This is investors' biggest problem currently

Feb 5, 2010

In this issue:
» The dangers of a self-fulfilling prophecy
» One trade that every human should have
» A boost for domestic power equipment producers
» The huge bubble that no one is paying attention to
» ...and more!!

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Markets have once again been pushed on the brink of turmoil. Policymakers, especially in the developed world, are puzzled. They desperately want to know what still remains to be done to save their economies. Trillions of dollars worth of stimulus money has already been pushed into the system. But job recovery, a phenomenon that is so crucial to the long term sustainability of an economy, remains dismal.

So, what might have possibly gone wrong? Robert Shiller, the prominent Yale economist has perhaps the most pertinent answer. And it is not found in some standard textbook of economics. Instead, it has been borrowed from human psychology. In an op-ed in NY Times, Shiller argues that 'fear' is the root of most ills plaguing the US economy currently.

Shiller adds that negative feedback cycles where pessimism holds back economic activity keep on repeating themselves during a recession. Indeed, if banks do not have confidence to make loans, business cannot proceed, and the lack of confidence becomes a self-fulfilling prophecy. This phenomenon could take years to reverse itself, thus delaying the return to normalcy.

Hence, the fear amongst ordinary citizens of losing their job or seeing their investments evaporate could be the biggest hurdle in the path of recovery - of economies and stockmarkets. And how long is this fear expected to last? Shiller suggests if history is any indication, the US is staring at a deep, deep hole.

As for the Indian stockmarkets, we at Equitymaster believe that after the sharp rise in stock prices we saw in 2009, a correction this year should be expected and not feared. Treat such corrections as just a normal part of stock markets that will not do much in altering the long-term bull market that is India.

 Chart of the day
FIIs are certainly amongst the most influential set of investors in the Indian stock markets. Hence, the kind of impact their buying has on Indian stock markets is certainly worth a look. Today's chart of the day tried to address this issue. As can be seen, barring 2004, every time FIIs have bought stock worth Rs 100, the Sensex has witnessed a market cap increase of a minimum of Rs 800, a ratio of 8:1. Infact, the number has gone as high as Rs 1,600 for every Rs 100 invested. Of course, there have been a lot of other factors at play like investments by domestic institutions and retail investors. But an argument can certainly be made that whenever FIIs have been strong buyers, Sensex has more often than not given good returns.

Source: CMIE, Equitymaster
*All the numbers have been rounded off to the nearest 100

Investors are seemingly scared of the volatility in currency rates and its impact on IT stocks. But the long-term future of the IT sector seems very bright. This is if one were to believe the IT industry body, Nasscom. As per its recent report, the Indian IT sector is 'set for a growth surge'.

In its FY11 outlook released yesterday, Nasscom estimates India's IT exports to grow by 13-15% during the year. Further, it expects domestic IT revenues to grow by 15-17%. This comes on the back of around 5.5% and 12.2% growth in these segments respectively in FY10. Nasscom is especially positive on the government sector to lead growth in domestic IT revenues during the next fiscal. In term of regions, it is particularly bullish on Asia Pacific.

Given what we've heard from most of IT companies recently, Nasscom's predications are not far from truth. IT companies are seeing sanity returning in global IT spending. This is leading to much better volume growth and greater stability in billing rates. Of course, we do not see the industry retouching its 25-30% growth trajectory again. But a 15% annual growth over the next 5-10 years doesn't seem far-fetched.

Most Asian nations - the developed ones in the Far East or the fast emerging ones i.e. China and India - have known the pain of running out of foreign exchange at sometime during the last century. Most have experienced poverty and dependence on imports. Little wonder then, they have developed an enormous appetite for foreign exchange reserves. But as they say, too much of a good thing can be bad. As per Bloomberg, that seems to be the case with China. Its foreign exchange reserves stands at US$ 2.4 trillion and is an enormous bubble that no one is paying attention to.

China is now in a position to bail our entire countries out of debt defaults. But no one can bailout an entity perpetually. As every banker knows, eventually, a debt that cannot be serviced is written off. And too large a write off can destabilize the system. Chinese money is only postponing a titanic meltdown. Such large reserves are unproductive. Instead of just piling it up, it could be better utilized in health, education and infrastructure. The moot point being - the global economy is increasingly becoming imbalanced. And imbalanced systems eventually become unsustainable.

