Facebook, One Year Later: What Really Happened in the Biggest IPO Flop Ever

Kannu

Couple of things to note here. Ipo's are strange times to buy and sell. The presence of big beasts can influence unknown stock movements. And for small investors like us, it can be too high. Never run with the herd son. One of the reasons why I've cashed out now. It's irrational exuberance all over. Think about it. All analysts are predicting a max 1% economic growth. Europe is negative. USA is 1% tops. Just how does that justify 6-10% stock market rises? 

Be that as it may, second lesson is to be wary of investing in places where you aren't comfortable. I rarely invest in tech stocks. Far too nebulous an investment. Never invest in anything that you don't understand or are unable to explain to a 10 year old. 

Love

Baba. 

Facebook, One Year Later: What Really Happened in the Biggest IPO Flop Ever - Khadeeja Safdar - The Atlantic
http://www.theatlantic.com/business/archive/2013/05/facebook-one-year-later-what-really-happened-in-the-biggest-ipo-flop-ever/275987/

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Continue to the TheAtlantic.com

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After Facebook’s disastrous debut, the preferred clients of big banks walked away with huge profits. How? Public documents and interviews with dozens of investment bankers and research analysts reveal that the Street caught wind of something the public didn’t. The social network and the banks told half the story. Here is the other half.

Khadeeja Safdar May 20 2013, 9:43 AM ET

Reuters

Uma Swaminathan tuned the television set in the living room of her ranch style home in the suburbs of East Brunswick, N.J. to CNBC. It was 9:00 a.m. on May 18, 2012, a day the retired schoolteacher thought might make her rich. She logged onto her Vanguard brokerage account on her computer and placed an order for 5,000 shares of Facebook at $42 a share.

The problem with high frequency trading

I was working in Solomon brothers son when I first came across algorithmic trading. This is around 2000. You were 5 years of age then. We launched 4 of these models and the limit was 50000$ per day. 3 would propose trades and one would decide and then launch the winning trade. 

Life has moved on hugely since then son. It's become something like skynet from the terminator days lol. The equity markets are really strange. There is no money to be made. Take a look at the major players, hardly anybody on the sell side makes any money because there's no margin. Spreads are so tight. And therefore it's difficult. Good for retail investors like you and I but for the big boys it's getting stupid. The buy side, the asset managers and fund managers, who buy and hold for longer periods are still around and will be so as well but it's going to be a difficult time for equities son. So do think again about your career option of being a stockbroker. Not enough money. 

Be somewhere where technology supports you. Like you come up with new complex instruments and strategies while technology helps. Or go into the advisory business where you need to take nonlinear decisions. Combine your mathematics knowledge with knowledge of technology, philosophy, politics, economics and something that you will pick up later on - psychology. That's what's will help pay huge dividends son. 

Love

Baba

The problem with high frequency trading | Felix Salmon
http://blogs.reuters.com/felix-salmon/2012/10/06/the-problem-with-high-frequency-trading/

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Last night, on BBC Radio 3, I was featured reading an essay about high frequency trading. I hope it’s fun to listen to, but if you want to read it, here you go.

One of the many consequences of global warming is that it’s now, for the first time, possible to drill under the sea bed of the Arctic ocean. The oil companies are all there, of course, running geological tests and bickering with each other about the potential environmental consequences of an oil spill. But they’re not the only people drilling. Because there’s something even more valuable than oil just waiting to be found under the Arctic.

What is worth so much money that three different consortiums would spend billions of pounds to retrofit icebreakers and send them into some of the coldest and most dangerous waters in the world? The answer, of course, is information.

A couple of days ago, I called a friend in Tokyo, and we had a lovely chat. If he puts something up on Twitter, I can see it immediately. And on the web there are thousands of webcams showing me what’s going on in Japan this very second. It doesn’t look like there’s any great information bottleneck there: anything important which happens in Japan can be, and is, transmitted to the rest of the world in a fraction of a second.

But if you’re a City trader, a fraction of a second is a veritable eternity. Let’s say you want to know the price of a stock on the Tokyo Stock exchange, or the exact number of yen being traded for one dollar. Just like the light from the sun is eight minutes old by the time it reaches us, all that financial information is about 188 milliseconds old by the time it reaches London. That’s zero point one eight eight seconds. And it takes that much time because it has to travel on fiber-optic cables which take a long and circuitous route: they either have to cross the Atlantic, and then the US, and then the Pacific, or else they have to go across Europe, through the Middle East, across the Indian Ocean, and then up through the South China Sea between China and the Philippines.

But! If you can lay an undersea cable across the Arctic, you can save yourself about 5,000 miles, not to mention the risk of routing your information past a lot of political flash points. And when you’re sitting in your office in London and you get that dollar/yen exchange rate from Tokyo, it’s fresh from the oven, comparatively speaking: only 0.168 seconds old. If everybody else is using the old cables and you’re using the new ones, then you have somewhere between 20 milliseconds and 60 milliseconds when you know something they don’t.

Which Short-Selling Regulation is the Least Damaging to Market Efficiency? Evidence from Europe

An interesting article. I am very jaundiced towards the European Politicians and assorted people who drive their economic future. its a mess, to put it bluntly.

I quote the abstract:

Exploiting cross-sectional and time-series variations in European regulations during the July 2008–June 2009 period, we show that: 1) Prohibition on covered short selling raises bid-ask spread and reduces trading volume, 2) Prohibition on naked short selling raises both volatility and bid-ask spread, 3) Disclosure requirements raise volatility and reduce trading volume, and 4) No regulation is effective against price decline. Overall, all short-sale regulations harm market efficiency. However, naked short-selling prohibition is the only regulation that leaves volumes unchanged while addressing the failure to deliver. Therefore, we argue that this is the least damaging to market efficiency.

This is the idiocy behind the governments and economics people who try to ban short selling. The evidence that banning short selling introduces inefficiencies into the market is clear and incontrovertible. Where they aren't banned, the markets work better, absorb information faster and generally are good eggs. This exacerbates the insider outsider issue. If the idea behind the European Regulators and Politicians was to improve their markets, then this failed miserably. Spreads become wider. Trade volumes reduce. not good.

