yet very few people practice it.
"The secret has been out for 50 years, ever since Ben Graham and Dave Dodd wrote Security Analysis, yet I have seen no trend toward value investing in the 35 years that I've practiced it." – Warren Buffett, 1984
It has been another 25 years since Warren Buffett said this. But the statement still rings true. He is now even more famous than before. The number of books on him has multiplied and business channels now have divisions that track his activities on a daily basis. While Buffett is the most famous, there are others who are successful value investors in their own right and also receive ample media attention.
But if you looked around to see how professional money managers go about their business, you wouldn't find too much of value investing there. The logical question then is ‘Why not?’ We believe there are certain behavioral stumbling blocks that explain why there are very few value investors despite all the media coverage the discipline receives.
Knowledge doesn’t translate to action
Unfortunately, knowledge doesn't always translate to behavior. It is common knowledge that we should use helmets, buckle up our seat belts, avoid smoking, take medical insurance etc. but we don’t strictly follow them. It takes deliberate action on our part for us to form habits, mere knowledge is not enough. If we are not able to always do the right thing in such important matters, it is not surprising that we don't choose the best path when it comes to investing.
One size doesn’t fit all
The general tendency of investors is to find that magic formula - a method that applies to all situations. In fact, the one time everyone asks for stock tips is when there is market euphoria. The right answer during such times is – ‘don’t buy anything’. But that’s a difficult answer to digest. On the other hand, when markets are unduly pessimistic, there are value picks everywhere. Value investing often doesn’t offer picks when we are most interested. That makes it a hard discipline to follow.
Patience in the internet age?
A few months ago Bharti Airtel had come out with a campaign called the 'impatient ones'. That seems to be an apt description of most investors. The way we have evolved, we are hard wired for short term rewards. Short term thinking comes naturally to us. It takes training and mental conditioning for us to shake off the habit and reorient our investment horizons. Value investing requires long term time horizons because there is no guarantee that out of favour stocks that value investors prefer investing in, will suddenly come back in favour.
Standing out from the crowd is difficult
As explained above, the best value picks come exactly at the time when there is pessimism all around. As Buffett himself said, "The most common cause of low prices is pessimism - some times pervasive, some times specific to a company or industry. 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.' Unfortunately, that means one has to do the exact opposite of what others are doing. Buy when others are desperately selling and vice versa. Since we are hard wired to stick to the crowd, it is inherently difficult for us to do the exact opposite.
To conclude, it is not the lack of intelligence or knowledge because of which there are so few value investors. The answer lies in our behavioral pitfalls. We need to master them in order to practice value investing.
Sunday 4 October 2009
Saturday 3 October 2009
25 Best Warren Buffett Quotes
On Investing
- “Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.”
- “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
- “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”
- “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
- “Why not invest your assets in the companies you really like? As Mae West said, “Too much of a good thing can be wonderful”.”
On Success
- “Of the billionaires I have known, money just brings out the basic traits in them. If they were jerks before they had money, they are simply jerks with a billion dollars.”
- “The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective.”
- “You do things when the opportunities come along. I’ve had periods in my life when I’ve had a bundle of ideas come along, and I’ve had long dry spells. If I get an idea next week, I’ll do something. If not, I won’t do a damn thing.”
- “Can you really explain to a fish what it’s like to walk on land? One day on land is worth a thousand years of talking about it, and one day running a business has exactly the same kind of value.
- “You only have to do a very few things right in your life so long as you don’t do too many things wrong.”
On Helping Others
- “If you’re in the luckiest 1 per cent of humanity, you owe it to the rest of humanity to think about the other 99 per cent.”
- “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”
- “I don’t have a problem with guilt about money. The way I see it is that my money represents an enormous number of claim checks on society. It’s like I have these little pieces of paper that I can turn into consumption. If I wanted to, I could hire 10,000 people to do nothing but paint my picture every day for the rest of my life. And the GNP would go up. But the utility of the product would be zilch, and I would be keeping those 10,000 people from doing AIDS research, or teaching, or nursing. I don’t do that though. I don’t use very many of those claim checks. There’s nothing material I want very much. And I’m going to give virtually all of those claim checks to charity when my wife and I die.”
- “It’s class warfare, my class is winning, but they shouldn’t be.”
- “My family won’t receive huge amounts of my net worth. That doesn’t mean they’ll get nothing. My children have already received some money from me and Susie and will receive more. I still believe in the philosophy - FORTUNE quoted me saying this 20 years ago - that a very rich person should leave his kids enough to do anything but not enough to do nothing.”
On Life
- “Chains of habit are too light to be felt until they are too heavy to be broken.”
- “We enjoy the process far more than the proceeds.”
- “You only find out who is swimming naked when the tide goes out.”
