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Would you short central banks if you could?

Jan 14, 2015

In this issue:
» China's ghost cities are coming back to haunt the government
» US to face another sub-prime lending crisis?
» Special dividends from central PSEs this year too?
» ...and more!

What has been your biggest disappointment about financial markets in the last few years? For some of you it may be the lack of access to cheap credit. For others it may be the sluggishness in prices of certain asset classes. And for many it may be the regret of never participating in the stock market rally having burnt your fingers earlier. If you ask us though, the biggest disappointment has been the inability of guardians of the financial system to do their jobs well. We are referring to global central banks (barring RBI), capital market regulators and rating agencies.

With the exception of RBI, almost every other central bank globally has dismissed the key objective of central banking. Which is to ensure that monetary stability and currency stability go hand in hand. Instead most have been busy colluding with governments in order to print money. That too, under the guise of stimulating growth. The situation has become so perverse in recent times that the credit bubble has distorted investment markets and corrupted governments. Therefore when in a recent interview to Bloomberg, Marc Faber said that his choicest asset class for short selling would be 'central banks', we were hardly amused. Short selling is defined as a trading strategy that seeks to capitalize on an anticipated decline in the price of a security. The core fundamentals of most central banks globally have certainly nosedived over the past decade. Therefore if any of the central banks were listed securities, they could have well been high on the radar for short selling.

The 'hedge' suggested by Faber against the poor management of financial system by central banks is buying gold. In fact he also predicted that the precious metal could go up by as much as 30% in 2015 if central banks continue with their money printing spree.

Now even though the flood of cheap liquidity from global markets has found its way to India, we have been fortunate to have very prudent central bankers at RBI. Not just Dr Rajan, but even his predecessors have done a terrific job of shielding India against asset bubbles. And therefore the risk of monetary instability and currency crisis is not as pronounced for Indian investors as it is for others.

Buying gold as a small proportion of one's portfolio is certainly recommended. But the same should not be in anticipation of annual returns. The demand for gold may remain firm if the central banks in the US, Eurozone, Japan and China refuse to mend their ways. However, investors in India would do well to seek returns from asset classes like stocks rather than buy too much gold in anticipation of poor central banking. With the comfort that the RBI will do what it takes to keep India's monetary system stable, buying safe stocks that can overcome market volatility is the best way forward.

What has been your biggest disappointment about financial markets in the last few years? Let us know your comments or share your views in the Equitymaster Club.

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Talking about asset bubbles, China's ghost cities are coming back to haunt not just its banks and investors but also the government. In fact as it turns out, the Chinese government may be the biggest victim of a bubble burst in Chinese real estate, if any. As per a report by Deutsche Bank, published by Economic Times, Chinese government revenue growth in 2015 is expected to be the lowest since 1994! And the key reason being land sales, which account for over a third of local government revenues, declining by as much as 20%! In addition, total fiscal revenues will likely grow just 1% YoY in 2015, the slowest pace since 1981. The Chinese government has also piled up some US$ 3 trillion in debt via opaque local government financing vehicles (LGFVs). And most of the funds have been invested in questionable infrastructure and real estate projects. Thus a crash in realty prices is something that the Chinese government can ill afford. Needless to say that this is exactly why the government has been so supportive of banks lending to realty sector and printing money to keep realty prices stable. However, whenever the inevitable happens, the Chinese government too could be staring at a fiscal deficit no lesser than India's.

  Chart of the day
With India's fiscal deficit already having almost reached full year's target in the first eight months of the current financial year, it does seem the government will find it tough to maintain its budgeted estimate of Rs 5.31 trillion for FY15. As of November end, the same stood at Rs 5.25 trillion.

As reported by the Hindu Business Line, there is a possibility of the government looking to seek special dividends from central public sector companies. This is because the tax revenues are not expected to be as budgeted. Tax collection stood at only 42% of budget target. The shortfall is estimated to be as much as Rs 1 trillion.

Government to rely on dividends to bridge deficit gap?

Today's chart of the day displays the budgeted revenues from dividends from PSEs as compared to the actual payments received by the government. Given the expected shortfall, as well as the divesture program not going as planned - the chances of a situation being similar to the previous year seem high; that is of the government relying on dividend payments from some of the larger cash rich companies.

Also, with the progress on the divesture plans being slow, it would only add to the pressure. To top it off, the Business Standard has reported that the government is rethinking its plans to divest stakes in the biggest jewels - Coal India and ONGC given their subdued prices. Dividend yields of these stocks stand at about 8% and 2.7% respectively. However, in case of the former, the payout ratio stood at 120% of profits as compared to 51% and 42% in the preceding two years - on the back of special dividend paid out by the company.

The year gone by was a very strong one for the US auto industry. Sales of light vehicles stood at their highest in a decade. Increasing demand for such items would be a sign of an economic recovery usually. But is this the case in the US as well? Well... US politician David Stockman is of the view that much of the growth in auto sales is attributable to the increase in sub-prime loans; the latest 'big bank scam' as termed by him.

Ever since the financial crisis, Americans seem to be in deleveraging mode. However auto and student debt still remain on the books of households. As per Mr. Stockman, as much as a third of the loans are being provided to such borrowers, which are being lent at interest rates as high as 20%! It is believed that the value of new and used cars have not yet started to decline. And as such, the going seems to be good for the lenders considering the vehicles themselves are the banks' collaterals.

However, the proportion of delinquencies - or defaults - has started to rise. As reported on the website 'more than 8.4 percent of borrowers with poor credit who took out loans in the first quarter of 2014 had missed payments by November, according to credit industry data. It was the highest level of such delinquency since 2008.'

Well... with credit quality declining - pretty much the premise of the last financial crisis - is there another crisis situation looming for the US?

The Indian markets were trading in a choppy manner today as the indices recouped their post noon losses and hovered around the dotted line at the time of writing. The BSE-Sensex was trading lower by about 11 points. The BSE-Midcap and Smallcap indices were trading flat as well. Stocks from the metal and FMCG spaces were least favoured today while information technology stocks were in demand. The Asian stock markets ended the day on a weak note today.

 Today's investing mantra
"In the long run, a portfolio of well chosen stocks and/or equity mutual funds will always outperform a portfolio of bonds or a money-market account. In the long run, a portfolio of poorly chosen stocks won't outperform the money left under the mattress."- Peter Lynch

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat and Tanushree Banerjee.

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