Islamic vs. conventional banking: Business model, efficiency and stability

This paper was quite an interesting one. I quote the abstract:

How different are Islamic banks from conventional banks? Does the recent crisis justify a closer look at the Sharia-compliant business model for banking? When comparing conventional and Islamic banks, controlling for time-variant country-fixed effects, we find few significant differences in business orientation. There is evidence however, that Islamic banks are less cost-effective, but have a higher intermediation ratio, higher asset quality and are better capitalized. We also find large cross-country variation in the differences between conventional and Islamic banks as well as across Islamic banks of different sizes. Furthermore, we find that Islamic banks are better capitalized, have higher asset quality and are less likely to disintermediate during crises. The better stock performance of listed Islamic banks during the recent crisis is also due to their higher capitalization and better asset quality.

Given the financial crisis, this new model has quite a lot of lessons for the modern Anglo Saxon world of banking. I've been keeping track of Islamic Finance for some time now and this has changed quite a lot since the early days.

 

The profit sharing element has quite an interesting behaviour as they end up being better capitalised with lower loan losses. In other words, they become a sort of private equity type of firm. Interesting, I wonder if these lessons will be learned by the regulators? Or force bad performing loans to be converted into equity like the CoCo’s? Not for the banks but for the firms to which the banks have lent to?

How to Save American Finance from Itself

In a previous email Kannu, I told you that we are living in a complicated world which is getting even more complicated. The grand poobahs recognise this. Instead of simplifying they decide to add to complexity by adding giant rafts of regulation. Adding much more complexity. And that's just now. 

Here's an economics Nobel prize winner talking about his student who is the fed chief and asking for a more complex set of instruments to manage the economies and financial markets. And taking a gratuitous swing at hedgies. 

The result? Another crash is coming. Guaranteed. Before you are 25. So what can you do? Avoid debt son. As much as possible. Have your investments in good solid sectors and companies who will keep on operating despite downturns and crashes. Have a technical skill son that will always give you a job. Or if you are running a firm, then be in one which will always have demand. Keep an eye on your cash flow. Or marry a rich girl :) 

But the article is interesting from a macroeconomics perspective. It's people like these who will be running the world when you graduate and start looking for work or are working. It takes time for macroeconomic prescriptions to work it's way through the economy and hit individuals. So decisions taken today will impact you in 3-5 years time. 

I studied wave theory once. Ocean waves. The science is poorly understood even now. Which wave will just give you a ripple or give you a dunking or a great surf is difficult to know. The ocean interacts with temperature, wind, continental shelf topology, currents, gravitation, climate, seashore landscape in poorly understood ways. So what does a surfer do? Understand as much as possible. Be prepared. Take chances. 

Love

Baba. 

How to Save American Finance from Itself | New Republic
http://www.newrepublic.com/article/112679/how-save-american-finance-itself

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TODAY’S EDITION

Other stories from April 27, 2013

BOOKS APRIL 8, 2013

How to Save American Finance from Itself Has financialization gone too far?

BY ROBERT M. SOLOW

Central banking is not rocket science, but neither is it a trivial pursuit. Excellent books have continued to be written about the art and craft of central banking, from Walter Bagehot’s Lombard Street in 1873 to Alan Blinder’s Central Banking in Theory and Practice in 1998. Running a central bank is in one way a little bit like flying a plane or sailing a boat: much of the time standard responses and small adjustments will do just fine, but every so often a situation arises in which fundamental understanding, knowledge of history, and good judgment can make the difference between riding out the storm and crashing. There was no such person in charge in 1929, and the result was disaster. There was one in 2008.

In his earlier scholarly life, Ben Bernanke, the chairman of the Federal Reserve Board, had been a careful student of the general interaction between the financial system and the real economy and especially of its working out in the Great Depression of the 1930s. So he had done his homework. His decisive and innovative actions at the Fed saved our economy from free fall with a possibly catastrophic end. I once non-joked that Bernanke was the Captain Kirk of central banking: he had loaned where no man had loaned before. In a life before turning to government service, first as a member of the Federal Reserve Board, then briefly as chairman of the Council of Economic Advisers, and then returning to the Fed as chairman in 2006, Bernanke was a well-known and highly respected academic economist. (The reader should know that I was one of his teachers in graduate school at MIT, and have remained a friend.) My opinion is that, after a briefly hesitant start as Fed chairman, probably still under the considerable aura of Alan Greenspan, Bernanke rose admirably to a difficult occasion and has been generally right in his judgments and his decisions, and in his willingness and his ability to explain both.

In March 2012, George Washington University invited Bernanke to give four lectures as part of a course devoted to the role of the Federal Reserve in the economy. The lectures are now reproduced in book form, apparently from lightly edited transcripts. Each lecture ends with half a dozen questions from anonymous “students” and Bernanke’s answers. Some of the questions are smart, some less so, in which case Bernanke exhibits the professorial skill of seamlessly answering a slightly different question. We are not told anything about the audience. I imagine a lot of people wanted to hear about the Federal Reserve and the financial crisis from the chairman himself. It’s rather like hearing Admiral Nelson reminisce about the battle of Trafalgar.

What’s in a name? actually quite a lot

Shakespeare said…

Juliet:
"What's in a name? That which we call a rose
By any other name would smell as sweet."

Romeo and Juliet (II, ii, 1-2)

But poor man was living in a different world, nowadays, the name of the company has a big impact on its performance. See this paper.

Research from psychology suggests that people evaluate fluent stimuli more favorably than similar information that is harder to process. Consistent with fluency affecting investment decisions, we find that companies with short, easy to pronounce names have higher breadth of ownership, greater share turnover, lower transaction price impacts, and higher valuation ratios. Corporate name changes increase fluency on average, and fluency-improving name changes are associated with increases in breadth of ownership, liquidity, and firm value. Name fluency also affects other investment decisions, with fluently named closed-end funds trading at smaller discounts and fluent mutual funds attracting greater fund flows.

An example that they quote is:

Practically speaking, when choosing from among drug manufacturers, people could instinctively feel more comfortable investing in a name such as “Forest Laboratories” than the less fluent “Allergan Ligand Retinoid Therapeutics.”

