'The next recession will be a lot worse'

Apr 21, 2010

In this issue:
» The US can't quintuple its debt again
» Move to a new inflation index soon
» Emerging currencies gain on capital inflows
» Realty will have its wings clipped
» ...and more!

There are many factors that separate a good investor from the bad. One of the key ones we believe is clarity of thought. Warren Buffett does certainly have it in abundance. And we are of the opinion that Jim Rogers may not be far behind. Especially in matters concerning the broader economy. Rogers' clarity of thought shone through again in a recent TV interview. Rogers believes that the next recession may not be pretty far away. And when it does happen, it is going to be much worse. The simple reason behind this is the fact that the US just can't increase its debt again by a factor of five! "They've taken on gigantic amounts of debt that you and I are now responsible for. The central bank is making it worse", Rogers is believed to have said.

Rogers is of the opinion that the world will be far more better off without the US Fed. He believes that it is the US central bank that is causing the majority of the problems. We cannot help but agree. By keeping interest rates low, the US Fed is not letting inefficient capital perish. Instead, it is just letting the pain prolong and is setting the stage for an even bigger crash should rates start rising once again.

This is certainly bad news for people hoping that the worst of the crisis is behind us. It should be noted that booms and busts are inevitable. However, it is the Government intervention that makes it even worse. For a rational investor though, such a scenario also presents a good opportunity. Opportunity to buy into fundamentally sound companies when their valuations are cheap. And exit companies when fundamentals deteriorate or valuations become too expensive.

 Chart of the day
Today's chart of the day highlights trade balance of the BRIC nations for the year 2009. It should be noted that with the exception of India, all the other countries have a positive merchandise trade balance. In other words, these countries export more than they import and hence, are able to have a positive impact on their GDP. Although India has a negative trade balance, the size of the same is small, thus minimizing the need for the country to depend a lot on capital inflows to fund its trade balance. Heartening to know that the Government is keen on having the exports pie grow at a rapid pace so that it starts contributing a couple of percentage points to India's GDP growth and thus, take it on a higher growth path much faster.

Source: WTO

Emerging markets are attracting world attention like never before. And it shows. No matter which asset class you look at, one thing is evident. Capital from the developed world is gushing in to emerging markets. It's not just stocks. It is also in the fixed income markets. The key driver is the ultra-low interest rates in the developed world and rising interest rates elsewhere are forcing capital to move to Brazil, Russia, India and China (BRIC).

Another driver is the improving creditworthiness of these nations. Not that it is necessarily a good thing. The deluge of capital has shot up exchange rates. In the last 12 months, Brazil's Real is up 27% and Russia's Rouble 14 %. This makes exports expensive and imports cheap. Then there is the fear of a sudden exit of capital. Ideally, this capital should be used for building infrastructure. The truth is, a lot of it ends up in inflating asset bubbles. If these trends continue, in our view, the bubbles could indeed reach dangerous levels.

So, the RBI raised interest rates by a quarter point yesterday. But real estate stocks still received a thumbs up from investors. The reason? There were no other announcements made that would thwart the sector's growth. But this does not mean that all will be hunky dory. Real estate prices in recent times have begun approaching pre-crisis highs. The reason for this is the cheap availability of funds, a trend which is set to change now that the RBI has started raising rates. So even if there was no roll back of certain measures which are benefitting the sector as of now, at some point in time in the future that is likely to happen.

What will turn the tide against the sector is the overall exposure of the banking sector to real estate. As reported on Wall Street Journal, at the end of February, a total of US$ 20.5 bn in real estate-related loans were outstanding in India, compared with US$ 9.8 bn in February 2007. So, it would not be wise to assume that real estate prices will keep on rising without the central bank undertaking some measures to temper this rise.

When was the last time you used a typewriter or a VCR? Probably a decade back. Since then more Indians own mobile phones than those who have computers or televisions. However, our archaic inflation measuring index seems to be oblivious to this. Called the Wholesale Price Index (WPI), this inflation indicator still takes into account rise in prices of a typewriter or a VCR! Provided anyone buys them. But ignores the cost of mobile phones. However, not for too long. Realizing the necessity to capture the real price rise at the consumer's level, India will soon shift to Consumer Price Inflation (CPI) index. The national CPI will include prices for rural as well as urban consumers and include products like mobile phones and LCD TVs. More importantly it will have FY09 or FY10 as the base year as against 1994 based WPI. February 2011 has been set as the deadline for India to move to the CPI inflation indicator. It will be then that the RBI will guide interest rates based on the prices affecting consumers directly.

