»5 Minute Wrap Up by Equitymaster

On This Day - 17 FEBRUARY 2014
UPA's last attempt to woo voters

In this issue:
» This could lead to another emerging market storm
» Is the worst over for steel sector?
» Does past economic growth predict future stock market returns?
» Is the worst over for India Inc?
» ....and more!

 Chart of the day
In his last Budget speech as Finance minister in the UPA-II government, P Chidambaram had a lot to say but much of it was high on intent and low on content. His vote-on-account, being a budget without any major new proposals, is important only for one reason: it tells us how honest the finance minister has been in showing a true and fair picture of the state of the government's finances.

As markets and rating agencies eagerly watch out for fiscal consolidation carried out ahead of the upcoming elections, the Finance minister reported a fiscal deficit of 4.6% of the gross domestic product (GDP), lower than his initial target of 4.8%, helped by a massive cut in expenditure and gains from telecom spectrum auction. He has also pegged next year's fiscal deficit at 4.1%. Current account deficit (CAD) will also be contained at US $45 bn. However, once the details of the fiscal deficit number are out then only the credibility of the fiscal policy statements can be ascertained. This is because the government has used many accounting tricks to bring the deficit number down.

The FM certainly deserves credit for not presenting a populist budget. The FM did not roll out freebies but the subsidy bill of Rs 2.4 trillion is likely to be another underestimate - for it is almost the same as this year, when Rs 350 bn has been rolled over. The FM has also cut excise duty on capital goods, bikes, cars and SUV. This will help consumption to pick up.

The FM has bravely tried to paint a rose pink picture of the economy. This is even as the major bottlenecks for growth remain. Chidambaram might win kudos for meeting the twin deficit target this year, but he has left a deep hole for the next government to fill. The next government needs to focus on key sectors which form an imperative part of our economy and overall growth of the country.

As far as stock markets are concerned, a budget without any major decisions on reforms is unlikely to have any effect on long term fundamentals of the economy. Hence, one would be better off not focusing on it too much. Attention should instead be paid to the fundamentals of the company and the valuations that it is trading at.

What do you think of the Finance Minister's interim budget speech? Let us know your comments or share your views in the Equitymaster Club.

India's fiscal deficit as a percent of GDP

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One would not be blamed for assuming that the storm in emerging markets has subsided. After all, the plunge in emerging market currencies has halted. Also investors have reconciled with the fact that the US Federal Reserve will taper its bond purchase program at a slow but steady pace. However, as per Moneynews, the start of the next financial year (FY15) would be anything but calm. And it is not just the Fed's moves but political upheavals in current account deficit economies that could trigger yet another storm. Needless to say, with elections in May, India could be at the centre of this storm. In fact there is more to it. The forex reserves in 11 out of 17 key emerging economies, including Russia, South Africa and Indonesia fell in first two months of 2014. Thus as investment inflows dwindle and trade with a slowing China declines, the deficit problem in emerging economies is here to stay. Investors would do well to not get complacent and make their portfolio resistant to the upcoming volatility in emerging markets.

The fortunes of commodity businesses are highly dependent on the overall state of the macroeconomy. Since commodity prices are broadly a function of demand and supply dynamics, commodity businesses prosper during a business up-cycle. Likewise, when there is a demand slump, commodity prices fall and the profitability of the business is adversely impacted.

Take the steel sector for instance. During the last couple of years, the sector has witnessed a severe slowdown. On the other hand, input prices have been increasing steadily. This resulted in a significant squeeze in the profit margins of steel players.

When will the steel sector turnaround? If you were to go by the views of the chairman of the largest domestic steel player SAIL, C S Verma, the worst seems to be behind for the sector. What is his rationale? As per him, steel prices have gone up slightly in recent months owing to improvement in demand. Inventory levels have also receded.

We would like to take his views with a pinch of salt since the poor business environment and the political uncertainty continue to remain major challenges that could jeopardise chances of a quick revival in the economy.

Are we beginning to see a turn for the better as far as India Inc is concerned? Analysis of the December 2013 results season seems to suggest so. As per an article in the Mint, Indian companies grew at their fastest pace in the last 6 quarters in the Oct-Dec 2013 period. While revenue growth was subdued at 7%, growth in net profits was healthier at 19%. This could largely be attributed to the focus of the management to reduce costs and make operations leaner in a weak and challenging macro environment.

The performance across sectors remained mixed though. While pharma and auto seem to have performed relatively better, cement and metal companies continued to face pressure. Overall, there still remains an element of uncertainty with respect to a meaningful recovery in the forthcoming quarters. It seems quite likely that there won't be much improvement before the general elections. Post the elections, the agenda set out by the new government could determine the timing and pace of the recovery.

Now, this is an interesting anomaly that every investor should be made aware of we believe. For long, the conventional wisdom was that it is the growth in GDP that determines the returns that the stock markets give. After all, stock prices are slaves to earnings growth and earnings growth can happen only if there is GDP growth. However, if an article in businessinsider.com is to be believed, this is certainly not the case. It points out to a study where returns based on extrapolation were compared.

So, if we were to start in the year say 1972 and were to invest in an economy where the GDP growth was highest in the past five years, this strategy would have returned a decent CAGR of around 15%. However, if investments were made in the economy with the slowest growth record, investors would have earned much higher 25%!

This clearly shows that starting valuations matter a great deal. Countries which have grown the fastest in the last five years also have their stock markets bid up accordingly. However, the ones with the lowest growth rates also have cheaper valuations and thus they tend to offer higher subsequent returns. Interesting to know that approaches that work in bottom up stock picking also has its applications when taking an economy-wide call. And why not. Human nature remains the same whether one prices assets top down or bottom up, isn't it?

In the meanwhile, the Indian markets were trading above the dotted line for most of the day. At the time of writing, the BSE-Sensex was up by about 50 points or 0.25%. Stocks from the power and banking spaces led the pack of gainers, while those from the metal and consumer durables sectors were amongst the top losers. Equity markets in other part of Asia were trading firm with Hong Kong, Japan and China up by about 1%, 0.6% and 0.9% respectively. The European markets were trading firm as well.

 Today's investing mantra
"You want to see, first, that sales and earnings per share are moving forward at an acceptable rate and, second, that you can buy the stock at a reasonable price."- Peter Lynch

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