From the Research Desk - Budget Impact

Budget Impact

General

Dividend distribution tax raised to 15% from 12.5%: negative for all dividend paying companies.

Dividends distributed by money market mutual funds and liquid mutual funds will now be paying dividend distribution tax at 25%.

Levy of additional 1% cess for funding of secondary and higher education.

Cement - Negative

Increasing excise duty from Rs400 to Rs600 for price above Rs190 per bag and reducing from Rs400 to Rs350 is a negative as cement price per bag in most of the places is above Rs190 at present. With demand strong we believe the increase in the duty would be largely passed on, but continuous efforts by the Government to curb the price increase and reduce the profitability of the industry is visible.

Increase in allocation for Bharat Nirman, Rural housing and roads is positive for the industry from demand side.

IT – Negative

Higher education allocation by 34.2% to Rs32,352cr to be positive for IT education companies like NIIT, Aptech, Educomp Solutions, etc.

Almost doubling of e-Governance outlay both at centre and state level to benefit companies like Vakrangee to major extent and TCS and other Government focused companies to some extent

MAT to be applied to IT companies to 11.2% on book profits

Inclusion of ESOPs under the FBT net negative for the sector

Non-extension of STP benefits beyond 2009 negative especially for medium & smaller sized IT companies.

HOW MARKET FARED

Will the dust settle on Budget?

The bulls were completely taken out as markets witnessed blood bath on the D-Street. Sluggish cues from International markets compelled the key indices to open with a negative bias. The indices further dropped tremendously after Finance Minister P Chidambaram announced a tax increase on dividends distribution from 12.5% to 15% in his budget proposal. The markets witnessed wild gyrations throughout the day as benchmark Sensex swung nearly 500 points and NSE Nifty swung over 200 points. The Cement, Construction and Technology stocks were the major losers dragging the benchmark index to hit a low of 12800.1. Finally, the 30-share benchmark Sensex slumped 540 points to close at 12938. NSE Nifty fell 148 points to close at 3745.

Technology index was the major loser and lost 4.65%. Others like Bank, Auto and Metal followed suit each falling over 3.5% each. Gujarat Ambuja, Satyam Computer and Wipro were the major losers among the 50-scrip’s of NSE Nifty. However, ITC, GAIL and Colgate were among the major gainers.

Hindustan Motors paced ahead by 6% to Rs40 after the automaker announced that it would develop a software township and an auto parts complex on surplus land around its factory in the eastern state of West Bengal. The scrip touched an intra-day high of Rs43 and a low of Rs35 and recorded volumes of over 68,00,000 shares on NSE.

Educational stocks were also on the receiving end. The Government proposed to increase the allocation for school education by about 35%. In 2007-08, an amount of Rs231.42bn has been allocated as against Rs171.33bn in 2006-07. Educomp Solutions ended flat at Rs900. However Aptech lost over 3% to Rs213 and NIIT slipped by 3.7%to Rs669.

Technology stocks also slipped heavily after the government said it will extend a minimum alternate tax on software companies that enjoyed tax exemptions. Heavy weights like Satyam Computer, Wipro and Infosys were among the major losers. Polaris plunged by over 12% to Rs174, Moser Baer lost by over 10% to Rs329 and HCL-Tech declined over 9% to Rs600 were the major losers among the Mid-Cap stocks.

Metal stocks lost their shine. National Aluminum lost nearly by 6% to Rs210, Tata Steel was down by 5.7% to Rs442, SAIL slipped nearly 5% to Rs108, Hindalco declined 3.1% to Rs139 and Sterlite Industries lost over 6% to Rs469.

Auto stocks were in reverse gear. Maruti plunged over 5% to Rs841, Tata Motors was down by 5% to Rs782, M&M slipped 4.3% to Rs811 and Bajaj Auto lost 4% to Rs2618.

However, FMCG index was the only gainer and gained 0.48%. Frontline stock ITC rose 4% to Rs171 after the government announced that it would increase the excise tax it levies on cigarettes by 5% in its budget for the year starting April 1, Marico rose over 2% to Rs60 and Colgate added 0.75 to Rs322.

Market may resume weak

Market lost more than 700 points in last couple of days on the back of steep fall in Chinese stock market and disappointing budgetary proposals. Also mixed Asian markets in the early trades may put pressure on the local indices. FII turning net sellers for last few sessions is the another cause of concern. However, overnight gains in the US markets may lift the investors sentiment. Among the indices, the Nifty may get support at 3670 and could test higher levels in the range of 3850. The Sensex has a likely support at 12800 and may face resistance at 13400.

US indices registered moderate gains on Wednesday on Fed chief Bernanke assuring investors that market is working well and the recent selloff hasn't altered the Fed's view on U.S. economic growth. While the Dow Jones gained 52 points to close at 12269, the Nasdaq ended 8 points higher at 2416.

Indian ADRs had a mixed outing on the US bourses. Patni computers fell sharply by 5% while, Satym Computers, Dr Reddy's, Wipro, MTNL dropped over 1% each while Rediff lost around 1%. While HDFC bank and ICICI Bank jumped by 5% and Infosys, Tata Motors and VSNL gained around 1-2%.

Crude oil prices in the global market moved up, with the Nymex light crude oil for April series rising by 25 cents at $61.39 a barrel. In the commodity segment, the Comex gold for April delivery tumbled $14.70 to settle at $672.50 an ounce.

Investsmart - Morning Call

Market Grape Wine :

In House :

Nifty at a support of 3690 & 3650 levels with resistance at 3810 & 3835
levels .

Buy : Steel stocks at dips

Buy : GACL above 115 s/l 114



Out House :

Sensex at a support of 12800 , 12786 & 12662 levels with resistance at
13131 & 13254 levels .

Maintain strict stop loss as markets to be very choppy and volatile .

