Why is the current easy-monetary policy ineffective?

Ben Inker, head of GMO's Asset Allocation team had a great article this quarter.

It has been the extended period of time in which extremely low interest rates, quantitative easing, and other expansionary monetary policies have failed to either push real economic activity materially higher or cause in ation to rise. The establishment macroeconomic theory says one or the other or both should have happened by now. It seems to us that there are two basic possibilities for why the theory was wrong. 

The first is a secular stagnation explanation of the type proposed by Larry Summers and others. 

The second possibility for why extraordinarily easy monetary policy has not had the expected effects on the economy and prices is an even simpler one: Monetary policy simply isn’t that powerful. is line of argument (which Jeremy Grantham has written about a fair bit over the years) suggests that the reason why monetary policy hasn’t had the expected impact on the real economy is that monetary policy’s connection to the real economy is fairly tenuous.

In this context, there are some important aspects.

First, monetary policy and economy are connected to each other by feedback loops. By now, every market participant knows that if there is any inflation up-tick the monetary policy will be tightened. This information prods the participants in asset classes where the inflation impact will be low. A look at inflation basket will tell us which are these sectors where price runs will not affect inflation. Exotic assets are in fashion for this reason. Art, diamonds, high-end real estate (trophy), luxury items etc all form part of this group.

Second, why does the low-cost debt not push investment for improving productivity for general items that form part of the inflation basket? The answer is there is no demand. When the market concludes that there is a substantial demand to justify the investment then the investments will come. There is no demand because there is excess capacity, predominantly in China for manufactured goods. This is the reason monetary policy is not effective. 

Monetary policy is effective when there is underlying demand is strong. Without demand monetary policy is just an enabling environment for nothing in particular.  That the monetary policy is not working is itself a data point. It is telling us that the masses do not have the purchasing power to fuel a demand pick-up. There are two reasons.

Most of these masses derive their incomes from the products that make up the inflation basket. If inflation remains subdued, their incomes remain subdued. The low-interest rate has reduced the cost of capital meaning it is cheaper to deploy robots instead of people. So in fact machines are replacing some jobs. These two factors currently suppress the purchasing power. To compensate, people want to build higher threshold of income-level before they start consuming normally. So, the general population is busy buttressing their purchasing power. 

The second reason is that the pre-crisis demand was inflated by debt. The low-cost debt created a hyper-demand which may never return. At the same time, the debts from the past consumption binge have come due. So the indebted families are busy working their debts off. If all the debts of the bottom 50% of the population were simply forgiven, it would have been cheaper than QE. But it would have immediately buttressed the purchasing power of the masses. 

It is a complicated explanation, but it cannot be simplified any more. When feedback systems are interacting, you will get complexity.

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Can MTNL and BSNL be salvaged?

I happened to look at the websites of MTNL and BSNL for seeking out their annual reports and financials. Long ago, I don't remember exactly when I concluded that it is a waste to invest in public sector telecom companies - MTNL (BSNL is not listed). It was so far back in antiquity that I thought may be it is time to revisit the decision. After all MTNL is a nav-ratna company - meaning it is prized Government PSU. Alas I was horribly wrong.

Where are the financials?

MTNL or Mahanagar Telephone Nigam Limited is listed for 20 years at least. But I could find only 2 annual reports. No quarterly information was available on the site. The website links to some other mtnl sites but the links on the site did not work.

The first rule of getting investor interest is to make all financial and operational data available. I was expecting to look at ARPUs of land lines, mobile, their satellite network subscribers etc. 

Shameful numbers! 

The two annual reports reveal pathetic situation. MTNL has employee cost 76% of revenues. Yes 76% [Seventy-Six] - no it is not a typo. The report talks of legacy issues with the government employees who cannot be sacked and do not work. These numbers make BSNL cost structure of employee costs at 52% of revenue look respectable. 

As a comparable IDEA Cellular has employee expenditure of ~4% of Total revenue.

How to fix MTNL / BSNL?

