»5 Minute Wrap Up by Equitymaster

On This Day - 23 AUGUST 2010
Isn't the govt. interested in retail investors' interest?

In this issue:
» Are the Indian markets ripe for correction?
» India lacks institutions that work for long term future: Murthy
» Realty remains a dirty word for RBI
» Biggest problem in business forecasting - Overconfidence
» ...and more!!

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Stability in governance is a key plank that an incumbent government plays after the end of its five year term. The argument is that if voters bring the same government back to power for a second five-year term, it might be able to complete a lot of tasks it couldn't in the first five.

It's very ironical then that the government itself wants some of the key men managing India's policymaking to not last more than a single term. And that too, a smaller term of three years! The SEBI chiefs are a case in point. First it was Mr. Damodaran, and now it's Mr. Bhave.

The former was not re-appointed after finishing his 3-year term that ended in 2008. Now, the government is repeating the process. It is all set to start the process of selecting the next SEBI chief. This gives a clear signal that it does not favour a second term for Mr. Bhave.

This is particularly sad given that Mr. Bhave has done some good work at the helm of affairs at SEBI. And his good work was largely to provide more safety mechanisms for small investors against the might of companies and mutual funds. But probably this has brought him in the eye of storm of these biggies - companies and mutual funds - who have occasionally taken out knives and blamed Mr. Bhave for taking sides with retail investors.

And we know whose side the government is more prone to take! After all, its habit of not reappointing well-performing men points to something fishy in its thought process.

Anyways, what do you say? Do you think Mr. Bhave deserves a longer term as SEBI's chief? Share with us, or post your comments on our Facebook page.

 Chart of the day
We recently heard how China has surpassed Japan as the second largest economy in absolute terms. However when one looks at the GDP data on a purchasing power parity (PPP) basis, China has long been the world's second largest economy and in fact is already more than twice as large as Japan's economy. As today's chart suggests, China was also the world's largest economy (on a PPP basis) 500 years back. In fact, India was the world's second largest economy then. But then, China and India were the biggest economies then because they had the biggest populations. After all, population size was a dominant factor in economic output then.

But once the industrial revolution came along, followed by the information revolution, population size did not matter much. First the Europeans, then the Americans leveraged technology to multiply their economy's size. Now, while China is again catching up, India still has a long way to go!

Source: The Big Picture

Indian companies have made considerable progress over the past many years. Many of them have made a mark in the global arena. And yet something seems to be missing. In this regard, founder of Infosys, Mr. Narayana Murthy has made a very valid point. He believes that India lacks institutions that work for the longer term. He is of the view that India needs to encourage research institutions that will look at the future. And moreover come forward with solutions that offer deliverable results.

This also means that one must tap the experience and knowledge of India's research institutions, and also involve them in policymaking. In fact, as far as research and development is concerned, Indian companies are a shadow of their developed market peers. Indeed, Indian companies need to have a strong vision of where they are expected to head in the longer term, and not get carried away by quarterly numbers and the need to live up to short term expectations.

Indian stock market had a volatile day today. The BSE-Sensex was trading up by around 15 points (down 0.1%) at the time of writing this. The BSE-Midcap and BSE-Smallcap indices however bucked the trend and closed with strong gains of 0.9% each. Selling in banking and FMCG stocks caused the pressure on the Sensex today.

Anyway, the performance of the Indian markets has been good off late. After a 3.5% drop in May over April 2010, the markets have clocked three consecutive months of gains (till August so far). These gains have taken the BSE-Sensex to its 30 month high. In fact, the last time the BSE-Sensex was at the current levels was just before the crisis started in January 2008.

So, are the Indian markets ripe for a correction? And what should you as an investor do?

Well, the answer lies in valuations. As we stand now, the overall valuations of the Indian markets are at high levels. And this makes the markets vulnerable to a correction.

But then, the answer to this uncertainty does not lie in selling all stocks and sitting on cash. The answer lies in the strictness with which you select stocks. Investing is a continuous process and like you need to be prepared for a bull run, you also need to be prepared for a correction (and not fear it). Having safe and sound companies in your portfolio, which you believe will do well in the long term and across market cycles, is the way to go.

The realty story seems to be spinning unreal dreams for players in the sector. The regulators like the National Housing Bank and the RBI are rather wary of skyrocketing real estate deals. And the last thing they want is real estate players lending money to prop up the value of their own assets. For the more debt real estate projects attract, higher is the chance of speculation on the value of the asset. The same can be dangerous to the health of a stable financial system. And given its repute, the RBI would rather prefer to be called a conservative central bank than encourage financing of overpriced assets.

The very proof of such negative sentiment is the RBI's refusal to grant licenses to real estate players. Even if that means going slow on the government's financial inclusion plans. We believe that unless we have a more regulated real estate market, such a cautious approach is warranted.

The future is inherently unpredictable. But we humans never give up trying to predict it. Much effort goes towards it in many branches of science. Then there are the oracles, tarot card readers, crystal ball gazers and fortune tellers. Some include the meteorologists and stock market analysts in the same category. The funny thing is - human beings have many limitations when it comes to making forecasts.

A new discipline called behavioral economics studies these limitations. One such limitation is 'overconfidence'. It basically says - most of us think that we are 'better than average' in most things. Also, our sense of the probability of events is out of whack with reality. Richard Thaler, a leading behavioral economist, writes in the New York Times how chief financial officers and chief executive officers of major US companies make poor forecasts.

When captains of industry have difficulty in predicting the business environment and are also overconfident about it, is it any wonder stock analysts are no different? It is for this reason that investors must always seek a margin of safety in valuations while making their investment decisions.

We are conducting a poll on our Facebook page that asks - "Given an opportunity, which investing guru would you like to meet in person?" From the answers we've received so far, Warren Buffett rules the roost. What's your choice?

 Weekend investing mantra
"Identifying bubbles is fairly easy. You don't know how big they will get and you don't know when they will pop. You don't know when midnight will hit, but when it does, it turns carriages to pumpkins and mice. What markets will do is pretty easy. When they will do it is more difficult. Some people want to stick around for the last dance, and they thought that a bigger fool would be just around the corner tomorrow." - Warren Buffett

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