The huge error that most value investors make - The 5 Minute WrapUp by Equitymaster
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The huge error that most value investors make

May 6, 2010

In this issue:
» Ignore the big picture at your own peril, says Grantham
» Chinese savings deposits at 140% of GDP
» Berkshire AGMs are losing their charm
» Rupee to appreciate by 20% in next 18 months
» ...and more!

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00:00
 
It will not be an understatement to say that value investors simply hate the big picture. Not for them is the daily grind of keeping up with things like inflation, fiscal deficits, quantitative easing and the like. They simply prefer to keep their nose to the grindstone and analyze individual companies. Bubbles and busts are simply too unpredictable for them and hence, can be ignored. However, if Jeremy Grantham, one of the most revered investors of our times is to be believed, nothing could be further from the truth. He believes that value investors would be making a big, big mistake if they ignore the big picture. And he has gone back in history to prove his point.

Grantham has argued that there have been up to 34 completed bubbles in history. And every single one of them has broken all the way back to the levels that existed prior to the bubble forming. Thus, not just value investors but investors overall are likely to increase their success rate manifold if they also try and look at the big picture. If markets look overbought based on historical data, it would be wise not to invest and wait for overvaluation to correct itself. A period of undervaluation is the time when one can zoom right in and cast the net of company analysis far and wide. Hence, it is not just the likes of Grantham who can benefit from such a trend. Even you can employ this approach.

00:51
 Chart of the day
 
If in 2009, it was all about the BRICs, then 2010 so far has belonged to the developed economies. We are talking about the stock market performance of various countries as indicated in today's chart of the day. No doubt the US has emerged as the best performer and is the only stock market that has put in a positive performance; but the question is for how long. It is a well known fact that the US economy is on huge steroids of fiscal and monetary stimuli right now and once these are removed, it will become very difficult for the stock markets to sustain their superior performance vis-a-vis other emerging nations. The emerging nations on the other hand have a lot of factors going for them and over the foreseeable future should be able to outperform the developed world, such temporary bouts of underperformance notwithstanding.

Source: Yahoo finance
*Stock market data for the year ended May 5, 2010

01:32
 
There is no dearth of Warren Buffett admirers in the financial community. But some are more thorough than others. One of them surely is Alice Schroeder, the author of Buffett's authorized biography. In an article in Business Week, Schroeder laments how the legendary shareholder meetings of Berkshire Hathaway have lost their charm over the years. She observes that much of the exclusivity is gone. The media is there. Self-promoting fund managers are there. To cap off, in the latest meeting Buffett defended the Goldman Sachs management. He also lobbied for exemption from funding requirements for Berkshire's derivatives.

We have read the transcripts of the question and answers that some attendees captured in detail. It does seem odd that Buffett would defend Goldman. After all, Buffett has often said in the past that merely complying within legal requirements is not enough. One has to pass ethical and moral limits. To that extent Buffett's defense was uncharacteristic, in our view. Charlie Munger (the vice chairman of Berkshire), however, called a spade a spade as usual. Ms. Schroeder also suggests that Buffett should have been more sensitive to public sentiments. Here, we disagree. Buffett has a long track record of doing what he thinks is right, even if that is against public sentiment. Be it is investment in mills and newspapers in the early part of his career. Or his stance on several public policy issues.

02:20
 
It appears that the Greek debt flu can spread to more countries in the Euro Zone. According to credit rating agency Moody's, Portugal seems to be next in the line of fire with its budget deficit hovering over 9% of its GDP. Having a cautious view on Portugal's weakening public finances and long-term growth prospects, Moody's might downgrade Portugal's 'Aa2' debt rating by one or two notches in next couple of months.

Though we are not great fans of credit rating agencies, financial crisis does appear to be pretty severe in the Euro zone. Portugal which has already raised ∈ 4.5 bn in 2010, is witnessing increase in borrowing cost after Greece's crisis. Nevertheless, as of now it has not indicated of any liquidity problem. The stock markets globally are already experiencing Greece's shivers. We only hope the disease doesn't become a global epidemic.

