Can Lehman manage any further blow?

Market has always been flooded with people who look for prudent investment as well as those who look for easy money. While the investors approach is to get consistent return in long term investment with proper risk management, speculators trying making short term profit by betting on the price of the asset.

Speculation brings great volume to the daily trading with high liquidity which indirectly helps the investors in looking for counterparty. With high liquidity, the price discovery becomes easier because of lot of players being available in market. This also brings down the impact cost significantly. But on the other side, when speculators come with negative prediction about a particular company; because of their larger volume, they have great impact on the stock price of such firms. Recently in March, speculation against Bear Stearns Cos. made its clients and creditors stop doing business with this bank and that subsequently led to the collapse of this relatively smaller investment bank.

The most talked about speculation of March this year after the fall of bear Stern, led to spread rumour of Lehman Brothers Holding Inc., once the largest U.S. underwriter of mortgage-backed bonds, facing difficulty in maintaining its’ solvency and struggling for its survival. After that Lehman had to really fight to get back to normal business. But that was not the end; once again as the home-loan financing companies Fannie Mae and Freddie Mac dropped further on credit woes, Lehman stock fell to an eight-year low in New York trading. The stock was further hit by the speculation of its biggest customers avoiding business with this firm. Pacific Investment Management Co. (PIMCO), manager of the world's biggest bond fund, and hedge fund SAC Capital Advisors LLC both had to publically make it clear that they are continuing trade with Lehman and the speculation is unfounded. The constant pounding of company’s stock with one speculation after other, sometime makes the client doubting the performance of the firm and impacts business.

The above chart shows that the March speculation led the stock fall from $45.99 to $31.75 in a span of just 2 days, a plummet of almost 31%. The firm found it really difficult to cope up with such unexpected fall. The financial sector all over the world is in bad shape this year. The credit contraction has forced brokerages and banks to writedown as much as $408 billion this year alone. After the March debacle, it did change its strategy to fight against the odds. Lehman boosted it’s cash holding and reduced dependency on short-term loans. That led to a stable stock price for a few months from then till May, 2008. But by the end of May, with negative news all over the world and high inflation index all over the world came down and Lehman was on target again. With the recent speculation of its client staying away, it further fell by 22% again in just 2 days. At its eight years low current trading price of $17.3 per share, this year alone counts for more than unprecended 72% fall. The market cap of the company has come down from $34.3 billion in the starting of this year to a mere $9.5 billion at present.

Time will decide if this is a concerted effort of bringing Lehman down or is the wrongdoing of business. But if it continues to follow current trend, then it is not far when this will become another Bear Stern.

Stagflation

"At the end of the third century A.D., Roman Emperor Diocletian struggled to contain an inflation that raised prices by more than 300 percent a year! At the end of the twentieth century, Brazil's president, Fernando Henrique Cardoso, struggled to contain inflation that hit a rate of 40% per month or 5600% a year!"

Hard times for Asian politicians and policy makers. The staggering double digit growth rate is now a thing of the past. Now they are worried about inflation combined with slowing growth- stagflation. The best time to learn another concept in economics though. Inflation can result from either an increase in the aggregate demand or a decrease in aggregate supply. What most economies in Asia are facing is a combination of both. In the recent years, the growth story has created wealth and have given people with a double edged sword. They are definitely spending more than last five years back. This is even true amongst the place like Asia where 2/3 of the entire worlds poverty exist. The social impacts of this are seen in many of our lives, including higher crime rate, rich poor divide etc. But the economic impacts are even more striking on our face.
Global food supply shortage, high crude oil prices and fear of recession in U.S economy and the sad story continues. High crude prices and Global food supply takes the other edge of the sword which is the lessing aggregate supply. Clearly economies are pulled by both these factors. High crude prices are attributed to the factors like increase in speculation. There are websites which talks about peak oil in big time. But this claim fails to answer the soaring prices of coal, commodities. Definitely there is much more to this story than just speculation. Remember, if it was just speculation then there is also a forward sell equivalent to the forward buy. And there should be relative increase in the supply of oil. Recently Saudi Arabia increased its production, but still the prices increased. Genuinely there is a demand surge in Asian countries. China is trying to make a coal free zone for the Olympics, which means replacing the entire system with diesel or alternatives. So we can reject the idea of speculation for soaring oil prices. It might be a reason but fails to explain in its full.
Lets address the fear of recession in U.S. . Of course there are signs of slowing economy. The labor market was one figure which was falling in the recent months. But can we say this will be a hint to the recession impending? Basically, according to Philips curve which gives the relationship between the inflation and unemployment holding constant the expected inflation rate, the natural unemployment rate, says there is a negative relationship between the two variables.
There is a rise in inflation rate coupled with slowing growth which has resulted in increasing unemployment rate. " Cash is King this year"

How securities are traded

The involvement of retail investors in capital market has increased significantly. While many of them invest in market passively through mutual funds, there are quite a few who either invest using demat account or get help of the broker for investment. Many might wonder how shares come to their account and money is deducted online? Why the exchange trading in India is termed as T+2? And what do clearing and settlement means?

The whole trading starts with decision to trade, when the investor looks for some script and place order for that. If the order matches with the counter order placed by some other investor, it gets executed. Once the order gets executed, on the next day it goes to the clearing house where all trades are confirmed. Which is shown in the diagram at T+1 days. Then these cleared trades get settled, where pay-in & pay-out of all the securities and funds takes place. This settlement takes place on T+2 days. Such settlement is called rolling settlement.

In India, rolling settlement was first introduced by Over the counter exchange of India (OTCEI). In the year 2000, SEBI made rolling settlement compulsory for 10 selected securities which had volume more than Rs 1 crore. With time by December 2001, other stocks were also included for rolling settlement. SEBI introduced T+5 rolling settlement in equity market from July 2001, which was subsequently shortened to T+3 from April, 2002. To reduce the risks in settlement like counterparty risk and system risk, SEBI mandated rolling settlement of T+2 days for all the scripts from April 1, 2003.

Can Mutual Funds stop the bear run?

The last 6 months have been really troubling for stock market all over the world. While Dow reached it 2 years low, Nifty dipped below its sentimental level of 4000. In such a volatile market investments made for short term made people lose drastically. The recent dip of NIFTY index from 6280 to 3800 made even the value investor worried.

Looking at the major inflow in the market, we see that two major players – Domestic mutual fund (DMF) and Foreign Institutional investors (FII); behaved differently in the market. While FII pulled out money amounting around 25000 Crore, mutual funds cumulatively invested 9000 Crore in the market. More over the pattern shown in the diagram above explains that; at every fall FII were the one who pulled out money while in most of the dips, mutual funds invested in equity. With more than 600 stocks trading at below its’ 52 weeks lows, fund managers find it quite attractive to take position while FII who are there in market for short term took their money out in panic. As discussed in the previous posts, the compounded annual return is more than 30% for NIFTY index; hence such unexpected fall should be taken as an opportunity by both mutual funds and retail investors to invest rather than to stay away from the market. Staying invested for medium to long term will certainly be rewarding.

Looking at the major players in the market, the question arises about the driving players in the market at present? Is it the FIIs who are running away from the market or the Mutual funds who are investing quite cautiously? FIIs’ pull-out of 25000 crore has been really a reason to worry. This exit has been the major factor of indices taking a dip, but with more than 20,000 crore fund and cash equivalent uninvested, asset management companies (AMCs) have the potential to change the sentiments and encourage people for value investing. Surprisingly this time, the retail investors in Mutual funds have not rushed to redeem the allocated units hence fund managers have more flexibility to move their investment into blue chips which are available at quite a reasonable price.