months from each bear-market bottom.

• Morgan Stanley: India - Flirting with QE

Since September 2008, India’s foreign exchange reserves have declined by US$34 billion. This, we believe, has resulted in a sharp deceleration in M1 growth to 12.7%Y as of March 13, 2009 from 19.4%Y in August 2008. Additionally, the choice of purchasing longer-term government securities and MSS bonds as a vehicle to inject liquidity should have the added advantage of capping and possibly reversing the sell-off in bonds since the start of the year, which persisted even after a 50bp cut in policy rates on March 4.

Both the net injection of liquidity to shore up M1 and the possible lowering of bond yields lead us to classify the RBI package as ‘active quantitative easing’ – outright purchases of assets with a view to increasing money supply and possibly easing financial conditions at the same time. This policy measure is in the same vein as the measures introduced by the Fed, BoE and the BoJ, but on a much smaller scale.

We believe that these liquidity injection measures initiated by the RBI, a likely further deceleration in banks loan growth and improvement in the government’s consolidated fiscal deficit (including off-budget subsidies), should result in the 10-year bonds declining to 6-6.25% over the next two months and further to 5.5% by end-2009.

• DNA: Pvt equity, venture cap deals fell sharply in Jan-Mar

PE firms invested $526 million across 36 deals in the quarter ended March 2009. According to Venture Intelligence study, the sum was much lower than in the same period last year.

While January-March 2008 saw 133 deals totalling $3.9 billion, the numbers for the same period of 2009 were lower than even those in the December 2008 quarter, which saw investments of $1.2 billion across 63 deals.

VC firms invested $44 million over just 9 deals during the period. This was lower than the $91 million invested across 18 deals in the December quarter and the $226 million across 33 deals in the year-ago period.

• Mint: Prepare for lower Q4 numbers: brokerages
  

Centrum Broking forecasts a 13% decline in the earnings of the companies it tracks.

Motilal Oswal Financial Services Ltd sounds more bearish, even though in its earning preview report, it wrote “…we could be at the end of the earnings downgrade cycle”. It forecasts a 19.3% decline in the earnings of the companies it tracks, excluding oil firms.

Typically brokerages track between 100 and 150 top listed firms among the pack of BSE-500, which make up for at least 90% of India’s market capitalization.

Religare Hichens Harrison predicts a 9% decline in net profit for the 30 companies that make up the Sensex.

• Harvard Business:Do Economists Breed Greed and Guile?

… most economists at top business schools are clueless about the nitty-gritty of management, which can’t be captured in elegant mathematical models. They treat any teaching remotely related to what leaders actually do on their jobs as a low status activity; at faculty meetings, I’ve seen economists and their followers dismiss and ridicule professors who teach “soft” skills. Those who speak in simple language and use words instead of numbers are often screened out, expelled or sentenced to spend their days at the bottom of the pecking order.

If MBAs are already attracted to business schools for the money, and are reinforced in the belief that that self-interest and greed (perhaps along with lying and backstabbing) are natural and inevitable, then no wonder we’re in trouble.

• Economist: Minsky’s moment

The cost of capitalism, to use the title of a new book* that draws heavily on Minsky’s work, is first, that financial bubbles are created and second, that governments are forced to rescue the sector when those bubbles pop. Those who believe blindly in free markets are thus mistaken, in the view of Bob Barbera, a Wall Street economist and the book’s author.

… central banks should build the level of corporate-bond spreads into their models. When spreads are low, risk appetites are high, as they were in 2005-06. That should lead central banks to tighten monetary policy. When spreads are high, they should ease.

• Bloomberg: High-Yield Default Rate to Reach 53% Over Five Years, Reid Says

About 53 percent of U.S. companies that issued high-risk, high-yield bonds will default over the next five years, according to Jim Reid at Deutsche Bank AG.

