Bubbles likely in emerging markets

Nov 15, 2010

In this issue:
» Jim Rogers suggests a world without central bankers
» India Inc.'s performance over the quarters
» Even lots of infrastructure isn't enough for India
» Indian banks facing short-term liquidity crunch
» ...and more!!

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"The US monetary policies may be positive for Asia, but these policies could also cause bubbles in emerging markets via capital flows." This is the view of Marc Faber, also known as Dr. Doom for his publication - The Gloom, Boom, Doom Report.

Faber was speaking to a leading business channel late last week. He said that the US central bank's easy money policy had led to the dotcom, housing and commodity bubbles in the past. And thus he is very skeptical about the success of QE1 and QE2 (QE stands for quantitative easing). He believes that QE2 has the potential to create yet another bubble in commodities as well as precious metals. He also fears that capital markets of emerging nations would see bubbles.

We second Faber's opinions. Too much of cheap dollars printed by the Fed can create massive bubbles in emerging markets, India included. And when those bubbles will burst, we'll have another problem on our hands the way we had with the previous bubbles created by this very flood of dollars.

Now, it is difficult to get the timing right on when a bubble will burst. As such, the key for investors is to stick with low debt companies, with simple business models and ethical managements. Their stocks might still fall under the weight of a worldwide crisis. But investors in such stocks will still be better off than those who speculate and expect their stocks to be fast money making machines.

For all the financial problems that the world faces now, commodities guru Jim Rogers has a medicine. And it is a world without central bankers! While this view seems too extreme, and highly unlikely, Roger's core ideas are not far from truth. He says that the US central bank has made it worse over the last 20 years with a staggering amount of debt, creating bubble after bubble, going from one mistake after another. Eventually 'they are going to bankrupt themselves with their own mistakes'!

 Chart of the day
Today's chart captures the performance of Indian companies over the past few quarters. It shows the YoY growth in sales and operating profits of 375 of the BSE-500 companies. As the chart suggests, while the profit growth has come in good for these companies during the quarter ended September 2011, what is worrisome is the gradual decline in sales growth over the past three quarters. Another concern is that now with commodity prices on an upswing, operating profits can also feel the negative impact going forward.

Source: Livemint

"India's future depends on it (good infrastructure)." This is what a Time magazine report suggests in a piece on the state of India's infrastructure. The report goes on to state how the Indian government and companies are getting active about sprucing up the country's dilapidated infrastructure. But then it adds even the currently planned infrastructure won't be enough for the country, given the huge deficit. One key sector when the gap between demand and supply will take long to fill is power. Even in the case of roads, the progress is painfully slow. Then there are issues of land acquisitions that infrastructure developers have to contend with. Amidst these problems with India's hard infrastructure, there lie the issues with soft infrastructure - like education, water supply, and medical care - that are in equally poor state.

Overall, as Time writes, "For India, there is still the old business of nation-building, and for that there is no substitute."

Anyways, Indian markets had a roller-coaster outing today. From being in the red for a large part of the first half of today's trading session, the markets moved into the positive, only to fall back in the negative. The BSE-Sensex was trading with losses of around 15 points (0.1%) at the time of writing this. These losses were largely led by stocks from the realty sector. Among other key Asian markets, while China and Japan closed in the positive, selling pressure was seen in Hong Kong and Singapore.

The Indian central bank (RBI) is sitting on a surplus cash reserve of around Rs 870 bn (US$ 19.4 bn). While this may give the impression of sufficient liquidity in the market, the reality is quite otherwise. Drained out of cash with tax payments, IPO payments and festival purchases, the banking system is facing acute short term liquidity crunch. So much so that the call money rates have spiked by 1.5% in the past two months! The liquidity crunch is in fact threatening to thwart the RBI's attempts to cool down inflation.

As per an article in the Wall Street Journal, banks claim that the current liquidity shortage is around Rs 810 bn (US$ 18 bn), and that could go up to Rs 1.3 trillion (US$ 31 bn) by December 2010. This means that short-term working capital loans for corporate India are expected to be priced very steeply. The higher base rates have, as it is, made short-term borrowing reasonably expensive. In such a scenario, we may see more companies wanting to dilute equity. This will enable them to maintain cash reserves rather than access expensive leverage.

The Indian IT industry now has a new market to boost its growth. This new market is none other than India itself. The domestic market provides a huge potential particularly in terms of software products. If a company has a good product, then it is sure to sell in India. This is driving up growth for IT players, especially the smaller players, who are not able to access international markets due to their size.

With the US playing a spoilsport for outsourcing and Europe reeling under crisis, the Indian opportunity comes as a fresh breather for the industry. While the companies cannot do much about the problems in the international markets, focus on the domestic front will definitely help boost their growth.

The Indian economy seems back on track. Stock markets are booming. Everything seems hunky dory. And policymakers are getting optimistic, and even suggesting that the Indian economy will soon return to the 9% growth path.

This optimism with respect to sustained economic growth is what is the fearful part here! A large part of the current recovery in emerging markets like India is a result is due to our connection to the western world. Central banks there are printing money like there's no tomorrow. And, in search for higher yields, that money is flowing straight to emerging markets like India, spurring growth here.

The fear is - what happens when this tap of easy money supply runs dry? India is growing, and growing fast as of now. But then, how much of this growth is real and how much is stimulated? We're not sure what the answer to this is.

