What investment bankers can learn from the actuaries

http://www.economist.com/finance/displaystory.cfm?story_id=10766330

Bad Company, Good Company

One of the ways Hedgefund makes money is illustrated below. Within an industry identify the good company and the bad company. Short the bad company Citigroup (C) and use the funds to buy the good company in this case Bank of America (BAC).



Since their performance differs around 30%. You gained 30% right on notional amount. But wait, you didn't really invest notional amount, you invested the margin you needed to keep in your margin account. So really it's just 30%*P. So return = Gains/Investment = 30%*P/30%*P = 100%! On top of the extraordinary return, you don't need to worry about market volatility, because they cancel each other out.



It's not too hard, I picked BAC and damned C back in September. Haha, I am so full of crap talking about this with the benefit of hindsight.



Look at the investment banks.

Good Bank - Deutsche Bank (DB)

Bad Banks - Merrill Lynch (MER), UBS

Decoupling Debate and China

For 2 years now, I have been an advocate of raising the value of RMB. Most Chinese people look at me weird and think I am out of my mind. I think what they fear most is the repercussion of a stronger yuan on Chinese export. In their view, everything, I mean EVERYTHING, in the Chinese economy is built for exporting to the United States.

Don’t get me wrong, global trade has benefited China more than anything else. But the export mentality means that even after 30 years of breakneck investment in education and infrastructure, Chinese people hasn’t created enough wealth for themselves to start consuming. The article below talks about how export dependent China (and other emerging economy) really is.

http://www.economist.com/finance/displaystory.cfm?story_id=10808782

“Sceptics argue that much of this investment, especially in China, is in the export sector and so will collapse as sales to America weaken. But less than 15% of China’s investment is linked to exports.”

“Over 95% of China’s growth of 11.2% in the year to the fourth quarter came from domestic demand. China’s growth is widely expected to slow this year but to a still boisterous 9-10%.”

In addition to the new wealth in China which created a lot of demand, there’s the investment needed to capitalize on China’s future potential. Corporate balance sheet in China is ridiculously healthy, thanks to years of exploding profits and growth. I just don’t think people will stop investing in China when a recession in America hits.

The case is even clearer when you think about the 1.3 trillion dollar of foreign reserve China holds. Let me put this into an analogy.

When you are a poor shoe shining boy, your only alternative are to shine shoes. So you are dependent on selling your service. When you are a rich shoe shining boy, you have more alternatives. (1) You can invest in yourself and get an education, or even buy a shoe shop, increasing your future income potential. (2) You can do (1) and in the mean time get an ipod nano for yourself. Or (3) You can get an iphone.

Of course, if you are stupid enough to choose option (3) (a lot of people did actually, think Africa), then too bad, you are doom to be a shoe shining boy forever. But even (3) is better than the option (4), which is to lend money to the ipod salesman so he can continue to pay you to shine his shoes. If the Chinese government, by holding the yuan and buying US bonds at ridiculously low interest rate (AND depreciating principal base –falling dollar!), is not taking money from the shoe shine boy and giving it to the ipod seller, I don’t know what is.

Addition: By holding down the yuan, what the Chinese government is effectively doing is taking say 30% of PRC’s people’s wealth and buying US dollar denominated bonds. The worst part is, the US dollar fell 40% in the past 4 years.

** USA really have some wisdom here. Not only can it pay back its loanes with pennies on the dollar now. It has been able to use those money to invest in FDI that earns positive returns. I sounds a lot like those Hedge Fund using leverage. Okay, maybe they bought an iphone on the way too, but who doesn’t want to buy an iphone when it’s on a 40% discount.

Negative Real Interest Rate

Nothing in economic theory precludes negative real interest rates, or even suggests they should be anomalous. Nominal interest rates cannot be negative, because people would just hold cash instead of bonds, but real interest rates can be negative. If real interest rates were very negative, investors could start investing in inventories of goods, but this arbitrage is not easy. Storing goods is costly, and many things in the CPI basket, such as services, are not storable at all.

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In standard models of asset pricing, negative real interest rates are most likely to arise if growth expectations are particularly low or if uncertainty is particularly high. Low growth expectations encourage households to save, which drives down equilibrium rates of return. High uncertainty drives up risk premiums, which in turn drives down the return on safe assets, perhaps below zero. Both forces seem to be working now.

