August 19, 2007

The Subprime mess and opportunity

Only when the tide goes out do you discover who's been swimming naked - warren buffett

It is diffcult to avoid reading on the subprime mess in the US. I have an oversimplified explaination –
'Losses being incurred by individual and institutions for overpaying for financial assets like CDO, MBS (mortage backed security) and other debt due to greed (for higher yields), ignorance (not knowing what was behind these assets) and overconfidence (too much faith on models)'. So what we are seeing is repricing (or correct pricing ?) of these assets.

Well for a much better understanding on what is happening and what may happen in the months to follow , read this
article on fortune.

In a nutshell the opinion is that this bubble will take some time to unwind, there could be volatility in the markets due to that and there could be steep losses for some.

I think india is not going to be affected much directly. However we could see second order effects. With a liquidity crunch, it is quite possible that the excess liquidity which is driving our stock and real estate markets may dry up. This could cause some volatility and short term drops. How much and when ? ...who knows. I think the equity markets are already reacting and there maybe be some anecdotal evidence of the same happening in the real estate market too.

If, like me, you have also been tracking some stocks or have surplus cash to invest , the next few months may provide a few good opportunities. For ex: the auto sector, oil and gas and several mid-cap, microcaps are now selling at much lower prices and could soon be great bragains.

The most common cause of low prices is pessimism. We want to do business in such an environment, not because we like pessimism, but because we like the prices it produces. It's optimism that is the enemy of the rational buyer - warren buffett


Anonymous said...

Don't be fooled into the hype that this is a "subprime" problem.
1.) It is a systemic problem with all lending practises. Too much money was given without consideration of the risk. Applies to subprime as well as LBO loans etc etc
2.) There will be a wave of defaults in the future as not much "real" economic development has happened in the US because of all this leverage. All this risky borrowing has been used to speculate on financial assets like stocks and structured products by the hedge funds. Not much infratructual development has taken place. All that was fine when the market was moving up. The real economic development happened in India and China.
3.) All the past moves up in stock had a kernel of innovation in them.
82-96 - PC revolution
98 - Internet revolution
The past move up is fully based on leverage and liquidity

In the end, liquidity is a nice word for debt. Ultimately all this debt has to be paid off.

Anonymous said...

Well said.

This debt doesn't actually have to be paid off. Two other options are default (not likely at the national level) and print more money to devalue our national debt to countries such as China, Korea and Japan. Expect the Fed to print money thereby pushing this problem further into the future. The real question is how do you exploit this opportunity now?

khali_pili_lafda said...

Any thoughts on the impact of FII's, hedge funds in the Indian markets.
1. They have poured in bilions over the last 3 years citing the India growth story. Some of this was indirectly routed through the Yen carry trade. Call it liquidity, easy money, hot money! With the carry trade reversing since Dec 2006 and the dollar weakening, the free Yen they borrowed is far more expensive now.
2. FII's and hedge funds don't BUY companies, they RENT stocks implying they move collectively in and out of countries to make their profits.
3. They own about 25% of the blue chip stocks in India and if they hit the panic button, the ripple effects could be huge.
4. In a liquidity crunch hedge funds and FII's will be quick to pull out when they can no longer deliver the phenomenal 35% return on investments they have been enjoying since 2005 (hot money being partially responsible for a tripling of the BSE since 2004)
5. Now we have the subprime mess (although confined to the US) and a probable weaking of the US economy in 2008. Could there be flight of capital to safer investment vehicles causing drops in the Indian markets.

Is it better to wait out a few months and track great companies for bargains to emerge? Your thoughts?


Rohit Chauhan said...

Hi niraj
i think all the above may be possible, but i do not have specific views on any of them. If the market goes down, there is definitely pain as a part of the portfolio drops. but at the same time a few companies which i am tracking become cheap and that allows me to invest some money.
i am already seeing that happen to a certain extent where some of the companies are selling at 4-5 times earnings (net of free cash). a further drop would make these stocks real bargains.
frankly i do not have any better view of what will happen (although i would bet that the markets could weaken). so i think it is best to be prepared by studying the companies, evalutate their intrinsic value and wait for the price to drop.
i would jump in once that happen without worrying of the near prospects of the market. i generally focus at the micro level (company specific) without worrying too much about the macro (which i cannot predict) like FII, liquidity etc