- “Someone’s sitting in the shade today because someone planted a tree a long time ago.”
- “A public-opinion poll is no substitute for thought.”
Funny Ones
- “A girl in a convertible is worth five in the phonebook.”
- “When they open that envelope, the first instruction is to take my pulse again.”
- “We believe that according the name ‘investors’ to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a ‘romantic.’”
- “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
- “In the insurance business, there is no statute of limitation on stupidity.”
Sunday 6 September 2009
Thursday 27 August 2009
5 things to know before investing
All of us need to manage our finances wisely. While some aspects of financial management change with age, the basic principles of good financial habits and planning remain the same throughout one's life. Here are a few things that should be kept in mind at all times before investing:
THE GOAL
If you have a goal that you are trying to achieve, then it becomes easier for you to track your progress and analyse whether your investment strategy makes sense or not. It is very important to be well aware of targets before planning to invest
THE TIME
Once you have identified your goals, understand over what time period you want to achieve your goals. This will not only keep you focussed and motivated, but will also keep you alert of the risks involved
THE RISK
Every investment has risks associated with it. Every individual should take risk according to his or her capacity. Some investments are risky than others. Before investing, it is good to know your capacity to take risks so that there are no jolts later
THE INFLATION
In a fast-growing economy, inflation is a fact of life. Manage your investments accordingly. For instance, stocks would offer better protection than fixed deposits against inflation
THE LIMITATIONS
It is always good to stay within your means. Stay away from 'bad debt' — debt you take for consumption purposes, otherwise you could risk falling into the debt trap where you have to borrow more to pay off your previous debts
Wednesday 27 May 2009
Did you make money or create wealth?
Arindam Ghosh
The recent equity market rally has caught a lot of people by surprise, whether they are investors, brokers, or seasoned fund managers. In fact, many have dismissed this rally as not sustainable, while reasoning why they weren’t able to catch the trend early on. In a short span of a couple of months, markets globally have witnessed a surge of 30-50 per cent. Indian markets too have witnessed a sharp rally having risen over 40 per cent post March.
While a lot has been written about how much would have an investor gained had he/ she invested in the best performing stocks in the last two months, the question is: how prudent was the investor?
Given the global financial turmoil, would anyone have risked investing huge monies in the equity markets in the last couple of months? Leave the hindsight for a moment, just go back to the environment in March and ask yourself if it was a good time to risk a new investment? You would probably not be alone in saying you saw no rational reason in doing so.
Even, if for a moment, one were to assume that someone had the courage to invest a lump sum (not more than Rs. 10,000 – 20,000) in one shot, around early May? An investment of Rs. 10,000 in the BSE Sensex in March would have fetched 50 per cent returns, and the investment would have grown to Rs. 15,000 today.
A roller-coaster ride?
While these are spectacular returns, by any reckoning, does the corpus (of Rs 15,000 in the middle of May 2009) represent wealth? To put it bluntly, where does one go from here? It is fairly obvious that the investor may not get the same kind of run every time, and the law of averages suggests the next big move may be down rather than continue in the upward direction. So, in terms of wealth generation, are you on the course of sustained wealth creation or a roller coaster?
A savvy investor would reason that getting money into the kitty like a high tide/ low tide flow only to see it ebb is not wealth creation or accumulation. It is time to get back to basics: Wealth generation is a process of disciplined investing which focuses on the financial goal rather than the market or economic situation.
Consider this: if one had started to invest Rs. 7,500/- every month in the BSE Sensex on the 24th day of the month since October 2008, he/ she would have accumulated Rs. 68,623/- as on May 09.
Remain steadfast
It’s quite evident that for an intelligent investor, the disciplined approach of investing a small amount, on a regular basis, goes much farther than trying to time the markets.
The latter course of action is contingent on immense amount of consistent good luck, but that too will not take you very far. If you do happen to invest at the right time before a rally, the total gains may still not be substantial given the size of the principal invested.
To be sure, the Indian markets have matured immensely over the last two years. Investors have come to agree that volatility is an integral part of traded asset markets, and that it is unlikely that we will see a sustained, one-way, bull phase for some time.
The only rational way to creating sustainable wealth in choppy conditions is to remain steadfast to the purpose, and keep investing a small amount every month with rigour and conviction.
The recent equity market rally has caught a lot of people by surprise, whether they are investors, brokers, or seasoned fund managers. In fact, many have dismissed this rally as not sustainable, while reasoning why they weren’t able to catch the trend early on. In a short span of a couple of months, markets globally have witnessed a surge of 30-50 per cent. Indian markets too have witnessed a sharp rally having risen over 40 per cent post March.
While a lot has been written about how much would have an investor gained had he/ she invested in the best performing stocks in the last two months, the question is: how prudent was the investor?
