The biggest reason for all our financial misery

Dec 29, 2011

In this issue:
» China's economy at the edge of a cliff?
» No impact of India's economy here
» Is this the trade of the next decade?
» 2011 second worst for investors in many years
» ....and more!
-------------------------------------------------------- India In Crisis --------------------------------------------------------

The Indian Economy has hit a rough patch. And based on media reports it almost seems certain that our future is doomed!

But is there an opportunity in this crisis that you can benefit from?

Well, there possibly is. And to be among the first to get in on this opportunity, just sign up for the Equitymaster WebSummit... It's Free! (Registrations close shortly!)


It is routinely observed that some of the biggest ideas in one particular field are often borrowed from an entirely unrelated field. There is no reason why finance and economics should be different. And if there is one discipline that could do more than any other in bettering our understanding of financial markets, it has to be ecology we believe. At the heart of ecology, lies a very important principle. If an ecosystem grows way too much, a destruction of the excess growth follows, laying the groundwork for a stronger system to evolve. This then leaves the ecosystem in a much better shape than before. And what happens if this process is interfered with. A real life example can be had from the famous Yellowstone National Park fire in the US in the 1980s and which was 30 times bigger than any previous fires recorded there. It occurred mainly because the forest officers there had decided to stop the earlier fires at the very first blaze. In other words, they had interfered with the nature's mechanism of destroying the most fire-susceptible vegetation which eventually grew bigger and bigger in size and thus increased manifold, the intensity of the final fire.

That's it. The Governments and central banks around the world need no more than this simple lesson to understand the implications of their actions. By repeatedly bailing out sick institutions and by throwing money at the most inefficient businesses, they are interfering with the natural process of capitalism i.e. survival of the fittest. It does not take more than perhaps a sixth grader to realise that every such action is increasing the possibility of a much bigger inferno further down the road, which will have devastating consequences on the wealth of the global economy. Not to forget that just like fire susceptible vegetation, continuous support of bad businesses is also causing unemployment to remain high and growth to remain low. Thus, while the forest officers at the Yellowstone Park seemed to have learnt their lessons, the policymakers seem far from doing it. They should realise that there is hardly any other solution in sight. They will have to let the fires run their course. This is the only way to create a new groundwork for stable, sustainable growth and higher employment. We hope the New Year will drill some sanity into them. Or else the market's way of making them realise this will be far too costly and devastating as per us.

Do you think the policymakers should stop interfering in the affairs of the markets and let capitalism do its work? Share your views with us or you can also comment on our Facebook page / Google+ page.

 Chart of the day
Today's chart of the day highlights the ever growing number of vehicles on the information superhighway. In other words, the unique users that will hop onto the internet bandwagon over the next few years. The chart should certainly make firms in the e-commerce space rub their hands with glee. However, as per a daily, this does not seem to be the case. May be the prospects for growth is attracting far too many players leading to cut throat competition and hence, lower profitability. The consumers though are not complaining much on account of the goodies on offer.

Source: LiveMint

It seems the Chinese economy could have a fall that could be extremely devastating. The trigger would certainly be the bursting of the Chinese real estate bubble. It seems to have already begun its course given that sales volumes and prices are dipping by double-digit rates in second-tier cities. What is more worrying is the fact that China's real estate bubble is much larger than those witnessed in the US and Japan. It permeates real estate across all sectors- residential, commercial, industrial and infrastructure. This bubble has been brewing for a pretty long time thanks to the Chinese government. While the governments of US and Japan did have a role to play in their respective real estate bubbles, the worrying thing about this Chinese bubble is that it is entirely the making of the Chinese government. Another disturbing fact is that Chinese official data is extremely unreliable. So much of the economic statistics are more propaganda than real facts. But a lot of anecdotal evidence is clearly pointing towards an impending meltdown. The process has already begun. How fast it spreads and how bad things get is for us to see.

It may be Asia's largest slum, a symbol of abject misery but when it comes to business operations, Dharavi is thriving. So much so, that there runs a parallel economy in these slums to that of the 'formal' Indian economy. Sample this. There are 60,000 structures in this slum, many of them shanties, and as many as 1 m people living and working on a triangle of land. On this, there are umpteen workshops with an annual economic output estimated to be US$ 600 m to more than US$ 1 bn.

So while the formal economy is recognized by the government and consists of businesses that pay taxes and adhere to labour regulations, this parallel economy or 'informal' economy would include millions of shopkeepers, street vendors, construction workers, tailors, repair men and the like. Indeed, it is testimony to the stark inequality divide that exists in India.