Hmmm, i wonder what that will mean to the financial institutions that i know and love? lol

He Who Makes the Rules

Kannu

Here's an excellent article on how the process of lawmaking happens. Or not as the case maybe. And all parts are important as its important all parties are heard. 

So now you see why financial institutions pay such close attention to what's going on in government. It can literally be the reason for success or failure. 

there is another quote which is relevant in these days, In democracy, its not the count of the vote which is important but also its important to know who counts the vote. That’s why an independent election commission is so vital. Unfortunately, we don't have something like that and therefore we end up with legal gymnastics like this. And this is the reason why I am sceptical of more regulation making economies safer.

Love

Baba

The Washington Monthly - The Magazine - He Who Makes the Rules
http://www.washingtonmonthly.com/magazine/march_april_2013/features/he_who_makes_the_rules043315.php?page=all

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Barack Obama’s biggest second-term challenge isn’t guns or immigration. It’s saving his biggest first-term achievements, like the Dodd-Frank law, from being dismembered by lobbyists and conservative jurists in the shadowy, Byzantine “rule-making” process.

In late 2010, Bart Chilton, one of three Democratic commissioners at the U.S. Commodity Futures Trading Commission (CFTC), walked into an upper-floor suite of an executive office building to meet with four top muckety-mucks at one of the biggest financial institutions in the world.

There were a handful of staff members present, but it was a pretty small gathering—one, it turns out, that Chilton would never forget.

The main topic Chilton hoped to discuss that day was the CFTC’s pending rule on what are known as “position limits.” If implemented properly, position limits would put a leash on speculation in the commodities market by making it harder for heavyweight traders at places like Goldman Sachs and JPMorgan Chase to corner a market, make a killing for themselves, and screw up prices for the rest of us. Position limits are also one of many ways to tamp down the amount of risk big institutions can take on, which keeps them from going belly up and minimizes the chance taxpayers will have to bail them out.

The financial institution Chilton was meeting with that day was a big commodities exchange, which is like a stock exchange except that instead of trading stocks they trade derivatives based on the value of actual products, like oil and gas. Chilton wouldn’t say which major commodities exchange he was meeting with that day, but suffice it to say two of the biggest—the Chicago Mercantile Exchange and Intercontinental Exchange—have a lot to lose from federally administered position limits. To them, the more derivatives traded, the better. They’ve been fighting the CFTC’s attempts to establish position limits for years.

The passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in July 2010 seemed to promise meaningful reform on this front. The law includes Section 737, which explicitly directs the CFTC to establish position limits and lays out detailed guidelines on how they should do so. “The Commission shall by rule, regulation or order establish limits on the amount of positions, as appropriate,” it reads.

Still, even with the strength of the law behind him, Chilton waited until the end of the meeting to broach what he knew would be a tense subject. He began diplomatically. Now that the CFTC was required by law to establish position limits, his commission wanted to do so “in a fashion that made sense—one that was sensitive to, but not necessarily reflective of, the views of the exchange,” he told the executives.

Chilton’s gracious overture fell flat. His hosts, who had been openly discussing other topics moments before, were suddenly silent. They deferred instead to their top lawyer, who explained that the exchange’s interpretation of Section 737 was that the CFTC was not required to establish position limits at all.

Chilton was blindsided. While other parts of Dodd-Frank were, admittedly, vague and ambiguous and otherwise frustrating to those, like him, who were tasked with writing the hundreds of rules associated with the act, Section 737 didn’t exactly pull any punches. The Commission shall establish limits on the amount of positions, as appropriate.

“You gotta be kidding,” Chilton told the executives. “The law is very clear here. The congressional intent
is clear.”

But the executives stood their ground. Their lawyer quietly referred Chilton to the end of the sentence in question: as appropriate. Those two little words, the lawyer said, clearly modify the verb “shall.” Therefore, the statute can be interpreted as saying that the commission shall—but only if appropriate—establish position limits, he explained.

Will you trust your colleague’s views on investments?

Fascinating article. I quote the abstract

To what extent conflicts of interest affect the investment value of sell-side analyst research is an ongoing debate. We approach this issue from a new direction by investigating how asset-management divisions of investment banks use stock recommendations issued by their own analysts. Based on holdings changes around initiations, upgrades, and downgrades from 1993 to 2003, we find that these bank-affiliated investors follow recommendations from sell-side analysts in general, increasing (decreasing) their relative holdings following positive (negative) recommendations. More importantly, these investors respond more strongly to recommendations issued by their own analysts than to those issued by analysts affiliated with other banks, especially for recommendations on small and low-analyst-coverage firms. Thus, we find that investment banks “eat their own cooking,” showing that these presumably sophisticated institutional investors view sell-side recommendations as having investment value, particularly when the recommendations come from their own analysts.

Once upon a time, I was quite taken by investment banking research reports. Used to invest based upon what a bank would say. But now that I am a bit more wiser after making some real duds, I observe these research analysis with a far more jaundiced eye, and rely on my investments with my own research and views. Only myself to blame when I invest in duds but at least I’m not being stupid to follow research which can and is frequently biased for a variety of reasons.

But this article is interesting from a different perspective. Looks like the asset management arms of these banks tend to rely more on their colleagues across the Chinese walls. Hmmm, so before you select a fund, make sure that you check whether the owner has an investment bank and what kind of analysts do they have..

High Performance Trading

I used to muck around with high frequency equities trading almost 10 years back at Salomon Brothers when I was in the front line trenches. The reason to share this graphic from CISCO is because of two reasons, first is to show a bit of the complexity of the system and second is that its a neat graphical representation, perfect for a poster on the wall…

Zooming in

Neato or what?

So what caused the financial crisis? We don't know

I thought you would be interested in this article written by Andrew Lo. I found this quote fascinating, specially since he managed to pull in Rashomon as a metaphor. (wonder why he missed out on the Blind men and the Elephant metaphor)).

it may seem like sheer folly to choose a subset of books that economists might
want to read to learn more about the crisis. After all, new books are still being published
today about the Great Depression, and that was eight decades ago! But if Kurosawa were
alive today and inclined to write an op-ed piece on the crisis, he might propose Rashomon as
a practical guide to making sense of the past several years.