Buy : RIL & RelCap at dips

Buy : ONGC & Gail

Buy : WelspunGuj & JainIrri

Buy : Sail & JSW at dips

Buy : NDTV & Tvtoday at dips

Buy : AbanLLoyd

Buy : Adalbs , Gitanjali & Glenamrk

Dark Horse : RIL ,Gail , Ongc , Infy , Gitanjali , NDTV & IFCI

Thanks Yash

Emkay - Morning Notes, Union Budget Analysis

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Anagram - Daily Call

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Major Global Macro Events - Chetan Parikh

“Today's managers, many of whom are alumni of the original global macro fund managers, earned their stripes during the ensuing crises and events. While Keynes had his 1929 event to learn about the positive and negative effects of trading on leverage, which he subsequently incorporated into his trading style and translated into future success, today's managers had the 1987 stock market crash, the sterling crisis of 1992, the bond market rout of 1994, the Asia crisis of 1997, the Russia/LTCM crisis of 1998, and finally the dot-com bust of 2000. (See Figure 1) The ways that today's managers look at markets, control risk, and manage their businesses include lessons learned through these important events.

Figure 1 Major Global Macro Events since 1971

The Stock Market Crash of 1987

Although the U.S. stock market crash of October 1987 is now a mere blip on long-term stock market charts (see Figure 2), as indexes fully recovered only two years later, the intensity of Black Monday for traders who lived through it has certainly left its mark. Most notably, the notions of liquidity risk and fat tails were introduced to the wider investment community without mercy. Entire portfolios and money management businesses were obliterated on that day as margin calls went unfunded. Indeed, even so-called "portfolio insurance" hedges didn't work as the futures and options markets became unhinged from the cash market.

Figure 2 S&P 500 Index, 1980-2005

Yra Harris (Praxis Trading) explains in his interview later in this book what he saw that day on the floor of the Chicago Mercantile Exchange:

It was eerie and scary because you just didn't know the extent if everything. People were clearly hurting badly but you just didn't know how badly. I've traded through a lot if devaluations and debacles but I've never seen as many people pulled off the floor by clearinghouses as I did that day. The pit was practically empty, which actually turned into a great opportunity to trade the S&Ps. I went into the S&P pit and starting making markets because nobody else was. Spreads were so unbelievably wide that it was pretty easy to make money just scalping around. Honestly, I couldn't help it.

Global macro managers from the equity stream, including George Soros, got hurt in the 1987 crash. Just prior to the crash, Fortune magazine ran a cover story entitled, "Are Stocks Too High?" in which Soros disagreed with the notion. Days later, Soros lost $300 million as stocks collapsed (yet Soros Fund Management still ended the year up 14 percent). Meanwhile, Tiger Management posted its first down year (-1.4 percent) only one year after an Institutional Investor article, noting Tiger's 43 percent average annual returns since inception in 1980, sparked the next wave of hedge fund launches.

For global macro traders from the commodities stream, however, the 1987 crash served as a windfall event. Paul Tudor Jones in particular was elevated to star status when he famously caught the short side of the stock market and the long side of the bond market by identifying similarities between technical trading patterns in 1987 and the great crash of 1929. (See Figure 3) Jones's Tudor Investment Corporation returned 62 percent for the month in October 1987 and 200 percent for the year.

The year 1987 also marked the introduction of a new Federal Reserve chairman in Alan Greenspan. Greenspan came into office in August 1987 and his first act a few weeks later was to raise the discount rate by 50 basis points. This unexpected tightening created volatility and uncertainty in the markets as traders adjusted to the style of a new Fed chairman. Some argue that Greenspan's rate hike was actually the cause of the subsequent equity market meltdown a month-and-a-half later. Immediately after the stock market crash, Greenspan flooded the market with liquidity, initiating a process that came to be known as the Greenspan put." The Greenspan put is an implicit option that the Fed writes anytime equity markets stumble, in hopes of bailing out investors.

Figure 3 Dow Jones Industrial Average: The Late 1920s versus the Late 1980s

Former Federal Reserve chairman William McChesney Martin famously observed that the job of a central banker is to "take away the punch bowl just when the party is getting started." Alan Greenspan, on the other hand, seemed to interpret his role as needing to intervene only as the partygoers are stumbling home. As he has claimed, bubbles can only be clearly observed in hindsight, such that the role of a central banker is to soften the impact of the bubble's bursting rather than to take away the fuel for the party.

Black Wednesday 1992

The term global macro first entered the general public's vocabulary on Black Wednesday, or September 16, 1992. Black Wednesday, as the sterling crisis is called, was the day the British government was forced to withdraw the pound sterling from the European Exchange Rate Mechanism (ERM)-a mere two years after joining-sending the currency into a free fall. The popular press credited global macro hedge fund manager George Soros with forcing the pound out of the ERM. As Scott Bessent (Bessent Capital), head of the London office of Soros Fund Management at the time, noted, "Interestingly, no one had ever heard of George Soros before this. I remember going to play tennis with him at his London house on the Saturday after it happened. It was as if he were a rock star with cameramen and paparazzi waiting out front."

The ERM was introduced in 1979 with the goals of reducing exchange rate variability and achieving monetary stability within Europe in preparation for the Economic and Monetary Union (EMU) and ultimately the introduction of a single currency, the euro, which culminated in 1999. The process was seen as politically driven, attempting to tie Germany's fate to the rest of Europe and economically anchor the rest of Europe to the Bundesbank's successful low interest rate, low inflation policies.

The United Kingdom tardily joined the ERM in 1990 at a central parity rate of 2.95 deutsche marks to the pound, which many believed to be too strong. To comply with ERM rules, the UK government was required to keep the pound in a trading band within 6 percent of the parity rate. An arguably artificially strong currency in the United Kingdom soon led the country into a recession. Meanwhile, Germany was suffering inflationary effects from the integration of East and West Germany, which led to high interest rates. Despite a recession, The United Kingdom was forced to keep interest rates artificially high, in line with German rates, in order to maintain the currency regime. In September 1992, as the sterling/mark exchange rate approached the lower end of the trading band, traders increasingly sold pounds against deutsche marks, forcing the Bank of England to intervene and buy an unlimited amount of pounds in accordance with ERM rules. Fears of a larger currency devaluation sent British companies scrambling to hedge their currency exposure by selling pounds, further compounding pressures on the system.

