Watch out for these risks in 2011

Dec 20, 2010

In this issue:
» Risks that could spoil the party in 2011
» What's behind the volatility in mid and small-cap stocks
» Gold to touch US$ 2,000 as per Jim Rogers, but then...
» Bubble in housing prices in Mumbai, Delhi-NCR
» ...and more!!

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The global economy remains broadly on track for recovery. Stock prices are doing decently well. The world is flush with cheap liquidity. Well, this is the scenario as we close in on 2010, the last year of the first decade of the 21st century.

Investors' eyes are now closely tied to what 2011 can bring for them? Will it be another year of high (or at least good) returns? Or will the new-year just see an extension of risks that have started to rear their face again?

Did we say 'risks'? Well yes, the globally economy is still a risky place. And as we can see from here, the risk of another downfall in 2011 cannot be written-off. We are not just talking about the developed world here. In fact, the risks for emerging markets like India are even greater.

"And what are the risks for India in 2011?" you may ask. Well, there are three that we can count - easy money, inflation, and current account deficit.

With respect to easy money, it all seems hunky dory as of now. But what if this easy money dries up? What if FIIs take back their money as tensions in their home countries rise? The answers to these questions are disturbing, so it's important to consider them as risks.

As for the other two risks of high inflation and rising current account deficit, we have already discussed deeper into these topics.

So overall, as we enter 2011, there is circumspection with respect to these key risks that the Indian economy and stock markets face. We would thus advise you to be cautious with respect to your investments. Be careful and watch out. You never know when any meaningful correction can give you chances to pick up good stocks at lower valuations.

 Chart of the day
Indian stock markets have been volatile over the past few months. Reasonable valuations of stocks, uncovering of several scams, and the overall weak global scenario can be attributed as reasons for this volatility. In fact, if one were to compare the markets' performance of the current quarter (Sep-Dec 2010) with the corresponding quarters of previous years, there comes out a revelation. And it is that the current quarter's performance has been the second worst over the past seven years for which we have data. Of course, the worst fourth quarter of a calendar year was in 2008 when the world was in midst of a deep crisis.

Data Source: CMIE Prowess

Anyways, Indian markets had a weak outing today. The BSE-Sensex was trading with losses of around 50 points (0.2%) at the time of writing this. Today's selling was led by stocks from the pharma and banking sectors.

All other key Asian markets were also down today, led by China (down 2%), Hong Kong (down 1%) and Japan (down 0.7%).

The noted investor Warren Buffett had once said that nothing hampers our ability to think rationally more than large doses of effortless money. We believe that it is indeed a very prudent thought from one of the world's greatest investors. Who would know this better than a group of investors who badly burnt their fingers in some Indian mid and small cap stocks recently.

A leading daily reports that Indian mid and small cap indices have fared worse than their large cap counterpart so far in 2010. And why not! With quite a few low market cap companies getting embroiled in scams, investors have chosen to dump them in a hurry. But this was not always the case. Just before the recent correction, the mid and small cap indices were the blue eyed boys with investors. They were lured towards them courtesy the prospect of making a quick buck. The initial returns did look good. But easy money blinded investors and they failed to check the underlying management quality and also the quality of the balance sheet. Ultimately though, they had to pay a heavy price for it. Let's hope they take away some very important lessons from this entire episode.

At a time when stock markets have been volatile and crisis stricken news is all over the place, investors have turned to gold as a safe haven. The result has been the spike in the prices of the yellow metal. It has been scaling new heights. All commodity experts have been gung ho over it. But none more than legendary commodity investor, Jim Rogers. Rogers predicts that gold would touch a new high of US$ 2,000 an ounce. While he declines to give a time frame for this, he definitely expects this to happen over the next decade. However, what is more interesting is that he is no longer investing in gold. Reason for this is that in his opinion gold is now too expensive to buy.

In our opinion there is an important lesson in this for all investors. The takeaway is that even though he expects gold to keep spiraling upwards, valuations are the key for investing in it. So while an investment may touch new highs, there is no point investing further unless the valuations are compelling.

Housing prices in Mumbai and Delhi-NCR have reached the peak level of 2008. Prices had fallen by about 25-30% after the global meltdown. However, it is feared that any further rise in the rates will adversely affect the demand. There was 58.9 m sq ft of residential space lying unsold in the Mumbai Metropolitan Region at the end of June 2008. In June 2010, the same had almost doubled to 96.3 m sq ft. This translates into about unsold 80,000 homes. This has been the highest-ever inventory pile up for the region. Whether prices remain stable or rise further remains to be seen. But buying a 'dream home' is surely turning into a nightmare for many.

Indians are known to be amongst the biggest savers in the world. But when it comes to investing there are few instruments that Indians trust their money with. Prime amongst them are bank fixed deposits and tax free provident funds. The reasons for the same could be cited as poor financial literacy and low penetration of alternative investment avenues. But the one reason that is often ignored is lack of transparency. Indian stock markets for instance attract less than 5% of household investments. The bond market is completely at the mercy of institutional investors.

Given such a scenario, the government's attempts to increase depth of bond markets are welcome. But to assume larger scale retail participation is necessary. The government is therefore hoping to channelize retail funds into infrastructure through the bond market. But ex RBI governor Dr. YV Reddy believes that such attempts could be futile. And the reasoning for the same is on solid grounds. The veteran banker believes that lack of transparency has ailed Indian bond market for ages. And without it retail participation could be an illusion. Dr. Reddy's comments also throw light on the poor execution of infrastructure projects. The same often unduly raise the cost of projects and lower returns. Thus, retail investors are unlikely to get attracted to volatile returns.

We believe that the bond market certainly has a lot of potential for risk averse investors in India. The time is ripe to enlist retail participation in it. Dr. Reddy's comments could help address the drawbacks holding back its growth.

 Today's investing mantra
"Gambling can be separated from investing not by the type of activity but by the skill, dedication and enterprise of the participant." - Peter Lynch

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3 Responses to "Watch out for these risks in 2011"

Vincent W

Dec 20, 2010

Regarding gold prices being to high to invest. Certain investors may believe that prices will go up AND choose not to invest anymore in gold. Is this a contradiction? NO. The reason why they don't invest more is risk management. Their portfolio has already enough exposure to gold. If they didn't have less gold, they would steel buy at the current prices.



Dec 20, 2010

One more factor which I think could be considered is that we will not have the luxury of the receipt of approx Rs 1 lac cr from the 3 G auction we got this year which was anyways squandered away - pl.correct me if I am wrong. Where will we go for matching revenue next year ? More taxes?? May be increase in already back - breaking service taxes ? Tough times ?!


virendra jain

Dec 20, 2010

housing indeed shall again attract correction untill salaries go up atleast by 25%.
Gold shall move up further as you rightly pointed out about investing in equity is fraught with risk. After going thro' this presentation readers ar

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