Of Monetary Policy, Unimportant Noise and Important Signals - The 5 Minute WrapUp by Equitymaster
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Of Monetary Policy, Unimportant Noise and Important Signals

Jun 2, 2015

In this issue:
» What Einstein and Rajan can teach you about investing!
» Made in India v/s Made in China
» Manufacturing jobs still not in sight
» Why even Nouriel Roubini thinks bonds may not be risk free!
» ...and more!

The year was 1902. And this young man working in the position of a clerk at the Swiss patent office had one of the most redundant jobs. However, it was the best job available to anyone with his kind of unimpressive university record. He served in the Bern office for seven years, from June, 1902 to July, 1909. Every morning he faced his bundle of patent applications. Back then a patent application had to be accompanied by a working model or a prototype if you will. And the man had to contend with not just the prototypes but also an extremely strict boss. One who gave strict instructions, if possible in a single sentence, in order to explain why the patent application should be granted or denied. Day after day the man in early 20's had to distill the productivity of objects of the greatest variety that man has power to invent. And put them on paper with hardly any help from his superiors.

Any guesses who the man was and what made him one of the greatest genius mankind has seen till date? Well, it was none other than Albert Einstein. Six years after quitting the Swiss patent office, he gave the world the formula E=mc2, as well as the Theory of Relativity.

The reason I am narrating this is to explain the kind of difference information, noise and signals can make to your lives. Einstein himself explained later that the patent office prepared him for the big discoveries. He learnt to sift the essential and important from the non essential. And he learnt to keep away the clutter.

Unfortunately, as an investor in financial markets today, you are dumped with information clutter. Right from your broker to newspapers to television anchors want you to capitalize on every little bit of information. Even something as mundane as a Monetary Policy review has been turned into breaking news-of-sorts. And every 0.25% change in rates is endorsed as an unprecedented opportunity to make money. In the process, your broker and the financial media make tons of money, whether or not you as an investor make any.

So the very first lesson, an investor who wishes to make well informed investing decisions, needs to take, is sifting information. Neither does the Monetary Policy instantly impact your equated monthly installments (EMIs), as propagated. Nor does it impact the fundamentals of stocks you wish to buy. It is nothing more than a liquidity management tool for the central bank. And it should be nothing more than a signal of the macroeconomic fundamentals for you.

As a serious long term investor, you would be better off paying heed to the concerns that the central bank is citing in making policy decisions. Other than that there is no reason to base any investing decision on marginal rate change noise. Treating the RBI's decision as a signal of times to come as against real information will make you a better investor.

Do you treat every Monetary Policy action and economic data point as important information for investing decisions? Let us know your comments or share your views in the Equitymaster Club.

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Now speaking of signals, here is something that you must take note of if you are betting big on 'Make in India'. Reckon this. Automating factories, putting in computerized controls and making high precision goods. Does this sound anything like China? Most of us associate Made in China with low quality and cheap goods. And the Chinese factories employing low skilled laborers are not exactly perceived as high quality value adding units. Rather they are perceived as clusters of labour exploitation. The very reason why some of the biggest outsourcers to China have tried to move away from the country. But China's latest effort at revolutionizing its manufacturing sector could give India's 'Make in India' dreams a run for its money! The government's Made in China 2025 is a 10-year campaign. The intent is to push the country beyond labour-intensive work into more sophisticated sectors. And the economy is leaving no stone unturned in using robotics to ensure quality and efficiency. So while PM Modi's goal is to bring basic manufacturing to an economy that needs enough jobs, China has set its sight on rivaling Germany and Japan. And given the mass scale of operations, it is quite likely that China could pip India in its own game plan.

 Chart of the day
Whether today's rate cut provides a small boost to the economy or not remains to be seen. However, there is no doubt that a key engine of growth, manufacturing, is still in the doldrums. While the government is doing its best to promote 'Make in India', the hard reality on the ground is not encouraging. A very good outcome of manufacturing growth is the creation of a large number of jobs. On this front, the news is not good. Today's chart shows the employment sub-index of the very popular HSBC India Manufacturing PMI (sourced from Livemint). A reading above 50 shows expansion and vice-versa. It is clear that manufacturing firms have hardly been hiring over the last one year.

Manufacturing jobs remain hard to come by

Why is this so? The answer has many aspects. Expectations of big bang reforms have been dashed. The land acquisition and GST bills remains stuck. Demand has been muted both domestically as well as in developed nations. Many industries are plagued with overcapacities. In such a scenario, competition too has continued to increase. Thus, it should come as no surprise that manufacturing firms are trying to improve productivity rather than hire employees. Compounding the problem is India's large number of un-employable graduates. Despite the government's best efforts, we believe it is difficult to be very optimistic about India's manufacturing sector.

Last week, we had written about investors in supposedly 'safe' government bonds in Germany receiving a rude shock when bond yields spiked sharply. Now, none other than Nouriel Roubini has expressed concern about such risks. He has described the scenario as a liquidity time bomb where everyone is on the same side of the trade, especially in the bond markets. Central banks of the developed world have pumped huge amounts of liquidity over the last 6 years or so. Has this helped to boost economic growth? Not really.

As Roubini explains, all the liquidity has gone into firing up asset bubbles worldwide. High frequency trading (HFT) strategies has helped to add fuel to this fire. This is true not just in stock markets but in bond markets too. The holdings of large institutional investors in global bond markets are at record high levels. This has resulted in an extremely crowded trade where everyone seems to be betting on the greater fool theory of rising bond prices. In such a scenario, even a small upward move in yields can cause carnage. To make matters worse, many bond markets operate over the counter and are not as liquid as stock markets. Also, many retirees hold their life savings in bonds. If and when the tide goes out, we believe the result could be most unpleasant.

Meanwhile, after a poor start, the Indian stock markets have fallen further through the trading session, as the monetary policy announcement by the RBI failed to enthuse traders. The BSE-Sensex is trading lower by 406 points (-1.46%) at the time of writing. All sectoral indices except oil and gas were trading in the red. Asian markets closed mostly in the red. European markets have also opened on a negative note.

 Today's investing mantra
"Being rational is a moral Imperative. You should never be stupider than you need to be." - Charlie Munger

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst).

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