Here is the abstract, the article is worth reading in full.

The recent financial crisis has generated many distinct perspectives from various quarters.
In this article, I review a diverse set of 21 books on the crisis, 11 written by academics, and
10 written by journalists and one former Treasury Secretary. No single narrative emerges
from this broad and often contradictory collection of interpretations, but the sheer variety of
conclusions is informative, and underscores the desperate need for the economics profession
to establish a single set of facts from which more accurate inferences and narratives can be
constructed.

in the long run, we are all dead

That's the famous saying from Keynes, Son, but this is an interesting perspective on long run investing. I like this idea because it forces you to think like an investor. A business person. One shouldn't get excited about short term results or returns because ups and downs will happen.

Think about it in a different way, if you were running a business of say making widgets, will you stop and sell the company if there were no sales in one day? or in a month? no, you will keep on persevering and investing and running it. Same thing here. Good companies will last. Obviously if they are tanking, then you must sell them, but good companies will definitely last. The current valuations are extraordinarily low. If I take the FTSE 100 stocks, which are perhaps comprising of one of the most liquid international stocks in the world, then these are the companies whose PE ratio's are below 10. When the long run average of US stocks is ar 15-16, then these are significantly undervalued. Now here's my question and something that you have already answered by your investments, these firms are good firms, they have good assets, they have a fairly good yield, good prospects, good management and still their valuations suck. So its a good time to invest.

Remember, the time to invest is when people are selling....

 

Lloyds Banking Group	£22,281.17	£43,467	£369	£46,902	0.00%	-0.50p	n/a
BP	£80,683.62	$297,107	-$9,140	$95,891	1.04%	-19.81¢	n/a
Cairn Energy	£4,088.08	n/a	-$299	$3,838	0.00%	-19.17¢	n/a
Resolution Ltd.	£3,804.46	£1,288	£1,083	£6,549	6.61%	81.10p	3
Kazakhmys	£4,664.59	$3,237	$1,098	$8,219	1.60%	259.00¢	5
Barclays	£21,502.95	£32,204	£5,926	£62,262	3.12%	30.40p	6
Eurasian Natural Resources Corp.	£8,389.69	$6,605	$2,710	$10,033	2.97%	170.00¢	6
Aviva	£9,735.98	£36,274	£3,966	£17,725	7.50%	55.10p	6
Old Mutual	£6,015.41	£3,582	£3,926	£11,474	3.68%	16.00p	7
BAE Systems	£9,338.63	£21,097	£1,505	£5,403	6.19%	40.80p	7
AstraZeneca	£39,415.56	$33,269	$11,494	$23,410	5.44%	671.00¢	7
Vedanta Resources	£3,204.93	$11,427	$2,534	$13,679	2.76%	262.80¢	7
Rio Tinto	£48,158.80	$56,576	$19,694	$65,274	2.07%	713.30¢	7
Legal & General Group	£6,135.87	£5,348	£1,475	£4,874	4.55%	14.07p	7
BHP Billiton	£40,340.57	$71,739	$31,816	$57,755	3.35%	393.50¢	8
Xstrata	£27,799.79	$30,499	$7,102	$42,021	1.67%	177.00¢	9
Investec	£1,989.07	£2,013	£410	£3,961	4.64%	43.20p	9
BT Group	£14,078.21	£20,076	£2,578	£1,951	4.09%	21.00p	9
Anglo American	£30,487.82	$27,960	$10,245	$37,971	1.79%	413.00¢	9
International Consolidated Airlines Group SA	£3,031.67	£6,683	£342	£2,400	0.00%	18.05p	9
Man Group	£3,032.30	$1,655	$305	$4,436	8.68%	28.00¢	9
GKN	£2,955.62	£5,084	£385	£1,687	2.63%	20.70p	9
Marks & Spencer Group	£5,309.30	£9,740	£837	£2,677	5.08%	34.80p	10
ITV	£2,426.82	£2,064	£364	£663	0.00%	6.40p	10

 

