Are equity markets set for a turnaround?

Dec 23, 2008

In this issue:
» US investors pull out money from stock funds
» Currency traders are relatively unscathed
» Will 2010 see India's first patented new drug?
» Recession raises threat of protectionism
» ...and more!

Investors who were hoping for a quick turnaround in the fortunes of equity markets will probably not like this. No, we are not talking valuations here. Infact, as per most experts, they appear cheap by any historical measure. What we are worried about is that there could be very few buyers left on the other side of the table. As per a leading business daily, US retail investors have pulled out a staggering US$ 72 bn from stock funds in the month of October alone. And worse still, if the past trends are any indication, they are not likely to return in a hurry. It is believed that US retail investors form the bulwark of the market and hence, their disenchantment with equities does not augur well for the long term performance of the US equity markets. This change in attitude though has not been sudden. The dot com crash, which marked the end of a 17-year bull run in the US stock markets, left a bitter taste for a lot of investors. Although they returned during the subsequent bull run, pouring in as much as US$ 65 bn per year between 2002 and 2005, the recent deep correction is perhaps the last straw. Thus, while the recent pullout points towards a deeper malaise, for the sake of the equity markets, let's just hope that this is indeed a temporary phenomenon.

------------------------- Investor Survey -------------------------
The Equitymaster Investor Survey (December 2008)
Make your collective opinion count. Take the Survey Now!
It's designed to take no more than 2 minutes of your precious time! Click here.

The biggest financial crisis since the Great Depression has resulted in several layoffs across industries around the world. The developed nations especially have been worse off. But in an effort to minimize layoffs and rationalize costs at the same time, corporates in the US have been coming out with various initiatives such as four-day workweeks, unpaid vacations, wage freezes, pension cuts and flexible work schedules. In fact, as reported in the International Herald Tribune (IHT), many of the employees are volunteering for pay cuts, it being a much preferred option than being asked to leave. Interestingly, the rationale behind these strategies is to have the required workforce at hand should the economy suddenly improve just as it had deteriorated so rapidly in October. The idea is to not cut too much. And corporates are being careful about hiring and firing, choosing to keep the productive workers on the payrolls.

Satyam's reputation is taking a nosedive. After serious corporate governance issues raised over the company's failed buyout of two firms owned by its chairman's family, it is in the limelight for the wrong reasons yet again. As per a leading business daily, it appears that at least one independent director had not fully signed off on the US$ 1.6 bn valuation placed on the two companies by the management of Satyam. While the proposal for acquisition had been cleared, the price at which it would be done had not been decided. What's more, another independent director seconded this news.

This development shows the management in an extremely poor light. However, it continues to stand by the fact that the deal was called off only because it was strongly opposed by its key shareholders. Whatever, be the case, it is apparent that the management of Satyam needs some serious lessons in good corporate governance practices.

While bankers, investment bankers and people of their ilk are struggling to hold on to their jobs, currency traders are having it relatively easy. As reported on Bloomberg, while bonuses, which account for the bulk of annual pay for traders and investment bankers, will fall an average 45% this year, currency traders will see declines of about 15% from 2007; a huge gap indeed. With the significant volatility in currencies, foreign-exchange markets have been witnessing robust growth.

Fathom some statistics on Bloomberg. Forex trading revenue at US commercial banks rose 66% in the second quarter from a year earlier. Global heads of foreign exchange trading will receive average bonuses of US$ 3.5 m to US$ 4.5 m, down 10% from last year. Not only that, foreign-exchange contracts traded at the CME Group Inc., the world's largest futures market, surged in September by 32% from a year earlier, to a notional value of US$ 111 bn. What's more, Deutsche Bank and UBS AG, the world's two largest currency traders, posted three consecutive quarters of record revenue from foreign exchange. Therefore, with the reputation of Wall Street reduced to tatters, it is hardly surprising that foreign-exchange trading was the only area that got away unblemished. And as the volatility is expected to continue, the scenario for the forex markets and traders only appears brighter.

As per reports, liquor and airlines business magnate, Vijay Mallya is in the race with Mexican billionaire and one of the world's richest men, Carlos Slim Helu among others to buy the Formula One (F1) team of Japanese auto company Honda. We wonder if this is the best use of the cash that Mr Mallya has at his disposal. Perhaps, he would have been better off injecting money into his fledgling airlines business.

