Ignore this economic indicator at your own peril

Sep 17, 2011

In this issue:
» More Indians will Google in next 5 years
» Can copying Buffett's portfolio make you a billionaire?
» Unemployment in the US is forcing an age-old trend to reverse
» Why should petrol prices remain low when car prices don't?
» ...and more!
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We are not big fans of economic indicators when it comes to stock investing. We certainly do not believe in taking investing decisions based on economic data coming in on a monthly or quarterly basis. It is not that joblessness, drop in consumption spending, fall in asset prices, falling GDP growth and high debt to GDP ratio are nothing to worry about. Especially when they do not pertain to our own economy. But investing decisions are best taken considering only the normalised and sustainable economic scenario in mind. Hence we suggest that investors in India factor in long term average GDP growth and higher inflation numbers for their equity return estimates.

But can every economic indicator be overlooked? A less popular indicator that unlike most others suggests long term trends is giving warning signals on recession. And if you don't believe us, it would suffice to say that historically the indicator flashed red in 1974, between 1979 and 1985 and in 2008. Needless to say that each period saw severe global recessions. A report from Casey Research alerted us on the Oil Expense Indicator. This is nothing but the share of oil expenses as a proportion of worldwide gross domestic product (GDP). Since 1965, this indicator has averaged roughly 3% of GDP. The ratio exceeded 4.5% only during Arab oil embargo (1979), Iran revolution (1979-1985) and subprime crisis (2008).

Shockingly in 2011 we are no better! As per Casey's, brent crude prices would have to fall to a low of US$ 90 per barrel for the Oil Expense Indicator to drop below 4.5%. Instead, brent crude prices have hovered above US$ 100 per barrel for more than six months of this year. Thus if oil prices do not get cheaper, economic growth is bound to get chocked. Vested interests of the members of OPEC cartel are unlikely to let this happen. For a country like India that still imports two thirds of its oil requirement there cannot be a bigger threat to growth.

Do you think rising oil prices is bigger than most other risks to India's long term economic well being? Let us know your comments or post them on our Facebook page.

 Chart of the day
After telecom, power and infrastructure, the one sector that is being vetted as the next sun shine sector in India is pharmaceuticals. Indian pharma majors are all set to reap millions of rupees in revenues once the MNCs see the patents on their blockbuster drug expire. Moreover, the growing and urbanized Indian pollution also sets the stage for higher demand for drugs. As today's chart shows, consulting firm Mc Kinsey estimates that India will have amongst the fastest growth in pharma market globally in the decade running up to 2015.

Data source: Mc Kinsey report

Is logging onto Facebook or Googling something almost second nature to some of you? Well, even with only 8% of its 1.2 billion strong population online, India is already the third largest Internet market by users. And this is only set to grow. With mobile companies betting big on the advent of 3G networks and cheaper smartphones on offer, surfing on the go is becoming much easier. In light of this, Google expects India to reach at least 300 m internet users by 2014. This is an increase from the 100 m users currently.

But, even though Indians are spending a lot of time online, are they actually spending money? Unfortunately, India doesn't really make much of a dent globally in this regard. Indian online ad spending is only about US$ 200 m per year - a small slice of the US$ 80 bn global digital advertising industry. Even other e-commerce like online shopping, ticketing, etc in India is just a fraction of what it is globally. Billions are spent on TV ads instead of more targeting online ones. But, with the proliferation of new India centric websites, and social networking sites, online revenues are only set to increase. The internet is definitely the way forward for India. The new norm is either be online, or be disconnected from the rest of the world.

There is nothing new when we say that unemployment rate in the United States (US) is rising. These days everyone on the street talks about this. But this prevailing unemployment scenario in the US is forcing an age old trend to reverse. Earlier developed countries such as US and UK used to be the hot destination for the job seekers in developing countries like India. Now job seekers in the US are heading to Asia for employment. Why Asia? The simple and well-known reason is the economic scenario in the US as well as some parts of the European regions is deteriorating by each passing day. At the same time, the economies such as Hong Kong, Singapore, China and India have been witnessing a robust growth. It is expected that these countries would continue their growth momentum as well, may be at a slower rate.

One more interesting point which is surfacing that the people in the US are searching jobs in Asian regions not just for the sake of employment, they are finding job opportunities in this region equally or even more lucrative. While we have talked about the issue of brain drain in the past, this trend reversal definitely comes as a great reliever.

Many investors feel that there is an easy way to make money in the stock markets. Simply mimic the actions of legendary investors. And who better to copy than the Oracle of Omaha, the legendary Warren Buffett. Several investors may feel that rather than studying the stocks for themselves, it is easier to just buy the stocks in which the legend is investing. After all such an action should help them get similar returns as well. Well people who think so are actually in for a rude shock. As reported by a leading daily, Buffett has been using a different route for investing in companies and this is the route of preference shares. Buffett has invested in companies like the General Electric, Goldman Sachs and recently in Bank of America through the preference route. As a result, his investment earns the preference dividend that is offered by the shares. At the same time, the terms of conversion offered by these companies to Buffett make the final conversion to equity shares very attractive as well. However, if one were to invest in the equity shares of the same companies, one would have ended up with a whopping loss as the shares have seen a drop of up to 40% in price. Therefore it is important to do your own homework when it comes to investing. Just copying someone else's actions may end up making you poorer instead of richer. Following Buffett would have taught this lesson to his copycats at least.

A series of petrol price hikes has made life difficult for the middle class Indians. While the poor anyways cannot afford vehicles in our country, the rich are least bothered about price increases. Hence, the worst sufferers are the middle income families. With the state-run oil companies deciding to increase petrol prices yet again (by Rs 3), it will most certainly disturb the budgets of these households.

