Speculating Fear

There are all sorts of reasons over what caused the crash last week, but real question is how can the market go, on a random Thursday afternoon, completely insane? Everyone is looking for someone to blame. But what made the crash on May 6th so absolutely shocking is the market dropped close to 1000 points in a few minutes… I mean in a few MINUTES!!!! Between 2 p.m. and 3 p.m. the Dow lost over 900 points before dramatically bouncing back about 600 points.

One thing is for sure, as the trading volume soared, data systems across the stock market began to get clogged. By 2:37 p.m., the overload seemed to have taken its toll on the NYSE's ARCA electronic-trading system. The bid/ask prices got out of control and the price of stocks were going insane. Accenture went from trading at around 40 dollars a share all the way down to one cent before bouncing back. Nasdaq detected what it felt was questionable information in the data and sent out a message saying it would no longer route quotes to ARCA. This step—known as declaring "self-help"—doesn't happen often among the major exchanges. By evening however, all exchanges in a rare coordinated manner put out a statement saying "All trades executed between 2:40 PM and 3:00 PM that increased more than 60% or decreased more than 60% away from the consolidated last print in that security at 2:40 or immediately prior" will be cancelled." Obviously this decision will not be open to appeal but while Nasdaq and others canceled trades on more than 200 largely NYSE-listed companies whose shares fell or rose more than 60 percent, investors unlucky enough to have sold depressed shares of other companies that fell less have little recourse and those who made money by buying at the bottom and made less than 60% can rejoice at others expense. Exchanges have never been blamed for losses, but my guess is this will be tested in courts this time around.

So far, a lot of people have been blamed. But even after a couple of days, there is no real rational explanation as to what went really wrong and caused the drop. There are theories, but no real answers yet!!

So what are the theories circling around?

• Fat Finger Issue - It has been widely suggested that a "fat finger trade" was responsible for triggering the panic. A trader entered a "b" for billion instead of an "m" for million in a trade involving Procter & Gamble. No confirmation yet but after a few days, this explanation possibly looks untrue
• Computer Glitch - There were many erroneous trades due to bad pricing, but the systems of course do not know that and did one thing lead to another and the systems get out of control?? Anybody’s guess at this point
• Stop Orders - There were 1000's of stop orders which got triggered due to the market breaking certain levels. Did a series of stop loss orders trigger a downward spiral maybe?
• European Debt Crisis - Greece definitely contributed to markets going down, but it is unlikely to be the sole cause that led to the all out assault on the markets
• Just plain Fear and Panic - There is also the possibility that this was a real financial panic. There are huge concerns about what is going on in general with the debt levels and the currency markets are fluctuating wildly. The Dow was already down several hundred points even before the massive plunge took place. The reality is that there is a lot of fear in the financial markets right now. But if it was a real panic, then why did the Dow bounce back so quickly?
• HTF - More than 60% of today’s trading is done electronically, so could High Frequency trading have been the cause for what happened? But if it was just high-frequency traders bailing out, why wouldn't [that drop] happen on every stock? It just doesn't add up.
• Hacking - Implausible without proof, but possible. It does sound farfetched, but hey, till now the exchanges have never been held responsible for the losses. So did someone hack into NYSE and purposefully create this mayhem not to mention walking away will a ton of money and a big smile as others are scrambling around to understand what went on.

As more details of last Thursday's collapse become clear, the picture is one of a highly rare confluence of events, some linked, some unrelated, that exposed weaknesses in the stock market large and small. But the only interesting thing here is the catalyst that stopped the fall. Whatever caused the market to crash stopped after a point which led to the reversal. So what was the catalyst?? I doubt anyone can really get to the bottom of this for a long time to come.

Citi - Finally Going To Sleep

$3.77 – Closing price of Citibank today. Investors have seen similar stories this year, with Bear, Lehman, Merrill, and the endings are very unpleasant when consumer confidence falls. Looks like the end is in sight for yet another great American company: Citigroup, once the biggest U.S. financial institution of them all, looks like it is dangerously close to merging, tanking, folding, failing, falling or however else you want to say it. The shares fell today to a 12 year low even while there was a big rally in the market.