In an effort to discourage speculation, UK Chancellor Norman Lamont raised interest rates from 10 percent to 12 percent, making the pound more expensive to borrow and more attractive to lend. However, this action only served to embolden traders and further frighten hedgers, all of whom continued selling pounds. Official threats to raise rates to 15 percent fell on deaf ears. Traders knew that continually raising interest rates to defend a currency during a recession is an unsustainable policy. Finally, on the evening of September 16, 1992, Great Britain humbly announced that it would no longer defend the trading band and withdrew the pound from the ERM system. The pound fell approximately 15 percent against the deutsche mark over the next few weeks, providing a windfall for speculators and a loss to the UK Treasury (i.e., British taxpayers) estimated to be in excess of £3 billion. (See Figure 4)

Figure 4 Sterling/Mark and UK Base Rates, 1992

It was reported at the time that Soros Fund Management made between $1 billion and $2 billion by shorting the pound, earning George Soros the moniker "the man who broke the Bank of England." But he was certainly not alone in betting against the pound. While he may have borne a disproportionate amount of the criticism because of his significant gains, the government's own policies are believed by many to have been the root cause of the problem, the speculators merely a symptomatic presence.

The pound eventually traded as low as 2.16 deutsche marks in 1"95 but then rose as high as 3.44 in 2000 as the British economy recovered from recession and Germany suffered from the negative effects of euro integration. (See Figure 5) Some credit today's strength in the British economy with the interest rate and currency flexibility afforded by its position outside of the euro system. This is especially striking when the United Kingdom's economic growth over the last decade is compared to the growth rates of formerly strong euro area countries such as Germany and France.

Yra Harris amusingly claims in his interview that Great Britain should erect a statue of George Soros in Trafalgar Square as an expression of gratitude for taking the pound out of the ERM. Bessent adds, "A lot of credit should go to the UK officials . . . they knew to fold their hand quickly. UK Chancellor Norman Lamont and Prime Minister John Major suffered short-term humiliation for long-term good. I mean, look at the muddle France and Germany are still in."

Figure 5 Sterling/Mark, 1990-2005

Following the sterling crisis, the next systemic event for the global macro community was the bond market rout of 1994, but this time, the outcome was not profitable.

Bond MarketRoutof1994

As the euro project gathered political steam throughout the late 1980s and early 1990s, convergence trades-trades profiting from the convergence of various currencies and bonds toward a single currency and interest rate-became the dominant theme in European foreign exchange and fixed income markets. The early 1990s especially witnessed several strong years in the European fixed income and currency markets. Global macro traders at banks and hedge funds jumped on the trend along with relative value traders and trend followers, who were all heavily long European bonds. Leveraged positions were predominantly taken in the bonds and currencies of the weaker, high interest rate eurozone countries which, after the United Kingdom opted out of the ERM, were Italy and Spain.

Then, in February 1994, Fed Chairman Greenspan surprised the markets by raising overnight U.S. interest rates from 3 percent to 3.25 percent, beginning a series of hikes that served to abruptly end the early 1990s' period of easy money. Given the sizeable leveraged positions that had built up in the falling interest rate environment pre-1994, especially in the budding derivatives market, this unforeseen reversal of trend led to a generalized market sell-off. The 10-year U.S. government bond yield moved from 5.87 percent to 7.11 percent three months after the first hike, and most other markets also suffered trend reversals and declines. Likewise, the European bond trade that had worked so well until this point began to unravel. The sell-off was further compounded as margins were called, leveraged positions unwound, and continued price declines created a vicious cycle of forced selling. (See Figure 6 )

Figure 6 Yields: U.S. 10-Year Treasury, UK 10-Year Gilt, and German 10-year Bund, 1993-1994

Corporations on the receiving end of Wall Street's derivative prowess, such as Procter & Gamble and Gibson Greetings, suffered major losses as their hedges went against them; Orange County, California, the wealthiest county in the United States at the time, declared bankruptcy as interest rate derivative structures imploded; and several well-known global macro funds either closed or went into hiding. Indeed, 1994 was the only down year for the HFR global macro index, which lost 4.3 percent.

Asia Crisis 1997

For most of the 1990s many Southeast Asian countries had currency regimes that were linked to the U.S. dollar (USD) through trading bands that were set and managed by the local central banks. For the first half of the 1990s the USD was falling, improving the competitiveness of the Southeast Asian countries. Then, in 1995, the USD started to appreciate on a trade-weighted basis and especially against the yen, where it appreciated by more than 50 percent from April 1995 to January 1997. Due to their link to the USD, the Southeast Asian currencies appreciated in kind, slowly eroding their competitive advantage. (See Figure 7)

The USD link allowed local Southeast Asian borrowers to access cheaper funds offshore as U.S. interest rates were below local rates and their currencies were essentially pegged. They also borrowed a lot from Japan where interest rates were less than 1 percent and, post-1995, the Japanese clearly had a policy to weaken their currency. Given their confidence in the stable currency regime, Southeast Asians deemed such cross currency borrowing as largely riskless. But expanding current account deficits, along with a rising competitive environment, most notably from China, and a strengthening USD, created pressures in the managed exchange rate system. Towards the middle of 1997, the Japanese banks were forced to increase their asset bases and were thus less inclined to roll over short-term debts. This drying up of liquidity for the Southeast Asian borrowers, coupled with a sudden rally in the yen in May 1997, brought to light some of the strains in the system.

Figure 7 Japanese Yen, 1990-1998

As the risks became increasingly apparent, locals began to hedge their foreign exchange exposure, which meant heavy selling of local Southeast Asian currencies. As pressures on the system built, it became more difficult and more expensive for the local central banks to defend their currency regimes when their exchange rates approached the lower ends of the trading bands.

By July 1997, the Central Bank of Thailand saw its foreign currency reserve position dwindle in a futile effort to defend their currency regime and was left with little choice but to abandon the trading band. Without central bank support, the Thai baht immediately fell by 23 percent against the USD (See Figure 8) Lenders to Southeast Asian countries panicked en masse, withdrawing capital from the region or hedging their currency risk, which further depressed the Asian currencies. At the same time, locals borrowing in U.S. dollars and yen but getting paid in local currency rushed to hedge their worsening foreign exchange position. This led to a systemic sell-off across all Southeast Asian currencies, stock markets, and other assets linked to the former "Asian Tigers," creating a contagion-like" effect. Foreign investors rushed to pull their capital from the region without regard to specific country situations. The Thai baht eventually lost more than 50 percent of its value with other Southeast Asian currencies and stock markets sharing a similar fate. It was like a classic run on the bank, but in this case it was small economies and an entire region.

