After trillion-euro QE, which amongst stocks, gold and bonds look most attractive? - The 5 Minute WrapUp by Equitymaster
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After trillion-euro QE, which amongst stocks, gold and bonds look most attractive?

Jan 23, 2015

In this issue:
» Will Indian markets outperform ASEAN counterparts?
» What the Big Mac index says about the Indian rupee...
» Is it time to invest in turnaround aviation stocks?
» ...and more!

ECB chief Mario Draghi's trillion euro dose of cheap money has certainly set him in the league of adventurous central bankers. After all, he is continuing the legacy started by the grandfather of QE, Alan Greenspan. This was later adopted by Fed's Ben Bernanke and Japanese Prime Minister Abe. Their firm belief that throwing more and more cheap money can revive an ailing economy has at least been lapped by stock markets, if no one else.Our own RBI governors meanwhile have chosen not to be part of the legacy! And in the process helped India skirt some serious crises. Now, India has been at the edge of several big crises ever since we began our own economic reforms in 1991.

There was the Tequila crisis when Mexico went bust in 1994.

There was the Asian Crisis when the Asian Tigers went bust in 1997.

There was the LTCM collapse which led to South Korea and Russia going bust in 1998.

And of course this was followed by the mega Subprime crisis in 2008, with none other than the US leading the pack of economies on the verge of collapse. In each of these crises, the central bankers of these countries had set themselves up for the fall. And it seems there are hardly any lessons learnt!

But, during the early crises, India was still a relatively closed economy. Our total trade with the developed economies was less than 10% of GDP for a long time. Today it is over 25% of GDP. Add to that the FII money that finds its way into Indian stock markets. Therefore whether trillions are pumped into economies of the US, Japan or Europe, asset prices in India are bound to get impacted. So as investors it is important to know which asset classes you should focus on.

Now, since we have little knowledge of which central bank will print how many trillions next, it is best to manage one's portfolio keeping the risk appetite and long term objectives in mind. And whether it is stocks, bond or gold one cannot speculate on the next round of QE to determine the investment.

Even as stocks move higher thanks to the fresh dose of liquidity, investors have no reason to allocate money to the same unless they find really solid businesses at attractive valuations. This asset class is likely to look most attractive if the earnings growth of Indian companies catch up with premium valuations. However, it will be extremely risky for investors to be exposed to overvalued stocks.

As cheap liquidity drives interest rates lower, bond prices too could move higher. However, the selection of bonds should be dependent on the quality of the issuer rather than the pace of correction in interest rates.

Gold too continues to reserve its rightful place as a safe haven for currency risk. However, to assume that every round of QE will push up gold prices dramatically is also very risky. Most importantly, investors should hold only a small portion of the portfolio in gold as against treating it as a speculative investment.

Thus even if the US Fed stops printing money, the QE trend is far from being dead. We hope that the RBI will continue to safeguard the Indian economy against QE risks. And even if asset classes like stocks and gold look increasingly attractive, investors will be better off not taking any speculative bets.

Will you change your allocation to stocks and gold based on QE? Let us know your comments or share your views in the Equitymaster Club.

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Now even as the benchmark indices in India continue to make new highs, their counterparts in neighboring ASEAN countries do not seem to be enjoying the same fortune. In fact as per the guys at, the stock markets in Indonesia, Malaysia and the Philippines are likely to underperform this year. And the reasons are multifold.

First is the fact that stocks in India have seen the average return ratios (RoE) move up from 14.5% to 15.2%. Meanwhile, the ROE is slowing in the Philippines, Indonesian and Malaysian markets. Secondly, the risk free rates in these economies are near zero and there is no further room for rate cuts. As against this, the risk free rate in India continues to be relatively healthy. And most importantly in terms of valuations, the Indian indices continue to remain closer to long term averages. The PE multiple for others are already well above long term averages. Now, one can be content with the fact that India is currently not one of the most expensive markets in Asia. However, the fact remains that as the Sensex PE moves closer to 20 times the PE is not cheap either. And hence investors should not rule out the possibility of a correction in Indian markets as well!

  Chart of the day
The famous 'Big Mac' index created by The Economist is back with an update on how overvalued or under-valued various currencies around the world are. But before we dive into the details, an explanation is in order. The magazine invented the index in 1986 as a lay person's guide to whether currencies are at their 'correct' level or not. It is based on the idea that in the long run, exchange rates across various countries should move towards a rate that would equalise the prices of an identical basket of goods and services in any two countries. They chose the 'Big Mac', which is a large burger served by fast food chain McDonald's, to represent this basket.

For example, the average price of a Big Mac in the US in January 2015 was US$ 4.79 and in India it was only US$ 1.89. So the Big Mac index could be used as a very broad indication that the rupee may be undervalued to the extent of about 60% compared to the dollar.

Today's chart illustrates these undervaluations of various currencies around the world compared to the US dollar using this very measure. India clearly features as a country having one of the most undervalued currencies, second only to Russia.

The rupee undervalued by 60%?

Various airlines in India are being widely expected to post profits for the December quarter. This is a direct result of the steep fall in aviation fuel prices (as a result of the fall in crude oil prices). As also a fall in the capacity available in the industry due to the SpiceJet Ltd's reduction in fleet size and its operational constraints.

Not surprisingly, December was a great month for the other carriers. Estimates indicate that both yield and occupancy of airlines' rose to lucrative highs. Expectantly, this also has many investors excited about airline stocks, with Jet Airways trading close to its 1 year high.

So should you jump in too? Our answer to you would be a very definitive no. Why? Because airlines have demonstrated to be very poor businesses over the long term. Their terrible profitability over the business cycle means that not only do not create any wealth for their owners, they actually destroy it. A quarter or two of good times is not going to change this grim but basic fact about the airline industry.

So, buyer beware! - is all we can say here.

The Indian stock markets were trading strong today on the back of sustained buying activity across most index heavyweights. At the time of writing, the BSE-Sensex was trading up by around 237 points. Gains were largely seen in auto, capital goods and realty stocks.

 Today's investing mantra
"If the job has been correctly done when a common stock is purchased, the time to sell it is almost never." - Philip Fisher

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee and Taha Merchant.

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Jan 23, 2015

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