Citi Never sleeps - The once famous phrase used to describe the company may just be used for the last times in the coming weeks (or should I say days) Looking back, I guess the whole idea behind Citigroup was flawed from the start. Unbeatable scale in financial services? Forget it. We now see the good Citi's size has done for investors: the company has an unworkable business model. It is run by a senior management team that's largely unproven, with scant experience operating a large financial institution. And the company's risk controls (if the past few years are any evidence) are hopelessly inadequate to the task. While the conventional wisdom says Citi is too big to fail, the reality is it's too big to manage. As a result, the company has become a publicly traded incarnation of Murphy's Law: anything that can go wrong almost certainly will-and probably sooner rather than later. And $25 billion in TARP money isn't going to do much to turn things around. Worries about Citigroup’s problem assets will continue to weigh down investor confidence. Citigroup’s shares have traded as high as $35.29 in the past 52 weeks. It closed today under $4. Its market capitalization (market cap) – the actual value of a publicly traded company – has plunged from $195 billion at the stock’s 52-week high to just under $21 billion today.

I think it is better for the management to move quickly to sell parts of the company or merge with someone else (Goldman and Morgan Stanley have been mentioned).Citi has notched losses in each of the past four quarters, including a $2.8 billion loss in the third quarter, and has taken in excess of $40 billion in write-downs. With news like 52,000 job cuts and slash expenses by 20% just weakens the confidence and is not helping its stock. Most institutional investors and pension funds are barred from owning stocks below $5. So if Citigroup's stock remains below that level, it could trigger a wave of selling that would send the share price even lower. Though not immediately, the money managers have to get out before the end of the quarter if the price does not bounce back.

On the upside, Citi does have a strong franchise overseas and there is no sign anyone is making a run on the bank. It has sufficient liquidity and is in a comfortable position capital wise. All the institutional traders are still doing business with the bank. But the question is, can Vikram Pandit withstand the pressure or will he give in and do a deal or even sell of pieces of the company to appease the public sentiment.

It's getting to the point where it's make-or-break time. The only thing going against Citi is the loss of confidence and it may just be strong enough to bring the behemoth down to its knees. If today is any indicator, Citibank in its present form cannot, and almost certainly will not, continue to exist.

The Big 3...or Just 3

There has been so much drama over the last 2 weeks focusing on Detroit. GM, Chrysler and Ford (or the Big 3) wants a government bailout (heck why not, everyone else on Wall Street is getting free money for screwing up) but no agreement has been reached so far. The democrats flew to Detroit, headed by Pelosi, and met the big guns and promised them a bailout. The big three came back to Washington and in their private jets (what were they thinking) and asked for a 25 Billion package and said Bankruptcy was not an option for them. Then the lame duck congress rebuffed them and now the democrats have given them until 2 Dec to submit a viable turnaround plan so assistance can be given to them. Phew!!

I guess in this economy it is all but boiling down to consumer confidence. And make no mistake, it will get worse and fear has already taken over the entire country. But giving the auto industry a bailout does not solve anything. Assistance of some, shape or form will probably be worked out by the new administration, but my point is nothing is going to change until the American auto industry fundamentally changes its current practices. GM, Ford and Chrysler may ultimately receive loans or other financial support from the U.S. government, although the form, timing, and magnitude of this assistance are difficult to predict. The govt will probably give billions without knowing what it is getting into (read AIG, after announcing a $85 billion bailout, the govt increased it to $140 billion and still no one knows what’s going on there). Anyways, it is important to stress that such assistance will only buy more time for these companies rather than as a solution to their fundamental business risks, which will remain no matter how much money they are given.

If any bailout is given, there should be a lot of strings attached. First, Detroit’s huge disadvantage in costs relative to foreign brands must be eliminated. There needs to be a fundamental shift in the cost burden weighing down the industry and the cumbersome contracts with UAW that make work rules a constant challenge. The American car companies are unable to compete as they are not able to align pay and benefits to those of competitors like Honda, Nissan and Toyota. Also, the existing management must be shown the door. None of the CEO's want to step down and take responsibility but all of them want a free pass (read tax payer's money). Rick Wagoner has been the CEO for the last 8 years at GM and he literally has nothing to show for it. I wonder what change he is going to bring once he gets our money. If he was going to bring the change he is promising, GM would not be begging for assistance. Robert Nardelli who heads Chrysler took a $210 million package from Home Depot last year and landed this job. Wonder what real incentive he has to bring about any change. Alan Mullaly, CEO of Ford, has indiscriminately fired his workforce in the name of cutting costs and Ford literally has no one left to bring about any change no matter how much money they receive. The stakes are high. The Detroit automakers employ nearly a quarter-million workers, and more than 730,000 other workers produce materials and parts that go into cars. About 1 million more people work in dealerships nationwide. They burned through nearly $18 billion in cash reserves during the last quarter - about $7 billion at GM, almost $8 billion at Ford and $3 billion at Chrysler. GM and Chrysler have said they could collapse in weeks. So no two ways about it in my opinion. The existing management has to be fired if any meaningful turnaround is to be achieved in the Auto Industry.

