A decade of Dow

 

Call it curiosity or joblessness, today I decided to spend few hours looking at the Dow Jones Index data for the last decade. I have no stake in any US stock, but my objective here is to understand the magnitude of impact of any event on the stock market. Though doing this exercise on the Sensex would have made more sense to me, I figured that finding data and information on something that is US based is probably faster than its Indian counterpart. 🙂 

Thanks to MSN, I got the Dow Jones Industrial average data for the period Oct 1998 to Oct 2008 within seconds. I marked all the major high and low points in the graph (in blue). And a mouse over feature on MSN helped me find out the dates and correspoding closing values of the index. That data, in turn was used to create the left side of the table below the graph. 

The right side of the table shows information collected on the events that coincide with the corresponding high-low points. These events have been gathered from google searches which resulted in articles and news reports relevant to the months/indices in question.

 

 

 

The first row of the table shows an important event that is not marked in the chart. 1997 saw turbulence in the Asian market that affected the world markets. The major event was the fall of LTCM hedge fund and default by Russia which led to a major financial crisis. Prior to that the US economy, since 1992 was on a Clinton Bull Run. The Dow was at around 4000 when Clinton took office and went on to hit 12000 by 1999.

Bush took office in 2000 and for the next 3 years a series of major events of all kinds – social, economic and financial, resulted in a very erratic market behavior. During that period, Federal interest rates were cut multiple times resulting in very cheap credit. Slowly, the housing mortgage market began growing. Internet and technology companies continued seeing good boosts and grew at phenomenal rates.

The Bush Bull Run from mid 2003 to 2007 was initially marked by the capture of Saddam Hussein. The same period saw tax cuts and rise of internet giants like Microsoft and Amazon. General confidence in US market started growing and companies across industries did well. The Industrial average index saw new Tech companies being a part of it. The year 2005-2006 saw setbacks that had impact on oil (in the form of hurricanes Katrina and Rita) and uncertainty (due to change in Fed Chairman). However those were minor and the general trend was bullish.

The subprime mortgage credit crunch that we talked about in previous posts, characterizes the major dip since end of 2007. As you can see, the fall till date is a very steep one. And every other day marks a new record of historic importance. The past year has seen a tumble of about 7000 points which is more than the points gained in the Bush Bull Run.

While there is no particular conclusion I can or like to draw from this post, I am wondering if I can do something with this and my earlier post about technical analysis and make some predictions. Well then, I guess the agenda for the next post is set and if it doesnt work, I’ll go on and do the Sensex version of this one! 🙂

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What just happened??

[A layman’s view to understanding the present US Financial Crisis]

 

Before we get into the events, it is important to understand certain basic terminology and mechanisms.

Mortgage backed securities – Banks have two primary functions. Accept deposit and lend loans. When a borrower approaches a bank for a loan, the bank (after due diligence of the creditworthiness of the borrower) lends him money from the funds it has accepted as deposits. The bank charges a rate of interest for the time the borrower takes to repay the loan.

Given this simple mechanism, the bank may face a problem when the market rate of interest fluctuates or when it may run out of funds for further lending at a certain point. 

In order to solve these problems the concept of mortgage backed securities was introduced. In this system, the bank issues bonds against the loan and sells it to investors at a rate of interest that is equal to the interest payable by the borrower on the loans.

For e.g, say X borrows $1,000 for a home loan at 8% interest p.a from Bank of America. The bank may sell 100 bonds worth $10 each to an investor promising an interest of 8% on the amount. This way the interest payable and receivable are cancelled out by the borrower and the investor. So basically whatever the borrower pays as interest goes to the investor as his return on investment. The problem arises when X defaults his interest payment.

Subprime lending crisis – Check out my earlier post, Crash, boom, bang!

Credit crunch – A situation in which there is a sudden reduction in the availability of loans or increase in the cost of lending by banks and financial institutions. This is usually caused when banks and institutions have suffered losses in lending and have bad debts.

Bankruptcy – A legally declared inability or impairment of ability of an individual or organization to pay their creditors. This is also known as Chapter 13 in financial circles.

Bailout – A situation where a bankrupt or nearly bankrupt entity, such as a corporation or a bank, is given a fresh injection of liquidity, in order to meet its short term obligations. Often bailouts are by governments, or by consortia of investors who demand control over the entity as the price for injecting funds. 

