»5 Minute Wrap Up by Equitymaster

On This Day - 7 JULY 2011
Is this asset class ripe enough to crash?

In this issue:
» Developed nations are highly indebted
» Sensex to touch 22,000 by the end of 2011?
» Extending Subbarao's term is logical
» India's fuel subsidy bill rises further
» ...and more!
----------------------------- A Good Time To Sell Bad Stocks -----------------------------

It's never too late to get rid of 'bad stocks'.

After all, you never know how bad a market crash could get.

But what are these 'bad stocks'? How do you identify them?

For answers to these questions, and more,click here to read on...


What goes up at a dizzying pace has to come down at some point. And that seems true for commodities as well. After softening in 2009 as a result of the global financial crisis, commodity prices enjoyed a meteoric rise. This was due to a number of factors, chief among them being the strong recovery exhibited by emerging economies such as India and China. So robust has been the appetite for growth that this translated into huge demand for commodities and metals thereby driving up prices as well. Not just that, speculators and investors joined the bandwagon too in anticipation of a prolonged bull run in commodities.

But the sustainability of this strong run in commodities is now being questioned. In this regard, investor and author Gary Shilling is of the view that commodities are not only about to end their bull run but are going to come crashing down. And one of the main reasons for this has been attributed to the likely slowdown in China. Indeed, the Chinese economy is battling inflation and its government has been raising interest rates to tackle the same. This is bound to have some negative impact on demand as well as profitability of companies. At the end of the day, there is only so much that China can consume. And as its economy enters the cooling phase, it will no longer needs as much oil, base metals and other commodities.

For India, meltdown in commodity prices would certainly be a big boon for India Inc. India, too is grappling with high inflation. The central bank's rate hiking measures have begun to weigh heavy on the profitability of companies. In such a scenario, high input prices have further compounded woes and a softening on this front will certainly be a welcome relief for companies. But while it seems that a fall in global commodity prices is inevitable, when that will happen is anybody's guess.

Do you think that commodity prices are likely to crash anytime soon? Share with us or post your comments on our Facebook page.

 Chart of the day
Debt in developed countries have assumed gargantuan proportions post the global financial crisis. As today's chart of the day shows, Japan, US and some European countries had a very high percentage of gross government debt in 2010. And while cutting this debt down is the obvious solution, actually implementing the same may not be that easy. Take the case of Japan for instance. Debt will have to reduce by around 30% for the debt to GDP ratio to come down to around 60% of GDP by 2026. Indeed, the outlook for these nations looks quite grim.

Data Source: The Economist

"Sensex will touch 22,100 by end of 2011". This is a statement made by Nomura Asia, a leading investment bank. Nomura's top officials opine that Indian companies are global in their operations and focus. As a result, they stand to benefit hugely from the global recovery. This in turn would boost the companies' performance. And all that would give an upward push to the stock prices and eventually the stock markets. Reading such news articles is bound to boost investor confidence. But we would advise investors to turn cautious when such bold announcements are made. These create a general euphoria that leads to sharp incline in stock prices. But most of the times, the price increase is just due to the herd mentality of the stock market players. It is in no way justified by improved company fundamentals. And we all know what happens when the euphoria wanes away. Stock prices correct sharply when that happens. So it is better for investors not to get carried away in the flow. It is better to identify fundamentally sound companies and keep buying them at attractive valuations. That is the only way to maximize returns in the long term.

India owes a lot to its key financial regulators - the RBI and the SEBI. Especially at a time when global markets are in a state of turmoil and the Indian government is trying to salvage its graft stained reputation. The regulators have been at their best trying to protect the economy from the maladies in the West. Balancing growth and inflation, keeping a close watch on capital inflows and streamlining investments have been at the top of their minds. These have ensured that despite the near term headwind of high commodity prices and lower growth, the future is not all bleak for India. The RBI in particular deserves a mention for being the key reason for India resilience to economic shocks. While the attempts to rein in inflation may not have been very successful, the proactive nature of RBI's warnings to Indian banks on risk exposure can hardly be bettered. In such a scenario, allowing the RBI governor Dr Subbarao an extension of his tenure over 3 years seems to be the most logical thing to do.

In India, a vast majority of domestic savings are held in bank fixed deposits. This is considered a safe investment. But, over time it is expected that individuals will discover that holding money in mutual funds is beneficial, and will help them multiply their money over the long term. More than 20 years back, UTI funds were the only available mutual funds. But, now there are hundreds of different schemes to choose from.

Now, while Indians trust their friendly neighborhood bankers, are mutual fund managers to be trusted? What strikes us as a surprising fact is that while one needs a certification by SEBI to 'distribute' mutual funds, no qualification per-say is needed in order to 'manage' one. So how important is a fund manager in the scheme of things? Most big mutual funds have various processes in place in terms of an army of analysts, and researchers. Some passive funds, just benchmark their investments to a certain index or benchmark. These are thus more dependent on IT and software systems. But, there are funds which are actively managed, and where your hard earned money lies at the mercy of the fund manager. He can decide his allocation to various sectors, when to buy and sell stocks, and what kind of stocks to invest in. Stock picking does require certain skills and qualities. Maybe some guidelines like minimum experience in the money management field, or some certified training will help ensure that your money is in safe hands.

Well, this news is nothing new. The country's fuel subsidy bill has risen again. Despite the recent fuel price hikes, India is expected to incur an additional under recovery worth Rs 300 bn over and above the budgeted amount for FY12. The subsidy given in the budget was peanuts as compared to the huge expenses seen in the past and has already been exhausted before the end of second quarter itself. An amount of Rs 250-300 bn is likely to be offered in monsoon session of Parliament that commences on August 1. The relief offered assumes oil prices below US$ 100 a barrel which is unrealistic. This is also not commensurate with the paltry relief of Rs 50 bn on account of the recent fuel price hikes.

Hence, we will not be surprised to see another round of price hikes for fuels. However, this will only raise inflation and hurt growth rate of the economy. But the other option is no good. Leaving fuel prices unchanged will shoot India's fiscal budget deficit well beyond the targeted 4.6% and lead to higher debt. A higher fiscal deficit will push inflation anyhow.

So, is there a way out of this catch 22 situation? While the main culprit, crude oil prices, remain beyond India's control, we believe the best that the Indian Government can do is to be realistic about the subsidy grants. While uncertainty in the oil prices will stay, it can at least announce a clear subsidy sharing mechanism so that the stakeholders can plan accordingly. This will only help the Government in its alternative disinvestment plan to control the deficit.

The Indian stock markets have been trading strong throughout trade today. At the time of writing, the benchmark BSE Sensex was up by 209 points (1.1%). All sectoral indices were trading in the green led by FMCG and Capital Goods. Asian stock markets were trading mixed with Indonesia and South Korea leading the gains. However, China and Taiwan were the major losers. Europe has opened the day in the positive.

 Today's investing mantra
"The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share." - Warren Buffett

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