Is it time for investors to switch to debt?

Apr 3, 2014

In this issue:
» Why CPI matters in India!
» RBI allots licenses only to two entities
» Jim Cramer believes US stocks are not in a bubble situation
» Dr. Rajan hopes for a good budget
» and more....

As the days go by, Indian stocks continue to remain in the headlines. The benchmark indices have been hitting new highs - day after another. And investors now have gotten used to it. While some are of the view that the market is being driven by the election frenzy, others believe that the better health of the Indian economy - especially when compared to its peers - is what is driving up stock prices and therefore increasing expectations.

There are a bunch of factors that are being gauged keenly. Some of which include the falling inflation levels, and its effect on interest rates in India. The latter is expected to drive the much needed revival in capex cycle. In addition, there are strong hopes of a stable government coming into power in a couple of months from now. And that the new government could possibly accelerate the reforms process and thereby improve the fiscal situation of the country.

But then, if one thinks about it... there are many ifs and buts here as well. As pointed out by the author of a Business Standard article, the RBI may find it difficult to achieve its inflation target of 8% by January 2015, despite it being at such levels in present times. This is because of the expected weak monsoons in the current year. And if that were the case, inflation would move in the undesired direction. As such, this brings about a big amount of uncertainty - something which market participants seem to not be too concerned at the moment; maybe because of the not so high probability of this development (yet), one that is still a few months away.

Then, there is uncertainty over the Crimean region, which would impact global oil prices and thereby lead to deficit assumptions going for a toss. Not to mention, the impact it could have on gold prices as well, which if purchased by Indians could impact the country's current account deficit levels once again. There has also been news of the government looking to lower the duties on gold over the past few days.

Further, the entire episode of the QE tapering also needs to be accounted for. The acceleration of tapering, coupled with expected rise in interest rates would lead to money being pulled out from across the world and back in to the US. This would lead to a stronger dollar while weakening the other currencies - including the Indian rupee.

In short, the author of the article suggests that given the many uncertainties, the RBI is unlikely to tinker with the monetary policy for a couple of months. And this will keep the yields in fixed instruments high. Now, when this is compared to earnings yield of the benchmark indices which stands at about 5.5% currently, debt yields are much higher; thereby hinting that investors could consider the option of moving to debt at the current juncture.

In a sense, it boils down to the question of whether stock markets in India seem expensive or not.

When we look at the way valuations have moved since the start of 2008, it's been quite a volatile ride. At the peak then, the BSE-Sensex was trading at about 28 times. This was way above the long term average. Next high was touched around October 2010, when the Sensex crossed the 21k mark once again. Valuations at the time were about 24 times, which was still on the higher side.

This time around however, the Sensex has been trading at levels of about 17 to 18 times, ever since the market has been hovering above levels of 21k; which it has been doing since the end of 2013. Presently, the Sensex is trading at about 18.2 times, which is slightly above the long term average. As such, we do not believe that there is a sign of concern yet; but maybe so in certain pockets.

Parameters that investors should keep an eye out for are the performance and valuations of mid and smallcap companies - especially when compared to their larger peers- to take a call on whether a bubble situation or a 'time to be concerned' has arrived. As such, the best approach continues to be the bottom up one, wherein investors need to take a call on valuations of each stock based on its fundamentals and growth potential.

Having said that an overexposure to stocks or debt could be risky. And instead of considering the option of switching over to debt, investors would do well to keep a fair balance of debt and equities in their asset allocation.

Do you think investors should book profits in equities and move their money to debt instruments? Let us know in the Equitymaster Club or share your comments below.

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 Chart of the day
With the RBI now targeting Consumer Price Index (CPI) as an inflation benchmark understanding the constituents of the index will help interpret the movement in consumer inflation in a better way. As can be seen in today's chart, the weight of food, alcohol & tobacco is 50% in India's CPI index. This is highest amongst BRICS. A higher share of these items means Indian CPI is more sensitive to movement in prices of food, alcohol and tobacco when compared to other countries. In fact, as per an article in the Mint, a 5% swing in food prices affects the Indian CPI inflation by 2.5%. And with food prices having remained at elevated levels, CPI inflation in India has hovered in double digits over the last two years. Hence, the RBI continued to maintain its hawkish stance in the recent monetary policy review.

Food constitutes a high proportion India's CPI
*- Weight of food, alcohol and tobacco as a percentage of CPI; ^- South Asia

But the question is whether RBI can tame CPI inflation through its monetary policy. Well, not really. Monetary policy tools are ineffective to curb food inflation which is a function of demand and supply. With a high weight of food products in the CPI index, taming inflation by raising interest rates may not fetch the desired results. Good monsoons, better irrigation & storage facilities and bumper harvest will increase supply and reduce food prices. This in turn shall reduce CPI inflation.

The much awaited bank licenses from the RBI was made available to just two entities. Of them IDFC is the only listed NBFC while Bandhan Financial Services is an unlisted entity in the Microfinance space. Others in the fray including corporate groups like Reliance, Aditya Birla Nuvo, L&T etc seem to have got sidelined. This on the back of concerns that allowing private sector to open banks would lead to 'profiteering'. Also, at a time when the banking sector is facing huge NPA problems from even large corporates, bank licenses to corporates could have been a retrograde move. The last time bank licenses were issued was in FY04 when Yes Bank and Kotak Mahindra Bank were the only two entities to fetch them. While both Yes Bank and Kotak Bank have had to struggle to grow their low cost deposit base, IDFC and Bandhan will also face hurdles in costs and priority sector loans. Thus, while the initial hiccups may not allow the new banks to be profitable in the short term, it could be a step towards financial inclusion.