So can these companies even be salvaged? I think we need radical reform.

1. Disclose all information - no matter how ugly. Go back and disclose everything. Let us have ARPUs, Segment-wise, detailed costs as much drill-down as possible. From these numbers someone may be able to gather the strengths of the companies.
2. Ground Realities - corruption and compromised staff: The sad reality is that the staff of MTNL works for private companies. They take bribes and ensure poor service quality thereby herding the customers in droves in the arms of private telecom service providers. I have also seen MTNL linesmen working for private land line operators in Mumbai. They take home dual incomes. 
3. Staff Costs are too high: MTNL costs at 76% of revenues and BSNL are at 53% wheresa idea cellular is at 4%. There cannot be any rational justification for this mess. More than MTNL, the government of India should take a decision and remove this staff. It will be difficult for MTNL to bear the burden of this. Let the staff be transferred to some other productive work - which they are incapable of. Just pay them and let them go. At least they won't damage the government elsewhere.
4. Asset sweating and location leverage: Both BSNL and MTNL have superb location from where they operate. These locations can work for telecom base stations, interconnection zones and network switches for all firms. Such operational asset sweating can release vital cash for operations.
5. Good Telco - Bad Telcos solution:  Create a new listed Telecom entity - say National Telecom and sell MTNL and BSNL assets to that entity and order closure of MTNL and BSNL under Companies Act. There is no reason to have two telecom companies in the same business with different geographic coverage.
6. Keep transparent pricing plans and decent customer service and customers will flock to PSUs. Those with customer service of private telcos will agree whole-heartedly. With complicated subscription plans and bill discrepancies private telcos are sitting ducks.
7. Telecom-Internet-TV Fibre bundles: The current landscape allows for one state-owned voice-focussed player. After 5 years there wont be any such opportunity. However the PSU Telco will have to quickly shift to data and preferably internet and TV offerings together. It will be easier for this entity to operationalise this than other private operators.

If you let me run these two, I can make them profitable in 3 years. 

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What should governments spend on when faced with fiscal stimulus?

At the time of financial crisis of 2008-09, we were lucky to have the best monetary policy experts around. They seemingly used their various tools - some conventional and other unconventional. Yet about 8 years after we find we need fiscal stimulus as Mario Draghi put in an ECB statement in early summer. Luckily the US presidential candidates agree with this view. So in all likelihood, we should see some fiscal stimulus coming in.

Yet, the understanding on the fiscal side does not seem to be as well developed as the monetary sides. For one, exactly what Keynes prescribed is still much debated. Second governments don't know what to spend on. Obama famously called for "shovel-ready" projects. Milton Friedman (who died in 2006) would cringe in his grave. There is nothing more dangerous than a government committed to a fiscal stimulus that does not know what to do with it.

Looking at Roosevelt/Eisenhower

It is, however, well-accepted that after the World War II, the Roosevelt/Eisenhower initiative of building inter-state highway was one of the biggest fiscal stimuli to the US economy. The genesis of this project was the cross-country trip Roosevelt took in mid-1920s which may have given him a hint of its potential. Once it was implemented, its fruits accrued at least till late 1990s. Even in the era when the internet made distance irrelevant, these highways continued to contribute by way of lower transportation cost thereby giving firms advantage in making supply available at lower costs than otherwise. 

If fiscal policy is to be deployed today where can we deploy it? What areas would have as much purchase as did the highway program of 1930-40?

To answer this we need to imagine the economy as a network of value chains. Such a network has some common elements which need government support. These are the areas where fiscal policy needs to be directed. This is the efficiency angle. If any government wants to orient its economy in a certain direction then this would be the time to make investments in the missing parts of the value-chain that can be shared in the new era. 

