This impending bubble could disrupt India's recovery - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

This impending bubble could disrupt India's recovery 

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In this issue:
» Not paying heed to Buffett's warning could be 'catastrophic'
» Is this SEBI's chance to prove it's no more a toothless tiger?
» What is causing investors to be optimistic about emerging markets again?
» FII holdings in the BSE 200 index at record high
» ...and more!

When things are bad, there is a general tendency among investors to focus on all the bad news. In the same way, when things seem to be on a recovery path, they get too fascinated by all the good news. In doing so, they often miss seeing the lurking dangers and opportunities.

Over the last several months, there has been a sea of change in investor sentiment. From utter dejection to hope to some level of over-optimism. Well, it does seem that the new government is committed to bringing the economy out of the mess. And this will certainly generate great money-making opportunities for investors.

But it will be a mistake to presume that nothing could go wrong now. For there are indeed threats looming right around the corner that could jolt our ever-so-vulnerable economy and markets.

One of the most imminent threats is the brewing bubble in the global bond market. Though man tends to be a poor student of history, it would be worth noting that the going is never easy when bubbles burst. And because the US provides a major chunk of the capital to the world, any crisis in the bond market would create widespread distortions in the global financial markets, including India.

The other elephant in the room is China. As per an article in, the Chinese corporate bond market has emerged as the world's biggest, surpassing even the US. And according to rating agency Standard and Poor's, it is set to account for a third of global company debt needs over the next five years.

This is nothing to cheer about. What this means is that China's burgeoning debt market is a very major risk for the health of the global financial system.

This means that we shouldn't be wasting too much time celebrating the change of government at the Centre. The current buoyancy in the global markets and the flow of capital into India should be used as an opportunity to fix things up in the economy. There are enough reasons to believe that this breathing window may not last very long. If any crisis breaks out and there is a flight of capital out of the country, the much-touted recovery may die a premature death and push India into another downward spiral.

For investors, we believe that they must keep in mind that huge expectations are riding on the new central government. The markets seem to have priced in a healthy recovery in growth and earnings. Now, what we need to look out for is whether the government manages to deliver.

What, according to you, is the biggest threat to the Indian economy now? Let us know in the Equitymaster Club or share your comments below.

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When Buffett gives a warning about something, it always makes sense to pay attention to it. However, the Oracle of Omaha's grouse these days is not about equities or derivatives for that matter. Rather, what is making him nervous are the falling yields in an asset class known as catastrophe bonds. Businessweek reports how Buffett recently warned about the prevalence of the low premiums towards writing hurricane insurance. For those who are new to this, insurance companies typically sell catastrophe bonds in order to cover their most extreme risks. The proceeds of the issue are set aside and paid out in the event a disaster happens. Buyers on the other hand are paid higher interest rates for holding the bonds. But they also risk forfeiting the entire amount if the securities are triggered before they mature.

Now, as per Buffett, the interest rates being paid to cover these risks have come down in recent times. And therefore the holders risk getting creamed over time. It's remarkable how Buffett seeks a margin of safety in everything he does. And if the same is not adequate enough as per his evaluations, he prefers sitting out rather than participate in the game. Yet another example perhaps of how value investing is literally hardwired into him.

Regulatory practices in Indian stock markets have always been a grey area. Though we have a regulator in place, time and again stock markets have witnessed scams and retail investors have lost money. The recent NSEL scam was a prime example. However, it seems that SEBI has decided to bring an end to the practice of market manipulation and insider trading by tightening its screws on offenders.

Towards that end, SEBI has started probe on one foreign investor who allegedly benefited via information leakage. This is the first time SEBI has ever probed a foreign investor for insider trading. All its past actions have been against penny stock operators. As such, this is a first high profile case where SEBI is taking a foreign investor head on. We believe this is a welcome step. Indian regulator has the history of being lax in dealing with issues of manipulation and insider trading. Though steps have been taken, the penalties are not stringent to dissuade investors from illegally benefiting at the expense of others. Perhaps it is high time that SEBI takes some lessons from SEC, its US counterpart on dealing with such issues. This shall increase transparency in the Indian markets. Further, more money from abroad will flow into mid & small cap spaces which foreign investors shun due to apparent chances of manipulation in stock prices.