Figure 8 Thai Baht, 1997

Many economists and institutions at the time blamed the Asia crisis on I the openness of the global capital markets and the herd mentality of speculators. Malaysia's prime minister, Dr. Mahathir Mohamad, publicly blamed George Soros for the economic ills that Malaysia suffered following the crisis and even considered currency speculation a crime. He shut down his country's economy to so-called hot money by instituting draconian capital controls and fixing the Malaysian ringgit to the USD at 3.80. (See Figure 9) As Scott Bessent recalls, it "was slightly worrying [because] it was the first time that someone had actually stopped paying lip service and actually shut down an economic system."

While Soros Fund Management returned 11.4 percent for the month of July 1997 largely from shorting the Thai baht, if profiting from the collapse of the Southeast Asian market deserves blame, then Julian Robertson should have received the lion's share of attention. His Tiger Management made $7 billion in profit after catching Asia crisis trades across currency, commodity, and equity markets. Going into July 1997, the fund's returns were approximately flat for the year on an asset base of $10 billion but after a strong finish, Tiger completed the year up 70 percent.

Figure 9 Malaysian Ringgit, 1998-1998

To say that speculators caused the Asia crisis, though, would be oversimplifying the situation. More likely the local borrowers, who built up excessive foreign exchange exposures prior to 1997 when the system was still largely stable, were also largely to blame. As such, the Southeast Asian governments merit responsibility for running ill-conceived policies that allowed excessive foreign currency borrowing to build up in the first place.

Russia Crisis 1998

The Russia crisis, according to some, was essentially a continuation of the Asia crisis as the Asian "economic flu" made its way around the globe, causing investors to retrench and reduce exposure to riskier investments such as emerging markets. Prior to 1998, Russia was the darling of the investment community as the large, commodity-rich economy emerged out from under the Iron Curtain. But as foreign investors retrenched and pulled their capital from Russia, the deteriorating situation was compounded again by locals moving money offshore and by less-than-perfect government financial management.

As capital started to flee Russia, successive changing of finance ministers, increases in interest rates to incredibly high levels, and various proposals of international bailout packages were all attempted by the Russian government before it finally capitulated. On August 17, 1998, the government of the Russian Federation and the Central Bank of Russia announced a currency devaluation and a moratorium on 281 billion rubles of government debt. The ruble fell from 6 to the U.S. dollar to 20 (and eventually to over 30 in 2002), while the bonds became almost worthless. The Russian stock market index (RTSI$) collapsed from a high of 570 to 36 during the lead-up to the crisis. (See Figure 10) At the same time, many Russian financial institutions immediately became insolvent. This caused ripples through the world financial system, as many institutions had exposure to Russia that was thought to be hedged through derivative contracts with local Russian banks. Rather than being hedged, these positions became the subject of counterparty credit risk when the Russian banks became insolvent, leaving only the losing side of the trade.

Figure 10 Russian Ruble and Russia Equity Index (RTSI$), 1997-1998

The devaluation of the Russian ruble and simultaneous default of the country's sovereign debt caught many macro managers poorly positioned. It also marked the beginning of the end for the great global macro hedge funds, with 1998 denoting the peak in assets for Soros and Tiger (approximately $22 billion and $25 billion, respectively). George Soros made headlines again by losing between $1 billion and $2 billion on a single day (but yet again managed to finish positive for the year, returning 12 percent to investors) while Julian Robertson also took an estimated $1 billion hit in Russia. Tiger's woes were compounded with large losses in other markets, notably yen carry trades. (See Figure 11)

Figure 11 The Dollar/Yen Carry Trade, 1997-1998

As with most major crises, the Russian event created anomalies in other seemingly unrelated world markets. In this case, as investors dramatically reduced overall exposure to risky assets, they moved their capital into on the- run U.S. government bonds in what was called "a flight to quality." As I a result, spreads between the benchmark U.S. government bonds and all lather risk assets widened dramatically, leading the world to its next financial crisis: Long Term Capital Management.

Long Term Capital Management 1998

Although Long Term Capital Management (LTCM) was not a global macro fund, it is worth mentioning for several reasons. For one, the arbitrage focused fund drifted into global macro trades and its subsequent unwind had ramifications for global macro markets. Two, it offers insights into what can go wrong at a hedge fund, as well as shed light on such important issues as liquidity, risk management, and correlations. And three, almost every interviewee in this book mentions LTCM.

LTCM was started in 1994 by infamous Salomon Brothers proprietary I trader John Meriwether, who hired an all-star cast of financial minds including former Fed vice chairman David Mullins and Nobel Prize winners Robert Merton and Myron Scholes (pioneers in option pricing theory and methodology). LTCM started with $1.3 billion in assets from a who's who list of investors and initially focused on fixed income arbitrage opportunities (which had become more attractive as spreads widened after the bond market rout of 1994). The original core strategy was to bet on the convergence of the spread between "off-the-run" and "on-the-run" bonds, as well as other relative value and arbitrage opportunities, primarily in fixed income. Due to the small spread in these arbitrage trades, the fund was leveraged many times in order to generate the 40-plus percent annual returns it posted for the first few years of its existence.

LTCM's success at exploiting these arbitrages caused assets under management to grow at the same time that the opportunities were disappearing. LTCM was forced to increase leverage to maintain returns as well as allocate risk capital to markets and trades that were beyond its original scope of expertise. Going into 1998, LTCM had $5 billion in assets with notional outstanding positions estimated at well over $1 trillion. At the same time, risk arbitrage trades (bets on mergers and acquisitions), directional positions, and emerging market bets became a larger portion of portfolio risk.

As the summer of 1998 approached, global markets became increasingly unsettled due to a combination of the fallout from the Asia crisis and the hint of trouble in Russia. To exacerbate matters, Salomon Brothers, Meriwether's former employer, decided to exit the arbitrage business, closing out similar positions and causing a widening of spreads in LTCM's trades. Russia's eventual devaluation and default then led to a large-scale reduction in risk appetite and a global flight to quality. Long-term fundamental values were deemed irrelevant by investors, causing a further widening of the spreads on LTCM's arbitrage and relative value trades. (See Figure 12) LTCM's losses escalated to worrisome levels.

