»5 Minute Wrap Up by Equitymaster

On This Day - 11 NOVEMBER 2010
Have you made uncertainty your best friend yet!

In this issue:
» Look what has beaten Sensex by more than 3 times this year
» Why gold demand in India is virtually a cinch to go up
» Roubini opposes the return to gold standard
» Morgan Stanley is finding equities quite cheap currently
» ...and more!!

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A simple question to begin with. Are you more comfortable buying in today's stock market environment or the one that existed in March 2009, when the markets were really staring at the abyss? If you are amongst the ones who believe that today's environment is indeed far more conducive for stock picking, then we think you are making a big mistake. The mistake of buying at a time when there is greater certainty about the market's future course of action.

Allow us to explain in greater detail. You see, as per a famous blogger Barry Ritholtz, if you want to earn good returns from the markets, there has to be some degree of uncertainty involved. This is because it is only during times of uncertainty that a stock will tend to be mispriced. As per Ritholtz, uncertainty drives the market's price discovery mechanism. Without any uncertainty, who is going to take the opposite side of the trade?

We believe Ritholtz could well be right here. Whenever there has been an absolute certainty about something, markets have tended to take a completely opposite stance. Recall what happened in Jan 2008. Investors were almost certain that Sensex could go on to scale new highs and within no time, a bear market began. Similarly, in March 2009, investors were absolutely certain that there is no recovery in sight for the markets. But what transpired was completely different. We saw the biggest turnaround in recent times.

Thus, to conclude, it is uncertainty that drives markets and contrary to popular perception, absolute certainty about something could actually result in an unexpected disaster. Little wonder, Warren Buffett often likes to say that uncertainty is a friend of a long term buyer of values. Hence, the next time you try your hand at investing; it could help to see the extent of uncertainty or the lack of it prevailing in the market place. If investors are absolutely certain that markets are going to go higher, it is perhaps time to take a completely opposite view.

 Chart of the day
Last week, the Sensex managed to close at its all time highs, surpassing its previous peak achieved in January 2008. However, a benchmark index touching new highs does not necessarily mean that all its constituents also have to do the same. Today's chart of the day will help explain what we are trying to say. Nifty constituents like Suzlon, Reliance Communications etc, are still way below the highs reached during the previous market peak of January 2008. Infact, these stocks are down anywhere between 60% to 90%, indicating that a large cap may not necessarily be the safest stock going around.

Source: Trend

Inflation has been a cause of concern for fast growing economies, especially India. As per the latest economic release, it has become a concern for neighbour China as well. China inflation in October has increased by 4.4% YoY, which is highest in two years. The gains on selling its own currency as well as burgeoning foreign exchange reserves have led to a huge inflow of money in the economy. This is fuelling a spike in the prices of the commodities.

While inflation has not yet reached alarming levels, the upward trend indicates that the government is likely to announce an increase in interest rates quite soon. The country is also grappling with the risk of asset bubbles which further intensifies the need for interest rate hikes. The Chinese government had hiked its interest rates last month.

Here's yet another instance of how inflation is playing havoc with the purchasing power of the poor. As per Bloomberg, prices of Turmeric, that essential Indian spice is up a whopping 64% this year. This is three times more than the surge witnessed in India's benchmark, Sensex. And it is not just Turmeric under whom the inflation has lit a big fire. Cardamom and Pepper, the other two spices important to Indians are also up sharply this year.

Besides lower production, what is leading to sky rocketing prices is the huge rise in speculation in these commodities. Just to put things in perspective, average daily turnover by value of spices futures on the National Commodity Exchange has almost doubled from a year earlier. And to make matters worse, since the markets lack depth, only a handful of wealth entities can sway the markets in their favour and hold other people at ransom. Clearly, an adverse demand supply situation has been made even more adverse by mindless speculation.

With stocks having run up so steep, the view is that prices are now expensive and way ahead of fundamentals. But Morgan Stanley believes differently. It opines that stock prices are 'crazy cheap' in comparison to bonds and cash. Sounds surprising? Morgan Stanley is of the view that global stocks are in the middle of a multi-year bull market that began in March 2009. And what more, this run will last for at least two more years. Therefore one should remain invested in the equity markets, especially those of emerging countries. The latter has especially caught its fancy largely due to the growth in the middle class and the consequent rise in demand for goods and services.

We agree that the growth prospects in the emerging nations are much better than those in the developed world. But the key here is the price that one should be willing to pay for this growth. At present, loose monetary policies by the US is driving money into emerging markets and is raising fears of asset bubbles forming there. Thus, while there could still be opportunity in US stocks, at the current levels one would have to tread cautiously while investing in emerging market stocks.

A few days back, we talked about how the World Bank President had mooted the idea of going back to some form of a gold standard. This, he believes would bring an end to deliberate devaluation of currencies by a large number of nations. However, not all experts favour this move. Nouriel Roubini is a case in point. As per MoneyNews, Roubini, one of the most clairvoyant economists of our times, has argued that reviving the gold standard may not be that good an idea after all.

Roubini believes that a fixed exchange rate regime or a gold standard takes away from the central banks' ability to induce pro cyclical measures in an economy. According to him, in a gold standard, monetary policy instead of helping to bring about a recovery ends up making it worse.

Roubini could well be true. But the current system has its share of flaws as well. In the current system, the central bankers are just not aware of when to stop printing more money. Take the US Fed for instance. Its money printing efforts are showing no signs of stopping or even slowing up. And this is highly risky as well. Infact, more risky than perhaps the gold standard. The key then is to maybe, have an entirely new approach. However, what is it going to be like is anybody's guess.

What has grown faster than India's GDP, inflation, and population growth over the past ten years? Gold indeed. Yes, that's right. Demand for gold in India has grown at an average annual rate of 13%, over the past decade. India, currently owns 11% of the above ground stock of gold. This equals to 18,000 tonnes, worth US$ 88 billion. Looks like we own a lot of this precious metal. However, Indians only own half an ounce of gold per capita (approx 15 grams). This figure is significantly lower than consumption in the Western world, showing huge scope for growth. So, either as an inflation hedge, an investment tool or to make jewellery, India's appetite for this shiny metal is far from being satisfied.

Meanwhile, after opening in the positive territory, selling pressure led the benchmark indices to slip into the red with the BSE-Sensex down around 90 points at the time of writing. Heavyweights like TCS, ONGC and Reliance were exerting the maximum selling pressure. Asian markets closed mixed today whereas Europe has also opened on a subdued note.

 Today's investing mantra
"The boom and the bust were normal-just two more swings in stock returns over the past century. Reversion to the mean is the iron rule of the financial markets." - John Bogle

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