Stocks For The Long, Long Run By
Morgan Housel
http://www.fool.co.uk/news/investing/2011/10/18/stocks-for-the-long-long-run.aspx?source=uoofolrf0010002
Inside the mind of Jeremy Siegel.
A version of this article originally appeared on our US site, Fool.com.
"Oh, you're meeting with Jeremy Siegel tomorrow? Lucky you," a professor at the University of Pennsylvania's Wharton School told me. "You'll leave feeling much better about your investments than when you entered," he said with a laugh and a hint of sarcasm.
This is the Jeremy Siegel -- Wharton's famed finance professor -- the public has come to know: A perennially bullish academic who was born an optimist and never looked back, leading to criticism that he's more stock market cheerleader than rational analyst.
But after meeting with Siegel at a conference at Wharton in Philadelphia this week, I left with a different view. He is perhaps as bullish on the stock market as he's ever been. "The pessimism these days is just striking," he notes. And some of his arguments are still as controversial, if not logically curious, as ever. But agree with him or not, Jeremy Siegel's view on the stock market is fascinating. There's a reason people still pay attention to him.
Siegel is quick to note that being characterized as a permabull is undeserved. "People ask me, 'Jeremy, why are you always so bullish?' Well, I'm not. I wasn't bullish on stocks in 2000," he says. And he's right: In March 2000, Siegel penned an op-ed in The Wall Street Journal warning that technology stocks were grossly overvalued.
But it's his book, Stocks for the Long Run, that people remember. First published in 1994 and now in its fourth edition, the book has sold hundreds of thousands of copies. Its message is clear: Over time, stocks outperform all other assets classes. They are, definitively, the greatest wealth-generating machine that investors can get their hands on. Hitting the shelves just as one of the largest bull markets in history was heating up, the book served as a bible during the 1990s for investors anchored to the idea that stocks could go only one way -- up. After stocks crashed and then languished for the past decade, Siegel has been the butt of all kinds of criticism. As markets bottomed in early 2009, Business Insider wrote, "No, the charming Wharton professor isn't dead. But he may just have killed what's left of his reputation." It continued: Siegel "has been very bullish, and very wrong, for the past two years."
But perpetual bullishness isn't what Siegel preaches. Most of those criticizing his bullishness ignore the title of his book. He isn't just bullish on stocks; he's bullish on stocks in the long run. I'd even qualify that: Siegel is bullish on stocks in the long, long run.
A group of financial writers had been at Wharton for four days, listening to lectures on behavioural finance, outsourcing, and accounting fraud. Siegel's presentation had a feel different from all others. He isn't just a professor presenting his research. He's a seasoned (he's been a professor for 40 years) financial philosopher meets historian meets talented showman. The last part is perhaps Siegel's most underappreciated strength. The man is far more charismatic than you might think. When presenting otherwise dry data on historic investment returns, Siegel drops his voice to a whisper and then booms into a punch line for dramatic effect.
It's that data that underscores Siegel's view of the market. In the late 1980s, then a monetary policy economist, he began collecting historic returns on stocks, bonds, cash, and gold going back to 1802. It's the most complete set of historic investment returns available, he points out.
What the data show is crystal clear. One dollar invested in stocks in 1802 would be worth more than $700,000 today, adjusted for inflation. The same dollar in bonds would be worth less than $1,500. In gold, it's about $4. In a dollar kept under your mattress, it's $0.05. Over two centuries, there is no substitute to stocks.
Which would be an open-and-shut finding if we were Methuselah, and had 200 years to save. Unfortunately, we don't. And within that 200 years of data sits an uncountable number of chaotic swings, with stocks moving from wild bull markets to crushing bear markets -- even a 90% collapse during the Great Depression. Over some periods, stocks dramatically underperform bonds, gold, and cash. That holds true for the past 10 years, as investors know all too well.
But it's at this point -- the point where so many become skeptical of Siegel -- where his work becomes the most persuasive. Comparing risk between stocks and bonds, the opposite of what most assume is true emerges when measured over long periods of time.
Modern finance theory holds that stocks should return more than bonds because they're riskier. What Siegel's data show, however, is that this risk diminishes, even flips upside down, when you hold an asset long enough. Since 1802, average stock volatility is much higher than for bonds when looking at one-, two-, or five-year periods. But then it flips. When held for 10 years, average real stock returns become less risky than bonds. Over 20-year and 30-year periods, there's no comparison: The upside potential is far greater for stocks, and even the worst periods generate positive real returns, while the worst period for bonds leaves investors with substantial real losses. "Even when looking at periods that ended in the bottom of the Great Depression, stocks had a positive real return if held for 20 years," Siegel said. "You have never lost money in stocks over any 20-year period, but you have wiped out half your portfolio in bonds. So which is the riskier asset?" he asks, his voice now booming. "And nothing that's happened over the past 10 years negates this data." Nor are these unreasonable periods of time. Twenty or 30 years is about the average time between when people start saving and when they retire.
This is where those criticizing Jeremy Siegel often get it wrong. The key to understanding his analysis is that he's only concerned with long, long periods of time. Asked about stocks' recent lost decade, he notes that average annual returns since 1991 have actually been quite good. Ten-year periods aren't of much interest to him. They're too short.
"Stocks go back and forth, back and forth," he says. "The past decade has been frustrating. But that's only because we had unreasonably high returns in the 1990s. The last 10 years has just offset the previous decade."
Siegel is especially bullish on stocks today because he thinks valuations are extraordinarily low. Stocks now trade at a price-to-earnings ratio of 11.5, compared with a historic average of closer to 19 when interest rates are this low. Analysts expect the S&P 500 to earn $112 next year, putting stocks at just over 10 times forward earnings.
Now, most investors think the $112 figure is far too high, and will come down -- a reason many use to justify being bearish on stocks. Siegel actually agrees. "I don't believe the number. I think it will come down," he says. But that's fine. Even if earnings fall 25% from current levels, stocks would still sell at a P/E ratio close to their long-term average. If earnings stay at current levels forever, stocks would still be a great buy, Siegel says. "You don't need growth to justify these numbers," he says. "And if we actually earn $112 next year? Oh, god. It's a bonus. You'll see stocks up 30% or 40%."
The amount of pessimism in today's market is totally overdone, he says. "It's one of the most bearish forecasts I've ever seen." Bond giant PIMCO has a gloomy theory called the "new normal," which forecasts real economic growth of 1%-2% going forward, compared with 3%-4% in the past. At the same time, gauges of economic growth expectations, such as the yield on Treasury inflation-protected securities, or TIPS, are now near zero percent. The market panic of the past few months has made even bearish analysts like PIMCO look cheery. "It's the ultimate sign of pessimism," he says.
What keeps Siegel bullish on the long term is a belief that what drives our economy over time is still alive and well. In the short run, economists focus on demand as the key economic driver. In the long run, the real fuel is productivity, or output per hour worked, and population growth. This is one of the least controversial theories in economics, but it, too, is prone to criticism when viewed over different time periods. Most economists are bearish on the economy right now because demand is low as consumers deleverage. Siegel agrees, but remains bullish on the long run for a simple reason: Productivity is not only increasing, but it's increasing at an accelerating rate as technology connects the world. When ideas build on top of other ideas, prosperity multiplies. "We've brought 2 or 3 billion people online sharing ideas," Siegel says. The impact that this has is astounding. People used to work full time just to feed and shelter themselves, he notes. Today, the average person in the developed world needs to work just an hour a day to support basic human needs. Productivity has dramatically increased the quality of life around the world, and there's little sign of it slowing down -- in the long run.
Still, there are legitimate critiques of Siegel's views that remain open to debate. Yale economist Robert Shiller -- a good friend and former classmate of Siegel's -- values stocks based on an average of the past 10 years' earnings, adjusted for inflation. He calls it the cyclically adjusted price-earnings ratio, or CAPE. Based on CAPE, stocks are currently fairly valued at best, if not overvalued.
Asked to defend his analysis against CAPE, Siegel's views turn fuzzy. "CAPE shows valuations to be quite high, but the source is purely the earnings collapse of 2008-2009, when financials had these enormous write-offs," that aren't indicative of corporate America's earnings power, he says. When I point out that Shiller and others (including our own Alex Dumortier) have shown that this isn't so clear -- even ignoring the earnings collapse of 2008-2009, CAPE doesn't move significantly, which is the point of using a 10-year average -- Siegel doesn't come up with much of a response, noting that the losses were spread out over several quarters.
He is equally incredulous of the idea that corporate profits are at a cyclical top as profit margins approach record highs. "Those profit margins are up because foreign sales make up a larger percentage of companies' business. And guess what? Foreign business generates higher profit margins because they have lower tax rates," he says, although foreign sales as a percentage of total S&P sales have actually declined since 2008. "Some say we're at the top of this boom. I just don't understand that. Have you looked around? What boom are they talking about? The recession just ended two years ago. Unemployment is still high. How can cyclically adjusted profits be at a cyclical high?"
He then says something that catches my attention: "Forget the numbers. Go back to the logic of it all," he says. This was an interesting turn. The same Siegel who an hour earlier asked us to ignore our feelings about stocks and look at the data was now asking us to ignore the data and look at our feelings.
It is moments like this, I believe, that cause Siegel to face criticism. His work is valuable, persuasive, and intriguing. But it's very specific to the long run. Those critical of his work often ignore this, and it appears Siegel may forget it at times, too. The truth is, short-term profit peaks or 10-year earnings multiples aren't that relevant to his findings. Almost any critique thrown at Siegel can be properly defended with the words, "That shouldn't matter to investors with a long-term time horizon." Ironically, the beauty of Siegel's work is the idea that the short-term market fluctuations his critics obsess over set the stage for the long-term returns he emphasizes. "Fluctuations unnerve investors," he says. "Why? Because people can't stand them in the short run. Volatility scares enough people out of the market to generate superior returns for those who stay in." In that sense, those critical of Siegel's work are often actively proving its validity.
What might change Siegel's mind? Another uncontrolled collapse of the financial system, similar to what happened in 2008, could set the global economy back in a big way.
Will that happen, someone asks?
"Stay tuned," he says.
************************************************************

