Why stimulated share prices are unsustainable

Jan 8, 2010

In this issue:
» Stock markets are too dependent on government stimulus
» Is China staring at an economic crash?
» Babus to disclose assets
» Credit rating agencies to undertake operational audits
» ...and more!!

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A few months ago, the world economy was like a patient in need of urgent revival. Central banks around the world responded quickly, and in unison. A deluge of easy money flowed. Interest rates in most of the developed world are now at 1% or less. It has helped revive the patient but with some serious side-effects.

As reported in the Economist, the Morgan Stanley Capital International (MSCI) world index of share prices has recovered by around 70% from its lows in March, 2009. True, most stock markets are below their all time highs. But when profits are adjusted for the swings of the economic cycle, current valuations are at par with the other peaks of the last century.There are three classic signs of a bubble - steep valuations, growth in debt taken by the private sector, and enthusiasm for an asset class. So far, the other two symptoms have not surfaced. But they will, if the central banks carry on with their stimulus packages for much longer. Especially in commodities and emerging markets like China and India. Hence, policy makers must soon revisit their stance on interest rates. They must also chalk out plans for cutting their fiscal deficits.

Just because we are not at all time highs does not mean share prices will keep moving upwards. In fact, when we look at the valuations of high quality companies on a case by case basis, we find most of them beyond reach. Our advice - be very careful about the price you are paying for your investments right now...and always!

 Chart of the day
Speaking of peak valuations, today's chart of the day shows how far off share prices as on December 31, 2009 were from their all time highs. The equity returns of the world's 1,500 largest companies classified by industry shows that Telecom and IT shares which peaked during the dotcom bubble are the worst off. There are two possible interpretations of the chart. One is that we are way off the stock market peak. The other, which we subscribe to, is that one pays a dear price for getting carried away by enthusiasm. After all, the entire rally during 2009 has not been able to wipe off earlier follies. As is often pointed out, the Japanese stock market still trades at merely 25% of the high it reached 20 years ago. The NASDAQ still trades at 50% of its dotcom-bubble highs.

* Materials includes chemicals, construction materials, metals and minerals
Source: The Economist, MSCI

Wikipedia describes James Chanos as a billionaire who has a knack of spotting stocks that he thought to be overvalued and then short selling them. Indeed, if you have the distinction of being amongst the first people to pull the plug on companies such as Enron and Tyco International and most recently, the US financial institutions, you have something going for you. The New York Times reports that the world's foremost short seller is currently bearish on the biggest conglomerate of them all, China Inc.

Thus, as most of the world looks to China to pull itself out of the economic mess, Chanos is of the view that the dragon nation might get crushed under its own debt burden. "Bubbles are best identified by credit excesses, not valuation excesses and there's no bigger credit excess than China," he is believed to have said recently. He further opines that he has a strong feeling that China is cooking its books and perhaps faking its strong GDP numbers.

Well, there are stories doing the rounds that the enormous stimulus of US$ 586 bn that the dragon nation undertook is feeding bubbles in asset classes like real estate and stocks. But not everybody is convinced that it could lead to an economic collapse. Take Mark Mobius for instance. The emerging market guru believes that the bubble in Chinese property market may not burst. "The Chinese will act rationally and they're not going to kill the market," Mobius said recently in an interview. As to who turns out to be correct, we will have to wait and see.

The collapse of the likes of Lehman and AIG taught some very important lessons. Most important was taking the ratings accorded by credit rating agencies with a pinch of salt. Such has become the reputation of credit rating agencies after the subprime debacle that damage control has become necessary.

India was amongst the least impacted by the rating fiasco. However, SEBI seems to be keen in taking proactive steps. It has ordered all credit rating agencies to undertake an operational audit every six months. SEBI will also follow up on the steps undertaken to correct the shortcomings reported, if any. The move is certainly welcome in the light of maturity of Indian financial markets. However, to begin with, audit firms themselves need to get their house in order. The Satyam scam has hardly left them with much to boast about.

Rampant corruption in India's political system has been the bane of the average Indian. Therefore a landmark order passed by the Central Information Commission surely comes as welcome relief. This order states that disclosure of information such as assets of a public servant, routinely collected by the public authority, should be made available to the public under the Right to Information Act.

Earlier the assets of politicians and Supreme Court judges were available for public scrutiny. Now this list has been expanded to include babus as well. The ruling has specifically stated that disclosure of assets by a babu is no longer a matter just between him and his superiors. Corruption is nothing new to India as umpteen scandals and scams in the past have shown. In fact, it is deeply ingrained in the psyche of Indians given the apathy of the government in tackling the same. Therefore this ruling is definitely a step in the right direction.

If you are an aspiring car buyer, or are looking to buy your first car, there is good news for you. The Indian small car market is staring at a price war. Now whether the competition can get as fearsome as we are seeing in the Indian mobile services market remains to be seen.

But the consumer will surely have a host of small cars to pick from as MNCs like Toyota, Volkswagen, Ford, and Nissan gear up to launch small cars in India.

While the Indian consumer is rejoicing, existing players like Maruti, Tata Motors, and Hyundai might be sweating. After all, their years-old grip on the small car market is gradually loosening. Tough times for these companies, indeed!

The Indian markets witnessed a volatile trading session today after a muted start. Amidst choppy trade, the BSE-Sensex was down by about 60 points at the time of writing. Profit booking in stocks from the banking, telecom and IT sectors led the weakness in the benchmark indices. However, realty, capital goods and power stocks managed to gather investors' interest. The Indian indices were the only losers in Asia, while Europe has opened in the red.

 Today's investing mantra
"Obviously, we can never precisely predict the timing of cash flows in and out of a business or their exact amount. We try, therefore, to keep our estimates conservative and to focus on industries where business surprises are unlikely to wreak havoc on owners." - Warren Buffett

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10 Responses to "Why stimulated share prices are unsustainable"


Jan 11, 2010



prabhakar rao kurra

Jan 10, 2010

Respected Sir,
I appreciate your views and comments.It is for the first time I am reading your article.I am of the opinion that most of the share prices are over valued and one should be very careful in investing.
Pl continue.


Jagadeshwer Rao

Jan 9, 2010

Very True. Credit Excesses are more dangerous both in terms of proportions and consequences than valuation excesses. I would like to thank '5 Minute Wrapup' Team for bringing the opinions of various leaders in trade to our Desktop. A big Thank you once again!


Abhay Datar

Jan 9, 2010

It's about corruption in Indian Political system. Why only politicians, even a small Indian man whether in a government office, a tehsil office, a rationing office is corrupt.



Jan 9, 2010




Jan 8, 2010

Please provide more information on the following equity shares:


B B Malhotra

Jan 8, 2010

Very pointed issues concerning all presented in capsule form i must say a good attempt.



Jan 8, 2010

Thanks. It is after a long time, I have read some logical comments on the present valuations of markets, in comparison to the historical backgroud valuations, younhave given. Good work. Pl. continue it.
J.L. Tickoo



Jan 8, 2010

Today's write-up under the title "why stimulated share prices are unsustainable" made interesting reading.It is a fact that credit rating agencies have not lived upto their reputation in recent times. As such SEBI's directive that they should undertake an operational audit every six months is a wlecome one. However, as mentioned in the write-up, the audit firms themselves have to first get their house in order.



Jan 8, 2010

dear sir,
Here the overvaluations are due to stimuli given to equities sothat we can very well say presnt asset valuations unsustainable.

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