Given the leverage and size of LTCM's positions, liquidation was all but impossible. At the same time, LTCM's counterparties knew they were in trouble and at risk of imploding, leading them to hedge their own counterparty risk, further compounding LTCM's mark-to-market woes. To mitigate default-and, some would argue, the potential collapse of the world financial system-the Federal Reserve Bank of New York called a meeting with LTCM's creditors and implemented a bailout package. It was yet another iteration of the Greenspan put.

LTCM was at the forefront of investing at the time and offers insight into some of the failings of risk management systems. Risk management systems based on historical prices are one way to look at risk but are in no way faultless. Financial market history is filled with theoretically low probability or fat tail events. In LTCM's case, its risk systems calculated roughly a l-in-6-billion chance of a major blowup. Ironically, however, one correlation the brilliant minds of LTCM neglected to consider was the correlation I coefficient of positions that were linked for no other reason than the fact hat they were in LTCM's portfolio. In other words, their models didn't provide for the LTCM liquidity premium.

Figure 12 Corporate Spreads to Treasuries, 1994-1999

LTCM was a reminder of the notion that there is no such thing as a risk-free arbitrage. Because the arbitrage positions they were exploiting were small, the fund had to be leveraged many times to produce meaningful returns. This put them at risk to their lenders' financing fees as well as general market liquidity. The problem with liquidity is that it is never there when really needed.

Dol-Com Bust 2000

Chairman Greenspan issued his famous "irrational exuberance" speech on December 6, 1996, warning of the perceived overvaluation of the U.S. stock market. Over the next three years, the stock market did nothing but go up, minus a hiccup during the Russia/LTCM episode, which Greenspan quickly corrected by cutting interest rates by 75 basis points. The rate cuts included a famous intrameeting cut normally reserved for emergencies, despite the fact that the U.S. unemployment rate was 4.5 percent (so much for taking away the punch bowl). Meanwhile, !Tom the famous speech through to March 2000, the broader S&P 500 index doubled while the technology stock-laden NASDAQ quadrupled. (See Figure 13)

Figure 13 Boom! 1996-2000

As such, the returns being produced by global macro hedge funds were no longer as interesting to investors as the 50 to 100 percent or more annual returns being posted by some technology mutual funds. At the same, time, the two largest global macro fund managers struggled with the new momentum-driven paradigm. Robertson and Soros both became vocal naysayers of the tech stock-driven rally. It was widely perceived that dotcom and tech stocks were in a bubble but, as shares rallied ceaselessly, it was all but impossible for many investors to jump on the bandwagon. Indeed, Soros Fund Management flipped its position in late 1999, going from short to long high tech stocks, and in the process converted a 19 percent loss into a 35 percent gain for the year.

Julian Robertson, on the other hand, chose to maintain his core theme of long "old economy" versus short "new economy," which led to further losses in 1999 and 2000 as old economy stocks continued to decline and growth rallied. Eventually, Robertson was forced to close Tiger Management as investor redemptions piled up and assets under management sank from $25 billion to $6 billion. Upon shuttering his fund, Robertson remarked in his final investor letter, "As you have heard me say on many occasions, the key to Tiger's success over the years has been a steady commitment to buying the best stocks and shorting the worst. In a rational environment, this strategy functions well. But in an irrational market, where earnings and price considerations take a back seat to mouse clicks and momentum, such logic, as we have learned, does not count for much." Ironically, Tiger's final month in operation, March 2000, coincided with the absolute top of the tech stock bubble, after which Robertson's investment thesis would have proven a winner. (See Figure 14)

Meanwhile, Soros's long tech stocks position that had been rewarded so handsomely in late 1999 and early 2000 turned viciously against him after March of that year. Down 22 percent by April 2000, Soros announced plans to change the nature of his Quantum Fund to a lower-risk vehicle dubbed Quantum Endowment. Soros remarked at the time, "We have come to realize that a large hedge fund like Quantum Fund is no longer the best way to manage money. Markets have become extremely unstable and historical measures of value at risk no longer apply”.”

Figure 14 Bust! 2000-2003

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Budget Takeaways

Takeaways on Budget 2007-08



Ambit Capital



· Agri investment to go up by +2% of GDP

· Irrigation focus to benefit Kirloskar Bros

· Education thrust to benefit paper & stationery cos; +ve for BILT, Navneet , Camlin

· Rural thrust to benefit Infra, Irri, Power;+ve for IVRCL, Jain Irrigation

· Education sector focus to benefit NIIT, Aptech, Educomp & Prithvi Info

· Rural focus will benefit SBI, PNB, BOI for agri advances

· Immunisation prog +ve for Wockhardt, Panacea Biotech

· Farm sector focus +ve for tractor cos - M&M, Punjab tractors, Escorts

· Agri focus +ve for Monsanto, Rallis, Bayer Crop, JK Agritech

· Irrigation thrust to benefit Jain Irri, Finolex pipes

· APDRP +ve for Jyoti, KEC Int'l, Kalptaru

· Ultra Mega Power Projects +ve for BHEL, Alstom, Siemens, ABB

· UMPP also +ve for PFC

· Increased outlay to NHDP +ve for L&T, Gammon, HCC

· CBM projs benefits Shiv Vani, ONGC

· TUF extension to benefit textile sector

· Higher tourism allocation to benefit Hotels, Pvt. Airports

· More branches for RRBs Positive for PSU Banks

· Short selling allowed for inst will improve liquidity in the mkts

· Higher defence exp to benefit BEL, BEML, L&T, Dynamatic Tech, AstraMicro

· Increased focus on PPP to benefit construction cos

· E-governance thrust benefits Vakrangee, 3i Infotech, TCS

· Rural telephony to benefit Rel Com, Bharti Airtel

· Fiscal deficit of 3.3% to ease pressure on interest rates

· Reduction of peak import duties to benefit Capital goods cos

· Customs on man-made fibre reduced from 16 to 8%

· TUF continuation to benefit textiles, +ve for SRF

· RSM: concession rate of 5% to all research units

· CVD on aircrafts incl helicops negative for Global Vectra, Air Deccan, SpiceJet