The Welfare Impact of Microcredit on Rural Households in China

So? does it? Read the abstract.

Microcredit has gained worldwide acceptance in recent years as a flexible mechanism to expand individuals’ (especially the poor's) access to financial services, which is considered as an efficient way to achieve poverty reduction and other social development. A large number of empirical studies have been done to examine the welfare effects of microcredit on the borrowers and such effects are well documented in many other countries such as Bangladesh. However, the impacts of microcredit on China rural households’ livelihood are not well documented. This paper attempts to empirically evaluate the impact of microcredit on household welfare outcomes such as income and consumption in rural China. The estimation is based on the difference-in-difference approach which is an increasingly popular method of tackling the selection bias issue in assessing the impacts of microcredit. The study uses a two-year panel dataset, including both primary and secondary data collected through a household survey in rural China. Our empirical results favour the wide belief in the literature that joining microcredit programme helps improve households’ welfare such as income and consumption. Despite the optimistic findings on how microcredit has changed the rural households’ living conditions, our results show that the vast majority of the programme participants are non-poor, which casts some doubts on the social potential (such as poverty reduction) of China's microcredit programmes.

So the results are, it helps in improving welfare, but its usually aimed at the non poor. So sort of half way house, that little bit of credit helps but not the absolute poor. Perhaps Bolsa Familia?

Just what is a 25 Standard Deviation Move?

I had mentioned this level of movement last year at several lectures. Mr. Viniar who was the CFO of Goldman Sachs said in 2007, we are seeing things that were 25 standard deviation moves, several days in a row.

What does a 25 Standard Deviation mean? Does it really mean anything? These chaps actually tried to put some context around this 25 SD move. I am going to quote some extracts:

a 5-sigma event corresponds to an expected occurrence of less than just one day in the entire period since the end of the last Ice Age; a 6-sigma event corresponds to an expected occurrence of less than one day in the entire period since our species, Homo Sapiens, evolved from earlier primates; and a 7-sigma event corresponds to an expected occurrence of just once in a period approximately five times the length of time that has elapsed since multicellular life first evolved on this planet

So we are at 7 sigma and we are already way back into the mists of time on this planet. “ok ok, so get on with it”

These numbers are on truly cosmological scales, and a natural comparison is with the number of particles in the Universe, which is believed to be between 1.0e+73 and 1.0e+85 (Clair, 2001). Thus, a 20-event corresponds to an expected occurrence period measured in years that is 10 times larger than the higher of the estimates of the number of particles in the Universe. For its part, a 25-sigma event corresponds to an expected occurrence period that is equal to the higher of these estimates but with the decimal point moved 52 places to the left! 

They explain this in a different way.

UK  National Lottery is currently was offering a prize of £2.5m for a ticket costing £1. Assuming it to be a fair bet, the probability of winning the lottery on any given attempt is therefore 0.0000004. The probability of winning the lottery  n times in a row is therefore 0.0000004 n , and the probability of a 25 sigma event is comparable to the probability of winning the lottery 21 or 22 times in a row.  
And we should not forget Goldman’s losing streak – Goldman did not just experience a single 25-sigma event, but experienced several in a row – or forget that other institutions also experienced 25-sigma events. If the probability of a single 25-sigma event is low, the odds of two or more such events are truly infinitesimal. For example, the odds of two 25-sigma events on consecutive days are equal to 3.057e-136 squared, which is 9.3450e-272. This is as likely as winning the lottery about 42 times in a row. The corresponding expected occurrence period is the square of 1.309e+135 years – that is, 1.713e+270 years – a number so vast that it dwarves even cosmological figures. As Oscar Wild might have put it: to experience a single 25-sigma event might be regarded as a misfortune, but to experience more than one does look like carelessness

So before you decide to beat up the banks, have a think about what they were faced with. But then again, one can question, just what kind of a business are you running where extremes of this kind are present? How do design contingencies of this nature? Or put in scenario’s of this kind? Scenario Analysis is one of the most common ways of trying to analyse how things might happen in the future, but if you had to have some scenario’s of wildly cosmologically oriented events like this will need several universe sized computers to analyse.

The mind boggles.

