Will stocks beat bonds again in 2015?

Dec 20, 2014

In this issue:
» Black money exports from India and China
» Mercedes and iphones for Chinese bank depositors
» More to Saudi Arabia's oil strategy than derailing the US
» Roundup on global markets
» ...and more!

Stock markets, not just in India, but globally, had a better than expected run in 2014. The central bank in the US, Europe and Japan continued to indulge investors by keeping the money printing machines on. And cheap liquidity ensured that stocks in both developed and developing markets soar in valuations. In India, the change of government and hope of reforms too buoyed sentiments. And supported by higher earnings visibility or not, over 300 stocks hit fresh 52 week highs in 2014.

At the fag end of the year, however, currency crisis in Russia, unexpected slump in oil prices and possibility of the US Fed raising rates are playing spoil sport. Investors who were so far basking under the 'Modi magic' in India have begun to worry whether the FIIs too will play along. And whether strengthening of the dollar will mean a flight of capital from emerging markets.

Now in the midst of all these, what is the outlook for stocks and bonds for 2015? Whether investors in India should continue to rely or stocks or allocate a higher portion of portfolio to fixed income assets?

There is no doubt about the fact that reforms, even if at a slower pace, will ensure higher GDP and earnings growth for Indian companies in the coming years. Therefore stocks that are backed by sound business model and good management are certainly ones to remain invested in. Even if the FIIs play truant, having invested in good stocks at attractive valuations will not subject investors to significant risk. And having said that, we have every reason to believe that higher growth will keep Indian stocks at the top of the most wanted asset classes list in 2015.

Bonds in India may soar if the RBI chooses to cut interest rates significantly by late 2015. However, we do not see such measures anytime soon. Plus the lack of consensus between central banks globally, about their stance on liquidity, will mean that the RBI remains cautious. But other than the possibility of rate cut, there is not much going in favour of bonds at least in India. Investors keen to fetch healthy inflation adjusted returns will continue to favour stocks over bonds in 2015 too!

Therefore whether or not 2015 sees as many stocks make lifetime highs as they did this year, we certainly see Indian equities outperform most other asset classes. And hence there is no reason for investors to move out of stocks, as long as they keep the quality of stock and asset allocation in check.

Will you change your allocation to stocks in 2015? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
India and China were always neck to neck when it came to bagging the crown of the fastest growing economy in the world. However, the latter always led the race by virtue of being an export driven economy. Seems, India has taken lessons from this export model and will fast catch up with China. However, the export commodity in question here is - black money! Globally, there is huge amount of illicit money that flows out of emerging economies. And India & China are no exception.

In 2012, US$95 bn of black money was siphoned off from India. Though this may be less than that of China which saw US$250 bn getting shipped away, the gap has narrowed over the last 10 years. And India may soon be a global capital of black money exports! .

One may think crime and corruption by Indian politicians is the prime reason for this black money menace. However, the truth is different. The real culprit is India Inc, typically organizations that deal in foreign exchange. By presenting false invoices while exporting or importing they do not reveal their true income. Say for example, you exported a commodity. In that case, you would under-report the export figure and thus save tax on it. This practice is rampant in India which is the prime source of black money creation. Unless, the taxing authorities become more vigilant, India will probably have to live with this curse.

Will India catch up with China in black money exports?

Speaking of China, there is a new and unique problem that Chinese banks are facing. That of attracting depositors! "Deposit a little over Rs 90 lakhs in a five year bank deposit and get a Mercedes A180 free." Or for that matter, "deposit about Rs 3.9 lakhs for the same period and get a 128 GB iphone 6 for free." Sounds too good offers to be true? Well, these are exactly the kind of offers that Chinese banks are making to depositors.

With banks offering not so attractive rates, people have been taking money out of their accounts and putting them into other higher yielding asset classes. As reported by Bloomberg, some of the avenues which are finding investor interest include online money market funds offered by e-commerce companies Alibaba Group and Baidu. Further, even high yield trust products - which invest into real estate and construction projects or provide corporate loans - are also finding favour considering they give yield of more than 10%. Or for that matter, money has been moving to stock markets as well, given the 45% rise in the benchmark index in the past six months.

All these developments are effects of China's central bank cutting benchmark rates in hopes of stimulating the economy. However, it turns out that China's banks lost 950 bn yuan (or US $ 154 bn) of deposits in the three months through September, with new deposits declining by 23% in the first 11 months of 2014. Whether providing such incentives is viable or not is a different matter altogether, but something definitely seems odd with the kind of funds that are attracting such massive amounts of investor interest, we believe.

As oil prices continue to slide, all eyes are on the OPEC and whether it intends to cut production to prop up prices. So far it has shown no inclination to do so. The glut of shale gas from the US has been the prime reason for oil prices cooling off. And the consensus seems to be that Saudi Arabia not cutting production is part of a broader strategy of forcing US shale producers out of business. Indeed, it is well known that shale fields are much difficult to develop and require heavy technology. As oil prices continue to tank, questions have been raised as to whether the current prices are viable enough for US producers to continue investing in energy production.

However, as per an article in Business Insider, there could be more to Saudi Arabia's oil strategy than just derailing the US. For instance, falling crude prices have been increasingly hurting Iran and Russia, two countries for whom oil is a major revenue generator. What more, Saudi Arabia is not necessarily on great terms with either of these two economies. Maybe it is all part of Saudi Arabia's grand plan to reinforce its position as the world's oil superpower. But will it work? Low oil prices may be hurting Iran, but it still has huge reserves to help it weather the storm. Russia's economy is also getting hurt but it seems to be facing more of a currency crisis right now than a budget crisis. So only time will tell as to what is the real thinking behind Saudi Arabia's present strategy.

The week gone by was a turbulent one for most of the global markets. Geopolitical worries, collapse of the ruble, gyrations in the oil prices indicated that global stock markets were only heading downward. But, the Federal Reserve's assurance towards interest rates quickly changed sentiment for global markets.

The key driver for this week's rally was the US Federal Reserve's commitment to take a "patient" approach toward raising interest rates. US Federal Reserve Chair Janet Yellen said interest rates would be kept unchanged for "at least a couple of meetings". This gave the much needed impetus to the US market too, and the US stocks ended the week at highest levels since 2011.

China was the biggest gainer for the week (up 5.8%). The statistics bureau raised China's gross domestic product in 2013 by 3.4%. However, this wouldn't affect GDP growth for 2014, though it would change the total size of the economy for the current year.

The Indian indices closed flat in the week gone by. Not only global geopolitical factors but even events back home spooked the stock market rally. Trade deficit figures for the month of November swelled. Further, the Indian Indices also got hammered due to FII sell offs. However, the markets gained the momentum during the later part of the week on the back of Fed's announcement.

Performance during the week ended December 19, 2014
Data Source: Equitymaster & Yahoo Finance

 Weekend investing mantra
"A pin lies in wait for every bubble. And when the two eventually meet, a new wave of investors learns some very old lessons: First, many in Wall Street - a community in which quality control is not prized - will sell investors anything they will buy. Second, speculation is most dangerous when it looks easiest." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee.

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