Uncovered! The biggest lie in finance - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Uncovered! The biggest lie in finance 

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In this issue:
» There's no going back on nuclear plans says Jim Rogers
» China economist vents his ire against US dollar
» 'Black Swan' fame Taleb is betting on hyperinflation
» Are infra stocks poised for a rebound?
» ...and more!


------------------- Crash Proof Your Portfolio -------------------

Imagine... The stock markets have crashed by 20%.

Trading on the exchange has been suspended.

Television anchors -- the cheerleaders for the rally thus far -- are looking as though they have seen a ghost.

But here's what matters the most- "How have YOU been impacted by the crash?"

If you want to be one among the very few who are geared up for any adversity, then, you need to see this right away!

Hurry... This opportunity will soon disappear forever!

-------------------------

00:00
 
Sometime in March 1952, an academic paper appeared in the popular magazine of that time The Journal of Finance. All of 14 pages long, the paper has the distinction of launching Finance the way we know it today. Nobel Laureate Harry Markowitz, the man behind the paper, had a very simple observation to make. He asserted that risk and return are inseparable. In other words, if one wants to earn above average returns, assuming above average risk is a must.

It goes without saying that Markowitz's discovery did receive a lot of attention. What it also did was it gave birth to one of the biggest myths in finance. Thanks mostly to the risk-return theory, most investors have come to believe that since equities are more risky than bonds, it is their birthright to expect equities to return 4%-5% more than bonds over a long term period.

Noted financial author Rob Arnott has argued that nothing could be further from the truth. And he has data from the US stock markets going back 10, 20 and 30 long years to back his claim. As per the risk-return theory, equities should be a cinch to beat bonds handsomely during these time periods, right? Wrong! Over the last 10-yr, 20-yr and 30-yr period, US equities have failed to outperform US long term Govt bonds! Infact, even after we consider the fact that stocks have doubled since their March 2009 lows, the last 10 years have seen stocks underperform bonds by as much as 5%!

The point that Arnott is trying to make is not that equities always underperform bonds over long periods. There have been periods where stocks have certainly outperformed bonds. The risk however lies in assuming that stocks will always outperform bonds over long term periods. And this is a dangerous assumption to make we believe. Hence, do not put all your money into equities resting on the assumption that over a 10-year period, you will certainly come out ahead. After all, as the US example shows, that may not be the case.

Do you think equities always outperform bonds over a long term period? Share your views with us or post your comments on our facebook page.

01:15  Chart of the day
 
Today's chart of the day perhaps throws some light on why, despite being such a dangerous source of energy, the world isn't quite willing to give up on nuclear energy just yet. As the chart highlights, the cost of preventing one tonne of harmful CO2 emissions is the lowest for nuclear energy. Biofuels and Geothermal will likely use up a lot of money if they are used to reduce CO2 emissions. The study, we believe, has failed to take into account environmental damage should there be some damage to nuclear plants. As the Japanese example shows, magnitude of damage wise, nuclear may not be all that cheap after all!

Source: Spiegel Online International
*European pressurised reactor

01:47
 
The Obama administration has claimed that it will achieve a reduction in the fiscal deficit from its current level of 12.9% of GDP to approximately 3%. Very neat! But how are you going to do that? Show us the arithmetic please.

It seems that the famed Black Swan author, Nassim Nicholas Taleb, has done the arithmetic already. And his numbers don't seem to match those of the US Fed and Treasury. So what does he plan to do? He plans to starts a hedge fund that will invest in commodities and options on oil and gold stocks. This is his hypothesis: Efforts by governments and central banks to end the global recession will lead to hyperinflation.

We pretty much agree. The US authorities have lost control over the massive debt levels and fiscal deficits. The painkillers that they are injecting into the economy are doing little good. They are only generating serious side-effects in the form of inflation.

02:19
 
Here's another one on nuclear power. Japan's disaster has raised several questions on the future of this energy source. Countries all over the world are rethinking their nuclear plans. Some are even looking at shutting down the reactors that are located in the seismic zones. But commodity guru, Jim Rogers, opines that nuclear power still has a future despite the natural concerns. The reason for this is that there is no other equivalent alternative for gas and coal for generating power.

He states that along with oil and coal, nuclear power stocks would become very good buys within the next few years. And he feels that this is the right time to pick these stocks up as they have suffered a beating since the earthquake in Japan. In addition to the nuclear stocks, Rogers is also optimistic on the outlook for oil. He feels that oil prices would continue to rule for at least a decade to come. We agree with Rogers on both count and agree that nuclear power and oil could be the right way to go for investors.

02:56
 
With US$ 2.85 trillion in foreign exchange reserves, two thirds of it in US dollars, the Chinese are in a quandary. The US has continued with its loose monetary policies battling to prop up its economy. This is expected to weaken the dollar and consequently would also erode the value of Chinese assets. Little wonder then that the dragon nation has expressed its discontent with the current state of things. China believes that the dollar is sowing the seeds of financial turmoil. And so it is of the view that the solution is to promote new reserve currencies.

China's dollar dilemma is more problematic than other nations. This is because it pegs its currency to the dollar. Thus, to limit the appreciation of the Yuan, it is compelled buy a large amount of the dollars streaming into the country from its trade surplus and recycle those into US investments. One of the proposals put forth by China is to have several reserve currencies and keep their exchange rates stable. That is hardly going to garner much support in an environment where most countries are attuned to a flexible exchange rate regime. And China will have to realise that it cannot blame the US entirely for its problems. If they refrain from pegging the Yuan to the dollar, there will be no need for China to buy dollars at a furious pace.

