The smart money is bullish on...

Jan 7, 2011

In this issue:
» IMF's solution to tame the 'elevated inflation'
» Why banks may be seen squeezing margins...
» Experts doubtful of India's future growth
» Geithner's fear of US debt default a boon for gold?
» ...and more!!

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Stock markets have been going up and down like a cardiac monitor. Higher inflation rates, oil prices, are all pushing the markets down. On the other hand, spectacular economic growth, FII inflows are pushing them up.

The bottom line is no one knows where the markets are headed next. Not even the 'smart investors' i.e. the major brokerage houses or the fund managers. They may all come on TV and talk about how they expect markets to touch new highs but their buying interests suggest otherwise.

The same smart investors are now turning towards the 'defensive stocks'. These are the stocks that may not rise much when the stock markets are raging upwards. But the most important part is that these stocks tend to outperform the markets when the bears take over. During uncertain and volatile times, having these stocks in your portfolio can save you from major losses.

Traditionally stocks in the consumer goods, pharma and utilities space are considered to be defensive stocks. The underlying reason for this is simple. Whether times are good or bad, the demand for basic necessities is unlikely to go down.

When investors turn their focus towards defensive stocks, it is a clear indicator that they either expect markets to come down or remain volatile in the near term.

In our opinion it is always good to have defensive stocks as a part of one's portfolio. But this does not mean that one should follow the 'smart investors' blindly and invest in anything that they suggest. The defensive stocks have run up quite a bit during the recent volatile times. Therefore, it would be better to be cautious and wait to pick up the good stocks only when they are available at attractive valuations. After all, it is always better to be safe than to be sorry.

 Chart of the day
Continuing with our discussion on defensive stocks, let us see if these stocks actually outperform during volatile times. Today's chart of the day shows the performance of the defensive sectors vis--vis the broader markets in 2010. 2010 was a year of high volatility in the Indian markets. During this time, defensive sector indices like BSE-Healthcare (representing the pharma sector) and BSE-FMCG (representing consumer goods) delivered gains of over 30% while the broader BSE 100 index was up by only 15%. Clearly, defensives do outperform during volatile times. But one must keep in mind that they have also run up a lot in recent times.

Data source: Prowess

The finance minister has been trumpeting a 9% GDP growth rate for 2011. But some top economists are a bit skeptical. Their best estimate stands lower at 8%. They cite two main concerns. One of course is the current account deficit. At 4.1% of GDP, it is quite high compared to many other fast growing emerging market economies. The fiscal deficit also is at a lofty 5.5% of GDP. Of course, these concerns are not new. Luckily, the high growth of the economy has saved us from these otherwise fatal ogres. Haven't we witnessed enough countries being punished for their reckless finances?

The other threat to growth comes from the inflation monster. It has already been occupying headlines for quite some time. The RBI had hiked repo rate by 1.5% in 2010. Further monetary tightening, which looks quite plausible, could be harbinger to lower growth. So these concerns are quite valid and definitely need to be addressed. However, our belief in the country's long term growth story remains intact.

Inflation has been a threat to the Indian economy for quite some time now. India did recover strongly from the slowdown on account of the global financial crisis. But poor monsoons in 2009 and higher food prices conspired to keep inflation at higher levels. To RBI's credit, it chose to tackle inflation first even if meant hurting growth to a certain extent. Accordingly, it has been steadily raising interest rates.

However, so far inflation has not been brought to acceptable levels. Which is why the IMF is in favour of further monetary tightening by the RBI to tame what it calls 'elevated inflation.' The IMF sees inflation as one of the near-term challenges confronting India in sustaining its high-growth momentum. The RBI and the government so far have been confident of bringing inflation down to an acceptable figure of 6.5% by the end of this fiscal. But persistently higher food prices mean that one will have to wait to see whether this target will be met. Although the central bank did take a pause this quarter, it would most certainly go in for more rate hikes if inflation refuses to cool down.