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Posted Verbatim from Greg Mankiw's Blog --> http://gregmankiw.blogspot.com/

Subprime mortgage defined!

http://docs.google.com/TeamPresent?revision=
_latest&fs=true&docID=ddv7hj34_03774hsc7&skipauth=true>

A friend of mine sent me a cute little cartoon to explain the sub-prime mortgage. My observation:

(1) No due diligence is necessary if someone is going to share your problem. It's better if it's a bigger share
(2) Assumptions should be challenged! "The stock market always rise!"

How companies think about climate change: A McKinsey Global Survey

http://e.mckinseyquarterly.com/W0RH01DED58D89BCAB52A358BAFC60

Mckinsey talks about how corporation view climate change.

"Despite the uncertainties around regulation, a remarkable 82 percent of executives expect some form of climate change regulation in their companies’ home country within five years."

It's coming, let's not haggle about it.

Assessing Obama on Free Trade

http://www.ft.com/cms/s/0/f24fa1c4-e92b-11dc-8365-0000779fd2ac.html?nclick_check=1

" Mr Obama’s economist is Austan Goolsbee, a brilliant Massachusetts Institute of Technology PhD at Chicago Business School and a valuable source of free-trade advice over almost a decade, Mrs Clinton’s campaign boasts of no professional economist of high repute. "
"Mr Obama’s main union support comes from the Service Employees International Union and the Teamsters, neither of which is protectionist: the SEIU’s membership is in the non-traded sector and, except on the issue of Mexican trucks coming into the US, Teamsters do well as trade expands. By contrast, Mrs Clinton’s support comes heavily from the AFL-CIO, which holds strong anti-trade views. "

Warren Buffet's annual Report

http://www.berkshirehathaway.com/letters/letters.html

"It’s a certainty that insurance-industry profit margins, including ours, will fall significantly in 2008. Prices are down, and exposures inexorably rise. Even if the U.S. has its third consecutive catastrophe-light year, industry profit margins will probably shrink by four percentage points or so. If the winds roar or the earth trembles, results could be far worse."

Another idiocyncracy of the market. People over-reaction to risks. When there were hurrican two years in a row (remember Andrew & Katrina), people got afraid and accepted higher prices. Now that catastrophies are forgotten, they undervalue risks again.

More on this later...

The Next Bubble: Clean Tech

http://finance.yahoo.com/tech-ticker/article/4585/VC-Money-Pours-In:-Is-Clean-Tech-a-Bubble;_ylt=Atoi_NgKIgAD2MZTQ32j3yq7YWsA?tickers=

Many people has asked me about what they think is the next bubble, I have told them times and again that I think it's gonna be green tech. In return I get suspicious look and silence that I regard as diplomatic disagreement. This is actually a good thing, if too many people believed in it, then the bubble would have been well on it's way. This way I agree with the commentator that

"I think we are really early in the curve".

Like the internet bubble of the past decade, these companies are building things that the society needs. " After the last bubble, we ended up with the world wide internet!" The same network, I might add is behind everything from the rekindled productivity growth of OECD to accelerated intellectual diffusion in developing countries that sustained almost 5% annualized global growth in the new millenium.

Certainly, a bust followed the over-investment, as we have more optical undersea cable than we know what to do with. However, I will not complain if we have a renewable grid in 15-20 years that has an excess of clean power. From a technological viewpoint, that is even less conceivable than the world wide web, does that mean the bubble will go on for longer than the internet bubble? Beats me, but I am certain that it will not pop for a year or two.

Some of you might retort " But the internet make economic sense!" So, you are saying clean tech makes logical sense but not economic sense? Well then, isn't it logical that human as a society will try to make economic sense out of something we need? (note, we need not we want). I see all fronts moving in that direction; all fronts being political, economical, and technological.

Crash Course: The Long Slump in China

http://www.economist.com/daily/news/displaystory.cfm?story_id=10757181&fsrc=nwl

For the most part I agree with the economist, but how deep would the slump be if China's intrinsic potential growth values it at a higher P/E than mature economy's corporations?