Monday, January 25, 2010

US Markets Plummet On Good Results And Flimsy Grounds

Last three trading sessions were literally devastating for bulls in US markets. Consider this fact. Dow Jones took most of November, full December of last year and half of January 2010 to rise from 10100 level to 10700 level, a gain of roughly 600 points. And it took just three trading sessions for the bears to erase these gains in Dow Jones. What alacrity on part of the bears in going about their business!

One must keep in mind that this has happened in the midst of result season. Companies have done fairly well. In fact some companies like Intel and Google have done exceptionally well. Intel had posted the best quarterly result of its lifetime. And how is that news greeted by Wall Street? The scrip is sold off, driving the stock price to nosedive into negative territory.

Mind you, here we are not discussing a high beta stock market, nor are we referring to any banana republic. We are analyzing market behaviour of the most developed stock market on this planet, a market that boasts of an army of highly evolved, rational and informed investors. Then what spooked the US markets so much that we had to become spectators to such sharp reactions? Comparable exhibition of panic selling was last witnessed in Oct 2008. But at that time there were enough global reasons to justify such investor-behaviour. What has happened this time around? To ferret out an answer let us dig deep into the state of affairs existing in the present global financial ecosystem.

The first bit of news that unnerved US investors emanated across the Pacific, from the dragon nation. Chinese central bank advised banks in China to go slow on lending. This was taken as a cue that China was feeling the negative effects of stimulus and hence was taking steps to slowly withdraw it. In limiting credit off-take, China was ready to sacrifice its growth curve. This action by the Chinese Government was not appreciated by Wall Street, and so in a gesture of utter disappointment US markets sold off.

In this episode I seem to have lost the thread of US investors' reasoning. Everyone has been accusing that China is fast entering bubble territory because of its loose credit policy. Such liquidity needs to be reined in so as to avert bubble situations developing in different asset classes. And Chinese bubble bursting will be 1000 times more catastrophic than Dubai default scenario. So far so good - I am with the thought process of US investors. If all that is true then China is taking measured steps to attenuate the effects of an anomaly existing in its financial system. It is simply taking corrective action gradually so that the world is not put into a crisis situation. We wanted China to promptly address its liquidity imbalance, didn't we? And if it has started acting judiciously in that direction, shouldn't we be happy? Do we have to express our happiness by selling off stocks indiscriminately? I am pained to admit but selling off Intel and Google shares at this point of time cannot be categorized as actions of any evolved investor.

The second tranche of bad news for Wall Street emanated from Washington. Well good or bad, its just a matter of perception. I don't think its so terrible, but Wall Street feels otherwise. Hence I leave it to you to decide. President Obama wants to tax Big Banks which had to be bailed out. He wants tax payers to be suitably compensated by these banks for having saved their skins during the height of financial crisis. He plans to extract $ 90 bn over a period of ten years as tax from these banks. Big deal!! How is it conceived as such a bad news for investors? These banks are today paying more than that to their employees as bonuses. And here the total tax of $ 90 bn is planned to be collected over a spread of ten years, which is hardly any negative. I wouldn't be surprised if Obama feels exasperated with such reaction from US investors on this tax issue. Who wouldn't?

President Obama also wants to limit the size of these banks and pass legislation to prevent them from proprietary investments. They will not be allowed to use their own money to invest in risky financial instruments. And they may not be allowed to grow so big by acquiring other smaller banks that their failure becomes unacceptable to any US government in terms of collateral damage that such failure will cause. President Obama points out that he is doing all this so that when these big banks take dumb decisions in future, the tax payers will not have to foot the bill for their mistakes. Very noble thought! Firstly the President is ensuring that big banks in future cannot gamble with the money of depositors, thereby making them safe destinations to park your money. Secondly, he is preparing the grounds to bury any bank that fails, without ever having to think of injecting tax payers' money into such a doomed bank. That will be possible since the bank will no longer be so big that on its way down it can devastate the entire financial system.

As one can see, the proposals are genuine and for the betterment of the financial system. By putting such reforms in place one is only going to ensure that US financial system remains protected from hurricanes caused by greed in the investment world. Global economy will remain stable only when US economy doesn't get jolted by crises caused by unscrupulous financial wizards, who have invented things like Credit Default Swap (CDS) and Collateralized Debt Obligations (CDO) . Then why has Wall Street reacted in such furious manner? Whose side are the investors taking - the side which is fighting to keep the investment world a safer place or the side which is constantly conjuring up some dirty tricks to dupe the investors?

Its time to see right from wrong. I hope US investors will come around and realize the long term benefits in President Obama's proposal of bank reforms. One should dismiss the politics in all this and assess it dispassionately for the merits. Of course timing of the announcement from President Obama could have been better, but that's no reason to dump all investment ideas like Intel!