For those who like to keep an eye on near term profitability, banking is a sector that is unlikely to look lucrative in 2011. Indian banks have basked in the glory of low cost deposits with rock bottom interest rates over the past two years. It now seems that they are all set to move out of their comfort zone. With liquidity showing no signs of easing banks have already hiked the interest rates on select deposits by as much as 2% over the past few months. If the RBI's stance on inflation is taken into account, the rate hikes are only set to get steeper. With this banks will have to compromise on margins if they are to keep the loan to deposit ratio intact. While this would mean a blip in near term profitability, investors well aware of the cyclical nature of banks' margins and EPS are sure to ignore the numbers. Instead they would do well to keep an eye on NPAs and operating costs that could hurt long term profitability as well.

In the meanwhile, the Indian markets continued their downward trend during the post noon trading session. India's benchmark index, the BSE-Sensex was trading lower by about 322 points or 1.6% at the time of writing. All the sectors are witnessing selling pressure with auto and metal stocks being the biggest losers. As for rest of Asia, markets ended on a mixed note Hong Kong closing weak and China and Japan ending higher.

Gold has come off a bit in the past one week. However, we have with us a brand new example of why we think the yellow metal may soon resume its northbound journey. And this example comes to us courtesy moneynews. Apparently, US Treasury Secretary Timothy Geithner has warned the republican leaders of a possible catastrophe if the US borrowing limit is not raised. It should be noted that the US currently has a borrowing limit of US$ 14.3 trillion. But thanks to its massive stimuli and other such measures, even this huge sum is proving inadequate. Hence the warning from Geithner that inaction on this front could drive up interest rates and also lead to job losses. We believe the reasoning from Geithner to be pretty naive. Although the US cannot default on its own debt, piling it on blindly may not go down well with the lenders. Sooner or later, they would start demanding higher interest rates. Or maybe the US Fed will have to step in by printing more money. Either way, gold is a cinch to go up.

Is processed foods the next big idea? We think so. Consider this. Prices for onions and garlic increased four folds over night in the past week. However, prices of ginger-garlic paste and other processed spices remained the same. The reason for this was that food companies buy in bulk and much in advance. As a result, their products are insulated from volatile prices. In fact the shift from raw onions and garlic to cooking paste saw sales of Dabur's Hommade paste growing by 60% YoY last month. Its competitors also witnessed similar jumps in sales. We believe that as a result of better sourcing, quality control, stable pricing and cooking convenience, processed foods will capture a large portion of the Indian kitchen shelf. While this will not happen overnight, the change in trend is there for all to see. Meanwhile, we think that investors in FMCG and food stocks must keep the trend in mind.

 Today's investing mantra
"The four most expensive words in the English language are - This time it's different." - John Templeton

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4 Responses to "The smart money is bullish on..."


Jan 8, 2011

Inflation indeed is the biggest monster making deep holes in the pockets of every ordinary Indian. The attempt of the government and its economic advisers to play it down clearly highlights the inability of the government and such strong body of economic advisers! lack of vision and a definitive long term policy to tackle this mencae is obvious. Let us not beat the trumpet of high growth economy when we cannot ensure easy availability of even the most essential vegetables such as onion at areasonable rate! Some time it was sugar,then serials and now the vegetables! What is the next shock in store for all of us, only GOD will Know!! The Government has all the time on earth to find ways and means of covering up scams and corrupion, but it seems this political class is least concrned about the normal Indian citizen! Shocking ineed is the state of affairs!



Jan 7, 2011

You should have written about Banking stocks couple of days ago.what is the point in writing when the whole market knows that and hampered even the well managed and reasonably priced banking stocks today!!.


R V Subramanian

Jan 7, 2011

In the context of the fact that most of the stocks in the Sensex basket are highly overpriced (very high PE ratios), in my opinion Sensex can ever cross 24K in the next two years. It is highly unlikely that the Sensex, in the current format, would even touch 24k, unless earnings from these companies (in the Basket of Sensex for calculating the index) dramatically increase substantially!!


C K Vaidya

Jan 7, 2011

The Pharma sector in India also had 2 other reasons to rise, namely,
a)foreigners' interest in acquiring Indian pharma companies resulting in 2 large transactions and rumours about other likely transactions pushing up their stock prices
b)with many more drugs coming off patents, the expected growth in US sales has given a fillip to PE multiples.

Both these factors have contributed to Pharma outperforming index. As regards FMCG, I think there is a genuine change in terms of trade between rural India and urban India. This has resulted in rural India buying more FMCG products.

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