A few I can think of:

1. Going green: Reducing Oil-dependance is an option : The very basic pieces of all value chains do contain energy. So an advantage in green energy may be quite advantageous in the long term. Green energy needs a lot of work but could be a potential candidate. It could do with some sort of Manhattan Project 2.0 (the first was for nukes) for making green energy possible. They could standardize the electrical charging stations for hybrids, developing standards and technology to allow smaller wind mill operators to supply into the grid at a time of their convenience. Tesla is looking at this vision through private means.
2. Going blue: Usable water: Food and water will continue to form part of value chains at a very basic level. While global food production is quite high (we destroy a lot of excess food), same cannot be said of global nourishment.  It is undeniable that whatever food we grow we will need potable water. Many say if we find green energy then we can desalinate the water. But low fresh water has an ecological impact on bio-diversity, food-chain dynamics etc. that cannot be dismissed. In that sense, the bio-diversity advantage may trickle into better nourishment and healthier foods - who knows. So I would focus on water management.
3. Carbon catchment could be more urgent: In his TED talk Bill Gates made a very poignant statement - we need ZERO emissions, not lower emissions. It is clear that we cannot cut emissions fast enough. But can we trap emissions before they cause global warming? Maybe we should! This is more engineering problem rather than technology problem and may be more beneficial. Alas, its effects are very difficult to quantify.

The nature of fiscal stimulus

The exact quantum of fiscal stimulus is immaterial, though it has to substantial. What matters more is how long is that quantum spread and the conviction behind it. That will decide its efficacy. The fiscal needs to be prolonged, substantial and certain. An uncertain prolonged stimulus or variable stimulus without visibility will have no appreciable impact. 

Ideally, it should also be employment intensive. Higher employment intensity will allow the benefits to spread faster through the economy.

The goal of the stimulus is to increase the certainty of jobs and employment while laying down a basic infrastructure for the future. If it achieves this then such a stimulus will work. With a certainty of income will come spending and further downstream positive economic effects.

Note: the suggestions made are simply most promising areas at the moment as per my reading. 

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Of Free drinks and negative interest rate policy...

If soft drinks (Coke/Pepsi/tea/coffee etc.) were freely available would you tend to have more of it? Often I end up having one extra coke. If its tea/coffee I end up having even more. I will have to work it off that day through exercise or it will cause some harm in the long term. 

Zero interest rate policy (ZIRP) is like that - if you already wanted Coke and it was easily available you end up having a little more Coke. Likewise, if you already wanted debt, and it was easily available at almost zero cost, then you will have a little more. But not a lot more - coz you have to work it off.

But what if you don't want them?

Say your doctor told you to not have soft drinks at all - no tea/coffee too. Now will you have that? NO? Even if I give you some money - say 2 cents - to have these soft drinks? Still NO? 

Well, me giving you some money is similar to Negative interest rate policy (NIRP). Or similar to one aspect of NIRP. You get a tiny advantage if you take on debt. Is it that difficult to understand why it doesn't work as central bankers hope?

But may be NIRP could work...

Now some will agree that ZIRP may not work, but, they say, NIRP could work. They point to the second aspect of NIRP which is that if you save you get taxed extra. Now if I have $100 in cash in a bank, next year I will have only $98 so next year I will be able to spend less than I can do today. Isn't that an incentive for spending now rather than next year? I say not always!

There are a few reasons:

1. If the trends are deflationary your $98 next year may be able to buy as much as $100 today - sometimes even more. If the efficient market hypothesis* were working prices would adjust to reflect the new purchasing power. NIRP would create some deflationary force as well. Yes, it is small but it is deflationary never the less. So unless the NIRP was creating an overwhelming inflationary force, it may push a precariously balanced economy into deflation. 
2. The NIRP tax does not affect those paying down an earlier debt. In fact, it encourages people to swap new debt for old debt. Debt repayment helps you avoid the tax. This is even more deflationary.
3. NIRP does not work if I anticipate unpredictable cash requirements - say because I want to keep some money to invest when prices correct, or I think my business loan may need to be repaid if my business does not do well in next quarter, or I expect health care costs etc. In fact, it works reverse - in such cases, I would be encouraged to save $102 or $104 just to keep a buffer.
4. NIRP may push those with huge cash balances to move cash abroad. Do you think Apple and Google will bring that extra cash into a country with NIRP? No way! They might move it to a destination where it will be easier to hold cash. So is this what you want to happen? NO! Who gets affected is the individual who keeps getting taxed extra.
5. I may not want debt or I may not want to spend at all. I have the clothes, I have the phones, computers, TV, house, car, swimming pool etc - all the goodies I can spend on when you nudged me to spend the last time. Now I have mostly everything I need. So why should I spend on something I am not excited about? Beats me!