Given the global financial turmoil, would anyone have risked investing huge monies in the equity markets in the last couple of months? Leave the hindsight for a moment, just go back to the environment in March and ask yourself if it was a good time to risk a new investment? You would probably not be alone in saying you saw no rational reason in doing so.
Even, if for a moment, one were to assume that someone had the courage to invest a lump sum (not more than Rs. 10,000 – 20,000) in one shot, around early May? An investment of Rs. 10,000 in the BSE Sensex in March would have fetched 50 per cent returns, and the investment would have grown to Rs. 15,000 today.
A roller-coaster ride?
While these are spectacular returns, by any reckoning, does the corpus (of Rs 15,000 in the middle of May 2009) represent wealth? To put it bluntly, where does one go from here? It is fairly obvious that the investor may not get the same kind of run every time, and the law of averages suggests the next big move may be down rather than continue in the upward direction. So, in terms of wealth generation, are you on the course of sustained wealth creation or a roller coaster?
A savvy investor would reason that getting money into the kitty like a high tide/ low tide flow only to see it ebb is not wealth creation or accumulation. It is time to get back to basics: Wealth generation is a process of disciplined investing which focuses on the financial goal rather than the market or economic situation.
Consider this: if one had started to invest Rs. 7,500/- every month in the BSE Sensex on the 24th day of the month since October 2008, he/ she would have accumulated Rs. 68,623/- as on May 09.
Remain steadfast
It’s quite evident that for an intelligent investor, the disciplined approach of investing a small amount, on a regular basis, goes much farther than trying to time the markets.
The latter course of action is contingent on immense amount of consistent good luck, but that too will not take you very far. If you do happen to invest at the right time before a rally, the total gains may still not be substantial given the size of the principal invested.
To be sure, the Indian markets have matured immensely over the last two years. Investors have come to agree that volatility is an integral part of traded asset markets, and that it is unlikely that we will see a sustained, one-way, bull phase for some time.
The only rational way to creating sustainable wealth in choppy conditions is to remain steadfast to the purpose, and keep investing a small amount every month with rigour and conviction.
Tuesday 28 April 2009
Thursday 16 April 2009
Should I discontinue my SIP?
January 28, 2009
Nowadays, a question that investors routinely pose to the Personalfn financial planning team is – “should I discontinue my SIP”. The downturn in equity markets has adversely affected the performance of equity funds. With portfolios languishing in negative territory, expectedly, investors are a worried lot. Some investors have concluded that now is a good time to discontinue ongoing SIPs. Is that the right strategy to adopt? Before discussing the same, let’s understand what an SIP (systematic investment plan) is and how it functions.
How an SIP works
Investing in a mutual fund via the SIP route entails making investments (often in smaller denominations) in a staggered manner as opposed to making one-time (lump sum) investments. This aids investors benefit from market volatility by lowering the average purchase cost. In an SIP, each installment i.e. a fixed sum of money is invested at the prevailing NAV (net asset value) on a predetermined date. In times of volatility, when the underlying fund’s NAV falls, it leads to a higher number of units being credited to the investor’s account.
For example, Rs 1,000 invested at an NAV of Rs 50, will result in 20 units being credited to the investor. However, should the NAV fall to Rs 40 in the subsequent month on account of turbulent markets, the investor will gain by receiving a higher number of units. In the process, the average purchase cost will fall as well.
An SIP investment makes market timing irrelevant. Timing markets involves attempting to make investments when markets are at their lowest and exiting at the peak. It’s a different matter that timing markets and doing so consistently is beyond most investors. By spreading investments over a period of time, the SIP mode does away with the need to time markets.
Finally, the downturn in markets has meant that several stocks are available at attractive prices. Also, the potential of the domestic economy to deliver over the long-term remains unchanged.
Now let’s come back to the original question – should investors discontinue their ongoing SIPs? Clearly, the discussion above suggests that now is the time to invest via the SIP mode, rather than discontinue ongoing SIPs.
The flipside
However, there is a need to understand that an SIP is a ‘means’ to achieve an end and not an ‘end’ by itself. In other words, the SIP should be aimed at helping investors achieve their predetermined financial goals. An SIP in isolation (i.e. one which doesn’t form part of a broader financial plan) or one in a poorly managed fund is unlikely to aid investors. The fund also needs to be right for the investor i.e. it should suit the investor’s risk profile and be equipped to aid him achieve his financial goals. Simply investing via the SIP route doesn’t eliminate the shortcomings of a fund or improve its prospects for the matter.
It is also pertinent that the SIP runs over a sufficiently long time frame. Often, investors are guilty of investing in a 6-Mth SIP, simply because, that is the minimum tenure offered by fund houses. Like investing for the long-term is pertinent in the case of equity investments, it is also important the SIP runs over the long haul i.e. at least 2-3 years. This can aid the SIP witness a falling market and deliver on the critical aspect of lowering the average purchase cost.