· RSM: no change in service tax rate

· Excise duty on petrol & diesel reduced, +ve for Oil Mktg Cos & economy in general

· Excise duty on footwear reduced, +ve for Bata, Liberty, Mirza Tanners

· RSM: Excise on cigarettes increased by 5%

· RSM: service tax exemption increased to 8,00,000

· ITC to marginally impacted by excise hike

· Service tax net widened, includes individual PMS services

· RSM Infrastructure status for Gas Pipeline & Storage Facilities & Navigation schemes

· Section 80 IA benefit extended to ppeline cos, very +ve for PSL, JSAW, Man Industries, GAIL, GSPL, IGL

· Diamond Mfg & trd deemed income taxation introduced

· RSM: Benign assessment procedure for gems industry

· Hotel & Conventions centres to get tax benefit

· Tax holiday for new hotels, +ve for Parsvnath, Anant Raj

· MAT introduction negative for software cos

· MAT levy on exempt Dividend & Cap Gain income for corporates

· Cap Gains Exemption for NHAI & REC bonds to continue

· Increase in dividend distribution tax -ve for corporates/MFs

· FBT exemption for Free Samples; to benefit corporates

· ESOP SUBJECT TO FBT

· Corporate Headline Tax Rate 33.99%

· Additional education cess of 1% to hit corporate earnings

· ATF exemption on smaller aircrafts to benefit Air Deccan

· Budget -ve for IT & Cement cos

· RSM: Tax deduction for housing projects not extended

· Housing Companies Exemption lapses

· Budget +ve for pipeline cos, cap goods, oil mktg cos, infra, FMCG & textiles

· Service tax exemption on clinical trials, +ve for DRL, Ranbaxy

· RSM: service tax on commercial rentals

· SEZ benefit restricted to new units; trf of exst bus not eligible





Ambit RSM



· Higher Defence Allocation; + ve Ashok Leyland, Tata Motors

· Dredgers exempt from import duty- Dredging Corp to gain

· Custom reduced on medical equipment to 7.5%

· Ad valorem on petrol down from 8% to 6%

· Excise duty exemption for water purified devices; +ve for Ion Exchange

· Increase in specific rate of excise duty on tobacco by 5%

· Asset Management service under service tax net

· New services - commercial renting of immovable property, asset management services

· Clinical trial of new drugs exempt from service tax

· Mediclaim deduction increased to Rs 15000

· Surcharge reduced for SME with less than 1 crore income

· Corporate Tax Rate Unchanged

· Surcharge removed on all cos with taxable income less than Rs 1 crore

· Senior citizen threshold limit increased to Rs 195000

· Venture Cap Funds benefit limited to Bio, IT Nano technology, select pharma, Dairy and poultry, Tourism sectors

· Art covered under capital gains

· FBT on free samples exempt

· Service Tax on Commercial Rental -ve for Retailers / Malls







CNBC-TV18





· Healthcare allocation increased; +ve Max India, Apollo Hospitals

· More focus on HIV eradication; +ve MNC Pharma, Cipla, Wockhardt

· Education allocation increased; +ve Educomp, NIIT, APTECH

· Healthcare allocation increased; +ve Max India, Apollo Hospitals

· Focus on HIV eradication; +ve for MNC Pharma cos like Novartis

· More allocation to self house groups; +ve ICICI Bank

· Higher Allocation for roads; +ve IVRCL, HCC, Gammon, Nagarjuna

· More agri focus spending; +ve ITC

· Higher Agri Focus; +ve Ruchi Soya, Agro Dutch, Agro Tech

· Higher farm lending; +ve for all PSU banks

· Higher agri focus; + Ve fertiliser & pesticide co

· More Irrigation projects; +ve pipe for cos esp PSL

· IT spending on Food corporation on India; Focus - TCS, CMC

· Seven more UMPP under process; focus: NTPC, Lanco, GMR, REL Ener, Tata Power

· Seven more UMPP under process; Focus - PFC

· Higher outlay under NHDP; +ve IVRCL, HCC, Gammon, Nagarjuna

· Higher Outlay for road infrastructure; + ve cement and CV players

· Seven more UMPP's to be awarded; +ve Electric Eq suppliers

· Higher outlay for TUF; + ve Lakshmi Machine Works

· Higher outlay for TUF; + ve Gokaldas, Arvind Mills

· Higher outlay for TUF; + ve textile cos

· Higher tourism allocation; + ve TFCI

· New mortgage guarantees/instruments to be introduced; + ve HDFC, HDFC Bank, Dewan Housing, LIC

· New mechanism for unlocking value thru exchangeable bonds against subsidiaries by group cos; Focus - Tata Motors, M&M, Bharat Forge, CESC, Bajaj Auto

· Allocation to defence increased; + ve BEL, Nelco, Astra, Avantel, CMC, Zen Technologies

· Higher e-Governance Spend; Focus CMC, ICSA, Wipro, 3i Infotech, TCS, Vakrangee Software

· PHASE OUT OF CST; PREPARE ROADMAP FOR INTRODUCTION OF GST BY 2010; + ve INDIA INC

· ON COURSE TO ACHIEVE FRBM TARGETS, + VE INDIA INC, MKTS

· PEAK CUSTOMS DUTY CUT ( Non Agri); + ve INDIA INC

· Customs duty on PTA, MEG Cut; + ve RIL, IPCL, INDO RAMA

· Cut in customs duty on Gem stones; + ve Vaibhav Gems, Gitanjali Gems

· Custom reduced on medical equipment to 7.5%; + ve Apollo Hospitals, Max India

· Customs duty cut on man-made fibre; + ve RIL, Indo Rama

· NO INCREASE IN SERVICE TAX; + ve INDIA INC, Indian Consumer

· Excise duty cut in Diesel & Petrol from 8% to 6%; + ve HP, BP, IOC

· Duty cut on water carriage pipes; + ve PSL, Ratnamani, Finolex Pipes

· Increase in excise duty for cement prices above Rs.190 per bag; -ve ACC, Guj Amb, Shree Cements

· NO CHANGE IN CORP TAX; - ve India Inc

· Infrastructure status for Gas Pipeline; Positive GAIL, CAIRN, RIL, GSPL

· Cut in service tax on Clinical trials; + ve Biocon

· MAT definition tweaked

· Tax Benefits extended for 5 more years; + ve Pharma & Auto co's

· IT/ITES sector to come under MAT: to pay 11.22% of adjusted Book profits; - ve IT industry - Infosys, TCS, Wipro