* I don't think Efficient market hypothesis works on a "point-in-time" basis - though it works on an average basis.

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Baltic Dry Index's positive prediction

Have a look at the following chart of the Baltic Dry Index.

I am particularly enthused about BDIY's recent uptick. BDIY was a very strong indicator of Global Trade and economic strength before it lost a bit of credibility in the post-Lehman crisis. The reason I am excited is this:

1. Shipping industry went through one of the most intensive asset building phase between 2006-2010 with almost double the DWT built as was existing.
2. This industry-specific weakness was coupled with economic weakness stemming from the global financial crisis.
3. The Oil-accumulation during post-Lehman phase provided some respite but it tarnished the image of BDIY as predictor of economic performance.

I think the disturbances in BDIY are past us and its present uptick does bore well for us. This means it is time to dip your toes into shipping cos. In India I would go with Shipping Corp [which I have from the previous high :(], Great Eastern Shipping. These companies should benefit from the Iran-Iraq Oil deal.

We need to watch for any global weakness and potential head-and-shoulder formation as happened in 2010.

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Dow Jones Industrial Average since 1900

Barry Ritholtz links to this awesome chart from J.P.Morgan. It tells us so many things when you look at real long term. Have a look and my comments are below this:

The graph tells us so many things:

1. Before anything else, I must highlight that the average line for 1937-49, 1966-82 and 2000- present are drawn wrong. They have a positive bias. 1906-24 seems to have a negative bias.
2. More importantly, we seem to have ~20 years of stability and ~20 years of secular bull runs. By that measure, somewhere after 2015 we will see the start of the next bull run.
3. But we must correlate these with actual developments. If you draw some key developments on the charts we will see better picture. 
• Periods of technology development
• 1930s and 1940s period signifies the development of US highways and railroad. This is phase where Americans were still exploring new frontiers within their country.
• Similarly 1966-82 period was time when computing technology was taking shape.
• Similarly, 2000- present internet technologies are taking root.
• Productivity increase periods. These periods are different from technology development periods. Here known technologies are being exploited to create new thresholds for efficiency and productivity. Concurrently, new technologies are being incubated but those are not the dominant forces as yet.
• 1949 onwards was post war reconstruction. Here known things were required to be produced in ever increasing numbers to satisfy the demand in Europe and Americas itself.
• 1982 till 2000 was a period when IT came of age. Computing allowed wider management control, better designs, higher efficiency etc.

Overall quite an interesting chart. What do you think?

update: I made a appalling mistake of commenting on exponential line which I have deleted. The graph is in log scale.

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Importance of Emerging markets in portfolio

Barry Ritholz has linked to a very important WSJ chart:

Here are my comments:

1. Growth is in EMs: If you use GDP growth in addition to GDP, emerging markets will come out still higher.
2. Currency story: The undervalued currencies of EM economies make it good opportunity from currency gains aspect as well.
3. Known trajectory: EM economies require product and services, regulations, infrastructure along well established and well understood lines. We have done such things in developed markets before and thus it is less risky.
4. Less consumer leverage: One significant difference between other economies and EMs is consumer is not leveraged. In fact there is substantial class of people with good amount of savings and latent demand. Thus, once government policies are on track, you can have growth and not face deleveraging.
5. Political risks: Government or political risks, to my mind are same as developed countries. All politicians are jack-asses and we have seen how politicians from any country, developed or emerging, can turn it into a banana republic. Further, some entrenched vested interest may work against developed economies in this case.