Housing Bubble – Is a type of economic bubble that occurs periodically in local or global real estate markets. It is characterized by rapid increases in valuations of real property until they reach unsustainable levels relative to incomes and other economic elements.

Foreclosure – Is the legal proceeding in which a mortgagee, or other lienholder, usually a lender, obtains a court ordered termination of a mortgagor’s equitable right of redemption.

 

So… what just happened?

7th September 2008 – Fannie Mae and Freddie Mac takeover

Fannie and Freddie are two very large mortgage companies that are sponsored (but not run) by the Federal Government. Their primary business is to guarantee the mortgage bonds to the investor in case payments are missed by borrowers. They also create a fund(as in insurance) to make up for losses in cases of default. This fund is created by taking a certain percentage of the payments or from sale of the house.

Since Fannie and Freddie, the Government backed institutions provided guarantee, the mortgage securities industry flourished.

When the subprime crisis started in 2007, all the defaults, bad credits and foreclosures largely affected Fannie/Freddie’s business. The two have more than $5 trillion in outstanding mortgage backed securities. The share prices hit rock bottom.

The Government had no option left but to take over the two companies and infuse money from the treasury to clean up the mess.

14th September 2008 – Bank of America acquired Merrill Lynch

ML is a large investment banking and financial firm that incurred billions (app. $51billion) in losses due to investing in mortgage backed securities that went bad during the subprime crisis. The company was recently acquired by its rival, Bank of America.

15th September 2008 – Lehman Brothers bankruptcy

Lehman Brothers is a 158 year old global financial services and investment banking company. It had ventured into mortgage backed securities and during the subprime crisis, one of its firms was closed. The company lost huge sums in the form of goodwill and its share prices tumbled. Neither Bank of America nor Barclays who were called for deals to buy the Lehman, made a bid. The Government also refused to bailout the company from bankruptcy.

16th September 2008 – AIG bailed out

AIG, the largest insurance company in the world is being bailed out by the Government. The problem is the same; loss due to subprime crisis resulting in bankruptcy. AIG’s main line of business is insurance services but the company had diversified and entered other areas including mortgage backed securities.

The Government decided to bailout AIG due to its enormous funds (trillions), public stake, global ties across industries.

 17th September 2008 – WaMu Auction

Washington Mutual or WaMu is a former mutual fund company which later became the third largest mortgage lender. In 2007, the company suffered huge losses in its home loan divisions due to the subprime crisis which resulted in layoffs and affected stock prices. Now the company has hired Goldman Sachs to take care of its auction.

 

Why this happened?

As you would have noticed by now, the answer to the ‘why’ is quite clearly the subprime crisis. Let us drill down further.

In the early years of this decade, in order to remove the sluggish nature of the economy, the Federal Reserve lowered the mortgage interest rates. This resulted in a trend of rising housing prices. Unlike traditional loan diligence, the borrowers were given loans without looking at their creditworthiness. Instead, people who were lower on their creditworthiness rating were charged a higher rate of mortgage interest. Because of the housing bubble and the high demand for loans, banks and financial companies didn’t waste their chance to make a quick profit out of the situation. Loans were endlessly given out. Very high rates were charged. These loans were in turn sold as mortgage backed securities to investors. This business picked up across companies in the financial industry and everything seemed to go well until the bubble burst.

When the interest rates reached a level where it was too high to afford by many borrowers, lot of the loans went bad. This in turn had an impact on the investments in mortgage backed securities. The demand for Fannie and Freddie guaranteed securities decreased. Foreclosures increased, house prices plummeted, and lenders incurred huge losses unable to value assets resulting in liquidation.

A major argument and an increasing realization is that there was very less regulation imposed on the financial instruments by the Federal Reserve/ Government.

 

Who gets affected?  

The real estate crisis infected the financial markets. This led to enormous job losses and money losses. The financial institutions were unable to lend money to business that really needed it to grow. This is leading to a snowball effect and is slowly hitting every industry one by one. This, coupled with the rising and highly fluctuating gas prices is resulting in a huge economic recession instead of what was hoped to be only a slowdown in the US.

Thats not all. Most of the afore-mentioned companies operate globally. They have presence in all continents. And in this global economy, a financial meltdown in the US market is bound to have far reaching impact on world markets.

 

Solutions?

The current Wall Street crisis is touted to be the biggest since the Great Depression that hit the US economy in the 1930s. It has been a chain reaction with people across industries suffering. Though the Government has been working on immediate short term relief like the economic stimulus package, it is very obvious that the economy needs a long term sustainable solution to get out of this mess.