· 150% weighted deduction extention ;+ve for pharma sector Sun Pharma, Ranbaxy, Dr reddys

· Dividend Distribution Tax hiked; - ve for high dividend payers - ONGC, NTPC, IOC, RIL

· Esops to be brought under FBT; - ve Tech, Media cos

· Dividend Distribution Tax increased; - ve Mf's

· Rent on Commercial properties; - ve Unitech, Mah Gesco

· EFFECTIVE TAX RATE UP FROM 33.66% to 33.99%; Tax rates of 30.90% for SMEs (total income < 10mn)

· Service tax exemption on clinical trials; + Ve Dr Reddy, Ranbaxy, Biocon

· Service tax on commercial property rent; - ve Pantaloon, Shoppers Stop, Trent

· Service tax on commercial property rent; - ve Multiplexes

· MAT not levied on 10 AA - SEZ's spared; marginally positive for SEZ players

· Proposal for Single tax levy on Telecom; directional + ve for telecom's

· Export Duty of Rs 300/tonne on iron ore; Negative for Sesa Goa

· Customs duty cut on coking coal; + ve for steel, power co's

· Measures to contain cement prices; +ve for construction co's





E&Y



· Immunisation programme to promote Pharma industry

· Higher outlay for seed procurement to benefit agri-based companies

· Coffee, rubber to get similar fund benefits as tea industry

· Rs 1800 cr allocated to NABARD +ve for banks

· Rural bonds worth 5000 cr to be issued will be eligible for tax exemption

· Higher outlay for seed procurement to benefit agri-based cos- monsanto,syngenta

· Agri focus with a view to increase production is a measure to curb inflation

· Focus on road construction to benefit cement cos

· Technology upgradation scheme to continue - handlooms to be covered

· Increased Allocation for textile parks to boost Garment and textile cos

· Retail sector in sports may get a boost on account of commonwealth games

· Tourism and Hotel sector to also benefit from Commonwealth games

· Higher VAT growth will reduce subsidy burden on Central Govt

· Interstate purchase to become less costly due to reduction in CST

· Reduction in rate step towards phasing out of CST

· Peak rates reduced from 12.5% to 10% for non-agri products

· Textile raw materials import duty cut

· Gem & jewellery sector to benefit from reduction in duties

· General rate on medical equipments reduced to 7.5%

· Medical equipment duty cut to benefit the Hospital sector

· No change in CENVAT & service tax rates

· Excise duty on petrol & deisel reduced from 8% to 6%

· Reduction in duty on petro products - Measure to curb inflation

· All types of food mixes exempted from excise

· Reduction in excise duty on biscuits/packed foods to benefit SSI:E&Y

· SSI excise exemption increased to Rs 1.5 crores

· Service tax minimum taxable slab increased from Rs 4 to 8 lakh

· Clinical Trial Industry to get boost - Cost of providing services lower by 12.24%

· Export of services rules undergo changes. May simplify the export definition

· Individual tax payers to pay less tax by Rs 1000

· Exemption from 4% CVD for crude & refined edible oil

· Food processing industry to benefit from import & excise duty cuts

· Corporate having turnover less than 100 lakhs not to pay surcharge: effective rate is 30.6%

· Corporates having turnover less than 100 lakhs gain by 2.68% from abolishment of surcharge

· IT/ITES sector to come under MAT: to pay 11.22% of adjusted Book profits

· 5 year tax holiday for hotels/convention centres will promote tourism/hotel sector

· Private sector R & D institutions to gain by import duty cut to 5%

· Dividend Distribution Tax increased to 15% - effective rate is 16.83%

· Private import of aircraft & helicopters now liable to duty

· Education cess increased from 2 to 3 percent

· Effective Corporate tax rate, Turnover > Rs 1 cr - 33.99%, DDT: 16.99%, MAT: 11.33%

· Effective customs duty at peak rates reduced from 36.74% TO 34.13%

· Effective CENVAT rate becomes 16.48%

· Effective service tax rates proposed to increase to 12.36%

· Rent on commercial property covered under service tax

· Taxation of ESOPs under FBT to adversely impact remuneration policies of companies

· Exchangeable bonds to facilitate borrowings against promoters holdings

· Retrospective amendment to section 10AA made pari passu with section 10A for SEZ Units - anti abuse provisions introduced

· TDS on professional payments increased from 5% to 10% from June 1, 2007

· TDS on rented plant & machinery reduced to 10% from June 1, 2007

· Supreme Court ruling on taxability of royalty/ FTS overruled - Explanation to Section 9 provides for no requirement to establish territorial nexus with India

· Definition of "India" under Income Tax Act, 1961 made pari passu to definition under Article 1 of Consititution - to include territorial waters and air space

· MAT impact for tax holiday companies would depend on tax credit available

· Effective tax rate (including DDT) of domestic companies increased by 1.76% now being 43.58%

Anagram - Derivative Wrap

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Budget Impact - Dhirendra Kumar

Last year, I thought that Budget 2006 was a 'low-impact' one as far as issues like savings and tax relief on savings went. The basic shape of taxes, both personal and capital gains, remained the same. In Budget 2007, things are much the same. This is yet another low-impact budget whose underlying message for savings and investments is that things are basically OK and there's no need to tinker too much. As I thought last year too, there's nothing wrong with a budget that's basically a do-nothing in these areas. Historically, Indian Finance Ministers have shown a tendency to do too much of the wrong things when governments are in some political pressure but Mr Chidambaram has stuck to his guns and basically emphasised that his policy on savings is just fine and I think that's a good thing. For individuals doing their tax-planning, stability of the tax regime has a great value.

Exemption: However, there are a few changes that will impact some segments. The increase in the basic tax exemption by Rs 10,000 means an extra Rs 1,000 a year for all tax payers. This kind of an increase should really be automatic and linked to some sort of an inflation index.