What is more, the poor conditions that they live in the metros have not deterred rural people from migrating to the city. The more obvious solution would be to put up Dharavi for redevelopment and recognize the entrepreneurial spirit that this slum represents. But that is easier said than done given the corruption that exists at various government levels. On a more broader note, the government needs to put more efforts on providing affordable housing to large section of the population and prevent the mushrooming of more slums in the future.

In an economy where as it is just 2 to 3% of investors put their money in stocks, 2011 has been another watershed year. Average losses of Rs 9.7 lakh per demat account holder in India is indicative enough of the extent to which investor portfolios have been bruised in 2011. In fact this makes 2011 the second worst year for investors in the last 14 years, next only to 2008. What is more, some of the heavyweight blue chip stocks have been the front runners in wealth erosion. With global financial markets in a state of flux and domestic markets offering little confidence with policy inaction, corruption, inflation and low growth, foreign and domestic investors have dumped stocks left, right and centre. It will certainly be a while before equity markets can win back investor confidence. However, not all is lost. In fact we believe that the time is ripe for investors to look for fundamentally sound stocks that are currently available at attractive valuations. As the near term concerns get ironed out, being greedy when others are fearful is bound to pay off in the longer term.

Over the last 10 years gold has outperformed equities. However, will the outperformance continue in the future as well? Although there is no denying gold's importance in one's portfolio it should be noted that gold is a non-consumption commodity, also having some aesthetic value attached to it. Agricultural commodities have an edge in this case. Owning to significant shortages, these commodities have garnered significant interest amongst investors in the recent past. So, are agricultural commodities the next trade of the decade? Well not really, if Stephen Diggle, a hedge funds manager is to be believed. The idea is already overcrowded with many trades in agricultural stocks and commodities. He feels that owning a farmland is an indirect way to ride the current commodity boom. With current food shortages and rising prices, agriculture presents the best opportunity for investors over the next 10 years. And if this turns out to be true, it will be farmers and not bankers who will drive Ferraris in the future.

The recent sharp drop in stock prices have thrown up some interesting ideas for investors who want to go shopping. Particularly for investors with deep pockets, they can now buy a listed company for less than Rs 1 crore. Of course, there are legal nuances of buying out an entire company that one has to endure. But nevertheless the point is that these companies are available at a cheap price. However, what investors need to bear in mind is that the absolute price is not what should be considered when it comes to investing in a business. It is how much the business is worth vis-a-vis what you are paying for it. In other words, it is the comparison of the intrinsic value of the company with the market price which is what makes more sense. And when you do that, you may just realize that the rock bottom price for such companies may still not justify the risk as well as the fundamentals involved.

Meanwhile, Indian stock markets indices opened slightly in the red today and had remained there at the time of writing, Sensex was trading lower by around 60 points. Heavyweights like Reliance and Infosys were seen driving most of the losses. While Asian markets closed mixed today, Europe too has opened on a mixed note.

 Today's Investing Mantra
"I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years." - Warren Buffett

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6 Responses to "The biggest reason for all our financial misery"

Sarat Palat

Jan 6, 2012

The policy makers should not interfere in the day to day operation of the business. It should be left with the professionals.

The loss making PSU's should be closed down or reduce the percentage and privatise it.



Dec 30, 2011

It is rightly said, yes if we do not allow the nature to take its course to do the correction, we are inviting a bigger disaster. This is what the treasury departments of the developed countries are doing so far.



Dec 30, 2011

Dr. Ravi Batra has explained this matter very well in his book "Crash of 90s", According to him, the crash would have occurred in 90s.and he mentioned that if interventions are done, you will delay the crash, but it will be of larger magnitude.


Digambar Kulkarni

Dec 29, 2011

I agree with youe views.
Bail out Packages are encouragement to irresponsible businesses/ financial institutions. This is upsetting the very basis of borrowing and returning.

In India sometime back, there was a Welfare idea of excusing loans to farmers! Such moves are not in the long term interest of farmers and the Country.
These cheap gimmics of winning votes are most counter productive. This discourages efficiency and productivity.
Ecobalance is a good simily but National Economy is a much short term phenomenon and needs to be tackled on urgent basis.



Dec 29, 2011

Thank God that our GoI displayed some prudence in the case of King Fisher Airlines. Such unwarranted support would definitely lead to inefficient running of business and an financial inferno would be the ultimate outcome.



Dec 29, 2011

mostly the corruption ,in government while making policy they do. and nothonest businessmen, not intending creating value of business ,instead more focused they are on manipulating sotck prices and cheating a lot way by maniplalted anual results.
someone can take opinion poll of all investors "do they belive in anual statments?"

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