Can the Markets be Saved?

Sep 2, 2015

In this issue:
» Agriculture loan quality is deteriorating consistently
» Is India staring at a drought this year?
» Developers' cash flows under major strain
»  ...and more!


Yesterday, the Sensex closed at a 52-week low. Even lower than last Monday's close. A sharp rebound after the 1,624 points crash did not happen. Fear has replaced greed on Dalal Street. Talk of another bear market has started doing the rounds.

The sentiment change has been so fast that investors have begun doubting us. 'Your recent recommendation is going down and down! Please advise.' We can empathize with these types of subscriber queries. The fear of losing money is powerful.

First, let's be clear. Market corrections are perfectly normal. They can happen even if the economy's doing great. And such corrections offer the chance to buy top quality business at good prices.

But why did the crash happen?

Indian markets move to the beat of foreign investors. And China has spooked them. The biggest driver of global growth is slowing down. The slowing dragon has taken commodity prices to historic lows. Countries dependent on these exports have been hammered.

Indian markets were hit even though the economy will benefit from falling commodity prices. That's the nature of global capital flows for you.

So what will happen now? What can save the markets if there's no growth? Here's Bill Bonner with the answer in The Daily Reckoning: "...And with the stock markets so fragile, would St. Janet risk being the one to cause a worldwide panic? Nah. No rate increase in September. Instead, when the crash resumes, we will see even EZ-er money, not tighter money."

That's right. Janet Yellen and the US Fed could come to the rescue. We will find out soon. The Fed meets in two weeks to decide if they should raise US interest rates. We don't believe they will. Instead, we tend to agree with Jim Rogers. He recently said the Fed will 'probably save the markets one more time'.

Don't be surprised if another flood of easy money makes its way to emerging markets like India. If that were to happen, you can safely expect higher Sensex levels in the short term.

But what about the long term?

We have always been clear with the answer. Only one thing determines the long-term level of a stock: the performance of the underlying business. This holds true for the benchmark indices too. This is why we always advise investors to pick stocks bottom up rather that top down.

Pick stocks with sound fundamentals when they are on sale at reasonable prices. Then hold on to them for the long term or until something bad happens to the business. Sticking to this simple formula will relieve you from the stress of market volatility.

So even if Janet Yellen and the Fed do not save global markets, remember the words of Benjamin Graham, the father of value investing: 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' When the dust settles on this latest crisis, the strongest stocks will come out on top, as they always do.

Should you buy stocks now or wait for the Fed to 'save' the markets? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
A big chunk of the India's population is dependent on the agriculture sector for jobs. Given the instability of the same, farmers do need support. And thus, it would be the government's duty to help out this section of the society. One way to do so is by providing access to financial resources. And that too by doing so at affordable rates. At present the government does so by asking banks to provide loans to the farming sector at a discounted rate. In return, the government funds the banks.

While this mode has its advantages - such as leveraging on the reach of banks, the fact of the matter is that banks do not differentiate between customers in the case of subsidized loans - as they have to meet the government's mandate of priority lending. Such an approach leads to deteriorating loan quality over time.

Today's chart of the day gives an indication of the same...

The rising agri loan defaults need to be addressed

As reported by the Business Standard, the Reserve Bank of India is believed to have written to the government suggesting it provide the subsidy directly to farmers. This would be a positive step we believe, as it could lower farming costs. In addition, such an approach would allow banks to provide loans keeping their commercial interests in mind; rather than their social interests.

Another point to ponder over - while the usual belief is that such priority lending is the key reason for the worsening NPAs, the fact of the matter is that this is relatively a smaller issue. What has really led to the worsening of the credit quality over the past few years has been the loans provided to the corporate sector. To put things in perspective, India's largest bank, the State Bank of India had gross NPAs of about Rs 568 bn as of March 2015. Of this, agriculture formed only about a fifth. The SME and the mid size corporate sector on the other hand had a much bigger share of 29% and 41% respectively in the bank's gross NPAs.

While small steps towards improving debt quality is more than welcome, the key focus areas we believe should be to address the elephant in the room - the poor lending processes to the corporate sector.

Continuing our discussion on the need for Indian banks' to improve their asset quality, here's a development that will turn out to make matters worse. As per the India Meteorological Department, overall rainfall deficiency has risen to 12% in the country and that 40% of the country has received deficient rainfall. The situation is unlikely to improve as the southwest monsoons are expected to start withdrawing from this month. The Business Standard has reported that chief ministers of Karnataka and Maharashtra have expressed their concerns and are looking to deal with this matter on an urgent basis. The drought is expected to be the worst in four decades in case of the former state, while in Maharashtra, the reservoirs are only half their capacities.

Should these points concern you as an investor? Well... yes and no. Yes, because if things are played out as bad as they seem, it could lead to a lot of the froth being scooped away. And thus, would make sense to be prepared accordingly. And no because, it should not change your approach of sticking with high quality companies over longer periods. Such concerns come up each year; investors would do well to take advantage rather than be fearful of them.

If the Real Estate sector didn't have enough troubles already, another report has predicted the bad times will continue. Project delays combined with weak demand have put the cash flow situation under pressure according to Moody's Investor Service. With liquidity being squeezed, realty firms are desperate to improve their cash collections. However, they have refused to cut prices which will boost sales. The report states that in FY15, volume growth improved marginally from 20.41 m sq ft to 21.1 m sq ft YoY for the country's top eight developers. Smaller developers have suffered due to people placing a lot of emphasis on the reputation of the developer. We believe the situation is unlikely to improve anytime in the near future. Until property prices decline to reasonable levels, real estate developers are unlikely to see better times anytime soon.

Vivek Kaul, the India Editor of the Daily Reckoning, just made a bold call - Real Estate prices are headed for a fall. Well, if you are someone who is looking to buy real estate, or is just interested in the space, I recommend you read Vivek's detailed views in his just published report "The (In)Complete Guide To Real Estate". To claim your copy of this Free Report, please click here...

At the time of writing, Indian markets were hovering around the dotted line. The BSE-Sensex was trading higher by about 66 points. IT and FMCG stocks were largely in favour today, while those from the power and engineering spaces were less preferred. Mid and smallcap stocks were trading firm with their respective indices up by about 0.33% and 0.8% respectively.

 Today's investing mantra
"Proper accounting is like engineering. You need a margin of safety. Thank God we don't design bridges and airplanes the way we do accounting." - Charlie Munger

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat (Research Analyst).

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