Whom to blame for the bubbles?

Prior to 2008, people and investor in particular were financial happy for wide of reasons, unemployment rate was low, housing ownership at all time high, and exceptional profits in the financial markets. However, things changed at the third quarter of 2008 as we were heading, with full speed, into the deepest recession since the great depression. Unsurprisingly, people started to point fingers looking at whom to blame. The person or, precisely, persons to blame are not in Wall Street. They have been in existence for decades, as they were responsible for, sort of to say, every recession or depression we faced. They are Leverage and Over Valuation. Have you spotted the next bubble yet? I will give you a hint. Twitter was valued at $4 billion as of January 2011 with zero revenue. Good Luck!!

Hussain Jubail

Morning Call: Another Internet bubble is coming

http://www.marketwatch.com/story/another-internet-bubble-is-coming-2011-04-05

During our morning calls we spend time analyzing a certain headline and dissecting it.  We addressed the following questions today to the article mentioned above:

Do you think we are in another internet/social media bubble? Why?

During our morning calls we spend time analyzing a certain headline and dissecting it.  We addressed the following questions today to the article mentioned above:

Opinion1:

I don't think so.

People are saying there are bubbles when valuing companies like Facebook and Groupon. I would agree with those who are saying that the $50 billion valuation on FB is not trustworthy because they couldn't see the real value of the company and how IBs did the valuation. But nobody can argue about anything simply because they don't see the reason by saying there's no reason.

Different from the dot-com bubble ends in 2001, the current highly valued social media/internet companies such as FB and Groupon have their soundable business model built and running well. Their revenue expectations are also based on the number of users that real exist. And different from the 2001 bubble, which was mostly caused by public investors' craziness that didn't even have any supportive existing numbers.

At last, as private companies, their valuations wouldn't be overvalued ridiculously like people are worrying now.

Opinion2:

Personally, I am sort of in support of the overpricing concern for Internet companies; as to whether another internet/social media bubble is brewing or not, still need more time to observe how things are going on in the market as well as the investors’ behaviors...



Data is below:

Facebook's valuation recently rose to $65 billion after private equity firm General Atlantic purchased 2.5 million shares, before surging to $85 billion on Second Market. It's not the only pre-IPO site with a billion dollar tag. Daily deals site Groupon is said to be valued at as high as $25 billion, while micro-messaging network Twitter's valuation just climbed to $7.8 billion.



Besides, as the billionaire stock picker and takeover specialist, Warren Buffett also commented recently that investors would better be wary of the high valuations circulating for social networking sites as some of the industry’s biggest startups prepare for initial share sales. "Most of them will be overpriced,” Buffett said. "It's extremely difficult to value social- networking-site companies. Some will be huge winners, which will make up for the rest."



Resources: http://www.bloomberg.com/news/2011-03-25/most-networking-site-companies-will-be-overpriced-buffett-says.html

Opinion3:

my argument:
I do believe there is another bubble in the making. But when is there not one. oil,microchips,computers,dotcom,realestate... However, the current changte we are seeing right now in the market, as in the markets getting stronger is not a direct result of the social media/technology sector hyper but a genuine increase in consumer confidence and spending.
Two articles presenting two different views, a good read:
Yes, this is a bubble:
http://erisds.co.uk/business/another-dot-com-boom

Opinion4:

http://steveblank.com/2011/03/18/new-rules-for-the-new-bubble/
I like the above link. It breaks the bubbles into time frams. And then it goes into our cuurent expected one. Overall, I do believe that we are going to have our next bubble in social media more than not. When I don't know. If I do know I will make a lot of money. All I can say is that the symptomes of a bubble are there. Higher valuations for business with almost zero revenue and urgent IPOs. And people are running to grap their share for these IPOs based on unjustiftable valuation. What else do we need of evidence. However, people never learn from their emotion. We had dot bubble not a while a go.

Opinion5:

This doesn't feel like the same type of a bubble which was created during the dot com era. Unlike the internet boom when money was pouring in due to speculation and sketchy valuations, 2011 has turned out to be one where valuations are looked at more closely. Facebook has a $65B valuation and for many that seems absurdly for a firm that hasn't gone public yet. I can understand the valuation and to some extent question it, but the fact remains that venture capital firms are not funding small start-ups run by Joe Blow, but are putting their money behind who businessmen who have a fundamental standing in the public eye and whose products are monumental in changing the landscape of society.

