Are stock fundamentals irrelevant? - The 5 Minute WrapUp by Equitymaster
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Are stock fundamentals irrelevant?

Nov 12, 2010

In this issue:
» Rupee is the best performer: Geithner
» QE II necessary for US - Roubini
» Grantham accuses Fed of manipulating US stocks
» Emerging markets have already emerged?
» ...and more!!

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00:00
 
Making investing simple through fables and stories in not something which only Warren Buffett excels at. There are other very good practitioners of this art as well. Consider the famous economist John Maynard Keynes for example. His magnum opus, General Theory of Employment, Interest and Money had a very interesting chapter which explained the concept of stock price fluctuations by linking it to something as far removed from investing as a beauty contest!

Confused? Allow us to explain. Keynes observed that in stock markets there are quite a few times when people do not price stocks based on what they think their fair value is. Instead, they price stocks based on what everyone else thinks their value is. This, as per Keynes, is exactly similar to a beauty contest where people are asked to choose the most beautiful face. But, with the condition that people who voted for the winning candidate, will themselves get a very handsome prize. Quite certainly then, a person would go on to nominate not his personal favourite but the one who he thinks could turn out to be the most popular choice.

As per a leading daily, something very similar is happening post the super successful IPO of Coal India. Suddenly, a huge buying interest has sprung up for companies in the mining and minerals space. Even companies that have been lying dormant for years are seeing buyers line up at their doorsteps. Factors like management quality and fundamentals are getting little attention if any. Surely, the temptation to invest in these companies is at an all time high. But investors would do well to remind themselves of the beauty contest analogy that we just discussed. Perhaps investments are being made not because these companies are trading way below fair value but because they are being valued highly by other investors. And this, we believe would be a dangerous thing to do.

01:32
 Chart of the day
 
The emerging markets are changing the pecking order of the world. While the developed world is struggling to grow, the emerging markets are zooming ahead. While in terms of the size of thier GDP, the emerging economies may not be as big as the developed ones, but they are growing fast enough to narrow down the gap and are posed to soon overtake the latter. As seen in today's chart of the day, the top 5 economies in terms of GDP growth for 2010 would be emerging economies.

Data source: IMF

01:58
 
Large influx of hot money has caused concern to several emerging economies. So much so that many have resorted to capital controls. But the Indian Finance Ministry seems to be in no mood to turn back foreign money. Especially given the economy's ballooning current account deficit. In fact as per the Ministry, India currently has the potential to absorb upto US$ 70 bn worth of foreign funds without causing currency risks. And hence net inflows of US$ 3 to 5 bn every month are not necessitating capital controls. This policy has found support from none other than US Treasury Secretary Timothy Geithner. Having articulated the US' loose monetary policy stance, he has praised India for not restricting foreign fund flows. This he believes will set an example for other developing nations (especially China) who have been attempting to protect their export competitiveness. We believe that India's passive currency management is endurable for the time being. But the same may have to be tweaked in the longer run to avoid trade imbalances.

02:38
 
The emerging markets may make up only 20% of the world's market value but account for nearly 80% of the world's total population. This growing population and the resultant growth in the wealthy middle class is resulting in the increase in demand for consumer goods. This in turn leads to a booming industry and in turn a booming economy. This combined with sensible banking institutions and governments that do not believe in loading on too much debt, makes emerging markets the place to be during this crisis. The GDP of the emerging markets has already surpassed the GDP of most of the developed world. For the rest, the gap is closing rapidly. Moreover the emerging markets would easily be able to surpass the developed world in terms of the growth in GDP in coming years. Maybe it is high time we stopped addressing them as 'emerging' and start calling them the 'emerged' instead.

03:08
 
Was QE-2 beneficial? Well, according to Nouriel Roubini, the Fed's second round of stimulus was a "necessary evil". He stated that, if QE-2 did not happen, risks of a double dip recession and deflation in the US would have become even more significant. However, the real economic benefits of the easing will be modest. This is because markets have already priced in most of the positives.

Roubini, also went to the extent of advocating that the ECB should also opt for the same 'evil'. He believes that monetary easing in Europe would help provide more liquidity in the system. Well, as they say money is the root cause of all evil. And, if the ECB also decides to save the flagging euro zone economy by monetary easing, we could be in for more asset bubbles and worthless currencies.

03:49
 
The US Fed has received a lot of flak for its loose monetary policies and its latest round of quantitative easing. Criticism has come in from all quarters including from various countries, economists and investors. And the latest to join this bandwagon is Jeremy Grantham. He opines that The Federal Reserve is rigging the stock market to boost the economy. He further states, "The Fed has spent most of the last 15-20 years manipulating the stock market whenever they feel the economy needs a bit of a kick. The Fed knows its easing will have little direct impact on the economy. The only weapon they have is the wealth effect. If you can drive the market up 50%, people feel richer, they feel more confident." Strong words indeed! What also works against the US is its badly deteriorated balance sheet and a persistent high rate of unemployment. But the US Fed chief Ben Bernanke seems to be in no mood to listen.

04:01
 
China is traditionally considered to be a communist economy driven mostly by internal politics and not profits. However, it is interesting to note that Chinese state owned firms are on an acquisition spree. They having accounted for a tenth of the cross borders deals by value this year. And the reasons are obvious. China has a vast pool of savings. And these savings are gradually channelized in overseas markets to acquire raw materials, get technical know-how and gain access to foreign markets. However, considering China's opaque political background, most countries are resisting China's advances despite the lure of much needed capital.

04:38
 
In the meanwhile, the Indian stock market have continued their downward plunge triggered by the weak IIP numbers. At the time of writing, stocks from the realty, metals and consumer goods sectors were the major losers. The sentiments in rest of Asia were negative as well, with China, Hong Kong and Indonesia ending the day with the maximum losses.

04:50
 Today's investing mantra
"Stock picking can't be reduced to a simple formula or a recipe that guarantees success if strictly adhered to." - Peter Lynch

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