Unlearn the old

“Change is inevitable - except from a vending machine.” – Robert Gallagher

Usually, Geographic texts remain the same across generations. You would not expect your child to learn about one less continent, or one more Sun. But in these changing times, even this is not true. Since 2006, we are now missing a planet. Our solar system now has 8 planets and not nine as we were taught. Something fundamental has changed here.

The same seems to be happening to the rules of investing. For the past many decades – almost since the concept of “fiat money” came into existence, it has always been assumed that earnings determine stock prices – atleast over an unspecified “long term”. Millions of trees have been sacrificed to propagate this thesis, and many investment gurus have made their reputations based on this “style” of investment – not least the great Warren Buffet.

It appears we are now in the midst of a change of tectonic proportions – much like the removal of “Pluto” for the count of planets – where we will take away cash flows and earnings as the primary sources of stock performance and replace them by regulatory and government action.

Two proposals merit attention. The first, originating in the USA, is a proposal by the Financial Accounting Standards Board (FASB), to allow creative accounting (obviously couched in more acceptable language). This will now be discussed and put to vote on April 2. Girdle up for “Ostrich Accounting” from here on – defined as “if I refuse to see it, it ain’t there”. If you assume that most companies already use some variant of this – this report mentions that GE Capital Corp. uses mark-to-market on only 2% of its assets – you understand why most brokerage reports use the words “we believe” so liberally. Whoever claimed that that an analyst was paid to analyse, not believe!

The other report is from our own shores. In an obvious attempt to keep up with the Joneses, in India, the National Advisory Committee on Accounting Standard (NACAS) has recommended a deferment of AS-11. While there is a flicker of hope that this will be rejected – the Ministry of Corporate Affairs has not yet accepted the recommendations, it seems highly unlikely. India will therefore pad along the footsteps of the “most advanced” market in the world.

Key changes – looking at accounting books of companies for clues of financial performance will soon become like reading fairy tales – it already is in many cases – but will now become entrenched policy – not meant for grown-ups. Equity markets will now behave much like debt markets. Debt traders are trained to look at the key market rigger (the Central Bank) for direction on how to trade. Equity traders soon have to look in the same direction – if the Bank prints more green-backs, buy equity, if it prints more bonds, sell equity. Did anyone mention earnings here?

To paraphrase a quote “Every time I find the meaning of investing, they change it”