What investors should do
In conclusion, it can be stated that there is no standard answer for the query – should I discontinue my SIP? It would depend on the facts of each case. Although the benefits of investing via the SIP mode cannot be disputed, several factors need to be considered before making an investment decision.
For instance, investors who have the ability to take on risk, a sufficiently long investment horizon (at least 3-5 years) and are invested in funds that are right for them need not discontinue their ongoing SIPs. Conversely, others would do well to conduct a thorough assessment of their investments. The investment advisor has an important role to play in aiding investors with the latter. The key lies in not evaluating SIPs in isolation and thus making informed investment decisions.
Nowadays, a question that investors routinely pose to the Personalfn financial planning team is – “should I discontinue my SIP”. The downturn in equity markets has adversely affected the performance of equity funds. With portfolios languishing in negative territory, expectedly, investors are a worried lot. Some investors have concluded that now is a good time to discontinue ongoing SIPs. Is that the right strategy to adopt? Before discussing the same, let’s understand what an SIP (systematic investment plan) is and how it functions.
How an SIP works
Investing in a mutual fund via the SIP route entails making investments (often in smaller denominations) in a staggered manner as opposed to making one-time (lump sum) investments. This aids investors benefit from market volatility by lowering the average purchase cost. In an SIP, each installment i.e. a fixed sum of money is invested at the prevailing NAV (net asset value) on a predetermined date. In times of volatility, when the underlying fund’s NAV falls, it leads to a higher number of units being credited to the investor’s account.
For example, Rs 1,000 invested at an NAV of Rs 50, will result in 20 units being credited to the investor. However, should the NAV fall to Rs 40 in the subsequent month on account of turbulent markets, the investor will gain by receiving a higher number of units. In the process, the average purchase cost will fall as well.
An SIP investment makes market timing irrelevant. Timing markets involves attempting to make investments when markets are at their lowest and exiting at the peak. It’s a different matter that timing markets and doing so consistently is beyond most investors. By spreading investments over a period of time, the SIP mode does away with the need to time markets.
Finally, the downturn in markets has meant that several stocks are available at attractive prices. Also, the potential of the domestic economy to deliver over the long-term remains unchanged.
Now let’s come back to the original question – should investors discontinue their ongoing SIPs? Clearly, the discussion above suggests that now is the time to invest via the SIP mode, rather than discontinue ongoing SIPs.
The flipside
However, there is a need to understand that an SIP is a ‘means’ to achieve an end and not an ‘end’ by itself. In other words, the SIP should be aimed at helping investors achieve their predetermined financial goals. An SIP in isolation (i.e. one which doesn’t form part of a broader financial plan) or one in a poorly managed fund is unlikely to aid investors. The fund also needs to be right for the investor i.e. it should suit the investor’s risk profile and be equipped to aid him achieve his financial goals. Simply investing via the SIP route doesn’t eliminate the shortcomings of a fund or improve its prospects for the matter.
It is also pertinent that the SIP runs over a sufficiently long time frame. Often, investors are guilty of investing in a 6-Mth SIP, simply because, that is the minimum tenure offered by fund houses. Like investing for the long-term is pertinent in the case of equity investments, it is also important the SIP runs over the long haul i.e. at least 2-3 years. This can aid the SIP witness a falling market and deliver on the critical aspect of lowering the average purchase cost.
What investors should do
In conclusion, it can be stated that there is no standard answer for the query – should I discontinue my SIP? It would depend on the facts of each case. Although the benefits of investing via the SIP mode cannot be disputed, several factors need to be considered before making an investment decision.
For instance, investors who have the ability to take on risk, a sufficiently long investment horizon (at least 3-5 years) and are invested in funds that are right for them need not discontinue their ongoing SIPs. Conversely, others would do well to conduct a thorough assessment of their investments. The investment advisor has an important role to play in aiding investors with the latter. The key lies in not evaluating SIPs in isolation and thus making informed investment decisions.
Saturday 11 April 2009
The 1929 crash
In the previous article we had discussed the '1987 Crash'. A five-year 'bull' market, which started in 1982, came to an end in 1987.
In this article we will discuss the crash in 1929 which led to severe economic collapse during the early twentieth century.
The 1929 crash
After World War I, during the 1920’s, the American economy was fuelled by increased industrialization and new technologies. At the same time, a new concept of installment plans came into existence which gave birth to a culture of consumerism. With installment plans, American families could now afford to purchase more than ever before. America prospered in this decade and became the richest nation in the world. Aided by this spectacular growth, stocks were on a roll between 1921 and 1929; the Dow Jones Industrial Average rose six times during this period. Booming stock markets made people believe that the markets could only rise higher. Very soon this era turned into an era of intense speculation on the stock market.
