Easy money has already been made in stocks

Nov 2, 2009

In this issue:
» Markets have run up too fast, too soon
» India Inc. does well in 2QFY10, but...
» China warns against an early withdrawal of stimulus
» We might see a double-dip recession, warns George Soros
» ...and more!

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Last week's 5% fall notwithstanding, the Indian markets have given investors a treat this year, rising almost 65% (BSE-Sensex, since January). This is unlike last year's scare when the markets had dropped around 52% between January and December.

October, however, was the first really down month for the markets since February. Herein, the BSE-Sensex came down by around 7% over September. However, despite this small decline, there is reason to think that the easy part of this bull-run is over. As we move towards the end of 2009, the markets wear a costume of boldness, but they're beginning to look tired.

This seems largely due to the fact that a large part of the rally since March has been on account of expansion in P/E multiples (see chart below) rather than any real improvement in Indian companies' overall financial performance. Sure, several companies have been able to improve profits in the latest completed September quarter, but a large part of it has been on account of cost cutting rather than any real improvement in sales.

Data Source: Yahoo Finance, BSE

We believe that easy money has been made in stocks over the past six months. The basis for this run was extremely low valuations of stocks - a factor that does not really exists now on a broader basis. It has really gotten difficult to find good quality stocks at attractive valuations. But that's not to say that some wonderful long term opportunities do not exist at all. They do, and it will require utmost care and discipline to identify them...on your part, and ours.

As we heard from most managements during the latest completed quarter, they're practicing caution and are not really ready to put fingers to when a sustainable recovery will begin. While most will continue with cost cutting to bring some stability to profits, this can go on only till some extent. After this, these companies would have to grow sales to grow their profits.

Markets' weariness can also be gauged from what investors are thinking these days. We had recently run a poll on our website asking investors what's worrying them the most these days. An overwhelming 58% said that the markets' fast and furious rise is their biggest worry. We believe that's a perfectly right thinking.

Source: Equitymaster

If you also feel so, one way you can get over the worry is to keep aside all noise of short term market volatility. Study and invest in good companies - those with sustainable businesses, ethical managements, and still available at attractive valuations.

 Chart of the day
With their backs to the wall, we believe that India Inc. has done a stellar job in managing to grow their profits during the quarter gone by. At least that's what the Equitymaster universe of companies seem to be telling us. If one considers these companies as one giant conglomerate, then that conglomerate has raked in a strong profit growth of 35% YoY, backed by strong cost cutting measures and a benign inflation environment. Topline performance however left a little to be desired. At negative 6%, it isn't something that India Inc. should be proud about.

A closer look reveals that a large part of that decline has been because of the energy sector as significantly lower crude prices hurt their topline growth. Other commodities like steel and aluminium have also played their part in denting the revenue performance of Indian companies. Going forward, a lot will hinge on how sustainable the economic recovery globally, and in India, is. In the long run however, we believe that the profit growth of the levels witnessed in the September quarter may not be sustainable and India Inc. should revert to its trend line profit growth of 12%-15% per annum.

* Representative of 480 companies from our database
Data Source: Equitymaster

While the optimists claim that the worst of the subprime mortgage crisis is behind us, there are those that still see red in the future of real estate sector. And that is not without reason. Wilbur Ross, one of nine money managers participating in the US government program to remove toxic assets from bank balance sheets believes that all the variables of real estate value are going in the wrong direction, simultaneously!

At a time when the occupancy and rental rates are going down in the US, investors are seeking a higher return on their property. As such an anomaly cannot last for long. Ross believes that the US commercial property sales are set to fall to the lowest in almost two decades.

Ironically, leading business dailies have recently reported about such possibilities in India as well. Nariman Point, one of the oldest business hubs in Mumbai, purported to become the Manhattan of India, is now seeing a mass exodus of tenants. A new tax structure announced by the Municipal Corporation in April has pushed the cost of rents beyond the affordability of many businesses. Thanks to the economic slump driven cost cutting focus, most of these businesses have now decided to vacate their tony south Mumbai address in favour of more economical offices in other parts of the city. Newspaper reports say that owners of 3,000 office spaces in the area are now worried as tenants have already begun to move, with many others likely to follow suit.

Several experts had expressed their fear that the US economy might cave after a short lived recovery - a phenomenon termed as 'double-dip' recession. Does the third quarter GDP growth number change that possibility?

"I regret to tell you that the recovery is liable to run out of steam and may even be followed by a 'double dip', although I am not sure whether it will occur in 2010 or 2011," says billionaire investor George Soros. He believes the IMF needs to be overhauled to prevent another crisis in the world financial system. He also believes that China would emerge as the big winner of the global crisis, due to its undervalued currency and a large trade surplus. He also believes that complete freedom of capital movement does more harm than good as it has become a source of instability.

We agree! Financial markets might provide liquidity, but people forget that it is a means to an end. Obsession with liquidity and suspension of common sense is at the root of several booms and bursts.

Just how grave the credit crisis induced recession really was is evident from the number of old, reputed and large financial institutions it has gobbled up in a very short period of time. The 101 year old CIT Group Inc. is the latest to add to that list. The American commercial lender filed for bankruptcy in the US yesterday, with US$ 71 bn in assets and US$ 65 bn in debt. And with that, it has also perhaps taken down with it the US$ 2.3 bn of aid it had received from the US government earlier. Considering this aid is in essence nothing but taxpayer money, US citizens continue to bear the brunt of Wall Street's shenanigans.

Chinese policymakers have joined leading economists in warning that a worldwide recession will follow if economic stimulus is withdrawn anytime soon. In fact, we had recently read the noted economist Joseph Stiglitz warning something similar - "For the world as a whole, it's premature to think about exiting stimulus."

Around the world, central banks are paring emergency measures taken at the height of the financial crisis. And this is sending out signals that the stimulus would be withdrawn soon, thereby sending jitters across global stockmarkets. India's RBI also hinted something like this last week as it tightened credit norms, especially for the bubbly real estate sector. However, in contrast, we recently heard Dr. Montek Singh Ahluwalia, deputy chairman of the Planning Commission, as saying - "For the present, there's no case for doing anything other than continuing the stimulus. It'll be a mistake to think that the world economy has recovered."

Anyways, while Indian markets remains closed today on account of Gurunanak Jayanti, its Asian peers had a weak outing. Leading the pack of losers were indices from Japan (down 2.3%), and Hong Kong (down 0.9%). China (up 2.7%) was the only gainer in Asia today. Gold prices are trading at US$ 1045.8 an ounce in the international market, up around US$ 1 over last Friday's close.

 Today's investing mantra
In evaluating people, you look for three qualities: integrity, intelligence, and energy. If you don't have the first, the other two will kill you." - - Buffett

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2 Responses to "Easy money has already been made in stocks"


Nov 2, 2009

I am not fully convinced


siddharth puwar

Nov 2, 2009

the reading material is quiet good. and i am very happy to say that This info will be good enough for me

Equitymaster requests your view! Post a comment on "Easy money has already been made in stocks". Click here!