Is your portfolio protected against future crisis?

Jun 23, 2010

In this issue:
» A trillion dollar gap in Indian infra
» India opposed to 'bank tax'
» The IPOs that destroyed wealth
» Realty stocks wear off investor minds
» ...and more!!

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The last two years were witness to a series of bailouts and government aids. These were considered as the ideal ways to revive a flagging global economy. But then, starting with Dubai, government themselves started going bust. The excesses that the too big to fail (TBTF) entities were accused of, were reflected in government balance sheets. Several government debt levels threatened to exceed the GDP several times. Credit rating agencies that had so far slept over poor quality debt were quick to declare governments bankrupt. Greece being a case in point.

With recovery measures going horribly wrong, austerity is the new mantra. Governments across the globe are trying their best to showcase their cost cutting efforts. Some even at the cost of letting the unemployed starve. Nobel Prize winning economist Paul Krugman believes that this could be suicidal. Krugman infact relates the current economic scenario to that in the 1930s (Great Depression). Then, President Franklin Roosevelt's attempts to balance the budget were accused of driving US economy back into recession. Obama's focus on deficit cuts rather than on economic growth seems to be giving similar hints.

It may thus be a long-long time before global economy gets rid of the crutches. Meanwhile, stockmarkets will continue to chart a volatile path. Investors would do well to ensure that they have only those stocks in their portfolio that can tide over any future crisis. Not throwing away the bad stocks can also give your portfolio the '1930s look'.

 Chart of the day
High debt level has been a curse some of the most well known firms in India have been subject to in their lifetime. Thankfully, most have come out wiser from the experience. After mismanaged balance sheets got them into trouble early last decade, most Indian companies made an effort to cut back on debt. However, the lower effective interest cost over the past three years had halted this effort. As today's chart shows, a rising trend in interest rates is once again forcing companies to restructure their balance sheets. The last thing that they want is to fall prey to leverage problems.

Data source: CMIE, Prowess

A lot has been said about how India's infrastructural development leaves a lot to be desired. And now when talks abound of India reaching the double digit growth soon, it has become all the more imperative for a major ramp up in infrastructure. If India has to grow 9% plus on a sustainable basis, it will require US$ 1 trillion over the next five years. Further, there is a potential funding gap of 25-30%. And India is hoping that US companies will come forward and help bridge this gap. Even if this money comes forward, execution will remain the key. In this department, the government has been found to be severely lacking. Already there is a big fiscal deficit staring in the face. This means all concerned parties will have to get their act together to bridge the gap.

Western nations riddled with high debt have been looking for a proper solution to the issue. The G-20 meet in South Korea recently also focused on this problem. Several leaders believed that banks should be taxed for funding future bailouts. The UK has in fact introduced such a tax on its banks. And it expects to raise a huge sum of over £2 bn (approx US$ 3 bn) annually.

India is however opposed to this concept of 'bank tax'. As per our foreign secretary, India's banking system is extremely healthy. It thus requires no such tax as banks can spend for themselves. The finance minister had also opposed this tax a few days back. His view was that western economies can take learnings from Indian banks, and rather use measures like CRR and SLR to maintain proper reserves for every rupee that is lent out. The CRR (cash reserve ratio) and SLR (statutory liquidity ratio) concepts in India ensure that banks do not take too much risk even if they wish too.

The rich definitely get richer. Easy borrowing and stimulus spending made sure of this fact even during the worst recession in decades. However, what was surprising was that in 2009, the fastest growth in wealth happened in India, China and Brazil. These poorer nations had markets that were hit the hardest during the 2008 crisis. Nevertheless, Asian millionaires' combined wealth jumped 31% to US$ 9.7 trillion, surpassing Europe's for the first time. Wealth in Latin America also reached new highs.

A major learning on how the rich grew their wealth was that they put their eggs in different baskets. They invested in commodities, real estate and fixed-income instruments. Major stock market recoveries also helped their cause. Going forward, with bank accounts still yielding very poor returns, the wealthy is likely to continue to look for riskier assets.

A short quiz. What according to you is an IPO? Is it an attempt by the promoters and investment bankers to cash in on the bull run? Or is it a genuine attempt to create wealth for minority shareholders? Well, the answer has arrived in the form of an analysis by a leading business daily. And those holding the view that IPOs create shareholder value could be in for a rude shock.

As per the daily, nearly 70% of the IPOs that have hit the market since 2007 are trading well below issue price! Please bear in mind that we are not even talking about positive returns here. A whopping 2/3rd of all IPOs have failed to keep even the wealth of its shareholders intact. The article further rubs salt into wounds by mentioning that only about 3 in 10 companies have given returns that would beat an 8% FD over three years. If this hasn't given you enough reasons to proceed with extreme caution when investing in IPOs, we don't know what will?

Once bitten, twice shy. That seems to be the case for investors when it comes to real estate stocks. After all, what else would explain their apathy to the companies from the sector. Despite claims of a revival in the industry and prices in Mumbai, Delhi and Bangalore rocketing to near 2007 highs. In fact, the BSE realty index has underperformed the broader index since the start of 2010. Moreover, some of the biggest real estate players are now quoting way below their listing price. For example, DLF has fallen almost 45% from its issue price in July, 2007. Companies like Puravankara, HDIL, DB Realty, Nitesh Estate and Jaypee Infratech also share the same fate. Clearly then, the upturn in property prices is not reflecting in the stock exchanges. While this highlights why investors must be careful about IPOs, it also shows the risks inherent in fantastic earnings projections.

Disturbing jobs report from the US and apprehensions over the Fed's stand on interest rates led the Asian markets to have a weak outing today. Except Hong Kong all major Asian markets closed lower today. Indian markets too were weighed down by selling pressure in banking, engineering and commodity stocks. The BSE-Sensex was trading nearly 13 points (0.1%) lower at the time of writing. European markets too have opened in the red.

 Today's investing mantra
"The person that turns over the most rocks wins the game. And that's always been my philosophy for investing." - Peter Lynch

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1 Responses to "Is your portfolio protected against future crisis?"


Jun 25, 2010

roo much gas!!! no substance.

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