The figure compares with a 31 percent five-year rate in the early 1990s and 2000s, and as much as 45 percent “in a very, very different market in the Great Depression,” Reid, the London-based head of fundamental credit strategy, wrote in a note to clients today. The estimate is based on the premium investors demand to hold the notes and assumes recoveries from the defaults will be zero, Reid wrote.

Guesstimate, but scary nevertheless.

• Economist: Global Heroes, A special report on entrepreneurship

This special report will argue that the entrepreneurial idea has gone mainstream, supported by political leaders on the left as well as on the right, championed by powerful pressure groups, reinforced by a growing infrastructure of universities and venture capitalists and embodied by wildly popular business heroes such as Oprah Winfrey, Richard Branson and India’s software kings. The report will also contend that entrepreneurialism needs to be rethought: in almost all instances it involves not creative destruction but creative creation.

… the threat to entrepreneurship, both practical and ideological, can be exaggerated. The downturn has advantages as well as drawbacks. Talented staff are easier to find and office space is cheaper to rent. Harder times will eliminate the also-rans and, in the long run, could make it easier for the survivors to grow. As Schumpeter pointed out, downturns can act as a “good cold shower for the economic system”, releasing capital and labour from dying sectors and allowing newcomers to recombine in imaginative new ways.

• Morgan Stanley: Trouble Zone and Debt Rollover Risks

The Trouble Zone is now facing the challenge of external debt repayment-related capital outflows. Indeed, in 4Q08, capital outflows from debt repayments not rolled over have probably been higher than portfolio equity outflows in Korea and India. These three countries have the highest ratio of external debt to FX reserves. They also have the highest ratio of short-term debt to FX reserves. Korea and Indonesia stand out on this measure, leaving India a distant third in the ranking.

The Eastern European credit turmoil has aggravated the problems for the Trouble Zone in AXJ. Deleveraging in the European banking system is indeed more concerning for the Trouble Zone than the deleveraging in the US banking system. According to the BIS, as of September 2008, about 52% of foreign debt claims on these countries were by European banks. While some of the large, decent-quality companies should be able to roll over their external debt (albeit at higher rates), the small and mid-sized companies are likely to find it hard to get their debt rolled over. In Korea and India, small and medium-sized companies had raised a significant amount of external debt over the last few years.

• Mint: Yield on 9-year bonds top 7% on oversupply

Bond dealers now fear that yields will touch and even cross its July 2008 highs of 9.5% in early next fiscal year beginning 1 April, if the government does not sell its bonds directly to the Reserve Bank of India (RBI). The government is estimated to borrow Rs3.62 trillion next year. It is raising Rs2.6 trillion from the market this year.

Banks will not be able to book treasury profits this quarter and may even have to book losses to show their bond holdings at the current market price rather than at the price these bonds were bought.

Remember those gung-ho articles from December/January - “bonds are the next great investment” ? The fast & furious drop in yields to nearly 5% was a sure sign of retail money flooding into debt funds. Now that most of them have taken a bath, we are getting closer to a good entry point to go long bonds - perhaps in May?

• Business Standard: Gold imports on crash course as prices skyrocket

Gold imports fell by a third to 20 tonnes in January this year from a monthly average of 60 tonnes last year. By all available indications, imports will be negligible in February when prices crossed the Rs 15,000-limit.

Sources in the association estimated that total imports would fall to around 400 tonnes in 2009 — one of the lowest in the last decade, and almost 45 per cent lower than last year’s level.

All India Gems & Jewellery Trade Federation Chairman Ashok Minawala said scrap gold sales jumped 20 to 25 per cent from the average daily recovery of 500 kg.

• Mint: ‘Holes in the ground’–the end of the commodity super cycle

In 2008, each one of these factors went sharply into reverse. The global financial crisis resulted in reduced availability and higher cost of debt, affecting commodities through several channels. Leveraged investors were forced to liquidate their positions as leverage was reduced and investors redeemed capital. The reduction in debt also reduced global growth sharply and the demand for most resources.