But the exuberance started fizzling out by early September of 1929 as news about failure of several banks, lower housing projects and lower steel production started making headlines. The market peaked on September 3, 1929. At this point, the Dow was up 27% from the previous year. The prices started their downhill journey from here. On October 23, 1929 fear crept in and before the closing bell rang, stock prices suddenly plummeted. This event shook the beliefs of investors in the market and panic set in. The next day, prices further plunged and 13 m shares changed hands on a single day. That was the highest daily volume in the exchange's history at that point of time. The southward journey continued on the following Monday and the Dow registered a drop of another 13%. With no respite yet in sight, on October 29 the Dow dropped another 12%. The 1929 crash set off a chain of events that plunged the US and the world into a decade-long depression.
Economic woes further aggravated, as the government did not try to prop up aggregate demand. The Federal Reserve (FED) also did not use open market operations to keep the money supply from falling. Instead the FED raised interest rates and discouraged gold outflows after the United Kingdom abandoned the gold standard in the fall of 1931. And the FED let the private sector handle the Depression in its own fashion. This choked the economy and unemployment skyrocketed, companies incurred huge layoffs, wages plummeted and the economy went into a tailspin.
Conclusion
The stock market prices are based, in a great part, on expectations. Thus, in stock markets when investors believe stock prices will increase, it increases the demand for stocks. This increased demand continues until stock prices become too high in comparison to the intrinsic value of the related corporation. These overvalued stock price result in excess supply of stocks, which in turn causes prices to fall. When a lot of investors decide to leave the market at the same time then markets plunge and little can be done to prevent the markets from falling. Thus an investor should understand the dynamics of the markets and take it in their stride. As Peter Lynch quips "You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets."
In this article we will discuss the crash in 1929 which led to severe economic collapse during the early twentieth century.
The 1929 crash
After World War I, during the 1920’s, the American economy was fuelled by increased industrialization and new technologies. At the same time, a new concept of installment plans came into existence which gave birth to a culture of consumerism. With installment plans, American families could now afford to purchase more than ever before. America prospered in this decade and became the richest nation in the world. Aided by this spectacular growth, stocks were on a roll between 1921 and 1929; the Dow Jones Industrial Average rose six times during this period. Booming stock markets made people believe that the markets could only rise higher. Very soon this era turned into an era of intense speculation on the stock market.
But the exuberance started fizzling out by early September of 1929 as news about failure of several banks, lower housing projects and lower steel production started making headlines. The market peaked on September 3, 1929. At this point, the Dow was up 27% from the previous year. The prices started their downhill journey from here. On October 23, 1929 fear crept in and before the closing bell rang, stock prices suddenly plummeted. This event shook the beliefs of investors in the market and panic set in. The next day, prices further plunged and 13 m shares changed hands on a single day. That was the highest daily volume in the exchange's history at that point of time. The southward journey continued on the following Monday and the Dow registered a drop of another 13%. With no respite yet in sight, on October 29 the Dow dropped another 12%. The 1929 crash set off a chain of events that plunged the US and the world into a decade-long depression.
Economic woes further aggravated, as the government did not try to prop up aggregate demand. The Federal Reserve (FED) also did not use open market operations to keep the money supply from falling. Instead the FED raised interest rates and discouraged gold outflows after the United Kingdom abandoned the gold standard in the fall of 1931. And the FED let the private sector handle the Depression in its own fashion. This choked the economy and unemployment skyrocketed, companies incurred huge layoffs, wages plummeted and the economy went into a tailspin.
Conclusion
The stock market prices are based, in a great part, on expectations. Thus, in stock markets when investors believe stock prices will increase, it increases the demand for stocks. This increased demand continues until stock prices become too high in comparison to the intrinsic value of the related corporation. These overvalued stock price result in excess supply of stocks, which in turn causes prices to fall. When a lot of investors decide to leave the market at the same time then markets plunge and little can be done to prevent the markets from falling. Thus an investor should understand the dynamics of the markets and take it in their stride. As Peter Lynch quips "You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets."
The crash of 1987
In the previous article of this series we had discussed about the Asian Financial Crisis. The economies of Thailand, Malaysia, Singapore, Indonesia, Hong Kong, and South Korea, had witnessed impressive economic growth rates in the world during 1980 to 1990 but these Asian countries began to crumble in early 1997 and lost a decade of economic progress due to this crisis.
In this article, we will discuss the ‘1987 Crash’. A five-year 'bull' market which started in 1982 came to an end in 1987, between October 14 and October 19, 1987 and major indices of the United States dropped 30% or more.
