Portfolios to get defensive

May 9, 2011

In this issue:
» Rain Gods to help India in maintaining fiscal deficit target?
» Bad times round the corner for Indian IT?
» US Fed can burst the commodity bubble?
» Legalize bribes to control corruption?
» ...and more!

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The Reserve Bank of India (RBI) has hiked the interest rates by 0.5%. This is the ninth time that the RBI has hiked rates to control the supply of money in the economy. The reason it wants to control the money supply is to bring down inflation, which continues to languish at higher levels. Higher inflation translates to higher input costs, which in turn is adding pressure to the companies' earning margins. These margins are getting further depressed by higher interest rates. It is a double whammy and the investors are stuck in the middle of it.

At such a time, the one question on everyone's mind is where to invest? Which sectors would do well in such times of turmoil? A leading daily has tried to answer this question by stating that investors should look at 'defensive sectors' during such times. Defensive stocks are defined as stocks that provide good dividends and have stable earnings regardless of the state of the overall stock markets. These are the stocks that tend to remain stable even during difficult economic conditions. Sectors that are traditionally termed as defensive sectors include food, consumer goods (FMCG) and pharma sectors. In particular, the FMCG sector has been touted to do well on the back of India's consumption led growth story.

The daily goes on to quote experts who justify that these sectors are worth investing in even at current valuations. These experts justify the higher prices based on future stream of earnings. But it would do well to remember a key nature of defensive stocks and that is their 'stable earnings'. Such stocks may not exhibit phenomenally high earnings that would justify very high valuation multiples.

Therefore, while we do agree that having a certain proportion of one's portfolio in defensive stocks is always good. However, it is still important to invest at the right valuations. In our opinion, that is the only way in which one can maximize their returns on investment.

Would you invest in defensive stocks at such high valuations? Share your comments with us or post your views on our facebook page.

 Chart of the day
As per the research conducted by Peer1, (a leading provider of internet hosting provider), if internet was a country, it would be the fifth largest consumer of energy in the world. The organization conducted a survey of the energy usage of the most popularly visited websites. The findings revealed that popular social website 'Facebook' is the largest consumer of energy amongst the popular websites. The survey shatters the popular myth that IT (information technology) companies are 'green' energy users. In fact, the survey throws up the fact that the data centers for these IT companies is actually using more of the 'dirty' energy sources like coal and nuclear power. Despite becoming more energy efficient, they are still not concentrating on the 'greener' renewable energy sources.

Data source: Peer1 UK

It is not the corporate sector alone that is likely to bear the brunt of RBI's rate hike actions. The finance ministry too is getting jittery over the kind of impact such a move is likely to have on the country's finances. It should be noted that the ministry had set an ambitious target of fiscal deficit to GDP ratio of a rather bold 4.6% for the current fiscal. Important to add that the same stood at 5.1% in the previous fiscal and hence, the ministry was looking for some sizeable improvement on that number. The target had at its heart a best case scenario of a 9% growth in India's GDP and a rather benign inflation. However, a few months since the projections and alarm bells have started to ring in. The RBI's rather hawkish stance and the persistently high inflation have meant that a 9% GDP growth may not be achievable after all. And this in turn could throw cold water on the Government's tax collection exercise and thus also put in jeopardy the fiscal deficit target. All is not lost though. If monsoon holds up well, rural consumption could get a boost and help shore up Government's revenues a bit. However, depending on divine intervention time and again may not be the best strategy to have in the long run.

Infosys, a company which made billions from outsourcing, may soon have its supply of bread threatened. It recently voiced concerns that the negative sentiment about outsourcing in some of its key markets could hurt its prospects. In the wake of a global recession and massive job cuts, off shoring jobs has received the flak. Legislations preventing outsourcing may severely affect its business.

The Ohio governor recently prohibited govt. entities from using public funds to offshore services. The US govt. has also put in place certain visa restrictions. Irrespective, if the company continues to provide only basic, commodity, IT services, it may face further pressure. Innovation is key for the company to maintain its margins and report strong profit growth in the future.