As per the Economist, recession in the developed economies raises a serious threat. That of protectionism worldwide. Protectionism could be the biggest spanner in the wheels of globalisation that rests on the two planks of trade and capital flows. As per the World Bank, international trade is set to decline by 2% in 2009, while the net private capital flows to emerging economies are likely to fall by 50%. While world trade affects export oriented countries like China and Germany, capital flows affect emerging countries with current account deficits like India.

Emerging economies will protect themselves with higher import tariffs. They have sufficient scope to raise tariffs because for decades they have unilaterally reduced them. Developed economies will protect themselves with subsidies and bailouts to troubled industries. Both hinder globalisation.

What's the solution? A combination actually: Enlightened politics from US and China, conclusion of the Doha round, greater transparency about tariff barriers and macro economic stimulus in capital starved economies.

It is a well documented fact that the advent of the patent regime compelled many domestic pharma players to increase their efforts on R&D of new molecules. It has been almost four years now since the product patent law was introduced. Thus, who is likely to hold the distinction of introducing India's first patented drug? It seems neither Dr.Reddy's nor Ranbaxy but Glenmark instead. Glenmark in partnership with Napo Pharmaceuticals had been working on a drug called 'Crofelemer' for the treatment of HIV-associated diarrhea. Given that Napo will get a NDA (new drug application) for this drug in the US by 2010, Glenmark plans to make regulatory approvals in the rest of the world markets and expects approvals to start trickling in starting 2010. The company expects peak sales of US$ 80 m from these markets.

Source: Company Annual Reports

Interestingly, while Ranbaxy and Dr.Reddy's had started their R&D efforts before Glenmark entered into the scene, the latter has been very aggressive about its research strategy and because of the strength of its pipeline, has been able to ink several out-licensing deals with innovators. Dr.Reddy's does have an anti-diabetic molecule 'Balaglitazone' which is in Phase III trials. But the problem is that it belongs to a class of drugs which has run into trouble with the US FDA. Given that the US FDA has become very stringent in approving new drugs, the scenario is only expected to get tougher for domestic pharma players. In the meanwhile, Glenmark has something to cheer about!

If you are thinking that the financial firms in the US may be feeling sorry for the mess they've helped create, think again. Six of the financial firms that were recipients of the American government bailout still own and operate fleets of jets to carry executives to company events and sometimes even for their personal trips. According to a review of the Federal Aviation Administration records, American International Group (AIG), which has received about US$ 150 bn of aid from the government, has one of the largest fleets of 7 jets amongst its peers. But it is not alone. Five other financial companies that got a total of US$ 120 bn of assistance from tax payers money: Citigroup Inc., Wells Fargo and Co., Bank of America Corp., JPMorgan Chase and Co. and Morgan Stanley, all own aircrafts.

This despite last month when chief executives of the big three US auto companies, Ford Motor Co., General Motors Corp. and Chrysler Llc. received acrimonious criticism for flying to Washington on corporate jets to ask the government for a bailout. Looks like Wall Street is taking its time in learning a few lessons.

The Indian markets closed lower today by 2%. BSE Bankex and BSE Capital Goods (down 4% each) contributed to the decline. While the Asian markets also closed in the red, the European indices are trading mixed currently. As reported on Bloomberg, crude oil fell by 2% to US$ 39 a barrel on speculation that deepening global recession is reducing fuel demand in Asia. Gold fell by 1% to US$ 842 an ounce as the drop in crude prices reduced the appeal of the yellow metal as a hedge against inflation.

 Today's investing mantra
"Time is the enemy of the poor business and the friend of the great business. If you have a business that's earning 20%-25% on equity, time is your friend. But time is your enemy if your money is in a low return business" - Warren Buffett

Today's Premium Edition.

Recent Articles

All Good Things Come to an End... April 8, 2020
Why your favourite e-letter won't reach you every week day.
A Safe Stock to Lockdown Now April 2, 2020
The market crashc has made strong, established brands attractive. Here's a stock to make the most of this opportunity...
One Stock that is All Charged Up for the Post Coronavirus Rebound April 1, 2020
A stock with strong moat is currently trading near 5-year lows.
Sorry Warren Buffett, I'm Following This Man Instead of You in 2020 March 30, 2020
This man warned of an impending market correction while everyone else was celebrating the renewed optimism in early 2020...

Equitymaster requests your view! Post a comment on "Are equity markets set for a turnaround?". Click here!