Look at how British Investors are protected

Not. I feel gobsmacked. This is incredible. So many charities and bloody government departments and THIS is what they do when one determined man wants to report a suspicious dodgy website?

10 commandments for investors

Dear Son

Here’s a great list of investor commandments. Nothing in here rings false. So how did your Dad do? well, your dad has frequent problems with number 10. And yes, Euphoria has lead me to problems. So whenever I feel like wanting to buy immediately, I wait for your mum to give me some money. Yes, I might miss a spike here and there but very frequently I find that it stops me from making stupid judgements. They should have added an 11th commandment. Get married to a very safe, conservative, doubting, debt hating, cynical, keeping you on the earth wife. Anyway, here’s the list.

1)      “Save. Invest your savings in your future happiness and security and education for your kids.”

2)      “Don’t speculate. If you must ‘play the market’ to satisfy an emotional itch, recognize that you are gambling on your ability to beat the pros so limit the amounts you play with to the same amounts you would gamble with the pros at Las Vegas.”

3)      “Don’t do anything in investing primarily for tax reasons.”

4)      “Don’t think of your home as an investment. Think of it as a place to live with your family-period.”

5)      “Never do commodities….Dealing in commodities is really only price speculation. It’s not investing because there’s no economic productivity or value added.”

6)      “Don’t be confused about stockbrokers and mutual fund salespeople. They are usually very nice people, but their job is not to make money for you. Their job is to make money from you.”

7)      “Don’t invest in new or ‘interesting’ investments. They are all too often designed to be sold to investors, not to be owned by investors.”

8)      “Don’t invest in bonds just because you’ve heard that bonds are conservative or for safety of either income or capital. Bond prices can fluctuate nearly as much as stock prices do, and bonds are a poor defense against the major risk of long-term investing – inflation.”

9)      “Write out your long-term goals, your long-term investing program, and your estate plan – and stay with them.”

10)   “Distrust your feelings. When you feel euphoric, you’re probably in for a bruising.”

Rest of the commandments, yes, I think I do tick them off as following them. One small thing, #5, I do invest in them but not directly. Buying good mining firms with broad based businesses with good management aint wrong in my opinion, but going straight into commodities or FX? nope.

Nice overview of high frequency trading

Takes me back almost a decade where I was in the middle of the trading floor mucking around with equities. Pretty nice and exciting stuff. Now I am a boring old project manager.

Smart fellow, eh? The kids these days are very smart indeed. I hope my son is watching this. I wonder if he would be happy to do a video post about his investments?

International equity portfolio allocations and transaction costs

I got an email out of the blue.

Dear Dr. Bhaskar,

Hope this email finds you in best of your health and spirit.

I am Chandra, Sunil Poshakwale’s PhD student and you were one of my external advisors in my MRes. I would like to thank you for all your help and support at the initial stage of my PhD. I have now completed my doctorate and working as a Lecturer at the University of Stirling, Scotland. In fact you were the one to float my doctorate’s idea when you visited Cranfield University as a guest lecturer in 2007. I still remember you saying to me that one of the reasons you do not trade in emerging markets because its not worth it, given the high transaction cost. You then asked me to prove this, if I could and that would be a good PhD project.

Tapping your idea of transaction costs I have now published a paper in Journal of Banking and Finance. Please find attached the article which I published with Sunil.

Once again profound thanks for all your support. I would be very glad to have further research ideas which I can work on, pariticulary those benefiting international investors.

Kind regards

Dr. Chandra Thapa
Lecturer in Finance
University of Stirling
Stirling
FK9 4LA
Scotland
UK
Webpage:http://www.management.stir.ac.uk/people/accounting-and-finance/academic-staff/chandra-thapa
--

Quite a nice man, eh? for him to remember an off the cuff conversation from many years back. This is the paper he has written along with my old friend Sunil Poskakwale. Journal of Banking & Finance 34 (2010) 2627–2638

a b s t r a c t
In spite of the critical role of transaction cost, there are not many papers that explicitly examine its influence
on international equity portfolio allocation decisions. Using bilateral cross-country equity portfolio
investment data and three direct measures of transaction costs for 36 countries, we provide evidence that
markets where transaction costs are lower attract greater equity portfolio investments. The results imply
that future research on international equity portfolio diversification cannot afford to ignore the role of
transaction costs, and policy makers, especially in emerging markets, will have to reduce transaction
costs to attract higher levels of foreign equity portfolio investments.

Interesting article indeed and something that does touch on one of my pet bug bears, the assumption that transaction costs are zero. This is ridiculous to assume that they are zero. They arent zero, this isnt a perfect world. Economics and Finance are applied sciences, what’s the bloody point of putting in an assumption like that? Next thing you know, you will assume that investors are totally rational and follow all economic laws. heh.

Making the eldest cost centre into a hedge fund manager

You remember what I talked about last time about my son getting educated on stock investments? Well, now we started on a new experiment. The genesis of this comes from the last parents teacher association meeting that I attended and the fact that I got him a summer internship at a friend’s software development shop to learn about website design for his business. Anyway, the teachers told us that the students have to make a good cv for the formal internship next year and concentrate on the extra-curricular activities to differentiate himself from the others. He is ok in sports, but not championship / trophy level, he is much better at the mental stuff. He does like playing football and guitar but not to that extent.

Anyway, so the idea was sparked in my head and I fired off an email to some friends asking if they would be interested in investing money in a UK Stock market fund run by Karn, say £200 per head investment, 3 year lock-in period, quarterly investor calls, with an independent investment committee of non subscriber experts and we pay him on an agreed % return basis.

So he has agreed to do so, he is now busy thinking up a name of the fund. Told him to think of a good name, it has to reflect solidity and trust, also explain what it does, but also has to give a frisson of excitement. He will line up the portfolio on www.iii.co.uk and send a spreadsheet around every 3 months, get the independent investment committee to help and guide, and have a quarterly call.