Yes...there are the so called "app" firms. These firms supply apps for Apple and Androids phones and many have received funding without having any indication if the app will become a platform. Sure, we can state that apps are much like computer software these days because much like computers, smartphones aren't going anywhere and will require new and updated software to feed the need of the customers. What percentage of the upcoming apps receive ludicrous funding? That I don't know and need to look more into before I can make a concrete stance on this comment.

Morning Call: IMF warning: Many European banks on shaky ground

http://seekingalpha.com/news-article/915741-imf-warning-many-european-banks-on-shaky-ground

During our morning calls we spend time analyzing a certain headline and dissecting it.  We addressed the following questions today to the article mentioned above:

1. List three disadvantages that European banks have compare to the US banks.

2. Briefly describe the bailout being done to Greece and Ireland to avoid defaulting on their debts, and being asked by Portugal.

3. What did the European banks do after the last stress test? Or what did they do after Irish banks, who passed the test but failed later?

4. Why does the article state "a source of short-term credit that can dry up rapidly in times of trouble"?  

5. Even after the interest rates were increased 0.25%, they are still at a historically low level. Why the article says small and mid-size European banks "have lost cost-effective access to term-funding markets"?

6. It's being said that the Dodd-Frank Act also put US banks in disadvantages to operate in Europe. What are these disadvantages?

A very brief outline of what each of us stated to the questions above is listed below.  This certainly isn't the complete description of our call:

1. List three disadvantages that European banks have compare to the US banks.

a. Structure: Remaining structural weaknesses and vulnerabilities in the euro area still pose significant downside risks if not addressed comprehensively.
b. Interest rates arisen: ECB key interest rates were arisen by 25 basis points, which reduce the risks as well as banks' profit
c. Need to raise capital: due to the two disadvantage, it's been one of the hardest time for European banks to raise capital to either meet regulation requirements or to acquire source of funds.  

2. Briefly describe the bailout being done to Greece and Ireland to avoid defaulting on their debts, and being asked by Portugal:

Brief summary:

Greece
In May 2010, Greece received a financial rescue from other European countries and the International Monetary Fund of up to €110 billion ($135 billion). The interest for the loans is 5.2%. The government of Greece agreed to impose a fourth and final round of austerity measures.

Ireland
In November 2010, Ireland reached agreement with the IMF and the EU for an emergency bailout package worth €85 billion as a rescue meant to both shore up that nation's banks and confront investor fears. By agreeing to the bailout terms, the Irish government would be given fresh resources to recapitalize its hard-hit banking sector. But in return for the loans, Ireland was forced to pay a relatively hefty 5.8 percent interest rate, higher than the interest charged to Greece for its bailout.

However, according to a report recently published by a former IMF director, when the current IMF-EU deal runs out, Ireland may be unlikely to wrest control of its finances even in 2013 and will be forced to seek a second bailout. (More details: http://www.guardian.co.uk/business/ireland-business-blog-with-lisa-ocarroll/2011/apr/07/ireland-second-bailout-imf)

Portugal
After Greece and Ireland, Portugal became 3rd who asked for financial help from EU. Analysts estimate that Portugal needs around 80 billion Euro to recover from debt crisis. Portugal's troubles differ from Ireland, which pledged to cover huge losses at its banks, and Greece, which lied about its debt. Instead, it had allowed debt to mushroom during a decade in which its economy grew at just 0.7% a year. 

3. What did the European banks do after the last stress test?

The stress tests which took place in July 2010 were largely considered to be too soft. Of the 91 banks in 20 countries which were put through the test, only 7 banks failed the test. Not much was considered to be stressful about these stress tests. The European stress test of 2010 was largely a joke in comparison to the stress test which the United States performed on the U.S. banks. While the European banks were told to raise 3.5 billion euros after the stress test, 10 of the largest U.S. banks were asked to raise $75 billion in capital. This affirms the fact that the European stress test needed to be more strict.

Though investors in 2010 were skeptical at first, the markets reacted positively to the European stress tests. This optimism only lasted a few months and soon after the Irish banks which had passed the stress test needed to be bailed out. Greece and Ireland are going through massive debt issues and thus are unable to shore up funds to support their banking system. The German banks also join the ranks of the Irish and Greek banks and need to acquire more capital from the investors in an effort to keep their doors open.  