Dividend Distribution Tax: Some of the mutual fund industries' debt fund products will come under increased pressure as the Dividend Distribution Tax in liquid and money market funds has been hiked to 25 per cent. These are the kind of funds that most corporates use to park short-term cash. Of course, banks will benefit because their deposits will not be as relatively unattractive as they are now compared to income funds, but on the whole this will definitely mean a higher tax outgo (even though this tax outgo is invisible in their accounts) for cash-rich companies. It's difficult to calculate the exact impact at this stage but it is entirely possible that fund companies that have been hyperactive in these kinds of products could be severely affected.

New Regulations: In his speech, the FM said the government sought to 'promote the flow of investment to the infrastructure sector by permitting mutual funds to launch and operate dedicated infrastructure funds.' I'm not sure yet what this means. Funds are already free to launch any kind of sector-specific funds and some infrastructure funds already exist. Another point about funds he made is that the government would 'converge the different regulations that allow individuals and Indian mutual funds to invest in overseas securities by permitting individuals to invest through Indian mutual funds'. Here again, individuals can already invest abroad through mutual funds. I guess things will become clearer when the actual regulations detailing these changes arrive.

Exchangeable Bonds: Another interesting statement is that the government will 'put in place an enabling mechanism to permit Indian companies to unlock a part of their holdings in group companies for meeting their financing requirements by issue of Exchangeable Bonds'. In countries where they are permitted, exchangeable bonds are bonds that can be exchanged for the stock of a company other than the issuer, generally a subsidiary. I guess this would be mostly of interest to business houses that like to use innovative financing and restructuring strategies.

Markets' Fall: As far as stocks' steep fall on budget day goes, I think investors were basically nervous and were looking for any excuse (the budget or the global stock collapse over the last two days) to sell heavily. The general story seems to be that the market expected this or that benefit and since nothing materialised prices are crashing. It seems that whether it is corporate results or the Union Budget, stock players routinely build up great expectations unilaterally and then complain when these are not met.

Research Calls

Emkay (Private Client Research) recommends a Buy Taj GVK Hotels and Resorts at Rs 196 with a price target of Rs 250. At Rs 196, the stock trades at 19 times and 14 times its estimated FY07 and FY08 earnings.

With Taj GVK’s predominant presence in Hyderabad and expansion of operations in Chandigarh, Chennai and Bangalore where the ARR's and occupancies are expected to remain strong, Emkay expects the company to register good growth over the next few years.

The company however registered a lacklustre growth year on year in the third quarter of FY07 primarily due to decline in occupancy rates in Hyderabad from 84 per cent to 78 per cent during the quarter though average room rate (ARR) improved by around 23 per cent.

Operating margins came under pressure due to lower occupancies and a significant increase in staff cost. The company has proposed a capital expenditure of Rs 400 crore over the next three years to add new properties and expand in some of its current properties.

It plans to add atleast one property in each financial year till 2009-10 which will result in an increase in the room capacity from the current 684 rooms to 1834 rooms by 2009-10.

Taj GVK Hotels and Resorts is a joint venture between Indian hotels and the GVK group with the former holding 25.5 per cent in the company, which is a market leader in Hyderabad and Chandigarh with consolidated room strength of 534 and 150 respectively.

Infrastructure Development Finance Corporation (IDFC)

BRICS Private Client Group recommends a Sell Infrastructure Development Finance Corporation (IDFC) at Rs 110 as it feels that there is a limited upside of 5 per cent from Rs 110 as it has risen by 50 per cent in he past five weeks.

In a sum of parts valuation, the standalone entity trades at 2.5 times estimated FY09 book value. With strong domain expertise and an established brand, IDFC is well positioned to capitalise on the burgeoning oppurtunities in infrastructure asset management.

However a key concern remains declining net interest margins though net interest income growth is strong, its inability to scale up fee income ( which declined by 13 per cent year-on-year in 9M FY07) any further to substitute the current high contribution of treasury and proprietary investments.

However the positive aspect about the company is its asset management business as well as its investment in the National Stock exchange.

Madhucon Projects

Angel Broking recommends a Buy on Madhucon projects at Rs 277 with a 12 month price target at Rs 351. At Rs 277, the stock trades (net of BOT and real estate projects) at 12.3 times and 7.3 times its estimated FY2008 and FY2009 earnings respectively.

Madhucon derives 99 per cent of its revenues from roads and irrigation sector which are expected to see huge investments. While investments in road sector are expected to increase at a CAGR of 24 per cent, another key positive is Andhra Pradesh's proposed investment in 5 years.

This macro-environment will boost the the company’s current order book of Rs 4400 crore and also expand the top line. Moreover its order book to sales ratio of 12.9 times its FY2006 revenue looks extremely comfortable and is executable over a period of the next 3 years.

Angel expects the company to post revenue CAGR of 68.3 per cent and a net profit CAGR of 58.8 per cent over a period of FY2007-FY2009.

Madhucon enjoys better operating margins than its peers due to large Build-Own-Operate (BOT) projects, sub-contracting low value added work and owned equipment for construction. The company has a land bank of 9 acres in Kukatpally, Andhra Pradesh and is expected to develop an area of 2.2 million sq feet over a period of the next 4 years.

Siemens

Networth Stock broking recommends accumulating Siemens at Rs 1162 with a price target of Rs 1250. At Rs1162 , the stock trades at 23.49 times estimated FY08 earnings.

During the December 2006 quarter, net sales rose 91.1 per cent year on year to Rs 1626.9 crore. Strong growth in revenues was mainly driven by power, industrial solution and services and building technologies while healthcare and other services showed a lacklustre performance.

The other business segments like information and communication, automation and drive, automotive and transport registered a marginal decline in their revenues. Operating profit grew 66.8 per cent to Rs 116.95 crore and net profit doubled to Rs 98.1 crore.

Operating margin continued to remain under pressure dipping by 105 basis points due to higher material cost. Order inflow rose 23 per cent due to a major repeat order from the power division of Qatar. Order book to sales at the end of Q1FY07 stood at 2.4 times its 12 months trailing revenue.

Networth expects the company's consolidated revenue and net profit to grow at a CAGR of 37 per cent and over 40 per cent respectively in the next two years.

Religare - Investment Picks March 2007

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Religare Tracker - Market Ideas Desk

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Budget 2008--Neither reformist, nor populist: Sharekhan Budget Special dated February 28, 2007

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