The 1987 crash
After 1982 companies listed on the US bourses started posting strong gains but soon the price of stocks outpaced earnings growth, thereby inflating price to earnings ratios. This led to markets becoming overvalued. This prompted an influx of new investors, such as pension funds, into the stock market during the mid 1980s. The increased demand supported the inflated prices. Furthermore, favorable tax treatments given to the financing of corporate buyouts, such as allowing firms to deduct interest expenses associated with debt issued during a buyout, which increased the number of companies that were potential takeover targets helped in pushing up their stock prices.
By mid 1987 the macroeconomic scenario turned less certain. The trade deficit of the US grew significantly. In order to manage this deficit, the treasury Secretary James Baker suggested the need for a fall in the dollar on foreign exchange markets. This move led foreigners to pull out of dollar denominated assets which caused a sharp rise in interest rates. The legislation regarding elimination of tax benefits associated with financing mergers also added to the fear and stock market started sliding.
The trading mechanisms in financial markets were not able to deal with a large flow of sell orders. This added to the woes of the stock market. Furthermore, insufficient liquidity also played a significant role in the size of the price drop. Stock markets and derivatives markets also failed to operate in sync and played their part during the crash.
Conclusion
The global markets have become more complex than ever. While financial innovations and new technology are creating new opportunities, they are also increasing the scope of miscalculation and mayhem. In times such as these panic is inevitable and anything rash that investors do might make the situation worse. So the best advice one can give to investors is to stick with their long-term investment strategy, and take advantage of the markets’ volatile movements. Especially, in the current scenario, given that there is all pervading pessimism due to the global financial crisis, now would be the time to buy good quality stocks at bargain prices.
In this article, we will discuss the ‘1987 Crash’. A five-year 'bull' market which started in 1982 came to an end in 1987, between October 14 and October 19, 1987 and major indices of the United States dropped 30% or more.
The 1987 crash
After 1982 companies listed on the US bourses started posting strong gains but soon the price of stocks outpaced earnings growth, thereby inflating price to earnings ratios. This led to markets becoming overvalued. This prompted an influx of new investors, such as pension funds, into the stock market during the mid 1980s. The increased demand supported the inflated prices. Furthermore, favorable tax treatments given to the financing of corporate buyouts, such as allowing firms to deduct interest expenses associated with debt issued during a buyout, which increased the number of companies that were potential takeover targets helped in pushing up their stock prices.
By mid 1987 the macroeconomic scenario turned less certain. The trade deficit of the US grew significantly. In order to manage this deficit, the treasury Secretary James Baker suggested the need for a fall in the dollar on foreign exchange markets. This move led foreigners to pull out of dollar denominated assets which caused a sharp rise in interest rates. The legislation regarding elimination of tax benefits associated with financing mergers also added to the fear and stock market started sliding.
The trading mechanisms in financial markets were not able to deal with a large flow of sell orders. This added to the woes of the stock market. Furthermore, insufficient liquidity also played a significant role in the size of the price drop. Stock markets and derivatives markets also failed to operate in sync and played their part during the crash.
Conclusion
The global markets have become more complex than ever. While financial innovations and new technology are creating new opportunities, they are also increasing the scope of miscalculation and mayhem. In times such as these panic is inevitable and anything rash that investors do might make the situation worse. So the best advice one can give to investors is to stick with their long-term investment strategy, and take advantage of the markets’ volatile movements. Especially, in the current scenario, given that there is all pervading pessimism due to the global financial crisis, now would be the time to buy good quality stocks at bargain prices.
The Asian Financial Crisis
In the previous article , we discussed about the dot com bubble. Dot com companies believed that the internet business would somehow instantly take off and the entire business landscape will change in a very short span of time. The hype didn’t live up to its promises. Unfortunately, the growth of the tech sector proved to be illusionary and the dot com bubble burst in the year 2001. In this article, we will discuss about the ‘Asian Financial Crisis’, which engulfed most of the South East Asian countries in the 1990s.
The Asian Financial Crisis
The economies of Thailand, Malaysia, Singapore, Indonesia, Hong Kong, and South Korea, were posting some of the most impressive economic growth rates in the world during 1980 to 1990. Their Gross Domestic Product was compounding by 6% to 9% per annum during this period. A combination of inexpensive and relatively well educated labor, export orientation, falling barriers to international trade and heavy inward investment by foreign companies led to this impressive growth.
The wealth created by these countries fueled an investment boom in commercial and residential property, industrial assets, and infra-structure. However, this unprecedented investment boom was mostly financed with borrowed money. Furthermore, the investments were made on the basis of unrealistic projections about future demand. Very soon this resulted into significant excess capacity, which in turn led to a significant decline in prices. The companies that had made the investments started groaning under huge debt burden that they were now finding difficult to service.