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Types of Investment and India's low-hanging fruit

I think India is much better placed at the moment primarily because there is lot of low hanging fruit. I attempt to list a few. When it comes to investment we have two kinds of investment. 

1. The first represents fairly well understood investments where there is ample evidence of cost and benefit and technology is available from the experience of the first world countries. The road-map for development of such infrastructure, its costs, pay-off timelines etc. is well known.
• Agricultural productivity
• Basic Infrastructure - roads, power
• Second-level infrastructure like cold chains, transportation hubs etc.
2. The second is complicated and more like venture capital where risks are higher. Here the objective is to invest in areas that will value-drivers of the future. Here we are breaking new ground and the pay-offs are not clear. US and first world countries are required to invest in such type of infrastructure.
• Alternate energy
• New types of infrastructure including 4G telecom and other related such as NFC payments
• High-end infrastructure e.g. intelligent Highways etc.

  

For India, substantial opportunities exists in the first part. This is what makes India an attractive destination. Starting around 1995, a lot of attempts have been made in estimating this demand. Most have been unsuccessful, but a substantial body of knowledge has emerged in this process. Today is the best time of all for companies to undertake massive infrastructure building projects. The question really is, will government facilitate the process balancing protection of citizen's rights and goals of developments.

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Investments in India - building long term advantage

India has always admired the high Chinese domestic investment. Policy makers have also talked of striving for higher investment-led GDP growth in India. Contrast that with a fall in investment numbers and we seem to have a problem. 

In light of huge global over-capacities, particularly in metals etc., is it right for India to invest in similar capacities? I believe this is not a right way of deploying resources at the moment. For a start, it is advisable to invest in things that the world cannot provide, either because it is too local or because the global investment climate does not allow it. In both these cases there is a huge opportunity.

In terms of local investments, infrastructure is paramount. In fact investment can be directed at easily accessing the idle global capacity. Thus transportation infrastructure, namely ports, highways, ware-houses and terminals, railways etc., makes a good case for itself. Such infrastructure will also unleash local supply-chain efficiency reducing cost of goods while maintaining better quality. Agricultural produce, on which 55% of Indian population still depends, will be main beneficiary. Long ago, my colleagues at CRISIL did a study that indicated it was possible to double farm incomes by improving supply chain. I believe we underestimated the impact on incomes and possibly the doubling can be achieved with today's income.

Second dimension that needs impetus is information. For a country that is a leader in IT, we have poor information infrastructure. We can plan for unique products effectively. Small cars, unique food items (like spices, fruits and flowers unique to our climate etc.), IT services etc. can be strengthened. Rather than recreate redundant infrastructure, we must deploy investments to strengthen our advantages.

The impetus, at the moment, must come from the government. Almost all areas where India has advantage, save for IT, we have no policy backing. Organized industry hardly has any presence in such areas. Primarily, that is due to lack of clarity from government and proper strategic direction among private players. Let us hope things change and we make right investment and create sustainable value than create redundant supply that will wither the value away.

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Behaviour of Indian Equity Markets

In the recent time Indian equity market are showing four distinct behaviour clusters. These zones are independent in the sense that their behavior does not seem to correlate with news or other stimuli. If that were the case, it would not be worth commenting on. However, this behaviour  is important to note this as it affects the trading strategy.

The trading happens in four peculiar disjoint zones. 

First zone represents the newly started pre-market operations. The price movements in this segment are very difficult to predict and the pre-market prices do not reflect in any way the likely direction markets may take post open. I avoid using the prices set in this phase totally.

The second zone represents the market open to about mid-day wherein European markets open. However, the timing match with European markets is not exact. The second zone lasts till about 1.30 -2 pm India time. 

Post this till close at 2.30 -3 pm represents the third zone. The performance in this zone is drastically different from performance in the second zone. Note, it is not necessarily opposite, just different. The markets may expand on second zone performance or simply reverse it.

The final zone is the last 30mins to 1 hour of trade. This zone appears occasionally. But can make or break your day trades.

