This is how you can spot the next bubble

Apr 15, 2010

In this issue:
» A prominent economist on the next bubble
» India's unique distinction
» India Inc bets big on solar power
» Contrarian guru bullish on stocks in long run
» ...and more!

There cannot be a sadder irony in investing. Most of the asset bubbles are identified only after they burst. And by then, it is too late to halt the wave of wealth destruction. Of course, there are always a few people who identify them. But the majority is too involved in the hype to pay any attention to it. Thus, given such a scenario, wouldn't it be wonderful if we have our own tool of identifying a potential bubble. There indeed exist a few asset classes like equities where there are already some tools available. But what about assets like real estate and foreign currencies. Here, bubble identifying tools would certainly come in very useful. Enter Harvard Professor and world famous economist Kenneth Rogoff.

Rogoff and his colleague have pored over financial crisis data going back centuries. And they have zeroed in on some surprisingly consistent patterns. They have concluded that investors should ideally look for situations where debt and asset prices increase rapidly. An increase that can suddenly collapse under its own weight when confidence fades. They also add that when equity markets collapse, a handful of people swallow the losses and the world moves on. But things are far more different when debt markets collapse. More often than not, a debt market collapse is followed by a long, drawn argument over who should bear the losses. Something extremely similar is happening this time around as well. So far, the US taxpayers have borne the brunt. But even they are becoming extremely reluctant now. Meanwhile, using leverage lessons from Rogoff, we could make out that there is another bubble lurking. That of Government debt. Especially in the developed world. Of course, the timing of its bursting is very difficult to predict. But one should certainly be on his toes.

 Chart of the day
There are controversies galore on the Chinese currency. But all that has still not changed one thing. And that is its continued dominance on the exports front. As today's chart of the day highlights, the dragon nation has emerged as the largest merchandise exporter in 2009. Also important to note that at US$ 155 bn, India's exports are but a very pale shadow of China's. Little wonder the dragon nation has amassed foreign exchange to the tune of US$ 2 trillion whereas India's reserves keep moving in the range of US$ 250 bn to 300 bn. Clearly, if India has to move people out of poverty faster, it will have to make a bigger splash on the exports front.

Source: The World Trade Organisation

International bestsellers in economics and finance often use this theme. Find startling facts about the way we live. Then present a theory that can explain them. So, here's a startling fact that appears in the papers today. As per a UN report, there are more cell phones in India than toilets. Surprising, if you have never been to India. After all, isn't basic sanitation a far more vital necessity than mobile communication? Yes, it is. But it is not only about demand. It is also about supply. Almost anyone can today buy a mobile handset in India and get a connection within minutes. The relatively free market conditions under which the Indian telecom industry operates in ensures that.

But toilets are a different ball game. There is the question of real estate which involves the land sharks and bureaucratic local governments. The result, there are about 45 cell phones per 100 people in India today. But around 665 m Indians defecate in the open. Besides the question of human dignity, there is an economic cost. It takes a heavy toll in the form of water contamination and healthcare costs. We wonder if deregulating toilets such will be the next big reform in India?

It has taken the US a Great Depression-like situation to realise its mistake in allowing cheap credit. It seems the economy needs another disaster to strike before it takes steps to correct the mistake. Fed chief Bernanke believes that the steep price rise in the US can be sidelined for the time being. He has cited lower employment as his key concern. Also, lower utilization of production capacity is hindering US growth, believes Bernanke.

The central banker, however, seems to be reluctant to accept that cheap money cannot solve the problem. But will only enhance it. Bernanke has insisted that the lending rates must be kept near zero for an extended period in the US. This he believes will induce US consumers to spend. After its worst recession in more than 70 years, the US economy is finally showing some respectable growth numbers. And Bernanke seems to be determined to sustain it at any cost.

The stakes have risen for India's solar power industry. As per reports, an investment of US$ 22 bn is likely to come to the sector over the next few years. This is after the announcement of the Jawaharlal Nehru Solar Mission, which aims at a big leap in solar power installation in India. The target is to set up 20,000 megawatt (MW) of solar power by 2022.