The 2008 Presidential Elections will certainly be one of the most important of its kind in a very long time. And the policies, ideas, determination and resolve of the next President will be the crucial factors determining this election.

references

www.wikipedia.org ; www.nytimes.com ; www.spiked-online.com  

Crash, boom, bang!

It has been a while since I posted. Just like our stock market, I crashed! The reason being the market itself. I spent few days finding out the possible reasons and how worse it could get and guess what, I am still as optimistic as ever.

The sensex is down more than 5000 points compared to the highest level it attained towards the end of 2007. Evidently it is a big blow to the traders, investors, funds, IPO’s and most of all to the tempo in the country. The Finance Minister has been trying hard to keep the optimism levels from going down far too much by assuring that our growth rate for the coming FY08-09 is posed at a very promising rate of 8.75% (There has been many statements with a different rate each time, but this one seems to be the final projection).

Now, what really happened?
Recession in the US which is caused by words declared as used the most number of times last year – “subprime crisis”, lies at the root of the problems. In simple terms, ‘subprime’ means loan given to a person who is not eligible for it, because of his low creditworthiness, income or any other unhealthy financial situation. Ironically these loans are given to the same person at a rate higher than the market(reasoning- risk involved). Since US real estate valuations were blown out of proportion and were simply not affordable by subprimes, there developed a crisis. This in turn created lot of pressure in the banking industry that indulged in a lot of subprime borrowing and did not have enough funds to lend to businesses and other consumers who needed them for growth. So slowly the economy began to dip and then crashed. Businesses didnt do well and large number of employees were laid off. Incomes and consumer demand fell and since many countries in the world depend a lot upon the US, exports being the main share of their GDP, those economies also crashed. India was among the least affected as our exports to the US are comparatively less.

There is a reason why our stock market took some time to take the hit. Towards the end of 07, there was a lot of optimism in the our market due to large purchases by institutional buyers, foreign investors, excellent performances by some large cap and mid cap companies, promises and prospects reflected by the Government and a lot of hype. This lead to an illogical overvaluation of stock prices; illogical because they were high not as a result of the company doing well but as a result of speculation. It was like a bubble that had to burst at some point in time. After the Subprime, lot of American investors started pulling away their investments from other countries. This, in hand with the rising oil prices and blow to the software industry, in terms of declining projects, employee lay off and rupee value appreciation paved way to a much needed correction.

This is more or less like a world correction and a lot of people including me are still optimistic because our nation has all eyes focussed on development and stability. This is an opportunity to buy shares of promising companies.
Corrections like these are just nature’s way of telling us not to get carried away but to focus and do things the right way!

(to read more about subprime crisis check http://en.wikipedia.org/wiki/Subprime_Crisis )

 

PC, our phenomenal FM

 I am so glad my friend Suchitra and I have these discussions outside work; discussions about work itself, friends, fun, nations-economies-investments-shares(in our own sweet way), cricket, movies, family and recipes. We agree, disagree, exchange online articles and videos and at the end of the day, its interesting because our chat history turns out to be truly historical !!

Today’s chat history was a milestone because we had this heated discussion about India and America, our economies, politics, culture and almost every other broad aspect we could think of(rather, using every keyword we have come across in our textbooks(i of course used google too)). It got really interesting because we were mostly disagreeing with each other and in the meantime many points came up. And while exchanging all the heat, cold and warmth Suchitra sent me this youtube link – an hour long interview of our Finance Minister, Mr. P Chidambaram by an American interviewer, Charlie Rose interview taken circa 2005.

Its been 6 hours since we ended our discussion and I have already watched this interview thrice, and i wholeheartedly feel it is a must watch for everyone. One hour of time spent on this interview is totally worth it, and i have two points to justify this. But first, watch the interview –

You would probably have guessed by now

point 1 – PC’s communication skills, articulation, confidence, eloquence and clarity

point 2 – the magnitude of content, simplification of economics, relativity of issues, representation of facts and reality

I found it phenomenal! Didnt you?

Stock Picking

I had mentioned ‘Technical analysis’ (and my ignorance about it) in my previous post and had promised to do some reading and get back on the topic in my next post.

 

Today, I’m happy that I finally could comprehend the funda in my very first attempt, and sad to think that I couldn’t grasp it during college, in spite of reading multiple times, from multiple books, sitting in multiple locations, both with and without my spectacles.