 Today's investing mantra
"Obvious prospects for physical growth in a business do not translate into obvious profits for investors." - Benjamin Graham

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5 Responses to "Bubbles likely in emerging markets"

Adi Daruwalla

Nov 18, 2010

First of all increasing the number of employees in the IT companies is not a bad idea. The problem starts with managing their expectations and defining a clear cut job role. Determining and defining a clear cut job role reduces ambiguity and controls expectations. Also by job definition there is a means to (see) get performance and to measure performance. Corruption is high in the corporate world also as in in politics. There should be good top management governance, and internal affairs management to enusre that the eons old tactics of you srcatch my back and I will scratch your back is not prevalent. This is spreading from IT firms to customers also and back from customers to IT firms. The greed of Senior and corporate level bosses should be conrolled, so finally that that top level corporate bosses and VP's etc. are not only warming the cushions they are sitting on and enjoying fat amounts in banks and ESOP's etc. There should be sustainable physical governance, e governance and Internal Affiars divisions to ensure fair play and no snatching away of junior employees credits by seniors too. There is a lot of curry rice being cooked in the corporate world today and I am hoping the curry does not spill out.



Nov 16, 2010

LIC or UTI is defacto 'Sovereign' Companies, and had enjoyed the Sovereign's (GOI) gift of monopoly, for so long that if wisely invested their almost guaranteed and ever growing receipts (by way of subscription to US64 and premium paid for often unwanted and un-remunerative insurance, to save tax, as these were the only legal tax avoidance schemes for vast middle-class salaried people) could have produced stupendous returns. Couple that with revenue receipts realised sans any cost of sales (they did not have to spend on sales efforts in a monopoly situations), indeed investors should have received stupendous returns that is almost guaranteed by the Sovereign backing. Alas, US64 investors in millions were robbed & so were UTI SCUP (Senior Citizen Unit linked Plan) that was supposed to offer cashless health-care in old age. Well, such quasi Govt organisation's usual incompetence (thanks to Left's agenda of hijacking such organisation as a social benefactor, employing 5 people to do the job of one and that too badly) & the consequent nil or low accountability ensured that millions of subscribers were left in the lurch with no higher up (naturally including any minister) going to jail, unlike some of bank fraud fall-outs! Infact the Chiefs who were responsible for the mess they created while in office & the ones that ingeniously split the UNIT into two, one having all loss making portfolios and the other carrying all the incompetent staff force built over the years of un-accountability was even rewarded with Super Cop post, for a while before eventually going into oblivion un-scathed. Only possible in Hindustan! Well, talking of higher return and yet guarantee, there had been precedents like SBI US/UK deposits giving nearly double the return compared to what market was offering (well, country was in dire need of foreign currency then and hence in their wisdom thought and blessed SBI to offer a premium return, that was nearly 'guaranteed' - well in this instance, it was an accident that they lived up to it! There is the other case of PPF/EPF rewarding sustained higher rate & Govt subsidising the premium, thanks to the Left Comrades on the 'interest rate' panel giving always better than bank deposits. The flaw in the system is the implied and explicit sales pitch made as though these are 'Sovereign Guaranteed' Schemes! Atleast after the horse manure has hit the fan, should the sovereign not ensure that for that officials who committed the offence of making such promises should be sent to jail?!? Well, the Govt is itself the mother of all un-accountability; QED no recourse to ordinary punters falling into such traps laid, ironically, by Govt blessed monopolies!!!


Agnel Pereira

Nov 15, 2010

Your repetitive concerns about the growth of capital markets and prices of commodities appear to be over the board. First of all, let me clarify, I too believe in conservatism, moderate yet consistent growth (better than steep rises in markets) and I too believe that global economy is still in trouble. But to be frank, Indian economy is on a different pedestal altogether and the current valuations are still not justifying the India potential. If you read through your own paragraphs carefully, there are massive reasons for India to break away from the rest and outperform. Whether US prints loads of dollars without a reason, whether China does a smart currency act, nothing should affect India. People are investing in India because of its strengths (and let me remind you, I am aware that more than 30% of Indians live below hopelessly low poverty line and a huge populace is uneducated and government is pathetic in improving the living standards of its citizen etc etc etc) and not because there is huge money available somewhere else.
So please be ready to welcome a Sensex of 24000 in 12 months time, international gold prices exceeding $1500 in 6 months time. I agree with your cautious approach, but I am not so sure whether you should go overboard with it. Is it because you guys did not manage to buy Indian stocks at low prices? dont worry guys, I am one who has sold SBI at Rs2100 levels and Aurobindo Pharma at Rs280!!!



Nov 15, 2010

Given the above, is it safe, for a long term (4-5 year) perspective, to not give much thought to such disturbances and assume that value companies with low FII expsoure (Such as those recommended by your excellent service) will continue to attract reasonable valuations?

My view is that India, on a long term, is going to grow, and hurdles if any are not impossible to overcome, as long as one sticks with undervalued stock of holistically well performing companies.

Could it be that a crash, bigger or smaller than the last, could have a much longer life than the last one did?


Shilpa Singh

Nov 15, 2010

5 Minute Wrapup is really helping me getting an overview of Indian Economy.

Thanks to 5 Minute Wrapup

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