By the mid 1990s, imports in these countries started growing dramatically, mainly aided by the investments in infrastructure, industrial capacity, and commercial real estate. This growth in imports moved the current account of their balance of payments into the red. To make matter worse, most of the borrowing to fund these investments had been in US dollars, as opposed to local currencies.
The growing deficits made it difficult for the governments of these countries to maintain the peg of their currencies against the US dollar. If that peg could not be held, the local currency value of dollar dominated debt would increase, raising a large scale default on debt service payments.
The Asian meltdown began in early 1997 in Thailand with a Thai property developer announcing its failure to make a scheduled US$ 3.1 m interest payment on an US$ 80 bn eurobond loan. This incidence raised the red flag and the Thai market started falling. Very soon the crisis percolated into the currency market. Thailand’s growing current account deficit and dollar denominated debt burden increased demand for dollars in Thailand and simultaneously decreased demand for Baht. Taking advantage of the situation currency traders began a concerted attack on the Thai currency. At that point of time, the Thai baht had been pegged to the US dollar at an exchange rate of around US$ 1=Bt 25. With this concentrated attack on Thai baht, the peg became difficult to defend. In order to defend the peg, the Thai government used its foreign exchange reserves to purchase Thai baht. The cost to defend the peg was US$ 5 bn, but Thai central bank had locked up most of Thailand’s foreign exchange reserves in forward contracts. Thus, Thailand only had US$ 1.14 bn available foreign exchange reserves left to defend the dollar peg. Ultimately, the Thai government had to bow down to the inevitable and the government allowed the baht to float freely against the dollar. The baht immediately started a slide. Following the devaluation of the Thai baht, a wave hit other Asian currencies and in a short spans of few weeks the Malaysian ringgit, Indonesian rupiah and the Singapore dollar all nosedived one after the other and the entire region was gripped by the crisis. These countries lost a decade of economic progress due to this crisis.
Conclusion
The region had been promoted by many as the future economic engine of the world economy. Investors have invested billions of dollars in the region on the assumption that the rapid growth of the last decade would continue. But it came grinding to a halt.
It once again proved that during periods of abundant capital, there is an often-irresistible temptation to anchor to false beliefs. This strategy may bear fruit for a while, but is costly over the long haul.
The Asian Financial Crisis
The economies of Thailand, Malaysia, Singapore, Indonesia, Hong Kong, and South Korea, were posting some of the most impressive economic growth rates in the world during 1980 to 1990. Their Gross Domestic Product was compounding by 6% to 9% per annum during this period. A combination of inexpensive and relatively well educated labor, export orientation, falling barriers to international trade and heavy inward investment by foreign companies led to this impressive growth.
The wealth created by these countries fueled an investment boom in commercial and residential property, industrial assets, and infra-structure. However, this unprecedented investment boom was mostly financed with borrowed money. Furthermore, the investments were made on the basis of unrealistic projections about future demand. Very soon this resulted into significant excess capacity, which in turn led to a significant decline in prices. The companies that had made the investments started groaning under huge debt burden that they were now finding difficult to service.
By the mid 1990s, imports in these countries started growing dramatically, mainly aided by the investments in infrastructure, industrial capacity, and commercial real estate. This growth in imports moved the current account of their balance of payments into the red. To make matter worse, most of the borrowing to fund these investments had been in US dollars, as opposed to local currencies.
The growing deficits made it difficult for the governments of these countries to maintain the peg of their currencies against the US dollar. If that peg could not be held, the local currency value of dollar dominated debt would increase, raising a large scale default on debt service payments.
The Asian meltdown began in early 1997 in Thailand with a Thai property developer announcing its failure to make a scheduled US$ 3.1 m interest payment on an US$ 80 bn eurobond loan. This incidence raised the red flag and the Thai market started falling. Very soon the crisis percolated into the currency market. Thailand’s growing current account deficit and dollar denominated debt burden increased demand for dollars in Thailand and simultaneously decreased demand for Baht. Taking advantage of the situation currency traders began a concerted attack on the Thai currency. At that point of time, the Thai baht had been pegged to the US dollar at an exchange rate of around US$ 1=Bt 25. With this concentrated attack on Thai baht, the peg became difficult to defend. In order to defend the peg, the Thai government used its foreign exchange reserves to purchase Thai baht. The cost to defend the peg was US$ 5 bn, but Thai central bank had locked up most of Thailand’s foreign exchange reserves in forward contracts. Thus, Thailand only had US$ 1.14 bn available foreign exchange reserves left to defend the dollar peg. Ultimately, the Thai government had to bow down to the inevitable and the government allowed the baht to float freely against the dollar. The baht immediately started a slide. Following the devaluation of the Thai baht, a wave hit other Asian currencies and in a short spans of few weeks the Malaysian ringgit, Indonesian rupiah and the Singapore dollar all nosedived one after the other and the entire region was gripped by the crisis. These countries lost a decade of economic progress due to this crisis.
