'Long term potential' no longer good for Indian stocks? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

'Long term potential' no longer good for Indian stocks? 

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In this issue:
» 18 years of gains in wealth for an avg US household wiped out
» No reason for cheer in Spanish bailout
» Will exemption from Iran sanction help India?
» Should Germany exit Eurozone instead of Greece?
» ...and more!

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How many engineers does it take to change a light bulb? Three. One to hold the ladder, one to hold the light bulb, and the third to interpret the Japanese text. It seems that the solution to India's economic flux is as funny as the answer to this riddle. At least that is how corporate leaders and investors seem to be looking at it. A host of politicians, regulators, economists and rating agencies have been pointing out what is wrong with the Indian economy. Some have also suggested how things can be set right. However, unfortunately no one seems to be willing enough to get the act together. Least of all, our policy makers!

One of the most respected corporate czars recently expressed his frustration with India's political limbo. This was not the first time he did so. But his words seemed more direct and worries more pronounced this time. "Investors can no longer be placated by talks of 'long-term'". Coming from HDFC chief, Mr Deepak Parekh, one cannot ignore these words. However, should investors really overlook long term trends?

There is no doubt that successive flow of negative news on economic and corporate well being is scary. Warning of rating agencies to downgrade India way below her BRIC peers is unthinkable. That investor confidence in India's long term future has sunk to low ebb is therefore understandable. But instead of trying to quell investor panic, regulators and the government are busy playing the blame game. Putting a brave defense to the S&P's downgrade threat many go well with the government's agenda. But investors cannot be convinced of lofty GDP growth projections without statistics to back.

Investors on their part would do well to look at long term trends with a dose of reality. Despite the warning cited by global banks and rating agencies, very little has changed in India's long term economic trend. Data shows that the BSE Sensex has yielded average annual returns of 15% since 1979 (inception) till date. Despite near term blips, there is no reason for the Sensex to not repeat this performance over the next decade. As long as investors keep their return expectations realistic, there can be very little room for disappointment. Especially in times like these. Mr Market is making things easier for long term investors. Probably it would suffice to say that the opportunity that Indian equity markets present now has come only three times earlier in the last 20 years. The common factors between now and then were challenging economic environment, poor market sentiments and low valuations. Hence investors would do well to shut out the noise and not lose sight of long term fundamentals.

Do you think 'long term potential' no longer holds good for Indian stocks? Let us know your comments or post them on our Facebook page / Google+ page.

01:20  Chart of the day
Public sector banks are no longer the biggest employers in Indian financial market. Despite that, as seen in today's chart, PSU banks' cost per employee expenses has far exceeded that of private sector banks in recent years. The staff strength of PSU banks has gone down dramatically between FY99 and FY11. Meanwhile that of their private sector peers has gone up. The cost per employee of PSU banks was nearly 1.3 times that of private entities in FY11. This is despite the fact that pension expenses of PSU Banks are not fully reflected in their staff expenses. This makes one thing amply clear. PSU banks have lost their competitive advantage in terms of staff costs to private sector peers.

Data source: RBI

Are money and wealth the same thing? Those still confused may find solace in this write up on Bloomberg. It says how the financial crisis wiped out 18 years of gains in wealth for an average US household. In other words, the net worth of an average US household in 2010 was the lowest it had been since 1992. Now, that is some wealth destruction isn't it? Furthermore, if money and wealth are the same, was money also destroyed to the same extent? Certainly not. On the contrary, it was available by the truckloads, courtesy the Bernanke printing press.

Perhaps this more than anything else dispels the notion that wealth and money are not the same. Money, we believe is just a medium of exchange. And its unlimited creation, as is being attempted by the US Fed, should be discouraged right from the word go. This is because as the above example shows, it does not create wealth but only a false illusion of it. And people who come to believe in this illusion have to pay a very heavy price once it breaks. Like the average household in the US is doing right now. Real wealth you see comes from increasing productivity and relying as little on debt as possible. Printing money and raking up debt is not wealth creation. It creates only bubbles, the breaking of which brings great hardships to the common man.

The Euro zone finalized a US$ 125 bn package to bailout Spain. Though the details of the bailout package are not known, the global stock markets cheered this development. But in Paul Krugman's opinion, the cause for cheer is short lived. In his opinion, the Euro zone is headed for an utter catastrophe. The problem with countries like Spain is the huge level of unemployment. What these countries need is job opportunities. Unfortunately, austerity measures like higher taxes wage cuts do not drive job creation. But these countries are increasingly adopting austerity to reduce their deficits and get bailouts. As a result, the bailouts provide a short term relief but the underlying problems get worse by the day. He opines that what these countries need are radical measures to boost long term growth through job creation. Short term bailouts would not help much.