Resources companies compounded the problems through aggressive acquisitions that were sometimes debt-financed. Unlike financial assets, commodities, for the most part, are subject to the laws of economic gravity—supply and demand.

The most emblematic project of this cycle is a project proposed by Tarek bin Laden, one of Osama bin Laden’s many half-brothers. The project entails twin cities on either side of the Bab al-Mandib (Gate of Tears) strait at the mouth of the Red Sea linked by a 29km bridge across the strait. The project cost was estimated at $200 billion.

• Malaysian Insider: Dr Doom says US govt bonds next bubble to burst

In Asia, avoid real estate in financial centres, but look at things such as soft commodities, which, while volatile, are on an upward trend.

There are also opportunities in pharmaceutical and hospital management companies, and in banks, insurance companies and brokers, especially in emerging economies.

Opportunities also abound in plantations and farmlands in Indonesia, Malaysia, Latin America and the Ukraine. He also advised investors to go long on gold and corporate bonds but to dump US government bonds.

• Barrons: Stay Away From Long-Term Treasuries

Right now the yield on the 10-year Treasury note stands at 2.89%. On an after-tax basis for an investor in the highest tax bracket, that translates into an effective yield of 1.88%. In order for such an investor to show any real (after-inflation) return over the next 10 years, inflation therefore would have to average less than 1.88% for the next decade.

In many ways, the current situation is just the inverse of what prevailed in 1981, when the yield on the 10-year Treasury climbed above the 15% level. That meant that investors were betting that average inflation for the subsequent decade would be close to double digits. That in effect meant that investors were betting on the financial equivalent of the end of the world, since double-digit inflation for 10 years in a row would have been nothing short of devastating.

• NY Times: Rogoff: The Exuberance of India

. . . the real reason my Indian companions were so cheerful was a strong sense of relief that they were living far from the epicenter of the recession, insulated by their country’s size and still-comparatively stringent restrictions on international capital flows. “Thank heavens for the strong regulatory framework we have in our financial system,” one leading provider of soft consumer goods said.

Walking around the room and polling quite a few people, I came up with a “Davos India dinner consensus” forecast of 6 percent to 7 percent for India’s 2009 growth, a remarkable figure in a year where the most developed countries are expected to have negative growth, and where world growth will struggle to reach 1 percent.

6-7% ? Wishful thinking!

• DNA: Bond fever rages out of control; issues top Rs 85k cr

Before the current fiscal year runs out, more of the same may be in the offing — especially in regard to oil bonds, if the oil refiners are to emerge in the black — so that we may reach a paradoxical situation of the off-budget liabilities approximating to the explicitly stated fiscal number for 2008-09 which is Rs 133,287 crore.

Already, the “bond burden” under these two heads alone had reached 1.6% of the GDP, sharply up from 0.4% for 2007-08.

. . . we must brace for the fiscal deficit for this year, including the off-budget liabilities, in the vicinity of 8%, as envisaged by the Prime Minister’s Economic Advisory Council, but with an upward bias.

• Forbes: Yet Another Credit Crisis: PIKs

Credit was cheap, and the owners financed the deal partly with toggle notes, a.k.a. payment-in-kind, or PIK, bonds. These paid an extra percentage point or so of yield and allowed Freescale to issue new notes in lieu of interest payments.

Credit was cheap, and the owners financed the deal partly with toggle notes, a.k.a. payment-in-kind, or PIK, bonds. These paid an extra percentage point or so of yield and allowed Freescale to issue new notes in lieu of interest payments.

• Guardian: Global recession - where did all the money go?

• Business Standard: Corporate bond market sees surge in trading volumes

Since November last year, 69 companies (including PSUs and banks) have issued bonds worth Rs 64,271 crore, according to Bloomberg. The banking sector, which is in the process of raising its Tier-II capital, has also been quite aggressive. Some like Bank of Baroda and Bank of India have already raised capital through this route. At present, Oriental Bank of Commerce is in the process of doing so. What has helped them is the sharp fall in the rates from December.