Sunday, July 20, 2008

Citigroup's loss and Mr Market

NY Times reports that hobbled by the credit crisis at home, Citigroup has limped through nine months in the red, reporting a $2.5 billion quarterly loss on Friday. The loss that Citigroup reported on Friday was not as gaping as many investors had feared. Wall Street cheered the results, which only a year ago would have been seen as disastrous. For the quarter Citigroup lost 54 cents a share, and reported write-downs of $7.2 billion on its investments. On the consumer debt front, the bank also announced $4.4 billion in net credit losses and $2.5 billion to increase credit reserves. Citigroup’s chief executive, Vikram S. Pandit, characterized the $2.5 billion loss as a sign of progress, compared with last quarter’s loss of $5.1 billion. After so much bad news from the financial industry, investors took heart from the results. Shares of Citigroup rose $1.38, or about 8 percent, to $19.35.

What made me feel sad was the fact that CEO of Citigroup is terming the loss of $ 2.5 bn as a "sign of progress" and the share price also goes up by 8%! Investors are so badly hurt that they are willing to buy any argument!! May be the CEO is hinting that you people expected much grand losses from our side (or, is it that we are capable of totting up much higher losses) but we have (unknown to us?) ended up with lower losses. Strange are the ways of Mr Market - an unforgettable character created by Prof Ben Graham.

The Indian Context

In India, the dramatic fall and the equally dramatic rise in the BSE Sensex in the week gone by, was nicely summed up by Equity Master - "
....on Monday, the markets started on weak note taking negative cues from the global markets. The BSE Sensex tumbled 101 points on very first day of trading. The downhill journey continued on the following day as the markets witnessed selling pressure across the broad and closed in a sea of the red. The BSE Sensex closed 650 points down on Tuesday. There was no respite on Wednesday either. Though the markets opened well above the dotted line, by the end of the session most of the gains had been shed and the indices once again closed in the red...."

When the Sensex fell for the first two days, Mint reported that - "...with the fall in Sensex, its PE multiple has come down from 27.67 in January to 15.88. Still, India continues to be more expensive than many Asian and emerging markets. For instance, the Hong Kong and South Korean indices are trading at 12.8 times and 12.1 times earnings, respectively..." The remark in the newspaper article that other markets are still cheaper, gave the feeling that further correction may be possible. This was further strengthened by the headline -"Worse may be ahead for the market". Interestingly, the reverse happened. Now continue reading Equity Master's summing up of the week -"..
Last two days of the week witnessed a different mood. The bulls came back fiercely to take on the bears and completely overpowered them. The markets notched up 536 points on Thursday joining the global party to celebrate the lower crude prices. The buoyancy lasted till the last day of the week, enabling the Sensex to close 512 points higher on the final day of trading."

Mr Market

Now what has happened in the last one week (or) for that matter each one of the days of the last one week for the market to fall or having fallen, then for the market to rebound, I don't know. But, I was reminded of the beautiful characterisation of Mr Market and his quixotic ways, which Warren Buffett had quoted in one of his annual reports. Some excerpts from Warren Buffett's 1987 letter
to shareholders of Berkshire Hathaway:-

Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.

Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market's quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business.

When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.

Mr. Market has another endearing characteristic: He doesn't mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.

But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren't certain that you understand and can value your business far better than Mr. Market, you don't belong in the game. As they say in poker, "If you've been in the game 30 minutes and you don't know who the patsy is, you're the patsy."

Ben's Mr. Market allegory may seem out-of-date in today's investment world, in which most professionals and academicians talk of efficient markets, dynamic hedging and betas. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising "Take two aspirins"?

The value of market esoterica to the consumer of investment advice is a different story. In my opinion, investment success will not be produced by arcane formulae, computer programs or signals flashed by the price behavior of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace. In my own efforts to stay insulated, I have found it highly useful to keep Ben's Mr. Market concept firmly in mind.

Following Ben's teachings, Charlie and I let our marketable equities tell us by their operating results - not by their daily, or even yearly, price quotations - whether our investments are successful. The market may ignore business success for a while, but eventually will confirm it. As Ben said: "In the short run, the market is a voting machine but in the long run it is a weighing machine." The speed at which a business's success is recognized, furthermore, is not that important as long as the company's intrinsic value is increasing at a satisfactory rate. In fact, delayed recognition can be an advantage: It may give us the chance to buy more of a good thing at a bargain price.