The US seems intent on cranking up the pressure on Iran and choking off its oil supplies in a bid to halt the latter's nuclear program. In this regard, US is looking to impose sanctions on countries trading with Iran. However, India, South Korea, Turkey and four more economies will receive waivers from financial sanctions in return for significantly cutting purchases of Iranian oil. That said, China, which alone buys as much as a fifth of Iran's crude exports, and Singapore, where much of the country's fuel oil is blended, have not yet received such waivers. And this has fuelled talks of whether sanctions would be imposed on them. On the face of it, it seems unlikely that the US will impose sanctions on China and would rather first gather evidence that suggests that China has been trading oil with Iran. It all boils down to how its talks with the Chinese government pan out. The US is also treading a fine line as it chooses to choke oil supplies at a time when the prices of the fuel are surging. All in all it spells uncertain times for the global oil markets.

Urban areas, especially metros see a huge influx of people from all over the country. Even smaller towns and districts are rapidly becoming more urbanized. But, as of now, only 27.8% of India's 1.2 billion populace lives in urban areas. The Jawaharlal Nehru National Urban Renewal Mission (JNNURM) expects this to increase to 50% over the next 25 years. But by that time, even the population would have increased. This Rs 660 bn scheme was launched as an infra scheme to address this issue. Its main tenants involved efficiency of urban infra and service delivery, communal decision-making, more transparency etc. Keeping in mind the scheme's objectives, the Planning Commission intends for the 6 year old scheme to be extended. For this, the govt. can raise funds through private money, sale or lease of urban land, management of property taxes, etc. The quality of education and healthcare is abysmal in the country. Hopefully this will help address severe urban deficits. However, the rural spectrum also needs to be addressed for sustained economic growth in India.

Excesses in Greece have led to a contagion of sorts in the Euro Zone. Financial experts are of the opinion that a Greek exit is the only solution to the current debt problem. If not, then euro as a currency could well head for disintegration. However, this entire debate of solving the debt crisis just revolves around this one particular troubled country. It misses a case of how exit by other nations could also be beneficial. For example, let's hypothecate a German exit. It may be noted that right now the problems in Euro Zone have exacerbated to such an extent that most member countries are either on the verge of a default or need a bail out.

So, in such a scenario what will a German exit do? With the exit of the weak members being uncertain, being the most powerful nation Germany can plan a swift exit without any panic. True, that Euro would depreciate sharply after that. However, it will still not be worthless as any re-issued Greece currency would once it exits the Euro Zone. Also, Greece's exit can lead to bank runs as a general consensus will be that the bubble has burst. Exit of powerful nation like Germany might be deemed as a calibrated step to resolve the crisis. This can help avoid contagion.

Despite initial jitters, the indices in Indian equity markets made a firm up move into the positive territory backed by investor interest in heavyweights in auto, engineering and banking sectors. The positive sentiments seem to be primarily based on hopes of rate cut by the RBI. At the time of writing, the BSE Sensex was trading 185 points above the dotted line. The indices in most other Asian markets closed lower in today's trade. Those in Europe have, however, opened in the positive.

04:50  Today's investing mantra
"It takes character to sit there with all that cash and do nothing. I didn't get to where I am by going after mediocre opportunities." - Charles Munger
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3 Responses to "'Long term potential' no longer good for Indian stocks?"

Venkata Shivakumar

Jun 12, 2012

The term "LT Potential" is still valid. However, the way things are going, it is sure to get the FIIs out from the country. Gold and Real estate and Public Sector FDs are still safe havens - atleast for the next two years. Equities will not attract retail participation. In any case, PE ratios are bound to go down making the equity markets "really cheap" but with not many takers. The domestic FIs will probably have to play their saviour roles again. How much they can do is ofcourse a moot question.


Ganapathy Sastri

Jun 12, 2012

AS the article points out productivity in India is very low. What can be done by one person, is typically done by two or more persons. There is very little discussion about changes or increases in productivity. As an accompanying article points, in ten years Bank wages have gone up from Rs.1,50,000 to over Rs. 7,00,000. How much has productivity gone up? Very little is known.
If stock market is to go up, we need to focus more on productiviy improvements, cost reductions etc etc. Very little of that is happening now in the private sector. Let us not blame the politicians alone.
Of course, reaction of politicians to what is becoming a STANDARD practice to make nations POOR is also unwarranted. It is no use saying " To HELL with you". We need to improve ourselves. Deficit financing has to come down and even become SURPLUS.

Like (1)

Kuldeep Nayar

Jun 12, 2012

Have you considered the fall in purchasing power of the rupee? I do not think that if you take that into account anybody has made substantial gains from long term holdings.

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