4. Why does the article state "a source of short-term credit that can dry up rapidly in times of trouble"?  

Because Supply & demand baby. In bad times, everyone will want ECB's easy and friendly supply of funds which will eventually dry up. 

6. It's being said that the Dodd-Frank Act also put US banks in disadvantages to operate in Europe. What are these disadvantages?

The regulations of the Dodd-Frank Act big European banks to take away business from US banks as across borders these rules do not hold good leading to the disadvantaged US Banks - In brief, analysts claim that European banks can profit from regulation arbitrage opportunities. Some of the reasons being;

1. Regulation of some of the derivatives market
2. Proprietary trading and their investment in hedge funds

One of the key factors is the Volcker Rule that prohibits federal insured banks to trade for their own benefit to prevent them from taking risky bets. This can be a disadvantage to big banks like GS. This rule also prohibits holding more than a 3% stake in hedge funds and private equity. Moreover the Dodd - Frank act requires that the derivatives trading desk be a separate capitalized entity creating regulatory disadvantage.

Also, a recent decision to remove all reference to credit ratings can put the US banks to a disadvantage because this would require them to have higher minimum capital requirements under Basel III. 

Morning Call: Goldman's Near-Term Bearish Turn on Commodities

http://seekingalpha.com/article/263135-goldman-s-near-term-bearish-turn-on-commodities
 
During our morning calls we spend time analyzing a certain headline and dissecting it.  We addressed the following questions today to the article mentioned above:

1. What's the reason do you think the Goldman's commodity team made the statement in their research note?

2. What does Japan use copper and platinum for? How much were the industries use these commodities affected by the earthquake and tsunami? (several examples and general numbers needed only)

3. How tight credit motivate will affect China's consumption on copper?

4. Taking all the supportive and negative effects that Currie mentioned in his note, briefly analyze the possibilities that the oil price will go up and down by listing several possible scenarios and their outcomes.

5. Any other commodities you think are being speculated? Any reason for the speculation?

6. How did the other companies reacted to Goldman's statement, if there's any? If there's none, how do you think they should behave?

A very brief outline of what each of us stated to the questions above is listed below.  This certainly isn't the complete description of our call:

1. What's the reason do you think the Goldman's commodity team made the statement in their research note?

a. The very basic and fundamental reason for this statement is that the current economy status doesn't support the high commodity prices at this level, as recently pointed out by medias and many economists.
b. The stabilizing situation in middle east and decreasing world-wide demand have started pressing the commodity prices down.
c. Because of the big stake that GS has in the commodity market, it needs to start cutting its position earlier at the beginning of any risk arises.
d. Worrying about market speculation by hedge funds and world-wide hot money investors is also one of the reasons. 

2. What does Japan use copper and platinum for? How much were the industries use these commodities affected by the earthquake and tsunami? (several examples and general numbers needed only)

Japan mostly uses the Platinum Group of Metals in the auto industry. They are used as autocatalysts and catalytic convertors. However, the recent events in Japan have caused a downside demand for the platinum group metals. Moreover, in the electronic markets that use platinum quoting, there has been a 5% drop in the demand. On the other hand, the demand for copper in Japan has increased due to the need to rebuild infrastructure. As of 2010, Japan consumed 4.8% of the world's refined copper.

"The demand for PGMs, following the recent events, car production in Japan could be 5% lower than previously expected. Japan had been expected to produce around 9 million light vehicles in 2011 - the world's third largest producer - which would have required around 15,000oz of Palladium and 7,000oz of Platinum each week".  

3. How tight credit motivate will affect China's consumption on copper?

China is the world’s largest copper user. Demand for copper is surging as the nation plans to build more homes, autos and appliances and upgrade power-grid networks. However, the government is attempting to cool its economy, especially its real-estate market.

Because of government measures to tighten lending and curb inflation, China’s demand for Copper will slow in the second half of the year. The main contributor to the slowdown in China will come from the construction sector as the real-estate market cools. Chinese regulators curbed loans for third-home purchases, increased downpayment requirements and raised mortgage rates in a series of announcements since last year, so as to rein in spiraling property prices. China’s property prices climb at a much slower pace this year, according to China Information News, adding to signs government measures are taking effect.

Besides, the demand for copper may also be undeterred on concern that surging oil prices may slow economic growth. 