Battle lines are now clearly visible between those who believe that US stocks have entered into bubble territories and the ones who don't seem to feel so. Count famous CNBC commentator Jim Cramer in the latter camp. He argues that the best performing Dow stocks in the quarter gone by were all old school stalwarts. These are stocks that have been around for many decades now. And are nowhere in the category like cloud computing and bio technology, which we thought are well and truly in bubble territory. Cramer seems to be right here. The craze that was seen at the peak of dot com mania or even the 2006-07 highs is certainly conspicuous by its absence currently. However, does it mean that one should jump headlong into stocks now? Certainly not. What can be the best middle of the road option would be to remain half invested in stocks and half in cash or some such liquid instrument we reckon. After all even, very successful asset managers like Seth Klarman and Steven Romick seem to be doing the same thing.

As per a leading financial daily, the National Housing Bank is considering a proposal to allow lenders to provide up to 90% of the property value as home loan. The proposal is meant for loans above Rs 20 lakh with a mortgage guarantee cover. A mortgage guarantee cover is nothing but an insurance policy which compensates lenders or investors for losses in the event of a mortgage loan default. Under such an arrangement, a housing finance company enters into a contract with a mortgage guarantee company at the time of loan origination.

Higher loan to value ratios backed with such guarantees are expected to boost the growth in the housing finance space. More importantly it's a win-win situation for the parties involved. That's because it's a margin driver for the housing finance company. And such a mortgage guarantee-backed securitization deal favours the lender who bags the deal. For bankers seeking to meet the priority sector targets, such mortgage guaranteed deals come to their rescue. Above all, it's the borrower who stands to benefit significantly as he would be able to avail a loan of Rs 90 lakh against a property value of Rs 1 cr, for instance. But on the flipside, the risk would be any compromises in due diligence, checks of creditworthiness of borrowers, fluctuation in interest rates, meltdown in real estate prices, amongst others.

It was quite clear from the RBI's monetary policy yesterday that the outcome of the elections would play a role in determining the next course of action in the coming quarters. And the Governor Mr Raghuram Rajan is hoping that the post-election Budget will focus on bolstering investments and fiscal consolidation. As highlighted above, the RBI has been fighting a lone battle in keeping inflation under control. The current government's apathy towards reforms and development meant that it did not offer much support to the central bank in terms of reining in inflation. And so there are hopes that the new government would emphasize on a good budget, agricultural reforms, reducing subsidies, amongst others, all of which would help in cooling inflation. As reported on Firstbiz, the RBI-appointed Urijit Patel panel, in its report, has set CPI target of 8% by 2015 and 6% by 2016. The RBI no doubt will work towards achieving this. But whether these targets will be met will depend a lot on how effective the new government is in implementing reforms.

In the meanwhile, the Indian stock markets were trading weak as selling intensified as the day progressed. At the time of writing, the benchmark BSE-Sensex was down by 125 points (-0.6%). Only pharma stocks were trading positive whereas capital goods and oil and gas stocks were leading the pack of losers. Asian stock markets were trading mixed with Japan and Singapore being the major gainers While China was trading negative. European markets opened the day on a weak note.

 Today's investing mantra
"The best stock to buy may be the one you already own." - Peter Lynch

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4 Responses to "Is it time for investors to switch to debt?"

Apr 4, 2014

No asset allocation must remain as the central focus. Some portion of equity where it has runup quite a bit cane be converted to debt.


Sandesha Laad

Apr 4, 2014


I have subscribed to your 2 years subscription for large cap stocks but hardly seen upward movement in ur recommendations even in the bull run except for few stocks . Need to know more on the same. Also ur certain exits like Voltas were wrong when others were giving a BUY report on Voltas Also u did not cover metal stocks
Need to more on the same. Also pls let me know if any one year discounted subscription for small cap and/or mid cap stocks

Sandesha Laad


parimal shah

Apr 4, 2014

1.The basic reason for current stock prices is FII inflows.
2.The CPI needs to get rid of tobacco and alcohol. With empty coffers the government's budget will keep raising tax on these items and the subsequent price rise in these items will skew the real CPI. In my opinion, the CPI must include only the basic needs such as cotton textiles, vegetables, milk, grocery, fruits, non-veg items, fuels excluding subsidy, and very important - housing in terms of construction cost of basic class A building. This CPI will reflect the true cost of basic needs and prices of these items then need to be monitored and targetted by both the central banker and (more) the government.
3. The banking licenses should NEVER be given to corporate entities - we need to learn from US (banks went bust) and our own co-operative banks where many directors lent money to their cronies knowing fully well that money will never come back. The corporate will use public savings, mainly of middle class, and then use the money for their own business - at the risk of losing savers' money and then declare bankruptcy. The speed of our legal systems will take generations to recover the money (if at all, remember FT?) and bring guilty to the book (like kingfisher and Sahara sagas).
4. THe present government has only focused on large 'so called' welfare schemes and intentionally left the leaky logistics as they are. The only objectives appeared to be siphoning off as much money as possible through grandiose plans on paper (a la Kalmadi). It did not give a damn to the real execution of any welfare scheme. Everything remained on paper an money in some one else's pocket.


virendra bapna

Apr 3, 2014

real profits in stocks is made only by all who have access to insider news.all other investors fool themselves,which they never agree.

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