It is not just Rogers who is worried about Government debt. The IMF also shares a similar opinion. "...sovereign risks could undermine stability gains and take the credit crisis into a new phase," it said in an update. It also feels that there is a danger that worsening sovereign credit risk could quickly spill over to domestic banking systems. This can then feed through into the real economy. This could lead to a fresh round of financial crisis.

We see the IMF as being right in its assumptions. This is because investors have started demanding higher interest rates to buy government debt. This is already driving up borrowing costs for both the public and private sector. If this continues along with the general increase in government debt levels, we might be in for some rude shocks over the next few months!

Indian IT industry has achieved great heights on back of its "follow the sun" strategy. It provides 24*7 business support to its clients round the world by utilizing its onsite-offshore global delivery model. Now they are innovating this business model by shifting focus to the emerging markets. TCS, India's largest IT exporter is seeing incremental growth coming from markets like Latin America, Continental Europe, Asia Pacific, China and India. As the global MNCs are shifting their development bases to emerging countries, they are taking Indian IT service providers along to cater to their IT needs. For instance, TCS will be providing IT services to Rolls-Royce research center in Bangalore. We believe that as the developing countries increasingly invest in technology to grow, Indian IT companies are all set to gain a lot. This will give them a cushion against overdependence on saturating markets in the West.

Meanwhile, the Indian markets remained quite volatile today and had managed to give up almost all their early morning gains at the time of writing. The BSE-Sensex was trading nearly flat on account of pressure from behemoths like Reliance and L&T. Most of Asia however closed in the red whereas Europe has started on a mixed note.

 Today's investing mantra
"The four most dangerous words in investing are 'This time it is different'." - Sir John Templeton

Today's Premium Edition.

Recent Articles

All Good Things Come to an End... April 8, 2020
Why your favourite e-letter won't reach you every week day.
A Safe Stock to Lockdown Now April 2, 2020
The market crashc has made strong, established brands attractive. Here's a stock to make the most of this opportunity...
One Stock that is All Charged Up for the Post Coronavirus Rebound April 1, 2020
A stock with strong moat is currently trading near 5-year lows.
Sorry Warren Buffett, I'm Following This Man Instead of You in 2020 March 30, 2020
This man warned of an impending market correction while everyone else was celebrating the renewed optimism in early 2020...

Equitymaster requests your view! Post a comment on "'The next recession will be a lot worse'". Click here!

6 Responses to "'The next recession will be a lot worse'"


Apr 22, 2010

The method of pumping federal funds into the economy during recession can be best termed as " CREDIT CARD ECONOMY".This is just a symptomatic cure for the recession and no sooner the credit is stopped the withdrawal symptoms will be more severe. The only way for a permanent cure is to reduce consumption in all spheres at a very nominal rate of around 1to 2 % P.A in the developed countries, whose consumption levels today are more than 30% the ideal.This reduction has to be applied right across all items from daily needs to luxuries. This will also reduce pollution and global warming.



Apr 21, 2010

you write

why dont you orgigase meetings


chandan sen

Apr 21, 2010

The article is a very useful and real reflection of the world economic trend and proper guidance to the investor who in turn educate themselves to cope up with the future oncoming danger.



Apr 21, 2010

thanks for your investing mantra



Apr 21, 2010



Vinesh Shah

Apr 21, 2010

the excerpts you provide with your comments too are best for small & medium investors & cautious for chargers -players with high stake...The world leaders,Politicians,fund managers,economist & listed co. industrialists,directors all know that people memory is too short & they all play hand in glow by keeping mood of the people in numbers game...The fact is they have high amount with them to dispose rather play,invest,grow & tools like printing money,circulating money,growing power is affecting life of our poor,middle class people who always see both sides of coin & keep on guessing work of to do & not to do..These people are best placed & i think the stock mkt. is a good tool for them to park,grow,hide their investment..with them , we just try to put our luck...

Equitymaster requests your view! Post a comment on "'The next recession will be a lot worse'". Click here!