Time to be fearful or greedy? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Time to be fearful or greedy? 

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In this issue:
» Raghuram Rajan stresses the need for RBI independence
» Car sales sees sharpest fall in a year
» The days of huge trading profits for banks may be over
» Could China's bad debt trigger a global crisis?
» ...and more!


00:00
 
The Indian stock markets are on a roll. Every day seems to bring with it a new life high for the indices. Hopes of a BJP led government coming to power have kept the markets in a buoyant mood for the last several weeks. Now that the general elections have come to an end today, these hopes are higher than ever. The Sensex was up about 650 points on Friday. Already questions are being asked such as 'will the markets touch 25,000 on the day of the election verdict'?

It would have been understandable if it were only retail investors who are caught up in this euphoria. But that is not the case. According to the Business Standard, most fund managers seem to be thinking along the same lines. A majority of fund managers from around the world were bullish about India in a recent survey. They were asked if they believed that a NDA government could revive the investment cycle in India within a year. A surprisingly high 70% responded positively. Why should this be surprising? Allow us to explain.

The investment climate in India has been on a downtrend for the last three years. It is highly unlikely to pick up in less than 12 months. The new government will need some time to settle in. Ministers will need some time to take charge of their respective ministries. They will need to assess the situation first hand and listen to various stake holders. Then they will have to put their heads together and come up with concrete policy measures. While all this is being done the government will have to ensure that corruption does not raise its ugly head. But even if sound policy measures are announced quickly, implementation will remain the key. If there is anything that we have learned from the last ten years it is that there is a world of difference between the government's intent and the execution. Unless policy measures are implemented on the ground, the fundamentals of the Indian economy will not improve. This will take time. For example, a big ticket infrastructure project will require a two year cycle from the concept stage to implementation.

In addition to this, there are other short term concerns as well. The El Nino is expected to adversely affect the monsoons this year. This could put upward pressure on food prices, resulting in higher Consumer Price Inflation. In such a situation, the Reserve Bank of India (RBI) would not cut interest rates in a hurry. Without the help of lower interest rates, a big improvement in growth is unlikely in the short term.

Now it is not as if fund managers are not aware of these issues. Yet they have chosen to believe in the impossible. Even the foreign investors have got carried away. In the March quarter, Foreign Institutional Investors (FIIs) had taken their holding levels of Indian stocks to a record high of 22.3% in the 1,200 companies listed on the NSE. This trend has continued in April and May. Thus it is clear that the markets are being driven by greed for quick profits rather than ground realities. In this context, we would caution investors about the euphoria in the markets. It is very important, now more than ever, to invest in only fundamentally sound stocks trading at reasonable valuations. Finally we leave you with the words of Warren Buffet: "Be greedy when others are fearful and fearful when others are greedy".

Do you think that this is time to be greedy or fearful in the markets? Let us know in the Equitymaster Club or share your comments below.

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01:45  Chart of the day
 
As per the Annual Survey of Industries (ASI) - carried out by the Ministry of Statistics and Programme Implementation - profits of the industrial sector rose at a sharp pace of about 37% per annum during the boom period of 2003-08; in comparison, wages rose only by 11.4% annually. However, during the slower phase of FY08 to FY12, profits rose at a much slower pace of 11% as compared to the 18.3% rise in wages. As reported by the Mint, the key aspects to consider here are the relatively higher inflation rates as well as increase in rural wages due to the various government programs. Not to mention the stickiness associated with the same.

However, when seen from a very long trend - i.e. post liberalization (FY91 till FY12), the rise in wages has been much slower as compared to the increase in rate of profits. While the former stood at 10.1%, the latter grew at 19.2%. As today's chart of the day displays, the share of wages in net value added declined from 25.6% in FY91 to 11.9% in FY12.

At the end of the day, it all boils down to where we are in the cycle. With the kind of depressed scenario that we have seen in recent times, wage pressures have eaten into the profits of the industrial sector. However, when the cycle turns, the situation is likely to go back to the long term trend. Nevertheless, what will have to be considered is whether the change in dynamics of the recent years will be a significant factor going forward.

Wages have not kept pace with profit growth


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02:10
 
If there's one institution we should be really proud of, it is India's central bank, the RBI, according to us. For time and again, it has refused to bow down to the diktats of the Government. And has taken decisions based solely on the long term interests of the country. Therefore it was hardly surprising to us when Raghuram Rajan, the current RBI governor talked about the independence of the bank in taking key decisions. "The key question is what kind of equation do you have with the government? I determine monetary policy, I say what it is," Rajan opined at a conference recently. He further added that the Government can fire him if it wants but the Government does not set the monetary policy.

Now, that's a bold statement we believe. However, no one can deny that Rajan has indeed walked his talk. Despite there being growth concerns, he has gone ahead and effected interest rate hikes, directly taking on the Government in the process. As a matter of fact, it is this act of his that has prompted many to speculate that the new Government may not take kindly to these measures. However, it will be a grave mistake if the new Government chooses to replace Rajan. They cannot punish someone for the mistakes committed by someone else. And in this case it is the Government itself that is at fault.