03:43
 
If one looks at the sectoral performance of Indian indices over the last one year, infrastructure might top as one of the worst performing sectors. And there are multiple reasons for this underperformance. Increase in commodity prices, rising interest rates, environmental delays and execution issues are the ones that come on top of mind. This poses a big question to investors. Is this the right bottom fishing opportunity or is there more pain on the cards from here on?

Although it is difficult to predict the trough of any cycle, we believe that the current stock prices have priced in the worst case scenario. And this is evident from the valuations of these companies. Right now, most of the infrastructure companies are trading at single digit valuations and some of them are available at even less than their book value. So, in terms of valuations, this seems exciting. But is the macro-environment conducive enough for the sector to re-rate? We have mixed reactions to this. Due to rising inflation, RBI will continue to maintain its hawkish stance. This means interest rates would continue to remain high in the near term. Amidst banks reluctance to lend, even funding risk will continue to remain a major concern for these companies.

Thus, even though the valuations are attractive, one has to be careful in assessing the overall macro-risk before taking exposure to these companies. We believe that pure play construction companies with sound management, low leverage and minimal equity requirement for their embedded BOT assets are the ones that are ripe for bounce back in the near term as they are partially shielded from the current macro-risks.

04:50
 
Meanwhile, Indian stock markets continued with its good form of the past few sessions with the Sensex trading around 280 points higher at the time of writing. Heavyweights like Reliance and Infosys were seen adding a good part of the buoyancy. Most other Asian indices have also closed on a strong note today.

04:57  Today's investing mantra
"I'd be a bum on the street with a tin cup if the markets were efficient." - Warren Buffett
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11 Responses to "Uncovered! The biggest lie in finance"

shome suvra chakraborty

Apr 2, 2011

In case of bonds both credit risks and market risks can be taken care of through credit derivatives.The yield-price inverse relationship can add also to the return when yield decreases. In case of equity return may be higher but it is uncertain.

Like 

S.K.DAMANI

Apr 1, 2011

Dear Sir,

Monies like water will always find the best way to move out shiftly. If in a growing developing economy like India, If you just buy bonds and keep, you will get your returns, but it will be equities only which will give you best returns. Moreover, unless you churn your portfolio and book profits over periods of time, you may lend up in negative. MArkets do not move only one side. The WB stories can be very few and far between.
Regards.
Damani

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prvrajan iyer

Apr 1, 2011

Yields on Bonds loose value on rising inflation as it is in India. Whereas the underlying assets represented by the equity rise in value over a period of time. Hence in Indian scenerio equities perform better over long period. When the reward is above average non-greedy
investors books his earnings and waits for opportunity to reinvest.If you are greedy you loose all opportunity and sleep as well.A watchful investor in equities wins over bond yields and disproves your sensational title.

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taffazull

Mar 31, 2011

The following comment from Nature News of 30th March that the effects of slowdown in Nuclear Industry would be felt in India and China but not in U.K. and U.S. as their nuclear plans are limited to only renovating preexisting nuclear plants more than 40 years old.In other words they have no plans to build any nulear plants and have left this very attractive option for China and India.Hopefully this may help to solve the worlds population problem also.
In my view the option is not to increse power generation but to prevent power wastage and increase efficiency of utilization.That will provide breathing space till science learns to make use of solar energy.Just one hour of solar insolation is sufficient to supply the entire worlds energy needs for one whole year

Like 

Ashish Shah

Mar 31, 2011

The reason being the US is implementing cheap money into the market with reducing bank rates which in turn leads to higher bond yeilds. Also reason for the higher bonds yeilds is that ample quantity of US bonds is been sold in the open market world wide , resulting into heavy debt on the US governement. Hence the cycle of debt continues.

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sayon ray

Mar 31, 2011

though one may or may not agree with the content, I must admit I like the way of writing and expressing ur views. Its fun. Keep it up.

Like 

Anand

Mar 31, 2011

India is different from USA. Till recently there were no long terms bonds available to retail investors ( except this recent SBI Bond issue).

If we compare stocks with FDs, NSC etc then it will depend entirely on the interest rates prevailing. In todays high interest rate scenario Fixed income security may appear to be a safe bet. High interest rates will reduce capex & consumption hence equities may underperform. But country is still growing at 8.5% real GDP & 17% if we consider inflation also.

In Indian scenario equities are likly to over perform despite cycle of high/ low interest rates over next 10 - 15 years because of growth of economy.

Like 

Turab

Mar 31, 2011

The observation may be true for the US markets.
In Indian market Equities rule and will stay as a better option according to your risk-return profile

Like 

Ashok Kumar

Mar 31, 2011

There is only one thing that can be said with certainty :
That nothing can be said with certainty.

Like 

sp

Mar 31, 2011

I disaree with the judgement made by the editor while writing the article.As could be seen, the point is : more the risk, higher the reward obtained. It does not mean that an entity like equity should rise more than a bond but what it means is that the rewards obtained in investing in equity would be more compared to bonds.As higher volatility generating higher risk would lead to more profit taking or rewards as proposed in the theory. Hence the contention that bonds have outperformed equities is a fact but irrelevant to the conclusion drawn. I hope the editor understands this point now :-)

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