So the opportunity is huge. But so are the concerns! Solar power requires an investment of Rs 160-180 m per MW. This is 4x the investment for a coal based thermal power unit! Then, solar power also requires huge land mass to set up such units (at least 5-6 acres per MW). Given that land acquisition is a huge challenge for any industry in India, it won't be easy for solar power aspirants to spread their wings without facing big roadblocks.

As for retail investors, there aren't many options for investment in the solar space. There are a few companies that have ventured into this space in small ways. But we are yet to see successful and scalable ventures where investors can invest without taking much risk.

Stocks have had a volatile run during the past couple of years. The global financial crisis rudely interrupted the massive bull run before it and caused markets to plunge. Once the word' green shoots' started doing the rounds, the rally in the stockmarkets was remarkable. Amidst all of this, gold gained more allure as a safe hedge against the frailty of paper currency and is still finding many takers.

So, in the long term which asset class will give more returns. Contrarian investor David Dreman believes stocks hold the edge. He admits that gold has done much better than bonds over a period of time. Especially in times of inflation, gold has performed well. But if one considers the scenario after World War II, stocks have done much better. Dreman believes that in an inflationary environment stocks should do well over the next 4-5 years. His advice is that most investors who do not need the money today and have a 4-5 year time horizon should do very well in stocks. We could not have agreed with him more!

Demand in any country comes mainly from two sources. The first is consumption. And the second is capital investments; that is investments by companies into capacity expansion. The former has held up quite well in India during the course of the recovery. However, the latter was caught lagging due to various factors. But that scenario is in for a quick change. Capital goods production has picked up sharply since December 2009. It saw a 44% YoY growth in February 2010. Further, the Centre for Monitoring Indian Economy (CMIE) expects capacity addition worth Rs 6.5 trillion during FY11. Large by any standards, and incidentally also the highest annual capacity commissioning ever for India. A bulk of this CMIE expects to see coming from industries like steel, aluminium, electricity, cement and tyres. Calls for some sanguine times for the capital goods companies for sure. Investors in these companies will have to tread with extreme care though. The current valuations of most large capital goods companies make us circumspect to say the least.

Meanwhile, after opening strongly in the positive today, the Indian benchmark BSE-Sensex went on becoming progressively weaker and were eventually trading in the negtive territory at the time of writing. Heavyweights like Reliance and ICICI Bank were the chief contributors to the selling pressure. Most of the Asian indices closed in the positive though. Europe however, has opened on a mixed note.

 Today's investing mantra
"The most important organ in the body as far as the stock market is concerned is the guts, not the head." - Peter Lynch

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9 Responses to "This is how you can spot the next bubble"

biplab banerjee

Apr 25, 2010

excellent analysis over all but what to do now?not to invest in equity or to invest in yellow metal?


pijush guha

Apr 19, 2010

Your observation is true but who will invest so much money for the poor in India, World renowned NGOs should enter via UNO to work with micro level villages,by adopting resolution in Asian development Bank and UNO



Apr 16, 2010

"We wonder if deregulating toilets such will be the next big reform in India? "

It is funny.....



Apr 16, 2010

Solar energy will be a far dream without research.Hydel will still be a good,cheap alternative as we need to anyway look at combining rivers to meet social needs.The US could be a bubble with little gold reserve & more greenback printing.



Apr 15, 2010

The wrapup of April 15 was highly informative. The tips given for timely spotting of asset bubbles are very useful. The sarcastic remark that the number of toilets in India is too small when compared to the amazingly large number of cell phones in use in the country should make us aware of our wrong priorities. In a tropical country like India, it will be ideal and most advantageous to go in for solar power/ wind energy.



Apr 15, 2010

Yes, this article acts as a energy booster at this present bearish market. And no doubt that spotting the next bubble is not a easy, but as the market is the matter of risk, its our effort to keep on updating our market knowledge just by reading 5 minute wrapup



Apr 15, 2010

This is for the day's investement mantra; India is the originator of the word mantra.. and how come we never have any Indian guru's mantra here ?



Apr 15, 2010

Today's investing mantra by Peter Lynch impressed me lot



Apr 15, 2010

it is true solar as well as wind energy and tourism can make india wealthier in greenway without disturbing fragile eco system.industry must concentrate on these fields more then any other.

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