 

But before we jump into the meaning, let’s understand the context.

If you had Rs.10000 to invest in shares and more than 6000 stocks to choose from, how would you go about it? Let’s look at certain thoughts that would hover while you try to make the right decision –

  

• Why am I looking at this option?
• What is the kind of growth in value I am looking at?
• Am I interested in short term or long term investment in shares?
• Do I have the time or patience for day trading?
• Do I want the facility of ‘no tax on long term capital gains’?
• Am I going to keep in pace with the news that affect my stocks?

  

A person who has no clue as to what is happening in the economy/market/country/world would want to take a look at it before he looks at his investment options. From what I found, literally everything around us has an implication in the stock market. So, keeping oneself reasonably in pace with it becomes necessary for making the right choices.

  

From an economy point of view, taking a look at indices like –

·     growth rate – will tell us whether there is optimism and opportunity in the economy

·     gdp – can tell us what the percentage of income contributed by each sector of our economy is

·     inflation rate – tells us how high the money supply in the economy is
similarly, bank rates, interest rates etc.

 

From a political point of view, budget allocations, government policies, coalitions, foreign policy, support to industry etc.
From an industry point of view, supply and demand levels, tax benefits, raw materials and work force supply, performance of related industries, etc.
From a company point of view, financial position, competitors, marketing strategies, funds available, staff motivation, performance etc.
 

 

Once you have a decent idea about these, you will be in a position to ‘relate’. When it comes to economy and investments, it is very important to be able to relate data to deduce informed opinions. ‘To relate’ would mean – to make out what pattern/news around the globe, in the economy, government, industry, competitor or people can affect a given stock. This is called fundamental analysis.

 

While many people think that fundamental analysis is sufficient to find out if a stock is worth buying, there is another school of thought that believes that whatever conclusion one has made out of a fundamental analysis is already reflected in the price of stock. This school of thought proposes to consider the actual price behaviour of the stock. That is, no matter how many highs and lows a stock price has, it will still follow a particular trend; and this trend helps determine whether the stock will do well in the future. This is called technical analysis.

 

Still confused? I guess this chart will make it clearer –

 

  

While the small dips and rises represent the stock price’s reaction to market news, the overall trend which is in an upward direction, shows that the stock is bound to do well and people would want to buy more shares of this company. The time period on the x axis of the graph can be minutes, hours, days or even years.

While some analysts use technical methods to make decisions others depend on economic factors only; still others use a combination of both.

 

My stock market crush

If only I knew, that two years later I would be betting on shares, I would certainly have worked harder on my finance papers in college.

The subject was so interesting, that I looked forward to enrolling for the paper and paid perfect attention in the first few classes. Then one day, came along Chapter 5 – Technical Analysis. I never understood the funda of doing a technical analysis on a stock to find out whether it was worth buying. After all, I was nothing but an average commerce student and anything technical or anything that captured the interest of my engineering background classmates was (bound to be) scary for the likes of me. I think it is from that point on, that I lost total focus on learning further, because all of it went way beyond my highest level of understanding. I spent the rest of my classes looking at the cardio-scan like graphs, wondering how many more classes were left for the course to end.

I always had a fascination for stock markets, but my afore mentioned lack of academic confidence pulled me away from it. Thanks to sufficient enthusiasm from my present boss and more than enough pushing from my better half, I decided to take a look at it once again. This time, the hard way.

Practical experience seemed much better.  But slowly, I felt the need to look at some theory and realized that academics is nothing but a compilation of practical knowledge. I started out learning about some basic terms that are used in the trade; things like stock, shares, quote, scrips, broker, gain, loss, market, sensex, nifty, bulls, bears, booking, sell, buy, short sell, limit order and so on. Then I moved on to understanding how a transaction takes place, who are the people involved, how are all the money and shares transferred, etc. Gradually, I got this idea of playing a virtual game of investment before taking the plunge. I registered at www.moneybhai.moneycontrol.com, in which, as a user I am virtually allotted a total corpus of 25lacs and allowed to trade on real stocks during the market hours. I played this for a couple of months; it was turning out to be a good experience, because, I knew I had to keep pace with what’s happening from the economy, market, industry and company points of view. The motivation was to be the top gainer and get a Rs.10,000 cash prize, but the actual reward is that it has kept my tempo going. It gave me the confidence to venture into the real market.
I no longer look at moneybhai, but since then, I’ve made it a point to keep myself fairly updated with what’s happening around me.