Conclusion
The region had been promoted by many as the future economic engine of the world economy. Investors have invested billions of dollars in the region on the assumption that the rapid growth of the last decade would continue. But it came grinding to a halt.
It once again proved that during periods of abundant capital, there is an often-irresistible temptation to anchor to false beliefs. This strategy may bear fruit for a while, but is costly over the long haul.
The dot com bubble
In the previous article we have discussed about ‘The Florida real estate bubble’ which started in the early 1920s, when Florida entered a period of frenzied real estate speculation. The bubble lasted for almost a decade and ended as the Great Depression began. Today we will discuss about the bubble that arose around the turn of the millennium – the dot com bubble.
The dot com bubble
The mid 1990s marked the beginning of a major growth of Internet users, who were viewed by companies as potential consumers. This prompted several entrepreneurs to venture into internet start-ups. These start ups came to be known as ‘dot coms’, as most of these companies had .com in their web addresses. At the pinnacle of the bubble many companies got engaged in unusual and risky business practices with the hopes of dominating their respective markets. Most of these dot com companies followed a policy of growth over profit. They assumed that if they built up their customer base, their profits would eventually rise. Investors responded to these risky business ventures with pots of money. With hundreds of companies being founded in a very short span of time, especially in tech hot spots like the Silicon Valley, the tech laden index NASDAQ rose dramatically during this time.
The euphoria was backed by the belief that internet business somehow would instantly take off and the entire business landscape will change in a very short span of time. However, no fundamental change was actually happening at the ground level. It was just wishful thinking on the part of companies that had no realistic business model to get these ideas off the ground.
The hype didn’t live up to its promises. Numerous high profile court cases regarding unscrupulous business practices started cropping up and the stock market began to tumble down. Unfortunately, the growth of the tech sector proved to be illusionary and dot com bubble burst in the year 2001. A decline in business spending combined with the market correction dealt a serious financial blow to many dot-com companies.
Conclusion
The internet caught the fancy of people in the 1990’s. This prompted many companies to promise life-altering changes. Though these ideas for change had a grain of truth in them, they were expected to deliver overnight instead of the decades they would actually require. The fundamentals of the dot com bubble were terrible. Most of the companies were not profitable and were having very risky business models. Some of them had no intention of ever making a profit. While the business model of these companies had no realistic way to turn a profit, their IPOs were skyrocketing just because of hype around them.
The burst of dotcom bubble once again highlighted the fact that the performance of a stock is dependent on performance of the company. As Peter Lynch says “I think you have to learn that there's a company behind every stock, and that there's only one real reason why stocks go up. Companies go from doing poorly to doing well or small companies grow to large companies.”
The dot com bubble
The mid 1990s marked the beginning of a major growth of Internet users, who were viewed by companies as potential consumers. This prompted several entrepreneurs to venture into internet start-ups. These start ups came to be known as ‘dot coms’, as most of these companies had .com in their web addresses. At the pinnacle of the bubble many companies got engaged in unusual and risky business practices with the hopes of dominating their respective markets. Most of these dot com companies followed a policy of growth over profit. They assumed that if they built up their customer base, their profits would eventually rise. Investors responded to these risky business ventures with pots of money. With hundreds of companies being founded in a very short span of time, especially in tech hot spots like the Silicon Valley, the tech laden index NASDAQ rose dramatically during this time.
The euphoria was backed by the belief that internet business somehow would instantly take off and the entire business landscape will change in a very short span of time. However, no fundamental change was actually happening at the ground level. It was just wishful thinking on the part of companies that had no realistic business model to get these ideas off the ground.
The hype didn’t live up to its promises. Numerous high profile court cases regarding unscrupulous business practices started cropping up and the stock market began to tumble down. Unfortunately, the growth of the tech sector proved to be illusionary and dot com bubble burst in the year 2001. A decline in business spending combined with the market correction dealt a serious financial blow to many dot-com companies.
Conclusion
The internet caught the fancy of people in the 1990’s. This prompted many companies to promise life-altering changes. Though these ideas for change had a grain of truth in them, they were expected to deliver overnight instead of the decades they would actually require. The fundamentals of the dot com bubble were terrible. Most of the companies were not profitable and were having very risky business models. Some of them had no intention of ever making a profit. While the business model of these companies had no realistic way to turn a profit, their IPOs were skyrocketing just because of hype around them.
The burst of dotcom bubble once again highlighted the fact that the performance of a stock is dependent on performance of the company. As Peter Lynch says “I think you have to learn that there's a company behind every stock, and that there's only one real reason why stocks go up. Companies go from doing poorly to doing well or small companies grow to large companies.”
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