02:50
 
A high savings rate amongst the denizens of a country is usually a good thing. But couple this with not having enough attractive avenues for investments of those savings and it can very easily lead to a bubble. Something similar seems to be happening in China.

A recent DNA Money report pegs Chinese savings deposits at 140% of GDP. However, with low nominal interest rates on savings deposits, equities performing poor off late, and an undeveloped bond market, these savings have few places to go. The result is a disproportionate inflow into the property market. And a consequent property bubble. Indeed, economic reform and a need to create alternative investment opportunities seems to be the need of the hour in the dragon nation.

03:16
 
The Rupee has already gained considerably against the US dollar. It now appears that this trend is expected to continue in the future months as well. Infact, the rupee is likely to appreciate by over 20% against the dollar over the next 18 months. What has been driving the rupee of late is not really the fundamentals but a surge of capital inflows. If one were to go by fundamentals, the rupee should actually depreciate. This is given the fiscal deficit that the country has to contend with. But the growth story in India has attracted foreign money into the country and this has fuelled the rupee.

Also, the RBI's reluctance to intervene actively in the forex market lest it spurs inflation has also played its part in causing the rupee to rise. And this trend is likely to continue in the coming months as well. But of course, if recession in the developed world further prolongs, the flows would then trickle and so the rupee may not appreciate that aggressively. Indeed, one will have to wait to see how the situation eventually pans out.

03:54
 
Today we came across one of the most interesting and compelling reasons for gold to touch US$ 3,000 an ounce. The fact that the world does not have enough trees is the key reason. To be able to print currencies for stimulating loose fiscal policies, central banks would need more trees. Particularly those in Europe hoping to get the economies of Portugal and Spain out of a Greece-like crisis. Although Greece has supposedly been bailed out, the EU's troubles are nowhere near getting over. The ECB is already contemplating substantial monetary easing. With credit rating agencies now putting Portugal's rating on review, the chances of a possible downgrade are not too far.

In such circumstances the quantity of paper currency needed to bail out these economies are bound to be humungous. And thus the need for a lot more trees. Until these trees supply enough pulp for paper, investors would do well to keep a small portion of their investments in gold. While we cannot confirm the possibility of gold going to US$ 3,000 an ounce as many analysts believe, the shine of the yellow metal can only get brighter in the current scenario.

04:34
 
Meanwhile, the Indian stock market continued with their downward trajectory today as well as the BSE Sensex was trading lower by around 90 points at the time of writing. Heavyweights such as Reliance and Infosys were seen exerting the maximum selling pressure. While most of the other Asian indices also closed in the red, strength was surprisingly on display across certain European stock markets.

04:48
 Today's investing mantra
"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved." - Ludwig Von Mises

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4 Responses to "The huge error that most value investors make"

bijaya

May 7, 2010

dear mr ceo of equitymaster.com , what is your view about sensex level at july 2010.... ....

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Vineet Gupta

May 6, 2010

I read your daily newletter 5 minutes with interest every day. Some time for now, though, I see that the quality of comments is more like prodding or rejecting hypothesis of self proclaimed genius of west. There is no denying of the fact that the next decade belongs to Asia and more of India. What we as investor are interested in knowing is the direction one should take and not what is correct or wrong in US. Let us shed our slave mentalilty and look inwards as we have lot to talk about happenings in India and around. Reporting like what Buffett said about Golman are of no interest. Talk about impact of current world happenings on India and strategy one should adopt.

Thanks..

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himanshu

May 6, 2010

I do feel that for value investor, it is equally important to see bigger picture. As of present scenario, there are preety good stocks available in mid cap and small cap at attractive valuation but any correction in market would offer this stocks at much better valuation. So, I feel one should try to buy partly this well studied stocks and wait for overall correction for better value matrix.

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dinesh

May 6, 2010

All Analysis what u have done is purely "Bakwas"
Market niche jata hai and again wapas upar aa jata hai
see 3 days chart

Regards

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