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My book "Subverting Capitalism & Democracy" is available on Amazon

Market View and trading strategy from Vitaliy Katsenelson

Vitaliy Katsenelson provides a clear and concise view on the market movement and strategies to make money.

Market Performance Outlook

He predicts another year of range-bound behaviour with higher highs and lower lows. I am not sure about the duration but I agree with higher highs and lower lows theory. Further I believe the cycles (high to low) will be much compressed this time around.

 

Investment Strategy

Katesenelson's investment strategy suggestions are must read for all investors. I would just add that one needs to pick winners/survivors in this crises. This is type of crisis that separates really dynamic companies from sitting ducks. So extra due-diligence is the order of the day.

Vitaliy Katsenelson's recommendation for investment strategy:

In range-bound markets, as P/Es compress they turn against investors; thus investment strategy in this very different and difficult environment needs to be adjusted for the new investment reality:

• Become an active value investor.  Traditional buy-and-forget-to-sell (hold) strategy is not dead but is in a coma waiting for the next secular bull market to return; and it’s still far, far away.  Sell is not just another four-letter word; sell discipline needs to be kicked into higher gear.
• Margin of safety needs to be increased.  Typically, value investors seek for margin of safety to protect them from overestimating the “E”.  In this environment it needs to be beefed up to accommodate the impact of constantly declining P/Es.
• Don’t fall into the relative valuation trap.  Many stocks will appear cheap based on past valuations, but past secular bull market valuations will not be in vogue for a long time, thus absolute valuation tools such as discounted cash-flow analysis should carry more weight.
• Though timing the market is alluring, don’t – it is very difficult to do it consistently.  Value individual stocks instead. Buy them when they are undervalued and sell them when they become fairly valued.
• Increased margin of safety and stricter sell discipline will lead one to have a higher cash position at times.  Don’t invest for the sake of being invested, because this will force you to own stocks of marginal quality or ones that don’t meet your heightened required margin of safety.  Secular bull markets taught investors not to hold cash, as the opportunity cost of doing so was very high.  However, the opportunity cost of cash is a lot lower during a range-bound market.

Links

The Big Picture » Blog Archive » Welcome to Another Lost Decade

Rahul Deodhar: Cyclicality of global slowdown

Rahul Deodhar: Picking Survivors

US Dollar views

I am starting a new initiative. I will hereafter add videos rather than posts. Here is the first one on US dollar.

Defining end of recession

Just a quick note:
If it takes three consecutive quarters of GDP decline to call a recession then how can we call it over by just one good quarter?

Dollar will go down - just not yet!

There is a lot of talk about return of the USD, specially after Jim Rogers declared that he is long USD. Jim Roger put out a counter trade argument. Simply put, there were too many people betting against the dollar. So no way it will go down right away. There is one more argument!

Exporter push developing country central banks to the wall!

While USD weakness is well known, the developing country central banks are under increasing pressure to  manage the exchange rates at current or pre-crisis levels. Entire exporter lobby staff is on just this one task. The thing they don't understand is that US demand is not coming back to pre-Sub-Prime Crisis levels.

I expected this lobbying. But I also expected large exporters to start geographical diversification. This would suggest that exporters are buying time while preparing for new world realities. But there is still no sign of it. I believe, exporters are still in denial!

Currency tango - It still takes two for it!

Central bankers, on the other hand, do not want to be the first developing country to let their currency appreciate. So it will be a game of who blinks first. The usual strategy is such a poker game is to suggest that one will defend the peg no matter what! That is what China has done.

But I would venture they will be the first to act, and they will act decisively. But till that time we are in for holding breath under-water! It is unlikely that anything substantial will happen in 2010 on this front, may be during fall of 2010. One can only guess the impact once currency revaluation sets in. Lord have mercy!

Hidden Risk in Indian Tech

One of my hobbies is to poke holes in stock ideas of analysts. Recently, these talking heads have put out strong buy ratings on Indian tech companies, the likes of Infosys, Wipro, TCS and even Satyam (post scandal). Here is what I need to know before I can be certain of such a trade.

