'Stocks could fall by 40%'

May 27, 2010

In this issue:
» History could repeat itself in US stocks
» An economic indicator that is out of sync with reality
» Silver has turned out to be second best
» We are doomed, says contrarian guru
» ...and more!

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The US stock markets are correcting alright. But no one can deny the fact that they have had a fantastic run up until the recent troubles. Truth be told, as per reports, there have been only two other times when the US stock markets have gone up so much in such a short span of time. The 112% gains in 1932 and the 116% gains in 1933 were two such instances. And what happened in the aftermath of such huge gains? Well, the stocks witnessed a 40% correction in the first instance and a 34% correction in the second.

It may be naive to simply extrapolate these events in the future and assume that a similar fate awaits the US stock markets today. But the case for a 35%-40% correction in the current times has been made stronger by one observation. That of the economic reality on the ground. Stock markets have factored in a very quick economic recovery. However, nothing could be further from the truth. Unemployment levels have failed to ease and credit is still hard to come by. Thus, the US stock markets could well start heading downwards once this reality catches up with them. Take into account some sort of overreaction and a 35%-40% correction in US stocks does look well within the realms of possibility.

Needless to say, even Indian stocks could feel the heat. But Indian investors have very little to panic from such an episode. On the contrary, it could turn out to be a fantastic opportunity. An opportunity to buy into the long term India growth story at attractive valuations. Thus, as it turns out, one investor's loss could turn out to be a gain for the other.

 Chart of the day
A lot of experts seem to be favouring silver over gold these days. Today's chart of the day however may just end up punching a big hole in that theory. As the chart indicates whenever BSE-Sensex has had an off year in the past decade or so, gold has turned out to be a much better investment than silver. Given this scenario, it is quite possible that of the two precious metals, gold continues to have an edge over silver in the future as well. Of course, when the economy is doing well, Sensex will have a definite edge over gold and silver. And when it seems to falter, gold has turned out to be a more preferable option than Silver. Unfortunately, silver has turned out to be second best on both the occasions.

Source: Quantum Gold fund ETF

"Debt will get you in trouble," writes Bill Gross of Pimco, the world's biggest bond fund manager. He has warned that the countries with too high debt (like the US and European nations) face a 'tortuous journey in the months and years ahead'! Gross has written this in his latest outlook note.

He has also warned that global investors must not expect more than 4-6% returns from a 'diversified portfolio of stocks and bonds'. "Investors must respect this rather tortuous journey in the months and years ahead," he has said.

Given his years of experience and the quantum of money that he has successfully managed over these years, you can't expect Gross to go wrong in his predictions. Anyways, we see one direct fall-out of the 'low return' years that Gross predicts for western investors. And that is more money will flow to the high-return' emerging markets like India over the next few years. Of course, investors here need to guard themselves against any bubble that such a huge flow of foreign money can cause!

Recently, the Baltic Dry Index (BDI), the index that tracks global shipping rates jumped as much as 9% in one single day. Infact, the index is up a huge 40% since the end of April. Now this is something really strange. Normally, the index should move in perfect lockstep with stock markets. This is because both the stock markets as well as the BDI rise and fall with the level of economic activity. But what has happened in the last few days has turned this logic on its head. The global stock markets have taken a huge beating and investors face an uncertain future. But not the BDI. This index has gone from strength to strength.

What gives? Apparently, the rise in BDI has been attributed majorly to the jump in rates of one particular type of ship. And these ships are nothing but capesize vessels. It should be noted that capesize vessels are amongst the largest in the world. And they are supposed to be the vessels of choice for transporting metal ores and can also be used as oil tankers.

Thus, looks like there is more metal and oil floating in the seas globally. And if this is indeed the case then are either the buyers hungry for products or sellers are getting desperate to unload. Looking at the economic scenario globally, appears more to be a case of the latter than former. However, we cannot be 100% sure. We may have to wait for some time before the real story is out.

Taking into considerations the buoyant market conditions prevailing in the past at least a dozen real estate developers had filed their IPO prospectuses with SEBI. Bulk of them planned to raise money to repay debt. But now as the market conditions continue to remain dampened, the developers are facing the heat. Investors fatigue in the real estate stocks is not helping them either. All of them are waiting for the market conditions to improve before hitting the markets. However, apart from timing - valuations play an important role in the fund raising exercise. If the developers are willing to leave something for the investors on the table we may witness a renewed vigor for the real estate IPOs.

In the current financial year, developers need to pay around Rs 250 bn towards debt repayment. Thus they have two choices right now - wait and watch for the conditions to improve or take a valuation hit. We believe that the latter option is more feasible in the current market conditions as it would be a win-win situation for both of them.

Anyone taking the government's promises to bring inflation to single digits in few months may be in for a rude shock. For those who are well informed on the subject beg to differ on such possibilities. Economists at OECD opine that inflation in India may remain 'stubbornly high'. Reason being the uncertainly prevailing over the deficiency of monsoons this year. Add to that demand for products outstripping supply with economic recovery underway at modest pace. The higher taxes on imports as well as sale of petroleum products would only add to the price rise.

