Markets - A Recovery or A Fluke - Part 1

Markets always have the dubious nature of surprising everyone, a bull market will make even the biggest bulls gasping for breadth while a bear market would in the end make even the most vociferous bears taking cover. While I am not at all convinced by the recent upswing in the market but then I could be one of the many who are thinking the same and the market could prove all of us wrong, nevertheless it would be foolish to go short in such a market, at best short condors/butterfly static trades might work for the time being.

The reason I wrote the last article was to set a setting for this article and the following ones, to emphasise on the importance of asset over cashflow. Hold this thought while you read on. The world was on the verge of a collapse (literally), the governments across the board came up with stimulus and relief packages, with relief packages of over 10% of current world GDP flowing in a span of 1 year it's a lot of money coming into the system in such a short span of time.

Ceteris Paribus if I put this kind of money flow in this basic Keynesian equation:

Y= C +I +(G-T) + (X-M) the economy size increases proportionately. The issue here is that this is just a very instantaneous type of equation i.e. captures just the moment. The point is that because of such Herculean government spending the global economy that was falling apart at rapid pace not only stopped falling but infact has even started to grow for the time being.

What the government's across the world did was important and should have been done but it would not be enough because there is a structural misplacement in the global economy (would discuss this in the next blog) and that the worst is yet to come and this is just the part 1 and unfortunately the global slowdown might be longer than earlier anticipated. Here is the thought process behind this argument.

By end of this year the debt of the great American nation would equal it's GDP, in other words the nation has to grow at around 3.5-4% annually to even pay it's interests!!! or else get into a debt trap or sell assets. Even at the best of the times US grew at around 4%, so simply put it US assets are going under the hammer, A 12 trillion dollar economy is currently driven by around 60 trillion dollar of assets, an impressive return of around 20%. But when this quantity of assets start going down the growth itself would start coming down and lower growth would mean more asset dilution leading to further lower growth leading it into a vicious circle. Europe is even in worst shape with debt ratios of many countries almost matching that of the US but even less growth. Lesser assets would further mean more exposure to event risk(last blog) and lesser financial stability. So while I believe that this temporary hump is because of this huge government spending all it has done is to shift the leverage from private balance sheets to that of government and the bolts of this ship would start falling apart once again but maybe not before it converts the last of the bears to bulls.

The next article I shall walk through the major countries of the world and talk about their debt situation and if and how they can come out of it, then after painting this doomsday scenario I shall talk (probably in the 3rd article) on how ultimately this issue would be resolved, by talking about the structural problem the world is facing today, till then hopefully enjoy the bull run......

Land or Stock where to Invest

The markets are at an interesting crossroads these days..... The classic "Bear Market Rally" dilemma - Is this rally a Bear Market Rally or a Bull market. But anyways let's leave this discussion for some other day..... Let's get to same basic investment dilemma, where to invest the money: Land, Stock.........

Let's first analyse Land as an investment asset - Let us say on a piece of land one is able to produce a crop yield of 100 rupees in one year. Taking a discounting rate of 10% we can come to the conclusion that the land would then be valued at 1100 rupees. 

Now let's say there is a productivity rise next year due to discovery of some new seeds, the rise would mean that the same land can now produce 10% more. The value of land rises to 1210 rupees. However if nothing of this sort happens my land still remains at 1100 rupees.

Now let's say that instead of just buying the land, I rent it start a business to grow crops and try selling some stocks of my business... at the average level of productivity of the economy I would

make almost no money and the value of my stock would be, yes you guessed it right "zero"

However I might be better than the average and could produce the crop at a higher productivity, so let's say instead of producing crops worth rupees 100, I produce crops on the same piece of land worth rupees 120..... My business would starts to make a profit but thats not all the 20 rupees I get can be reinvested in getting better seeds and that lets say increase my productivity by 9% anually!!! well because as I make more money I can buy even better seeds so now the value of my stock would be 2200 rupees!!!......

The story is still not over looking at my production strategy all those moron farmers copy it and now to my disadvantage (but to the advantage of the economy and the asset holders) start growing more. The value of land would then rise again and would catch up to 2200 rupees. What's more next year there is a drought that puts me out of business, the land prices suffer a decline but comes back to it's normal price that following year, unfortunately the business is not that lucky!!!

Now let's go to the third and final scenario.... I buy the land and start to till it.... Sell stocks in the market for this business, even if I am growing crops worth rupees 100 but can mantain the 9% productivity growth my stock would now be valued at 12,100 rupees!!!........ and now even if there is a drought next year my stock would still be valued at something as I still hold my asset which is land.......

So what can we conclude from this whole song and dance!!!........

- While investing in land is a sure shot investment decision, investing in stock is not so....

- Never invest in businesses with lower to average productive rates

- Even if the productive rate of the business is very high when it comes to taking a call of investing in land or a business "invest in land" unless.....

- the business "own its assets" and then do their production on it... and if this is the case then owning stocks is far better than owning land.....

- Land should be owned in places higher productivity rise is anticipated and most importantly the competition level is high

- To end the discussion I would add that the productivity of the economy and which means asset appreciation would happen in a society that encourages free flow of information or in other words is an open society, else after a point of time the productivity starts to decline and all the assets become worthless, this might be happening in some countries but because they are closed we may not know so soon... you can guess which countries I am talking about.........