There is another interesting question which the big three are asking to make a case for their bailout stating that Consumers will not buy cars from a bankrupt company. But at this point they have all accepted that they are burning through cash at an alarming rate and GM has publicly stated it may not survive for long as it has no liquidity. Interestingly, while all of them want money, none of them have anything to say explaining how the money will be spent. Though it is a tough decision, filing for Chapter 11 and/or an organized bankruptcy may give them the best chance of re-structuring and re-negotiating existing thorns and ultimately re-emerging as a stronger player.

Oil - Up, Up and Away

The price for a gallon of gas has been setting new record highs averaging around $3.7. Well, if you are in California, there is a good chance that you are paying more than $4 already. If all else is not enough, Goldman Sachs predicted on Tuesday that oil could soar towards $150-$200 a barrel because of a lack of adequate supply growth. Supply is up, demand is down, yet the price is soaring. So what is the deal with oil??

Crude prices have more than doubled in the last one year causing pain to millions around the world. Many analysts believe the dollar’s protracted decline over the past year has much to do with the doubling in oil prices since May of last year. Another school of thought thinks growing demand in rapidly developing countries such as China, Brazil and India, is the primary factor driving oil higher. Others have also attributed speculation in oil and a wave of fund money pouring into commodities, given the weaknesses in other financial markets.

What effect does the falling dollar have on the price of crude? Most oil price contracts are denominated in dollars. The dollar has fallen in value by more than 30 percent against a Federal Reserve index of major currencies since 2002. This means that the price of imports, including oil, have gone up. That brings us to speculation. Since September 2003, the total number of open crude oil futures and options contracts rose by 364 percent. Meanwhile the global demand for petroleum rose by just 8.2 percent. So the futures and options market has become more important than the physical supplies in driving the price. We are seeing investment flows into the oil market that don't have anything to do with the demand and supply of oil. Investors are treating oil as a hedge against inflation and a falling dollar. Oil markets are part of a negative positive feedback loop in which higher oil prices contribute to higher inflation, which in turn lowers the value of the dollar, which boosts oil prices, and so forth. In other words, the oil market is coming to resemble the gold market (which has also been soaring).

Economists also note that in the short run oil prices are very inelastic: A large change in price produces only a small change in demand. If the price of gas goes up a dollar per gallon overnight, you still have to fill your tank to get to work. However, over the long run, consumers and producers respond to higher oil prices. For example, Americans are driving less and have switched to buying more fuel efficient cars. Higher prices are no doubt encouraging innovation.
Oil companies have a two-pronged approach when it comes to innovation: seek alternative sources of energy that will both (1) reduce dependency on trouble-some, oil-rich nations and (2) utilize this energy in a manner that will still reap windfall profits. Although ideal in theory, it’s much tougher to implement in practice since renewable energies are just that - renewable. When products are renewable, profits go down since consumers purchase less. There is no doubt that several companies have already innovated alternative fuels, however these will take years before reaching a scale of production where profits can be made from them.

So what will happen to oil prices over the next few years? No one is predicting $10 per barrel oil. However, it sure seems to be the right time to give up that Hummer and switch to hybrids as this problem is not going away anytime soon!!

Wanted: Jérôme Kerviel

The elusive 31-year-old trader, Jérôme Kerviel, has given the slip to media from around the world pursuing the story of history's biggest trading misadventure. Kerviel has successfully shot from anonymity to international celebrity over the past week when Société Générale said he was behind a "massive fraud" that had cost it $7.1 billion. Internet search engines now turn up hundreds of thousands of entries bearing his name.