The OECD also believes that the RBI is not taking sufficient action to check liquidity crunch. Particularly ahead of the government's ambitious borrowing programme. We believe that the concerns of inflation level remaining high are justified. However, adopting a calibrated approach to contain price rise is the only way to do so, without hurting growth.

Meanwhile, Indian stock market traded strong yet again today with the BSE Sensex sitting pretty with gains of more than 140 points at the time of writing. Heavyweights like ONGC and ITC were instrumental in driving the gains on the Sensex. Most of the other Asian indices also closed strong today whereas Europe has also opened on a positive note.

'We are doomed'. Who else can say this but the famous contrarian investor and author of the famous gloom, boom and doom reports, Dr Marc Faber. Speaking at the conference in the US, Faber gave his perspective on the financial crisis and his take on the future. While he did raise a lot of pertinent points, the one amongst the few that was important from an investing point of view was his observation the US Fed will keep interest rates at zero in real terms for as long as possible and hence, cash and long term bonds will be a bad place to hold one's money and hence, equities and precious metals would be a sound place for wealth preservation. He also observed that everybody should have 50% of their money in the emerging world as these are not saturated and are growing rapidly.

As usual, he came down heavily on the US administration and commented that the lifetime achievement of Greenspan and Bernanke is really that they created a bubble in everything...everywhere. According to him, during the crisis of 2008, the financial system went bust but did not die. However, the next time it happens, the nations will go bust and ultimately, the world will go to war. Honestly, we couldn't have ended on a more bitter note.

 Today's investing mantra
"Questioning GAAP figures may seem impious to some. After all, what are we paying the accountants for if it is not to deliver us the "truth" about our business. But the accountants' job is to record, not to evaluate. The evaluation job falls to investors and managers." - Warren Buffett

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7 Responses to "'Stocks could fall by 40%'"


May 31, 2010

Mr. Shyam - You need to note a pattern emerging from various feedback from subscribers. All your points are taken, but how will you justify strong BUY calls from EM, when a stock and Sensex (both) hovering at its all/life-time high (Jan 2008, Sensex @19K), and with a target of 30% more in 6-12 months time! Today that stock is at 1/3 value, despite Sensex back to 17-18K. There are number of such examples. I was a novice investor then, and thought why to reinvent the wheel when Equitymaster is doing exhaustive research. It turned out to be a wake up call for me. EM spots good stock, but their judgments on valuations for BUY is poor. Staying invested for 3-5 years to reach your old BUY price is not value investing!



May 29, 2010

I think my co subscribers are missing a very important point in share investing. Through shares we are actually buying a stake in a company (of course, if we are not share trader). And, a company do not grow in a year or two and if it does, it will never be available at low valuation. Further, in shares (companies) their are lot of variables which keeps on changing and they are not easy to comprehend, even the promoters of the co.'s time and again fail to understand them. Therefore, Equity Master must not fear to fail but never be complacent and keep on enhancing their expertise as share investing is very dynamic.


Girish M

May 29, 2010

SD Pandey, you are absolutely right. I have had same experience with Equitymaster. They make very bad calls on 'BUY' or 'SELL'. They were reckless in recommending BUY (via Stock Select reports) when the market and stock were both at all time high in terms of their valuations (e.g. Bharat Bijlee). Like all credit rating agencies and financial advisers, they have no accountability. If you read their reports and articles, they have conflicting views. There is no consistent position. Use their research report only to shortlist good stocks, but BUY only when its PE is 25-50% less than its average PE. In other words, BUY when its price is nearly at 50% if its 52 week high. Only then there is a margin of safety even for 1-year or 2-year term. Equitymaster has nothing to lose in saying to keep your money invested for long term say 5+ year. That is not intelligence! Emerging markets are bound to grow in long 5-10 years. For that we don't need a paid service from Equitymaster.



May 29, 2010

the equity master needs to think on its strategies and instead of quoting others and history , its time to deliver on its role ,, most of its recommendations for stock buy. hold . sell .. remains totally wrong



May 28, 2010

I agree with the above comments. The
recommendation of Equitymaster is illusion. Nothing is
true.More of the stock recommended by the equitymaster
have come down at original value from middle stage. For
example kindly see the recommendation of Lakshmio(Lakshmi energy and food). The recommended price was 93.05 and target was 289.00. After a year the stock is
@98-100. How his recommendation can be accepted. I was is client but I feel it was my mistake and I have suffered.



May 27, 2010

I fully agree with Mr. Z.Goveas. Does it apply to Indian investors also, depending heavily or rather totally on EQUITYMASTER recommendations ?


zephyrine goveas

May 27, 2010

well, I don't know whether you mean the retail investor can get into at attactive valuations. A retail investor doesn't have inexhaustible resources to get into "at attractive valuations". For example you give recommendations to get into a stock which you call it attractive valuation and when a correction comes the retail investor is caught on the wrong foot, because you have told him to stay invested on "India story"

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