It what may come as a delight to Indian power equipment manufacturers, the Central Electricity Authority (CEA) has now made it compulsory for winning bidders to order core equipment for supercritical power plants from indigenous manufacturers. It will implement this by asking state and central utilities to incorporate an 'indigenous manufacturing clause' for all equipment bids. This will effectively shut out Chinese equipment manufacturers. Chinese power equipment companies have been the bane of their Indian counterparts, as their products are 10% to 15% cheaper.

Interestingly, this move comes on the back of another recent move by the empowered group of ministers barring the import of supercritical power plants for future ultra mega power plants (UMPP). Apart from BHEL which will benefit from this, numerous other players who are readying their own power equipment capacities in joint ventures with foreign partners will also receive boost of confidence. This includes L&T which has tied up with Mitsubishi Heavy Industries to indigenously manufacture such equipment.

Naseem Taleb's prophecy of highly improbable events through his book 'The Black Swan' is well recognized. This time the famed author chose to put his repute once again at stake by recommending a short (sell trade) on the asset that is perceived to be amongst the "safest in the world". You may have guessed it right. We are referring to US Treasuries. Taleb believes that as long as Bernanke presides over the US Fed, the economy's money printing policies will remain unchecked.

As per Bloomberg, the US government has already committed stimuli to the tune of US$ 9.7 trillion to bailout the economy. The marketable debt issued so far has been US$ 7.3 trillion. As the US government projects a deficit if US$ 1.6 trillion for FY11, the issue of US Treasuries is set to rise. The higher yields will thus push US bond prices lower. Hence Taleb believes that if there is one trade that every human should have, it should be - shorting US Treasuries.

Meanwhile, in tune with its global counterparts, the Indian stock market were taken to the cleaners today as fresh worries with respect to a double dip recession in the US began to resurface. At the time of writing, BSE Sensex was down a steep 450 points and was threatening to go even lower. Stocks from the metals and the banking space were particularly in the firing line. While the whole of Asia closed in the red, Europe has also opened on a very weak note.

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 Today's investing mantra
"Adam Smith felt that all noncollusive acts in a free market were guided by an invisible hand that led an economy to maximum progress; our view is that casino-type markets and hair-trigger investment management act as an invisible foot that trips up and slows down a forward-moving economy." - Warren Buffett

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5 Responses to "This is investors' biggest problem currently"


Feb 6, 2010

It is very important that FII money will distort the valuation of assets of India. Because it is not the 'surplus' generated internally. Of course the so called FII money also gets distorted to the extent it contains our black money stashed abroad.
It is also the desire of the people that makes economy grow. If Americans are afraid, then it will affect us very much, we can not decouple so easily.



Feb 6, 2010

Lack of confidence in the bank's willingness to lend money is symptomatic of the lack of transparency in the toxic assets on their balance sheets. If the banks had taken a more radical approach and decided to treat these assets as a 'Big Zero' i.e written them off completely (the implementation details are not in the scope of this post), then they would have a much clearer picture as to the state of their balance sheets and anything else would be just an upside from thereon or a big bonus. Just my 2 bits.



Feb 5, 2010



V. Ramasubiramanian

Feb 5, 2010

It is not only an excellent write up but also very meaningful one. It should be read by everyone who has faith in their country. It will create a good awareness in our Political system and economic scnerio.

Good job, please continue your good and yemon service for the benefit of general public at large.


Dr. Atul Tiwari

Feb 5, 2010

Dear Sir
It was encouraging to read a hyperlink to your issue dated 18th Nov-09, this time.
Every body is puzzled with this dip!! But it was expeted this time. If any of you have gone through my last post, I quoted that Dip will not wait till March but will appear in Feb, as usual, due to March Factor (I named it)
I am afraid, Budget could make it even worst!!
Well we people just use it common sense, but you are experts, so a word of consolation from you (like that link to old megazine) at least gives us courage, if not money!

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