However the situation is quite ironical. While middle class households are ready to splurge on discretionary items, they do not want to spend on the basic necessities. The fact that all the big companies are targeting the rising incomes of middle class Indians is evidence enough of the fact that they are willing to spend liberally on discretionary and lifestyle products. Petrol is an essential commodity which was until recently heavily subsidized by the government. Keeping petrol prices low has already taken a toll on the finances of oil marketing companies (OMCs). We believe that there is no reason for the OMCs to price their products any differently from other commodity manufacturers. If textile, steel and cement manufacturers can enjoy any pricing power, so should the oil behemoths.

Renewed optimism that central bankers across Europe will take steps to ease the sovereign debt crisis fuelled relief rally in the global stock markets. The developed markets registered healthy gains while emerging markets ended the week on a flattish note. The US stock markets rallied for five consecutive days and were up 4.7% during the week. However, it would be interesting to see whether the current momentum continues in the next week or not. Investors are keenly eyeing the outcome of the Federal Open Market Committee (FOMC) meet scheduled on Tuesday. Further, existing home sales data for the month of August would also be released on Wednesday. The outcome of these events is likely to set the momentum for next week's trade.

Indian stock markets managed to stay afloat during the week notwithstanding another rate hike undertaken by the RBI. Positive global cues overweighed rate hike concerns with Indian shares registering gains for third consecutive week. Amongst the other markets, Germany was up 7.4% while UK was up 2.9% during the week. However, Singapore (down 1.3%) and Hong Kong (down 2.1%) closed the week in red.

Data source: Yahoo finance, Kitco

 Weekend investing mantra
"You can wait for opportunities that fit your criteria and if you don't find them, patiently wait. Deciding not to panic is still a decision." - Seth Klarman

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7 Responses to "Ignore this economic indicator at your own peril"

anupam garg

Sep 18, 2011

for a middle class person, textile, steel & cement r capex, usually incurred once while petrol is like opex whose rise is denting savings severely



Sep 18, 2011

This is regarding your comments on petrol price hike. Your views are not acceptable! Already middle class is reeling under the pressure of galloping inflation. Many a house holds have pruned their life style to adjust to this catastrophe. But the government is bent upon breaking the back bone of economy by breaking the back of main stream population. Higher middle class and the rich now ride luxuriously in diesel sedans and SUVs. They can afford to by one and the running cost is rediculously low. The only luxury of the lower middle class is a two wheeler or a compact 4 wheeler at the lowest end of the price tag. Even this is being denied now to them. Cap it all the wide disparity that exist between the price from state to state. No state, even those ruled by opposition party are willing to reduce their loot every time the price is hiked! The disparity in the price existing in India and most other countries is yet another major point. IT IS TIME THAT GOVERNMENTS AT ALL LEVELS REALIZE THE MISERY OF THE PEOPLE AND STOP THE LOOT THROUGH HEAVY TAXATION. By bringing in huge amount of illegal money parked elsewhere many of the vows can be solved.


chinan shah

Sep 18, 2011

i believe over expansionary fiscal policy(non-plan expenditure)and corruption are two major contributors apart from Oil as far as Indian growth and Inflation story is concern. Oil is a reason given by govt to hide their inefficieny or to fool around themselves as otherwise oil has come down or stayed at same level almost for the entire year now.
Today's 7 to7.5% growth is something like we're back to square(without any major reforms being initiated or done at ground level) and it is happening only thanks to over poppulation,changes in demographic pattern and extra loose policy two years back and now everyone's is paying it bac by suffering extra higher inflation. infact no comparable country has such high inflation today if i was only due to Global and Oil reasons.

Infact next 12-18 months I feel there will be a revival in US economy and our real problems will start from there as cheap money will be fade away and if fiscal discipline will not be followed by that time, we and our generaion will face larger consequences.



Sep 18, 2011

The average import price of oil is Rs. 32 per litre or 5170 per barrel considering a rate of 110$ per barrel of oil and dollar conversion rate of 47.
THe rest of the petrol price goes in taxes. In fact I just read in TOI, that even considering the purchasing power parity, the rate of petrol is the highest in India than anywhere else in the world.
First we open our wallet and pay the tax to the government on petrol which probably makes the oil costlier than the price OMCs import at. Then the govn gives subsidies, out of the income tax we pay to it, to the OMCs. If the govn really cares abt people then it should lower the taxes on the imports of oil and then it wont have to pay subsidies to the OMCs.
So I disagree with your view that OMC should enjoy same pricing power as other sectors do. In face if you check the data the rise in steel prices in Indis is nothing compared to the rise in petrol prices!



Sep 17, 2011

We've assumed easy availability of oil and oil products for too long. The world economy has not yet experienced a real energy crisis. The price of oil is going up and staying strong not only because of excessive money printing in the world economies, but also due to peak oil and actual oil demand-supply gap. There is no doubt that in this scenario, growth prospects of all developing nations will suffer. Forget growth, we will have to struggle to sustain existing economic activity.


satheesh babu s

Sep 17, 2011

I think, oil prices are going to determine india's growth prospects for the next few years at least. For the last few months many experts and economists have been trying to put forward the impression that oil prices are coming down, where as it has HARDLY BUDGED from the highs it made 3 months back. India's growth prospects indeed seem dim.


sarvotham yerdoor

Sep 17, 2011

It appears that Oil Expense Indicator has been to some extent influenced / inflated by the QE policies of the USA resulting in the easy / cheap money being utilised for speculation / rigging of every asset class, particularly comondities. The moment QE is wound down / discontinued the balloons may start deflating.

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