Don't listen to these forecasters of doom!

Apr 8, 2010

In this issue:
» Sovereign defaults and its after effects
» India has two of the world's biggest car plants
» Bond king no longer favors bonds
» China to grow at 10% in 2010
» ...and more!!

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There are horror stories all around us. The financial world as we know it is coming to an end, say a lot of experts. Governments across the world have piled on too much debt. Soon, there will be a wave of defaults and then, everything will be over. These are scary thoughts indeed. And if you, like most others, are holding back your investment decisions fearing the above mentioned spectacle, we have some good news for you.

As per Economist, two major things happen when a country defaults. One, its cost of funds shoots up and second, GDP growth suffers. However, both these effects are rather short lived. The magazine points out that defaults where debts are restructured have no significant impact on interest rates after the second year. Yes, you read that right!

A huge event like a default, which the financial media is hugely cautioning us about, is all but forgotten in two years. Moreover, the impact on GDP growth is also not that sizeable. As the write up highlights, a defaulting country grows by 1.2 percent less per year while its debt is being restructured compared with a country that is not in default. And even this subpar growth lasts for just a year or two after default.

Agreed that things are little serious this time around and the effects could linger a little longer. However, an investor in India need not worry. A sovereign default by some other nation would surely have repercussions on the Indian stock markets. But that could actually turn out to be a very good long-term buying opportunity. So, if historical evidence is any indication, the hype around sovereign defaults should indeed be ignored. And such events should be used to one's advantage for building long-term wealth.

 Chart of the day
Indian investors have been subjected to a flood of primary market issues in recent months. Not just the private sector but the public sector also took advantage of the buoyancy prevailing in the Indian stock markets and rolled out one issue after another in quick succession. Little wonder, the year turned out to be one of the biggest in recent times in terms of total amount mopped up by the companies. It did not manage to beat FY08 for the simple reason being that the markets started turning buoyant only during the latter half of the year and hence, the first few months of the year were lost. Rest assured, if the current trends persist, the record of FY08 could well be broken in the current fiscal (FY11). What more, this could also mean increased competition in terms of liquidity for the companies that are already listed.

Source: LiveMint

The Indian auto industry stands out in sharp contrast with its global counterparts. At a time when global car volumes shrunk by 2.4% in 2009, India registered a growth of 12.5%. It is well known that most global auto giants are keen on India and are launching a spate of new models. But the size of India's booming auto market is borne out by another fact. India has two of the world's 10 largest car factories. Maruti Suzuki's Gurgaon factory is at number three, while Hyundai Motor's Chennai unit is at number seven in the top-ten list. Interestingly, some experts believe it is not only the domestic market and auto exports out of India which explain the size.

The fact that small cars form the bulk of India's auto market is important. Small cars require more units to achieve economies of scale, a key driver of profitability. In fact, most plant on the list make small cars. Another factor for the size is that companies prefer adding capacity at an existing location rather than start from scratch elsewhere. The reason is the proximity to existing component suppliers. Another reason is the poor infrastructure. States often build infrastructure around existing plants. Going elsewhere would mean waiting for the infrastructure to catch up. In our view, given these ground realities and the growth prospects ahead, more auto plants out of India will make it to the top ten list in the years ahead.

China is in the limelight again. But this time it is not because of its war with the US over Yuan revaluation or concerns over the Chinese bubble about to burst. A leading daily has reported that China's economy is likely to grow by more than 10% in 2010. What will fuel this growth is a recovery in the country's exports and rising consumption. And if that happens, China will surpass Japan to become the world's second largest economy. All very well indeed!

But there are hiccups. Concerns about the Chinese bubble bursting are not without reason. After all, Chinese banks have resorted to indiscriminate lending and a lot of this money has found its way into real estate. This has then led to inflated asset prices. While the reserve requirements have been raised, a lot may still have to be done to ensure that the Chinese growth remains intact. Moreover, if the recession in the developed world persists, it will be interesting to see how China will be able to sustain its growth in exports and thereby its GDP.

The world's largest bond fund manager Bill Gross might just be shifting his preferences. In December of last year, his asset management company PIMCO announced for the first time in its history that it will invest in stocks. Many observers are surmising this move to mean that Gross is of the opinion that the 30-year bull market in fixed-income securities is ending. And that a new bull market is emerging in equities. His bearishness on bonds stems from the fact that he expects yields on bonds to move higher in the US, which does not bode well for bond prices. As far as stocks are concerned, his advice to US investors is very categorical.

In Gross' own words, "What an investor wants to do, either from a standpoint of stocks or bonds, is go to countries with high real (inflation-adjusted) interest rates." Further, he adds that the typical suspects to invest in include Brazil, China, and India.

With renowned investors from developed countries like the US looking at India in such a positive light, don't be surprised to see foreign money piling onto Indian equities in huge amounts over the next few years.

"Upgrades rise on Corporate St, credit quality strengthening," reads a headline in a leading business daily. It shows how the number of companies being upgraded by credit rating agencies is now higher than the downgrades. This suggests that the economic recovery has helped companies out of the financial crunch they were facing in 2008.

But do the higher number of upgrades in one year hint toward anything? A lot of companies that are suddenly being upgraded now are ones that were in dire straits last year. So the question is - are rating agencies again going by the flow? Or are they more interested in giving good ratings only after seeing that the credit quality is sustainable across business cycles? In short, how sacred are these upgrades? We don't know!

Indian markets appeared in profit booking mode today as the BSE-Sensex headed lower with each passing hour. It is currently trading with a decline of around 200 points. Heavyweights from the banking and energy sectors are exerting the maximum selling pressure on the indices. Stocks across Asia have also closed on a weak note whereas Europe has opened amidst a sea of red.

 Today's investing mantra
"I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful." - Warren Buffett

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4 Responses to "Don't listen to these forecasters of doom!"

S. Ravindran

Apr 9, 2010

I read a disturbing report that Chinese auto ancillaries are flooding the India market as they are nearly 45% cheaper compared to Indian made auto components. How this will impact our Auto ancillary stocks? What are the short and long term implications for the investors? Please give a detailed analysis as to whether it is worthwhile holding onto stocks like Munjal Showa, Sundaram fasteners, Sona koyo steering systems, Subros, pricol and the other auto ancillary stocks which may do better despite the Chinese invasion.
Yours faithfully,
S. Ravindran


Vinay Shah

Apr 9, 2010

As always, an insightful read. I think the Country Credit rating and Company Credit rating agencies have been wrong too often over the last few years. India is one of the best markets to be over the long term and yet, I am told, that our credit rating is less than Greece even today! I would want Ajit to evaluate & do a larger piece in the single topic....



Apr 8, 2010

There is a good lot of substance in the write-up with the title 'Don't listen to these forecasters of doom'. There is absolute truth and seriousness in the firm view that the hype around sovereign defaults should be ignored. I am with those who fully agree with that.


rajinder wadhwa

Apr 8, 2010

pl tell me about good stocks to invest

Equitymaster requests your view! Post a comment on "Don't listen to these forecasters of doom!". Click here!