The run in commodity prices is assumed to be more of an unavoidable economic trend. Especially with supply constraints and insatiable demand from growing economies. Be it is food products or oil or precious metals. Each seems to have a solid fundamental reason attached to the sharp up-move in prices. Interestingly, an article in Forbes discusses how most of the bull run in commodity prices has been 'financed' by the US Fed. The US central bank's stubbornness with loose monetary policy is well recognized. Also the fact that it refused to acknowledge the inflationary pressure that the same was building up. But the fact that the cheap money being printed by the Fed was fuelling speculation in commodities was evident only recently. The sharp plunge in commodity prices, especially silver, gave it all away. Some minor changes in the margin requirements for silver trading triggered the fall. What makes it worrying is that silver is a relatively less traded commodity. And if margin requirements could cause such a price run, broad based rule changes could bring in a catastrophe. Thus with evidence of speculation in commodity prices, some of the 'fundamental factors' leading to their rally need to be relooked at.

The corruption conundrum goes on. There are the large scale big money scams and scandals. There are also the day-to-day cases of bribery involving commoners like us. There are times when you bribe officials to twist rules in your favour. And then there times you pay the so-called "harassment bribes"- paying bribes for things you're legally entitled to. For instance, you may have paid 100 bucks to register a complaint for a stolen wallet. Or maybe you paid 500 bucks to get your marriage certificate. The list goes long.

How do you end this evil? Kaushik Basu, India's chief economic advisor to the Finance Ministry has suggested an out-of-the-box solution. According to him, some kinds of bribe-giving should be legalized. Sounds outrageous? Hang on, let us explain you his reasons. It is a well-known fact that the law holds both the bribe-giver and the briber taker as criminals. In that case, it becomes difficult for the bribe-giver to blow the whistle because legally he is also party to the crime.

What Mr Basu is suggesting is that certain "harassment bribes" should be legalized. This means that the bribe-giver would not have to face prosecution in such cases. He further argues that if a complaint is proven, it should result not only in punishment for the corrupt official but also in a "refund" for the bribe-giver. This will incentivize people to report cases of bribery. At the same time, it will also act as a deterrent to the bribe-seeking officials.

Indeed, it sounds good in theory. But would it be so easy to execute? Not really, given how slow our legal courts are. Of course, the idea definitely has some merit and should be considered. But there are several other things that need to be fixed to make the idea work.

In the meanwhile, the Indian stock markets have resumed their journey in the positive zone. At the time of writing BSE Sensex was trading up by 52 points (0.3%) led by gains in stocks like Bharti Airtel and Tata Power. Asian stock markets have closed the day on a mixed note with markets in Hong Kong and Singapore closing in the green. However, stock markets in Japan and Indonesia have closed in the red.

 Today's investing mantra
"Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid." - Warren Buffett

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5 Responses to "Portfolios to get defensive"

Anupam Garg

May 9, 2011

Really interesting theory by Mr. Basu. If we really think tht its about time we remove corruption, then we shld establish special courts or forums (like consumer courts). although it'd b hard 2 prove evidence but it may alert the govt (if they want 2 wake up 4m slumber) on keeping a close eye on the reported officer. If we can remove the problem from the root cause, then corruption at top level will stop 2 (& ppl will stop opting for govt jobs also)

IT majors may not worry tht much as the expansion plans in other continents is on the rise. Infy is succssfully penetrating Africa & i wonder wht wld US do without our services



May 9, 2011

Nestle 48 times earnings trading at 4135 today..
Why not trade at 100 times at 8632?
If one can jot down the real difference between buying when it is 48 times and 100 times. And come out with a real objective satisying answer then i have another question to him/ her: Why not at 24 times when it will trade at Rs. 2072


kersi Mahudawala

May 9, 2011

There is no point in investing defencive stock at such high valuation.One may instead consider in investing in Power stocks which are at presently available at reasonable valuations and are also considerably safe.



May 9, 2011

Looks like Mr. Kaushik Basu stealing the model from IPC-498A :)

It will fail within first year, it will create more corrupt people than ever. :)



May 9, 2011

Any stock whether defensive or growth can only get you decent returns, if picked at right valuations. Else, you can be assured of losing money in it.

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