(Frankly, I still don’t know what technical analysis precisely means 🙂 but I vow to find out and write about it in my next article.) 

 

Basic Investment fundas

Finance and investments can get a bit intimidating if not understood properly. I myself have been a prey to this. But for the past couple of months I have been investing more time into understanding investments 🙂 , only to find out that I have been missing out on a lot.

 

 

There are certain prerequisites with respect to our mindset before we start off.

 

·     Its all about thinking clear, using logic and common sense

·     Its involves meticulous planning and discipline

·     It should be understood that there are risks involved

·     It is a must to keep oneself updated with whats happening around, at least in the economy point of view

·     And finally, its not about what others are doing but what’s best for you.

 

 

What’s investing?

Investing basically means putting your money to work. The money you earn and save after your expenses for a livelihood, need not be kept aside idle. It can be put to work and can earn a profit over itself.

Why invest?

By investing, one is making sure he continues his current standard of living even after retirement. He is ensuring that he is secure at the time of emergencies. Investing is a slow process, which bears tremendous results over a period of time.

Investment needs

Given that there are so many investment avenues, making a choice about where to invest in what amounts, for what period and all depends on the person’s needs or objectives, time, his current situation and personality.

·     Needs/ Objectives –General objectives for investments could be to generate current income, safety of capital or retirement planning.

·     Personality – Some people are risk averse or conservative investors, they would rather invest to generate less income if it is at the cost of keeping their money safe. Some people are vice versa.

·     Timeframe – How much time you have left, for your retirement is a crucial point in decided how to invest. Like, the lesser time you have, the more conservative you should be in planning it out. But if you have just started earning, there is time for making up for losses or investing in avenues that are riskier.

 

Types of investments <this section is referred from another site>

Bonds

Grouped under the general category called “fixed-income” securities, the term “bond” is commonly used to refer to any founded on debt. When you purchase a bond, you are lending out your money to a company or government. In return, they agree to give you interest on your money and eventually pay you back the amount you lent out.

The main attraction of bonds is their relative safety. If you are buying bonds from a stable government, your investment is virtually guaranteed (or “risk-free” in investing parlance). The safety and stability, however, come at a cost. Because there is little risk, there is little potential return. As a result, the rate of return on bonds is generally lower than other securities.

Stocks

When you purchase stocks (or “equities” as your advisor might put it), you become a part owner of the business. This entitles you to vote at the shareholder’s meeting and allows you to receive any profits that the company allocates to its owners–these profits are referred to as dividends.

While bonds provide a steady stream of income, stocks are volatile. That is, they fluctuate in value on a daily basis. When you buy a stock, you aren’t guaranteed anything. Many stocks don’t even pay dividends, making you any money only by increasing in value and going up in price–which might not happen.

Compared to bonds, stocks provide relatively high potential returns. Of course, there is a price for this potential: you must assume the risk of losing some or all of your investment.

Mutual Funds

A mutual fund is a collection of stocks and bonds. When you buy a mutual fund, you are pooling your money with a number of other investors, which in turn enables you (as part of a group) to pay a professional manager to select specific securities for you. Mutual funds are all set up with a specific strategy in mind, and their distinct focus can be nearly anything: large stocks, small stocks, bonds from governments, bonds from companies, stocks and bonds, stocks in certain industries, stocks in certain countries, and the list goes on.

The primary advantage of a mutual fund is that you can invest your money without needing the time or the experience in choosing investments. To know more about mutual funds, please visit our learning centre.

Alternative Investments: Options, Futures, FOREX, Gold, Real Estate, Etc.

So, you now know about the two basic securities: equity and debt, better known as stocks and bonds. While many (if not most) investments fall into one of these two categories, there are numerous alternative vehicles, which represent more complicated types of securities and investing strategies.

The good news is you probably don’t need to worry about alternative investments at the start of your investing career. They are generally high-risk/high-reward securities that are much more speculative than plain old stocks and bonds. Yes, there is the opportunity for big profits, but they require some specialized knowledge. So if you don’t know what you are doing, you could get yourself into a lot of trouble. We would therefore suggest that you start with simpler investment avenues and leave these investment vehicles for the experts.

 

Now that we have a basic idea, in my coming posts I discuss about options available under each of these investment vehicles, their pluses and minuses, trends and analyses.