4. Taking all the supportive and negative effects that Currie mentioned in his note, briefly analyze the possibilities that the oil price will go up and down by listing several possible scenarios and their outcomes.
Indeed this is a good article to discuss. Dispite what's in the article, I am bullish on the commodities markets.
Oil prices go up..... Opposition party in Libya can't able to export oil eventhough Qatar offered to market their oil

Oil prices go up...Some oil fields are Cut on fire in Libya

Oil prices go down.... OBEC decides to boost production.  

5. Any other commodities you think are being speculated? Any reason for the speculation?

The attach on the oil pipelines impacted oil prices and now the uncertainties in the currency market is impacting the price of gold and silver. JP Morgan has been widely tied to the silver story. The firm's short covering resulted in the price of silver sky rocketing to $40, resulting in a 121% change over the past year. According to an analyst, "there has been a statistically significant negative relationship between bank concentration and silver prices (96.4%). Every one percent decrease in concentration has resulted in a 40 cent increase in silver prices."

Take a look at the following U.S. Bank Concentration vs. Silver Price chart:
http://static.seekingalpha.com/uploads/2011/2/9/308162-129725975427497-Hyperinflation_origin.jpg

Here is a chart showing the price trend of silver:
http://apps.cnbc.com/cgi-bin/upload.dll/file.gif?z0383110az7cb641c40d20410aa720a6c90c59c6d2 

6. How did the other companies reacted to Goldman's statement, if there's any? If there's none, how do you think they should behave?

Firstly, I think there is no speculation happening here. In fact, what GS is saying is not based on facts but a psychic valuation. It is just like how they valued NetFlix at $300, BS!

Other companies per say have yet to react but reading some other articles and chatting with some investors, I get the feel that no ones buying into GS theory and are bearish on commodities. I believe the same mostly because there is an indirect relationship between commodity prices and the FX rate - value of dollar. And unless the Fed pulls back on the money supply allowing the Dollar to appreciate in value, commodity prices will continue to go up. 

Morning Call: JPMorgan Accused of Breaking Its Duty to Clients

http://www.nytimes.com/2011/04/11/business/economy/11bank.html?_r=1

During our morning calls we spend time analyzing a certain headline and dissecting it.  We addressed the following questions today to the article mentioned above:

1. Find out some background of this investment vehicle called Sigma of JPM.

2. What is investment vehicle? Are there different kinds?

3. Any other similar activities conducted by US banks that choose to not tell clients the bad news when the financial crisis hit?

4. How do you think this issue will affect JPM? (Hint: such as funding sources from pension fund)

5. How do you think this issue will affect the asset management industry? (You can listen to the audio stream on the website)

6. Why do you think JPM chose to hide the bad news to their clients instead of telling them to build their reputation?

A very brief outline of what each of us stated to the questions above is listed below.  This certainly isn't the complete description of our call:

1. JP Morgan and the story of Sigma

The management of JPMorgan Chase was raising red flags about a troubled investment vehicle called Sigma, which was based in London, in the summer of 2007, only 2 months after they had placed 500 million in customers’ assets into the vehicle. But the bank chose not to move out $500 million and just left their customers assets at risk in what they felt was a doomed investment vehicle.

As Sigma began to deteriorate, JPM lent them billions in capital in exchange for quality assets. Then when Sigma collapsed a year later (fall 2008), those same assets what backed JPM’s influx were moved to the banks ledger and eventually appreciated in value, giving them an increase of nearly 1.9 billion dollars.

JPM did not use that money to pay back their investors who had lost 500 million in the investment the JPM had put them in and had plenty of time to remove them from, instead, those investors lost virtually all of the 500 million that was placed in the SPV Sigma. In the other words, JPM did cherry pick of the remaining assets to cover their loans to the Sigma while again leaving the original investors hanging in the wind.

2. What is investment vehicle? Are there different kinds?

I thought investment vehicle is like those special entities under investment banks that are used to segment some special assets separately. It turns out this term means everything that is investable, such as bonds, mutual funds.

In this case, Sigma is a company that JPM invested their clients' assets and expected to generate return from it. 

3. Any other similar activities conducted by US banks that choose to not tell clients the bad news when the financial crisis hit?

Big banks were accused of preventing full access of infomation from their customers. For instance, Citi was accused by SEC of not fully informing their clients of the true exposure of risk during the financial crisis.

