Stock Market

I came across this cartoon a long time back and just loved it. Today I came across this and thought I should share it with my readers too. Here it is...

Future Computers?

see the following pictures:

1. What is this?

2. Look closely. Pens with Cameras?

3. Now?

4. This is the future of mobile computing...

No clue, if this is fiction or reality, but this could definitely be a possibility in future. I am waiting eagerly...

Wither Media?

A mail has been doing rounds here at ISB with the following picture. Is that what media has come out to?

MBA has taught me not conclude anything without looking at the facts and in this case, I must admit I don't know in what context was this news shown, but this definitely seems amusing and puts a question mark on the quality of news channels.

Predictions 2008

Ever since I started thinking about the global economic scene, I have been reading and hearing a lot of counter arguments and all of them seem credible. Now, I know why two economists always come out with three predictions. I being a novice will assume anything can come true and let me try to list down the various things that could happen.

US

Fed has cut interest rates: This will impact:

1. Inflation

Scenario 1: Inflation will go up

Lower interest rates and hence lower saving rates, will increase the supply of dollar leading to inflation.

Scenario 2: Inflation will go down, leading to deflation

a) Lower demand of Oil and Commodities will drive prices down.

b) Some people may settle debt and hence will decrease dollar supply because of money multiplier effect .

Conclusion: Inflation will remain under check.

2. Dollar

Scenario 1: Dollar will become strong

US Treasuries are still the safest instruments in the world. Governments invest in US treasuries not because they want to earn returns from it, but because they want to hedge their dollar. Also, China and India have strong internal demand and there is some decoupling from the US economy for both of these countries. Therefore, these countries will still demand more commodities and oil and to make their exports competitive, they will do whatever they can to keep dollar stable. Attractive valuations for US companies and US real assets will increase demand for dollar and will push it northwards. Cheaper US exports will increase demand for dollar too.

Scenario 2: Dollar will weaken further

Cut in rates will make US treasuries less attractive. Though countries that have trade interests with US like India and China will not take any steps that will make their exports unattractive, there are others who do not care. US dollar is the fiat currency and is used across the world for all international trade. Oil rich countries are raking in a lot of moolah because of higher oil prices. They have no obligation to invest in US and are looking at other emerging economies to get higher returns. If they have money invested in US, they may even withdraw it, further increasing supply of dollar and weakening it. China already is facing the heat of high inflation because of artificially maintaining Yuan at lower levels and will try to slow down its economy or may appreciate Yuan. If China will stop buying dollars, that will also decrease demand.

Conclusion: The dollar may fall a little bit, but there will not be a free fall. Dollar will stabilize near the current levels.

3. Stock Markets

Scenario 1: Stock markets will go up.

People will have less motivation for saving in Fixed Income instruments, they will

a) increase consumption - leading to higher revenues for companies; or

b) invest in stock market, making it cheaper and easier for companies to raise money.

c) borrow at lower interest rates and invest in stock markets.

d) Weaker dollar will make exports attractive and help US companies increase revenues.

e) Companies from outside may look at acquiring US companies because of depreciating dollar getting them higher valuations. Cheaper credit also available.

f) Weaker dollar will make imports expensive and demand for imported good will go down increasing domestic consumption.

g) Cheaper oil and commodity prices will make raw materials cheaper and hence decrease costs for US companies.

Scenario 2: Stock markets will go down.

a) People are more risk averse and will shy away from investing in risky assets.

b) No new inflows to stock markets.

c) Consumption will go down as people will have insecurity of losing their jobs.

d) Credit will not be available for investing in risky assets like stocks.

Conclusion: Stock Markets will be steady as both forces will play out.

4. Sub-Prime

Scenario 1: Worst is over

Worse may be over. Lower interest rates will help people settle their debt. Since the Adjustable Mortgage Rate is dependent on base rate, it will go down and hence lesser probability of defaults. Sub-prime crisis may be halted. Lower interest rates may encourage people to borrow and invest in housing assets including foreign countries bring the zing back to real estate market.

Scenario 2: Worst is yet to come

Worst may be yet to come. As the teaser period of loans issued in last two years would get over and AMR applicable, more cases of defaults and foreclosures may happen, further weakening the real estate market. More companies will have to write down the losses. Although rates are decreasing, slow economy and loss of jobs will prevent people from settling their loans. With no correct valuation available as no sales are happening currently, even foreign investors will shy away from investing in this sector.