Going by the IMF's outlook on the US, it seems that the country is unlikely to reach its desired unemployment rate by 2017. The organisation also lowered the growth rate target for the country to 2% for the current year; earlier estimate was 2.8%. This would seem to provide the Fed with some more time to keep the interest rates at current levels. How will this impact India? Well, on the face of it, this is likely to keep the pressure off emerging markets (EMs). In June last year, they had witnessed large scale capital flight.

As per the Wall Street Journal, the efforts made by the EM governments - which included making tough reform decisions as well as keeping interest rates firm; all aimed at restoring confidence - seem to have led to a reversal in trend of foreign investors. In June last year, investors pulled US$ 32.5 bn out of EM stocks and bonds. However, in the past eleven months, nearly US$ 222 bn has been pumped in; with US$ 45 bn coming in, in the month of May itself - the highest amount since September 2012. We believe this does give a sense of how investors need to be cautious as foreign investors can significantly influence stock markets. From what it seems, the high expectations from the new Indian government coupled with the preference for EMs as well as longer than anticipated recovery in developed markets is likely to keep Indian stocks quite volatile in the short term.
03:20  Chart of the day
We have written earlier about the sharp run up in valuations of PSU bank stocks. Also the fact that the sharp revision in valuation for most of the stocks was devoid of improvement in fundamentals. Now, as an investor, you do have the choice to avoid buying the overvalued PSU banks. But you do have a reason to worry if you are invested in mutual funds. As per Economic Times, the top mutual funds have their portfolios over exposed to the banking sector. Their investment in banking stocks has reached 22% of their total equity assets under management (AUM) of Rs 2.2 trillion. After all, the NAV focused mutual funds can hardly afford to let go of stocks that have been the biggest contributor to the rally in recent months. And booking profit on them may mean trailing other funds in terms of NAV in the months ahead. Thus despite the overexposure, funds continue to remain invested in PSU bank stocks. Now it is common knowledge that rise in NPAs may hurt profits of these banks in the months ahead. Further, the PSU entities will need about US$ 50 bn in capital to recapitalize themselves. Thus a dilution in return ratio is also a given. In the midst of these, funds that do not exercise caution are bound to hurt themselves badly once the tide turns. Hence investors would do well to remain cautious about funds that are over exposed to PSU banking stocks.

Is It Time To Book Profits On PSU Bank Stocks?

Going by the fund flows into the Indian markets recently, it seems that foreign investors just can't get enough of India! Fathom this: Foreign Institutional Investors (FIIs) have pumped in about US$ 17 bn into the Indian markets since September last year. From its lows in December 2011, the Indian markets have soared 61% till this month. It is now clear that the rally is being led by Exchange Traded Funds (ETFs). FIIs have increased their holdings in the S&P BSE 200 index to a record 20.8%. This has resulted in the huge gains seen in the benchmark indices. As the indices have risen steadily, retail investors have begun entering the markets again. We believe this is a time to be cautious. Foreign ETF flows are very volatile in nature and can leave at the slightest sign of trouble. Investors have been caught up in the euphoria of higher stock prices as the new government has promised far reaching economic reforms. However, until we see positive developments on the ground, the fundamentals of the economy will not improve. In times like these, it is advisable that investors remain cautious and stay away from companies with questionable fundamentals.

The Indian stock markets closed firm today. The benchmark BSE-Sensex was up by 331 points (up 1.3%). All the sectoral indices traded in the green with oil and gas and banking stocks being the biggest gainers. Realty and FMCG were among the few stocks that lagged behind. Most of the Asian stock markets were trading firm today with India being the major gainer whereas Hong Kong traded in the red. Even European markets have opened the day on an optimistic note.

04:45  Today's investing mantra
"You don't need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ." - Warren Buffett
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1 Responses to "This impending bubble could disrupt India's recovery"


Jun 19, 2014

with the backdrop of what mentioned in this article the biggest worry EXECUTION.
Planning exercised by the new government looks on a growth path which was most needed. Without any fault by this new government the challenge could be of Execution. And as said it takes time. Execution needs a willing team and to avoid risk means experienced team and stakeholders for the job at a bigger scale. Scope is large so the timeline can be hard and long.
I believe, Execution would take more time and resources and if scope and risk not ascertained earlier on there could be unidentified big risks without mitigation plans striking hard needing large budgets and longer timelines.
Of-course, not that the new government is not aware that the general investing public is unaware of.

Lastly, known Unknown and Unknown unknown risks can anytime take the wind out like the draw down of global investors. Coupling-decoupling to be watched out any minute from know on..get ready for some ride which ever direction.

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