02:38
 
The Indian economy has hit a rough patch for quite some time now. And one industry that seems to have been severely hit is the auto sector. Be it a weak demand scenario, labor issues, high interest rates, inflation or rising fuel prices, the industry is facing challenges on multiple fronts. The slowdown is quite evident in the monthly sales volumes numbers. As per the data from the Society of Indian Automobile Manufacturers (SIAM), the domestic car sales volumes in April 2014 declined 10.2% YoY. This is the steepest monthly decline in the last one year. As per SIAM, this is the longest period of slowdown in the domestic auto market. What is even more worrying is that no incentives seem to be exciting consumers. Even the excise duty cut has failed to revive demand.

This is an industry highly linked to the economic growth rate. So a change in fortune will depend upon bigger policy changes like roll out of Goods and Services Tax, mining reforms, interest rate scenario etc. While a new business friendly Government may help the industry turnaround, we believe it will take some time before the auto industry makes a comeback.

03:07
 
Trading income was a key revenue contributor for most global banks in the pre-crisis era. Western banks gambled heavily on fixed income, commodity and currencies then. However, it seems that the unprecedented era of gambling has come to an end. This is evident from the fall in revenues from trading activities post the crisis. In fact, the fall has been so severe that most banks will have to redraw their business models. This indicates how much they relied on trading income for profitability as against earning from traditional banking services.

However, with the advent of the Volcker rule, post 2008 crisis, banks' ability to indulge in risky trading has been curtailed. As such, the proportion of trading income has gone down but still it constitutes a major source of their overall business. As an example, Goldman Sachs' trading income was 72% of banks' overall revenue last year compared to 82% in 2010.

The sheer magnitude suggests the over reliance on trading activities by banks in order to maintain or boost profitability. It also speaks of the risk management practices in the western world. How can a regulator allow any bank to rely so much on trading income as against its basic bread & better business of lending? Are western banks casinos garbed as lending institutions? Some sanity may have returned now after regulations were tweaked. However, we wonder what would be the impact on banks of such a decision that were over-reliant on trading income in the first place. We reckon they will have to either revamp their entire business model or they may perish soon.

03:45
 
Just how serious is the problem of ballooning debt in China?. As per an article in Businessweek, the ratio of private-sector credit to GDP surged in China from 104% in 2008 to 134% by 2012. However, the non-performing loan ratio surprisingly has remained at 1% during this period. This raises the question then whether China is being forthcoming about this data in the first place. A report released by Oxford Economics certainly does not seem to think so. According to this consultancy, the bad loan situation in China is far scarier than what is being revealed. It is quite likely that the dragon nation's bad-debt ratio is somewhere between 10-20%. This would amount to around US$ 1-1.9 trillion, which by all means is a massive figure. How has this figure been arrived at? By looking at a similar trend that China faced in 1990s? Indeed, in the period 1995-99, China's credit to GDP ratio rose by around 27 percentage points. In that same period, the bad loan ratio increased by 13 percentage points. That is why it becomes a bit difficult to digest that bad loans have somehow remained stable now when debt has surged so much. All in all, whatever the numbers say, it looks quite clear that the debt situation in China is quite troubling to say the least.

04:35
 
The euphoria over the last polling phase of the elections continued to bolster the Indian stock markets. At the time of writing, the benchmark BSE-Sensex was up by 402 points (+1.8%). Barring pharma and IT, all sectoral indices were trading positive. Oil & gas and banking stocks were the biggest gainers. Majority of the Asian stock markets were trading positive led by China and Hong Kong. However, the Japanese index was trading weak. Most of the European markets have opened the day on a negative note.

04:50  Today's investing mantra
"The stock market is designed to transfer money from the active to the patient" - Warren Buffet
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3 Responses to "Time to be fearful or greedy?"

RS Rathore

May 13, 2014

I feel, none should get fearful or greedy. The investors will have to be patient and hold the stock(s) for long term. If EM's sincere advice is strictly followed, I dont think any one would be loser in equity market, for long term investment will definitely fetch Laurels.

As regards the Governor of RBI is concerned, Raghuram Rajan should not be disturbed at all. I fully agree with Rajan who does stress the need for RBI independence, otherwise he would leave for States where uncountable snow balls will be around him all the time. Raghuram Rajan is a dynamic person and he should be left alone at his discretion i.e. as free as bird to take his own dicisions in the interest of our beloved country.

Like (1)

Aruna

May 13, 2014

Completely concur.. Would advise part encashment of profits to benefit from possible upsides if any; But more importantly protect downside.

Like (1)

Savio

May 12, 2014

Dynamic bond funds are actually a myth.

I have lost money in them. Not because of an incorrect choice of fund but because the fund manager (like most dynamic bonds 2 years ago) chose long-dated bonds. All were expecting rates to fall and wanted to lock in high rates.

They were then saddled with those papers and could NOT switch to the shorter end of the yield curve. Investors were stuck because the basic feature of the scheme (of switching tenure of the papers) was not being fulfilled.

I therefore advise investors to choose the funds themselves....long term or short term. You can switch between these funds far more easily than a fund manager of a dynamic bond fund. So don't waste money on these products that could ideally fetch you great returns (if the fund gets the call right) or if you could lose money (if the fund manager finds himself at the losing end of the yield curve).

Like (1)
  
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