»5 Minute Wrap Up by Equitymaster

On This Day - 28 DECEMBER 2009
One big lesson for investors from 2009

In this issue:
» Don't buy gold for profits, but for protection
» Lessons from Buffett's buyout of BNSF
» Taxpayers to pay for India's legal reforms
» Prospects are good for emerging markets. But so are the risks!
» ...and more!!

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2009 was an extremely strange and trying year for stock market investors. It started with 'fear' as the buzzword. Stock prices across the world were on their way down. Investor dumped their holdings as if the world was approaching the death of equities. Now as we close in on 2009, fear seems to have vanished. Instead, greed of more returns in 2010 has emerged as the key underlying theme.

So, what according to you has been the biggest lesson one can learn from 2009?

We believe it is that the investors would be doing themselves a great disservice if they continued to believe in the Efficient Market Theory at all times! Simply put, an 'efficient market' is nothing more than the statement that stock prices fully reflect all available information. But the experience of 2009 clearly suggests that markets could well be highly inefficient.

After all, if markets were efficient, everyone would have known of the rally that was about to begin in March 2009. But everyone didn't! If markets were efficient, we wouldn't have seen extreme despair and then extreme optimism in a space of just a few months. But we saw that!

As we stand now, the world seems a much optimistic place, especially as far as stock market investing is concerned. The markets are on their way up and business channel experts predict even better times. (remember that these very people were predicting doom at the start of this year!).

So, are the markets right this time around? We don't know. But going by history, it's always better to be cautious when your neighbour and even his aunt are all greedy about 'more returns from stocks in the next few months'!

 Chart of the day
The fact that markets are inefficient can be seen from today's chart of the day. It shows the sharp contrast in valuations that investors have accorded to stocks across different sectors over a year. For instance, the BSE-Realty index currently trades at a multiple of around 60 times earnings, as compared to just 8 times at the start of 2009! Another sharp movement has been seen in the multiple of metal stocks. The BSE-Metal index has moved up from 6 times in December 2008 to almost 30 times today.

Data Source: CMIE Prowess

There were many who weren't convinced that Warren Buffett made a smart deal when he acquired BNSF, one of US' biggest railroads last month. After all, railroads are dull, regulated businesses and have a history of poor return on shareholders' funds. Hence, why would someone as astute an investor as Buffett waste his money on such firms? However, Buffett is not one of the most astute investor of our times for nothing. In an exhaustive discussion with BNSF's CEO, he has offered a point by point rebuttal of all the arguments that were stacked up against the deal.

Buffett reasoned that unlike a lot of other businesses that came and went, US railroads are not likely to go anywhere and they are going to remain right there in the US. Furthermore, he argued over a very long term period, the US is going to grow and is going to have more people, more goods moving etc and hence, rail is the logical way for many of those goods to travel. Buffett was also aware that railroads cannot be something like Coca Cola or Google because they are public businesses and hence, have to be regulated and price controlled but he appeared pretty confident that railroads have transferred themselves into highly efficient businesses and over the long-term, his investment in BNSF should do just well.

Any lessons for aspiring investors here? Indeed. Think long-term, study closely the dynamics of industries that are low return and not very popular currently but still have huge competitive advantages and bet big when the turnaround happens. Budding investors would do a huge favor to their returns if they keep these lessons very close to their heart.

When a person writes a book that becomes the biggest-selling financial book in history and is the editor of a newsletter that serves more subscribers than any other financial-advisory newsletter in the world, his views indeed need to be taken seriously. We are referring to Howard Ruff, the legendary author of the bestseller, 'How to prosper during the coming bad years'.

In a recent newsletter, Ruff has argued that the US dollar is in its death bed and hence, when you buy gold and silver, you are not just looking for a profit but you are looking for protection against the decline of the dollar. He further reasons that Fed and the administration are determined to drive down the dollar, so why on earth would someone want to invest in US dollar and not the precious metals. So, here's another financial guru, trying to drive home the importance of staying invested in precious metals such as gold and silver.

Stock markets around the world have witnessed a spectacular rally in 2009. What is more, the buoyancy in BRIC markets in particular stands out the most. As reported in Barrons, EPFR Global has highlighted that inflows into emerging-markets equity funds are at all-time highs of US$ 75 bn so far this year. This is up from US$ 54 bn in 2007.

The reason for the same is not hard to find. Developed countries have been mired in recession for some time now. Hence the focus has shifted to emerging economies where growth is expected to far exceed that in the rich nations.

However, the real question is whether emerging economies have witnessed any meaningful growth in corporate earnings. The answer is - no! For all the profit potential of these emerging nations, some two-thirds of their equity outperformance in recent years has come not from earnings growth but from expansion in price-to-earnings multiple and a weaker dollar. Nobody doubts the long-term growth potential of the emerging markets. But we believe that this growth has a certain price attached to it. And at present, this price seems to be running ahead of fundamentals.

The government of India is planning some great reforms for the country's legal system. It aims to expedite the resolution of 30 m cases that are pending in different courts of the country. A great step indeed, right?

However, before getting excited, you must note that you might have to pay for such an initiative. The law ministry is planning to setup an independent body having wide range of powers, fully funded by the centre. It might happen that later, it might be funded by an additional tax applicable to all the citizens of India.

So, just like the educational cess we pay as part of our income tax now, we might have to pay the 'legal reform cess' in the future!

Anyways, Indian markets missed out on Asia's strong performance as the former remained closed today for Moharram. China and Japan led Asia's gains as their benchmark indices closed up by 1.5% and 1.3% respectively.

 Today's investing mantra
"When proper circumstances present themselves, act with decisiveness and conviction." - Charlie Munger

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