Winning contracts in currency uncertain environment

Indian IT companies have been winning technology contracts from top companies, most recently Walmart. Now imagine a US company that knows USD will depreciate. So how would this impact my sourcing strategy? I, personally, would accelerate all the supplier contracts in today's dollars. Iron-clad them in legal fine-print to mitigate risks from demand collapse and currency fluctuations. The longer such a contract the better it is! Now the question for me is, sitting on other side of this agreement, how have IT companies managed this risks?

The currency risk

This is the most potent business killer, if ever one exists, in Indian IT companies. A lot of analysts have sensitivity analysis ranging from INRUSD of Rs 30/ USD to Rs 50/USD. A few smart investors have already stressed the financials till INR 20/USD and seen the impact. Even smarter investors know that the impact is non-linear in nature. Such currency volatility needs business model innovation (as above) rather than simple currency hedges. The volatility implied in such scenarios may actually test counter-parties in hedged transactions.

Survival Necessities for coming years

Given our current situations, IT companies will have to prepare differently to survive.

• Multi-location operations will be an advantage: This implies having robust processes to create and manage scaling issues well. Companies like ones mentioned above are operating in various countries thus helping them react better. 
• Flexi-sizing will be key: If the currency valuations reach new normalcy, it will be important to relocate manpower to cheaper locations. Companies will have to be quick to rapidly expand, move or lay-off employees. While, all the companies above have what it takes to do it, we should realise it is not an easy process.
• A bit more fat! The crisis is upon us and the IT companies are cash rich. The key is to keep higher than normal cash reserves and not fall into the acquisition trap at this early stage. 

The best time for investment is not now!

Once the currency crisis hits, there will be more clarity on winners and losers. At that point valuations will be saner and those that survive will definitely give better results. Till such time, I would keep a safe distance between myself and IT stocks.

Interpreting Equity Valuation and simple strategy

The way to interpret equity valuation has changed in the context of current crisis. The day CNBC talking heads realize this will mark a new beginnings in the history of mankind. 

At some stages, we find same cash-flows being looked upon more kindly (higher valuations). This does not mean that analyst should rework forecasts tampering with cash-flows to retrofit the price and valuation equations. Yet, that is precisely what I am noticing currently. That is bad analysis!

It is the liquidity stupid!

There is ample liquidity in global system at the moment. This money moves across borders, based on whatever reason it deems fit, and lands into a sector or stocks. So the traditional logic of valuation is stretched a bit. Though we don't throw it out of the door. Therefore, watch the global macro in a more meaningful way.

A simple investment strategy

Given the current environment, the best way to manage investments is going back to basics. 

1. We have to find financially robust companies that generate positive cash flows and have lesser leverage. 
2. We then look for managements that have a vision for growth. We are looking for cash-flow accretive growth. So companies with plans to buy market share are out. Growth should be profitable growth.
3. Thereafter we watch these companies for opportunities to buy. Any correction is opportunity to accumulate.
4. Exit when the market peaks! Exit is very critical otherwise all profits are paper profits.

Notes and disclaimers

Equity investment is filled with risks so beware. The ideas above are for investors and not for speculators.

Do not construe this as advice to buy at any time. (Timing is critical). These views, though fundamentally sound, are echoed by very few people. So mostly, you will hear very different ideas. 

Tele-density and MOU - changing Paradigms

A lot of telecom analyst base their growth forecast on tele-density figures. Tele-density refers to ratio of number of connections to population. It is usually expressed as a percentage. Tele-density determines the upper limit to subscriber growth.

MOU refers to minutes of usage or talk-time of subscribers. “Minutes of Usage” multiplied by Average Revenue per Minute (ARPM) to arrive at Average Revenue per User (ARPU). ARPM has shown a declining trend with respect to time. MOU, therefore, represents growth potential of current subscribers.