Conclusion: While it still remains to be seen what will be the total effect of sub-prime, the Fed is doing every bit to minimize the pain. Most companies have already written off their losses and are now looking forward to future. No fresh loans are being given which are as risky. It may take a few years to come out of the whole mess, but the worst may be over. Nevertheless, 2008 will still continue to face the consequences.

Overall Conclusion: I believe, it will be interesting to see which of the above scenarios will play out. Also, it will not be either of the two but will be a mix of two. Most will depend of the public sentiment and the direction that Fed and the government will give. The Iraq war is close to over and the spending there will be cut. I strongly believe that US will be able to come out of recession by end of 2008 because all factors will play in its favor, Fed and US govt will go whatever they can, and most countries in the world want US to do well. Most countries do catch cold when US sneezes. The forces of the economy will play out and free fall of such well connected economy will be very difficult. US has a lot of thought leaders, many of them from India and these sharp brains will make it happen!

Inflation or Deflation and impact on India

Unlike most countries' central banks, The Fed, or the central bank in US is not government controlled. From Wikipedia, The Federal Reserve is:

The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. Created in 1913 by the enactment of the Federal Reserve Act, it is a quasi-public (part private, part government) banking system^[1] composed of (1) the presidentially-appointed Board of Governors of the Federal Reserve System in Washington, D.C.; (2) the Federal Open Market Committee; (3) 12 regional Federal Reserve Banks located in major cities throughout the nation acting as fiscal agents for the U.S. Treasury, each with its own nine-member board of directors; (4) numerous private U.S. member banks, which subscribe to required amounts of non-transferable stock in their regional Federal Reserve Banks; and (5) various advisory councils. Currently, Ben Bernanke serves as the Chairman of the Board of Governors of the Federal Reserve System.

If you look at point 4, a lot of private banks are a part of Fed and they control most of the decisions. At the same time, these private banks control over 75% of Fortune 500 stocks. So, is there a conflict of interest?

It could be argued that these banks would like the stock markets to zoom. Given the happenings in the market in the last month, the argument seems credible. The argument goes, that by cutting the Fed rate, there is less incentive for the US consumers to save and they will have two options:

1. Increase their spending.

2. Invest in other higher risk instruments like stocks.

By increasing the spending, the US companies will have higher revenue and will help their stock prices. And by investing in stocks, the cost of capital for these companies will go down as more people will want to invest in stocks and that will also help the Wall Street. The Fed expects this to provide impetus to the economy and help US come of out recession, or rather avoid it. Whether, this is a good way to help economy is arguable because economic theory suggests that lower interest rates lead to more supply of money in the system (as people do not save it in banks) and leads to inflation. Higher inflation, higher commodity prices means curse for the end users. They will want to borrow more, given the lower interest rates, but with sub-prime ghost still looming finding credit will be difficult and economy may come to a stand still again.

Inflation or Deflation?

My friend, Pratap, argues that the lower interest rates will make more money available to the consumers. However, they will not spend because given the current economic conditions people will not want to spend but will want to keep it for a rainy day. Jobs are decreasing  (http://in.rediff.com/money/2008/feb/02us.htm), so people do not want to splurge yet. They have recently burnt fingers by investing in high risk assets (the whole starting point of subprime crisis), so they will be wary of investing in stock markets too. What they will most probably do is to use the money to settle the debt. With interest rates lower and subprime rate being calculated over that, people will have incentive to pay back the debt at lower rates and excess money supply.

The power of currency comes from the fact that, when a $100 is put in the bank, the bank lends the same to someone else, who will put $80 is the bank, which the bank will lend again and so on. So, the real liquidity of one $100 is much more than a $100. This is the money multiplier effect. So, if people start paying off the debt, the money multiplier effect will decrease because banks will not be able to lend the money as easily now. This will decrease liquidity and cause deflation.

Also, the commodity prices will decrease if US economy slows down. The demand for oil and other commodity like Iron Ore, Coal etc will decrease thus decreasing prices and hence causing further deflation. This will cause the dollar to remain strong and not go down further.