4. How do you think this issue will affect JPM?
Firstly, Innocent until proven guilty. Off course JPM's image is tarnished and confidence amongst their clients will be low. However, the real affects will occur when the verdict comes out and I am going to be watching this very closely. Moreover, I think its going to affect wall street in general. Fortunately, I think consumer confidence is high and hence, we have lost our memories of the last... whats the word... oh yeah market crash... and im sure this will not effect the market Major as every one will be cruising the highs of more jobs and more consumer spending, treating this episode less remorsefully. 

5. How do you think this issue will affect the asset management industry? (You can listen to the audio stream on the website)

1. I think there needs to be more transparency available for clients on their investments. This will raise concerns amongst clients in their investments. For instance, the client was not aware of that the investment was going to go bad.
2. The other issue is that of the Chinese wall that separates investment banking decisions from research to ensure that the research team is not affected or influenced by the investment bankers. I believe there should be more stringent rules on mediating these process. For instance, even though the issue was raised all the way to Jamie Dimon, the bank chose to take advantage of the opportunity to make more money.
3. In addition, since pension funds are geared towards long-term investment, there needs to be more caution exercised by banks.
4. This incident raises questions on the duty of the bank towards its clients - who is at benefit? 

6. Why do you think JPM chose to hide the bad news to their clients instead of telling them to build their reputation?

Clearly JPM stood to benefit regardless of the fact that Sigma would fall or survive. Just as any other company would do, they want to amplify their reputation through showing greater earnings and profits rather than telling their clients that their investments didn't come to fruition. Mark Crawley, an Executive of JPM, mentioned that providing additional loans to Sigma could tarnish the reputation of JPM, but other JPM Executives were probably concentrated on the $9.3 billion in assets vs. the $8.4 billion which it had lent to Sigma. JPM had to have known that their investment into Sigma would be HIGHLY risky, but they also knew that regardless of the fact if Sigma failed, JPM would come out on top...even if their clients suffered.

The Art of Financial Modeling

I often being asked, “How to better be a Financial Modeler?” The answer lies into understanding what goes beyond Financial Modeling. Of course someone will always argue that Modelers would need to be experts on using Excel and its complex functions and we strongly believe that this is something that is undeniable. 

However, Financial Modeling is not only about knowing Excel. I would like to affirm that Excel skills come last when it comes to being a good Financial Modeler. From looking into and asking many analysts during visits I personally made with the Equity Analyst Team, in addition to the current financial modeling work that I am currently doing, I can assure you that you need specific skills and knowledge to be as good as the Goldman Sachs’s Analyst who is being paid twice or more the average analyst somewhere else. 

Economics: It goes without saying that a good Financial Analyst needs to understand Economics for the reason being that an analyst would need a good judgment in order to well forecast some variables. In addition, in many occasions, the analyst would need to justify his/her numbers to the portfolio manager by giving good justifications that are based on some good economic readings. For instance, modeling a Financial Institution needs well understanding of the economics behind interest rate for the reason being that interest rate income is a major source of income to banks. 

Accounting: Understanding accounting is vital in doing FM. However, when talking about accounting here I don’t mean Journal Entry and that sort of things, but understanding the flow of the financial statements and the relationship between each one of them. More importantly, the analyst needs to know the effects and changes within certain items of the financial statements, meaning, the analyst should be able to explain changes in net working capital, depreciation, short term debt vs. long term debt, etc. and how these items cold affect the overall operation of the business. 

Finance: The challenge here lies in the ability of separating financial theories with real world applications. Financial theories are meant to explain the science behind financial events and variables such as discount rate, WACC, term structure of interest rate and others. However, when it comes to financial modeling the analyst would need to add some flavors to make such variables work for a real world application. 

Finally, I would like to say that Financial Modeling is an Art and not a Science. Two different analysts analyzing the same company with the very same numbers will get different results and have totally two different conclusions. The case is being this way is because both analysts are seeing the economics of the company differently and from different angles. It is important for the analyst here to have the ability to explain the choices behind the numbers and be ready also to explain the assumptions that have been made regarding the future of the company being analyzed.

Hussain Jubail

Madoff

Its been ages since we heard from him.
This article is a FT exclusive and quite a good read.
Enjoy!
http://www.ft.com/cms/s/2/a29d2b4a-60b7-11e0-a182-00144feab49a.html#axzz1JHCOJwH3