The growth potential of any telecom company is a function these two variables. Yet, the concept of teledensity and MOU have not been understood well. A few innovations in the past few years have added new life to both these variables in ways analysts have failed to grasp.

Era of bandwidth Node

The interpretation of teledensity as a cap is remnant of telephone as a voice call device era. This old era represented voice-based communication. We also discovered ways to send data over telephone lines. But this was inefficient. We were sending data over voice networks.

The era has changed and a new era is here. Today, telecom is essentially a provider of bandwidth node at a given location. The question of what to do with this bandwidth is entirely left to market forces. Market forces have deciphered one use of the node through “smart phone technology. Today our networks are essentially dual-mode networks. On the smart-phone or any 3G phone, we have access to a data network AND a voice network. We are no longer sending data over voice network.

So the correct way to look at MOU is in fact, to look at overall consumption of bandwidth. There is no doubt this is only going to go up!

Smart phones boosting data usage

The smart in smart phone is actually in usage of bandwidth tap. The smart phones have, through use of apps, created new uses of data. Further, the presence of 3G implies we are going to listen to move songs and watch more videos on the smart phone. Both these applications are bandwidth-hogging applications.

Overall data requirement of phone user has definitely gone up. And most of the time, data is served by a telecom company. Sometimes, it is your telephone cable connected to a wi-fi modem, other times it is your phones 3G network. As new apps spread, we will have increasing data requirements. So MOU, in terms of overall usage of telecom service will go up. Also, the more connected people are more are voice calls likely!

The upper limit on teledensity

Tele-density has another story. First, there is natural requirement for multiple phone connections per person. In developed countries the number is 2. So we can expect a natural phone penetration limit to twice the population. Further, simply put, there is a potential to connect all the laptops that are in use in the market currently. So the factor of 2 seems pretty understated. Thereafter, anything that is mobile and generates data is a target for embedding a phone connection.

Telecom can definitely cannibalize 50% of the GPS applications. Cars can share location data, engine performance and others. Trucks and delivery vehicles are already using telecom based location services.

Further, it does not take much imagination to foresee new applications. A door viewer that can send photo of visitors is pretty common. Telecom-equipped nanny cams are definitely well accepted. TV set-top boxes can have embedded connections transmitting viewing habits. Buses in Switzerland are already transmitting data about arrival times.

In sum, we can say that older paradigms of Tele-density need to be massively revamped.

It will happen within 5 years

The classical rebuke to these arguments is visibility. Analysts do not foresee such changes happening in near term. I think otherwise. All it needs is right pricing and little bit of imagination. The iPhone, is revolutionary in that sense. It has socialized the imagination part while retaining the basic bandwidth pipe control to itself! I am betting, we will see tremendous explosion in bandwidth consumption in next 5 years and most of this will enrich the telecom companies. That is why I have invested in Bharti Airtel (Bloomberg: Bharti IN).

Download the document in PDF format.Ideapaper - New Teledensity Paradigms

Some ideas on analysing Real Estate Developers

Real estate developers have been a significant part of value creation for investors. And they will continue to be. However, as times get difficult, it is important to pick the right developers to invest in. While these are logical, they are often ignored in my experience. I present an idea-Book looking into some key ideas while selecting successful real estate developers. Key points include:

• I believe first thing a developer must be sensitive to is business cycle. Irrational optimism leads to a fatal failure in preparing for eventual slowdown.
• Similarly, land bank quantity, quality and cost determine the future earning potential and growth of the developer.
• Developers’ also need an ability to manage through-cycle earnings for the company. In search of quick profits, developers often condemn the company to future revenue de-growth and lower or negative profitability.
• Cash flow management and debt structuring is other critical part of real estate business that can make or break the company.
• Lastly, I mention some ways in which real estate developers prevent value realisations for the listed entity.
• I hope these learning’s will be helpful. These do not comprise the complete list and must be used in conjunction with standard investment and valuation procedures and practices.

Please find the ebook enclosed below.

IdeaBook on Investing in Real Estate Developers