My argument against this reasoning is that, the assumption here is that that markets for US companies are all domestic. When fed dropped the rates, dollar becomes weaker because of excess supply. Also, the commodity prices have downward pressure because of lesser demand from China as was argument in my earlier post. This will decrease raw material cost for US, and make exports attractive. Rest of the world, will want to import from US because they can buy more for the same amount of their own currency that they will spend. China is purposely slowing down and this will also help US exports. This increased competitiveness may cause US economy to come out of recessions, increased jobs, better wall street profits, causing people to invest more, spend more and save more.

What will happen is anybody's guess.

Impact on India

Strong dollar is good news for India. So, if by any of the above arguments the dollar does remain strong, the Indian exports will do well. Also, the lower commodity prices especially oil will help Indian imports and will make Indian manufacturing exports competitive. India might be able to siege some initiative from China though it is light years away from catching up with China. India can also benefit by importing technology and machinery from US or by buying assets in the US. Indian companies can look at acquiring some US companies with a stronger rupee right now.

Microsoft proposes to acquire Yahoo!

This was the most attention grabbing news that I heard this year, more than the Fed rate cut, more the the fall in the Indian markets and the rise again. This news is important because this means that Microsoft despite its claims in the market that it doesn't consider Google a threat, is wary of it. On the positive note, MS does seem to be ready to take on this challenge head on and is going to go all out to defeat its competition as it has done in the past. The huge cash coffers that it has, are certainly going to help it fight this battle. However, the interesting thing is that this battle is between two goliaths. Google is smart, nimble, innovate, understands the consumer pulse and has a lot of its own cash too to fight this battle till the end.

Does it makes sense for MS to buy Yahoo!?

I believe that it may make sense for MS to acquire Yahoo!. As listed in the letter addressed to the Board of Directors there are four benefits that MS sees:

1. Scale Economies: Online advertising industry is growing and it is growing faster than print and television. Microsoft has developed a potent tool to monetize the revenue from its online business through adCenter. To get maximum revenue, MS wants more share of online traffic and it seems that has been eluding it. Yahoo on the other hand has lot of hits and repeat online traffic but is not able to monetize it. By this acquisition, MS can make use of Yahoo! traffic and with Zero Marginal Cost start getting more revenue. This is where the scale economies will come into picture.

2. Expanded R&D Capacity: In this knowledge economy, the products are phases out even before the companies realize that the maturity is reached. Therefore, it is important that you keep innovating and provide reasons for the end customers to keep coming back. This requires some of the best minds in the industry to innovate. Yahoo, Google and MS all have a very good pool of R&D professional, PhDs to work on this. By acquiring Yahoo!, though MS can add to this capacity immediately and this additional capacity will be more than the sum of parts because it was earlier working towards innovating against MS.

3. Operational Efficiencies: This is very intuitive because if two websites offer a storage space to store photos, videos, files etc, by combining the two you add capacity and can service more customers with lesser capacity. Even the support staff that is required to monitor servers and keep the infrastructure running with 0 downtime, can be optimised.

4. Emerging User Experience: Both companies would be working on some innovations. By eliminating staff working on similar innovations or by augmenting them, better innovations can be brought to market faster. It will also help combine the two different technologies to come out with something really path breaking.

The reason that is not mentioned in the letter though is, that by combining forces with Yahoo!, MS can focus its energy completely on challenging its sole competitor - Google.  It will be much easier for MS to deal with just Google, than Google and Yahoo!.

Making this compelling offer of $31 per Yahoo! share with a premium of 62% over current Yahoo! stock price of about 19$, MS has made an offer that will be very difficult for Yahoo! to ignore. With annual profits of only $600m, the shareholders have lot of incentive to cash out at this point. Unless Yahoo! has some innovation in its stable that can change the face of the world or which is the next Big Thing, I think Yahoo! will accept this offer. With valuation of $44b dollars, Jerry Yang has definitely something to cheer about. Whether Google will be the next Netscape, that remains to be seen. I am keenly watching, are you?

iPhone undergoes crash test

Read up the details on http://weblogs.baltimoresun.com/business/appleaday/blog/2008/02/now_thats_tough_lost_iphone_su.html how an iPhone survived 1 hour on an interstate highway!!

Bonus: Check out the iPod touch ad

http://www.apple.com/ipodtouch/ads/