Although his photograph - a grainy mug shot - made the front page of papers around the world, Kerviel has managed to remain invisible. He has not spoken a word to the press and has kept journalists guessing about his whereabouts. No fresh photos of Kerviel have been published since the scandal broke. After police held him for nearly 48 hours, judges Monday threw out any fraud charges against him but did file preliminary charges - and he is free on bail while the investigation continues. Although hundreds of reporters are staking out all his known whereabouts, he has still managed to slip away unnoticed.

One thing is certain...an image of Kerviel will fetch "lots and lots of money" and he has propelled Soc Gen right to the No. 1 spot in trading disasters of all times.

As the bank continues to reel under sudden scrutiny, three employees at Societe Generale in Paris have alledgely committed suicide as fresh concerns are being raised about the stressful work environment at the scandal-hit bank. I guess when it rains, it always pours.

TOP 10 TRADING DISASTERS

Here's a league table of the biggest bank trading disasters of all time.
1. Societe Generale - $7.1bn (European index futures) 2008
2. Amaranth Advisors - $6.5bn (Gas futures) 2006
3. Long Term Capital Management - $4.6bn (Interest rate and equity derivatives) 1998
4. Sumitomo Corporation - $2.6bn (Copper futures) 1996
5. Bawag - $2.5bn (Currency and interest rate swaps) 2006
6. Metallgesellscahft - $1.6bn (Oil futures) 1993
7. Sowood Capital Management - $1.6bn (Debt securities)
8. Barings - $1.4bn (Nikkei futures) 1995
9. Credit Suisse - $1.3bn (Emerging markets) 1998
10. Daiwa Bank - $1.1bn (bonds) 1995

Infosys: Ready To Play With The Big Boys

Infosys is ready to shop and the markets are ripe with rumors that they want Capgemini. Really? Agreed, Infosys has accumulated billions over the years, but can it afford to buy a company which is 3 times bigger…mmmm....

Lets look at some hard facts:

1. For 2007-08 Infosys has projected a 28-30% revenue growth and Capgemini has projected around 8%


2. Capgemini has a market value of 7.86 billion euros or $10.6 billion. Infosys has a market value of about 1.1 trillion rupees, or $27 billion


3. Capgemini has about 68,000 employees worldwide, including 12,000 in India, Most of Infosys's 72000 employees are in India, where wages are as low as one-eighth that of U.S. salaries


4. Infosys reported revenue of $3.1 billion for the fiscal year ended March 31 this year, and has forecast revenue of about $4 billion in its current fiscal year ending March 31 next year. Capgemini is 3 times bigger with revenue of $10 billion for its fiscal year ended December 31


5. Infosys’ operating margin stood at approximately 31% in the end of 2007, Capgemini's was 5.8%

"Lets take 'em boyz, there's only 70,000 of them and each one is paid more cheaply than the other"

In my opinion, this deal is highly unlikely to go through. With the weakening of the dollar, granted that all the big Indian players have to do something and take the next step, but let’s be realistic. Other than Capgemini's consulting arm (which is obviously stronger), they both seem to share the same strengths...So the question is what "real" value will buying Capgemini bring to Infosys? Infosys may be looking for access to the European markets, where it doesn't have a strong presence, but the cultural incompatibilities between the two companies are very high, and I for one don’t believe Infosys will be successful in bringing 70,000 employees under their wing who are culturally on the opposite end of the spectrum.

One thing is for sure. This rumor has certainly generated enough buzz to move the stocks (Capgemini is up 4.5%) and Indian outsourcing companies have shown they are “coming of age” and catching up with their European counterparts. But the question is will Infosys go above and beyond its reach at any cost. My answer again will be no as Infosys does not have such an aggressive mentality. They have downplayed the news not wanting to shoot themselves in the foot that one wonders why they are being so defensive. The CEO of Infosys himself came out and said he has not ruled out an acquisition in Europe, but said any target would have to meet Infosys' criteria (which no one knows incidentally!!!). Consider this approach to the one Rupert Murdoch took to acquire Dow Jones. Coming back to the point, another complication is the lack of M&A expertise for a deal of such a magnitude in India. Even if it goes through, can they truly integrate as one firm? Maybe I am being skeptical, but again, I highly doubt it.

Finally, Infosys is/has always been a debt-free company and a deal of this size will for the first time put them in a position where they will acquire a lot of debt and move away from organic growth. Though raising capital won’t be difficult, the real question is "Is Infosys ready to play like the big boys?"