So aiming for him to come up with the first list of stocks for about £1000, about seven people have already signed up, and one friend’s son also wants to invest. I did warn everybody that he is still a kid and he could lose the lot, there could be a double dip recession, there could be horrible returns in the UK, so they have to be warned that this should be looked upon as lost money. That did not worry the friends that much and looks like its a good start. And even if he loses the money, I think it would be an invaluable lesson on how to protect capital at the very least and try to make alpha. I will keep on reporting on the progress of the fund and what kind of returns he is making. Lets see if this experiment works out.

But more importantly, if you had to advice him, what would you say he would invest in? What kind of stocks do you think would be good for a good return over the next 3 years?

Teaching Work & Wealth Values to Children

While I wouldn't say that I was wealthy at all, we are comfortably well off and still owing a shed load of dosh. A long way to come for a refugee’s son in an extremely poor family indeed. Everybody thinks that their upbringing could have been improved upon. I would have liked being spanked and beaten up a bit less (heh!), but more seriously, I never got any education on how to manage wealth. My father used to complain about how much I would spend (still does), but his idea of investing and financial management was to have it all either in gold or in a savings account or land. Never got taught on how to manage wealth. As it so happens, I do think that most kids in the world do not really get this education either, although the situation is changing.

So I figured that as soon as my son will be ye high, will start his journey towards financial independence. So it was a multi pronged approach. First was to invest the Child Benefit which every child in the UK gets. So that is invested in a mutual fund and assuming 10% conservative growth, over 18 years, he should have a tidy sum of about 46k, enough for a nice little deposit on his first house. Second child onwards, you only get £53.6 per month which means that my little girl will only have £31k at the end of the 18th year period, so we bump it up to equalise.

Second was to open a savings account for both the kids when they are 6, and make sure that they contribute about 30% of their pocket money into the savings account. Not much, but the idea is to get them into the habit of making savings. Once they are 18, then will make sure that that gets converted into a pension fund. He seemed to have a reasonably good grasp of commerce from a relatively young age, here he is selling his old toys to the neighbourhood kids when he was 9 years of age. If I remember correctly, he made about £15-20 from the sale. He did it all himself, printed the fliers which were posted to the 40 houses around the green, went and stuck up the posters, and then ran the sale.

 

Third was to get my son to start learning about investments, my daughter will hopefully follow the same track with enhancements. So when he was 12, I gave him a copy of the bible of investments, The Intelligent Investor by Benjamin Graham and The Little Book that beats the Market by Joel Greenblatt. Since then I have been giving him other books such as on Warren Buffet and Rich Dad, Poor Dad. Had to very patiently explain the concept of values in the financial markets, what does ownership mean, what does price mean, how does company earnings translate into personal earnings, the importance of the P/E ratio, the importance of dividend yield, when to go for blue chips and when to go for penny stocks, the impact of FX, and so on and so forth.

Till he was 13, he was learning these things very gradually. Then he started to play a fantasy portfolio and I started to give him a hundred pounds once a quarter to get him started to invest. It was a very bad time in the markets last year, they were tanking badly and almost all the stocks he would invest in will head straight south, but his ideas were sound. I think he learnt a good lesson right at the beginning, that losses do occur and one has to have the balls to survive and ride out troughs in the market. He would invest in things like commodities, utilities, etc. So Now I am starting to feed him the official RNS reports, the annual reports, the analyst reports from the bank and any other news item that I find, give him my bits and bobs and thoughts, so that he picks up the idea that he needs to understand where he is going with the investment. Not doing too badly, over the past one year, his return has ranged between 40% and 15%, annualised its about 25%. Not bad at all. His dad made some stinkers of decisions as well, investing in Woolworths and Cattles so he is doing much better with his stock pics.

Finally, encouraged him to start thinking about earning money. So he would purchase sweet rolls and then flog them to his friends individually. So buy a roll of 10 sweets for 50 pence and sell them each for 10 pence. He also got paid £100 for making my wife’s website. Its pretty basic, but its a start. His career expectations and aspirations are all over the place, sometimes he wants to be a footballer, sometimes work as a stock broker, sometimes as a software programmer, etc. etc. Anyway, I dont have a view on what he should be, its up to him. I just need to make sure that he knows how to manage his financials. I keep on hammering the quote at him about compound interest being the strongest force in the world (an urban legend that it is a quote by Albert Einstein actually!). So asked around and got one of my friends to agree to take him in for a week or two in his software shop so that he learns how a software company works.

Separately, he came to me and said, Baba, I want to earn some money over the summer holidays and want to do a paper round. This involves school children working for news agents and using their bike, go about delivering newspapers at various subscribers. They get paid 2-3 quid per day for this. So I sat him down and talked to him about the power of leverage and bird and bees. Well, the former at least, I think he knows more about the latter than I do. So I told him how he can get others to work for him, gave him an example of doing web design for the neighbours, make up better websites for them to blog, share pictures and the like. So he is busy learning how to do proper coding after I passed some good tips from my tech guru friends. I hope he picks this up in the summer but no pressure, hope that will work out for him. No harm in him running a business and learn how to manage others. Also, couple of other things that I am working on should give him some investment options as well. So that’s under progress. Before you think he is turning into a boring old git, he is a keen footballer, loves to cook with me and has an interest in food,and I think he has a girlfriend. Plus he is studying hard at school, got a bollocking from me for having got some relatively low numbers on Religious Studies and Arts.

Hopefully when he turns 18, he will have a reasonably good net worth under his belt. He can use that for his education, to setup a new business and to buy a house. This started as an experiment, an experiment to see if one can use a basic set of resources in terms of education and a bit of cash flow to set kids up on their feet when they become adults rather than debt ridden well into their 30’s for their initial funding itself. If he can get to 31 and have all his basic life requirements (wedding, undergraduate and post graduate education, initial career, housing and car) paid for, then I think I will count myself as successful in giving him the right education, resources and tools as a parent.

Why am I writing all this? Because I read this article today and thought of jotting my experience down. I go about teaching young kids in various universities and tell them this constantly. Am also working with SIFE at LSE to further push the idea of investing out into the British education system. This isn't taught in the schools or in the universities either. The sad thing is that very few people listen and invest but the good thing is that more and more people are listening. But this doesnt mean that I have all the answers. What am I missing? Or better still, what have you done with your children to teach them about financial management and responsibility? Lets share experiences then :)