Category: Your Money

The Reliance on Correlation

Our previous discussion of correlation in the NSE looked at a years worth of data for the NIFTY 50 components to see how individual stocks correlated with the index. There are three ways to look at correlation:

  1. Highly correlated stocks can be substituted with each other. For example, if the price of stock A is highly correlated with the price of stock B (r approaching 1), then investors should be indifferent between owning A or B.
  2. Correlation can be used to expose relative value. For example, in the above example, if A pays more dividends than B, then owning A is better than owning B.
  3. Correlation as a trading tool. In the above example, say on a particular day A drops (or rises) more than B, then you can put on a trade betting on mean reversion – that ultimately A & B will start behaving similarly.

For example, lets have a look at RELIANCE over the NIFTY 50 index. I created a series of 10-day correlations (r)

For 2006:

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For 2007:

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For 2008:

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For 2009:

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For 2010:

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and lastly for 2011:

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It looks like RELIANCE is usually highly correlated to the NIFTY 50 and the range is somewhere between 0.7 and 1.0. Lets have a look at the histogram to get a better idea:

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You need to ignore the deviations around stock splits and dividend ex-dates (for example, on 26-Nov-2009, RELIANCE issued a 1:1 bonus so the displacement that you see surrounding that date should be ignored) to truly appreciate what’s going here.

The charts show that there are significant number of instances when the correlation breaks down but it always moves back into the range. Looks like betting on convergence seems to be a no-brainer.

Have a trade idea? Let me know!

Sunder’s List

india calcutta bookstore

Calcutta bookstore (FriskoDude)

Stuff I’m reading this AM

Playing to your strengths: a discussion on letting manufacturing go in the US that applies to India as well. (NYT)

Is the US headed towards more socialism? The lower Labor Participation Rates seems to lead to that conclusion. (Krasting)

In case you missed: Mark Zuckerberg’s 6 Ingredients For Success. Success = ambition + vision + execution + persistence + luck + timing; with the first four being things you can control and the last two being externalities that you cannot.

The Economist’s love letter to the RBI. (Economist)

India Infoline’s revenues from equities and broking down 32.5% from last year. But as the market turns up, so will trading volume. (ET)

India proves too hot to handle for Norway’s Telenor

Telenor-pirat

Telenor-pirat (Photo credit: Hanne LK)

This is the story of how Norway’s equivalent of India’s BSNL got involved in a $40bn telecom scam. The Indian Supreme Court cancelled 122 2G licenses given on a no-bid basis in 2007. Yes, we are talking about something that happened 5 years ago for technology that’s 10 years old. But the fascinating part is that the spectrum was first sold to a real estate company called Unitech about for $365.42 million which then turn around and sold a 60% stake in its wireless division to Norway’s Telenor for $1360 million! I’m sure some people were feeling pretty smart about turning in a 270% profit for their “navigating” skills.

The minister, A. Raja, who sold the spectrum is a nobody from South India representing a grand total of one million voters. It must be a pretty fascinating journey for him coming in #2 in Time magazine’s 2011 list of “Top 10 Abuses of Power” list (just behind the Watergate scandal).

The underpriced spectrum giveaway unleashed a price war where SMS and voice tariffs in India were hammered down to the lowest in the world. Telenor had planned to invest about $3 bn in India and is said to be almost 2/3rds there. So that’s $2 bn that just got vaporized. Besides, they had out sourcing agreements with a whole bunch of Indian BPOs. Wipro is said to have $550 million worth of deals.

Its funny how Telenor, one of the top performers on the Dow Jones Sustainability Indexes for the 10th year running, got dipped in Indian curry.

Sources:

Telenor History, Nilgiris Lok Sabha Constituency), A Raja, 2G Spectrum Scam, Uninor, IT BPOs Hit

Sunder’s List

Image used to convey the idea of currency conv...

Image via Wikipedia

Another reason why NREGA is evil: it tries to prevent urbanization. They only way we are going to lift peasants out of poverty is if you give them access to service jobs. Sound’s unreal? Look at China’s experience: Jobs Require Cities.

Pop quiz: Name a country where currency trading can get you executed? Answer: Iran. If they are willing to accept Indian Rupees for oil, they must be in some serious trouble.

Oh Greece! Quit the EU already. Looks like they need $20 billion more. Who would’ve guessed right? Besides, the amount of pain that the entire region need to go through to stay in the Euro common currency might just lead to civil war. (United States of Europe)

You many need to read this twice: Chinese nationals are paying for Japanese real estate through credit cards. (FT)

Wife loves Gold. Mom loves Real Estate. Stocks are for Gamblers.

Risk taking is inherently failure prone. Otherwise, it would be called sure-thing taking. –Jim McMahon (American Football Player)

The most favored assets for the Indian middle class remains gold and real-estate. And this is not a post-global-financial-crisis story, it has remained so since my grandmother’s time. The oft cited reasons are that these are “safe” i.e.: they will not depreciate in value. And evidence over the past 20 years suggests that it has indeed been so. But will it be forever into the future?

So lets see what happened over the last few years:

Devaluation: in 1980 1 USD bought about 8 INR. Now it buys about 50 INR.

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The stock market had its share of controversies, roller-coasters and outright fraud.

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Increasing urbanization post 1990 lead to a real estate boom in the cities.

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And Gold went parabolic.

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So basically, if you ask your mom, wife or uncle, the underlying belief would be that these trends are going to continue forever.

Please allow me to make a counter-point: What is the bid-offer for all these “investments”? For gold ornaments it about 20% (try selling a bunch of old jewelry). For real estate (land) it’s a 3-6 month process and trying to sell a 5 year old residential flat might give you a heart attack.

Stocks and ETFs, on the other hand, are liquid. If you want to buy gold as part of an investment portfolio, buy GOLDBEES or if you want to buy real estate as an investment, buy a basket of RE stocks. I am not advocating an “either/or” scenario. Its just that conventional wisdom has such a strong recency bias that you need to verify why it so by taking a step back every once in a while.