Do bonds make more sense than equities? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Do bonds make more sense than equities? 

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In this issue:
» RBI leaves interest rates unchanged
» Lack of funds to hit highways?
» Govt. 'bullies' rich PSUs for cash
» Greek vote a short term relief for global markets
» ...and more!


--------------------------- Urgent Update On Stock Market Crash ---------------------------

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00:00
 
For most part of 2012, the equity markets have been on a roller coaster ride. It has had its highs and its lows. And most of it seems to be difficult to predict. Investors have started to run helter skelter trying to make some sense of what is going on. Most importantly most of them are trying to figure out where to park their funds. How do they maximize returns? A leading daily has tried to answer this question. Their reply is invest in debt or bonds.

The underlying reason for this is that considering the dismal GDP growth numbers, the Reserve Bank of India (RBI) has little option but to cut interest rates. It is a known fact that bond prices are inversely related to interest rates. Therefore, if interest rates go down, bond prices go up. Thus helping investors earn more returns. However, in recent times, investors have side stepped bonds as an investment class. The reason for this was that given the high inflation levels, the RBI was forced to increase interest rates. The increase hurt the prices of the bonds. And most investors wanted to wait for rates to peak before parking their funds in debt. But most of these investors lost out as the RBI had cut down interest rates in its last policy meet. As a result, most of those who were waiting to call the peak of the cycle lost an opportunity to make money in the bonds.

The leading daily suggests that now is the right time for investors to pick up high quality bonds. And this would help them earn handsome returns over the next 12 to 24 months. This is earning high returns in the short term. But a question that we would beg to ask here is just like one cannot call the interest rate peak, how would one take a call on interest rate trough? What the daily has suggested for investors is to basically try and predict the interest rate cycle. And hope that in the short term the investor would get it right. This in itself is an extremely difficult task.

What investors need to do is to look at their long term returns. Short term blips should be treated as the name suggests. Short term. In the long term, equities have and will give the best returns. The volatile times that we are witnessing these days gives the rational investors the opportunities to pick up fundamentally strong stocks. That too, at good valuations. Investors would do well to pick up such stocks and maximize their long term returns. And leave the short term calls on complicated stuff like interest rate cycles to the economists and Central Banks. After all, it is their job.

Do you think it is better to invest in bonds over stocks? You can also share your comments with us or post your views on our our Facebook page / Google+ page.

01:15  Chart of the day
 
High inflation rates have been the root cause for higher interest rates. 2011 saw the RBI constantly increasing rates to reign in the monster of inflation. And for some time it did look like it was winning at the task. But since March 2012, inflation has started to rear its ugly head again. It has been steadily rising since then albeit at a slow pace. Unfortunately the reason for this is not higher demand but supply constraints. This in turn is the outcome of infrastructure bottlenecks which themselves are a result of the policy paralysis in the government. In short, the need of the hour is for the government to step up on its reforms. The RBI has done its job. It is time for the policy makers to do theirs'.

Source: Economic Times


02:05
 
Whenever there is high anticipation that RBI will do one thing, it either does nothing, or it does the complete opposite. Most investors believed that the central bank would cut policy rates during June review in order to stimulate growth. This is after the GDP growth for FY12 hit a nine year low and economic conditions deteriorated worldwide. However, the RBI maintained status quo. It kept the cash reserve ratio (CRR) for banks at 4.75% and the repo rate unchanged at 8%. The monetary authority believes that a rate cut at this juncture would increase inflationary pressure in the economy rather than supporting growth. High food and fuel prices brought the latest food inflation number to 7.6% in May from 7.2% in April, which is a cause of concern. This remains the highest level among industrialized nations and as well as the BRIC group. With little wiggle room on this front, the RBI Governor Duvvuri Subbarao had no choice but to keep things as they are. Without a major policy overhaul, India will keep tripping over its own feet. And the RBI cannot do much to help.

02:35
 
Request for generous dividend payouts are commonplace during AGMs of cash rich companies in India. But retail investors are not alone in their demand for higher dividend during difficult times. After all, excess cash lying idle is the books of companies are no longer comforting. Investors envisage lower returns on capital from idle cash. Many also fear misuse of the cash by the company management. Attempts at diversification or expensive buyouts have often earned minority investors a raw deal. Hence they would rather pocket the cash instead of allowing company management to have it at their disposal.

It seems the cash strapped government shares this view. Unable to bridge the fiscal gap, the government is banking on a kick up in industrial activity. At least that should stoke growth rates and bring in higher taxes. However, cash rich PSUs unwilling to spend excess cash are not fitting perfectly in the government's plan. The reasons for unwillingness may have to do with policy inaction, lack of resources etc. Hence the PSUs may want to wait before committing funds to project that have an uncertain future. But the government has warned them against keep the books cash heavy for too long. If investments are deferred any longer, the PSU may have to part with the excess cash by way of special dividends. Either ways there seems to be no consideration for the interest of minority shareholders!

03:20
 
The Prime Minister's statement on speeding up and expanding (national highways projects allotment targets have been scaled up by 8% to 9,500 km) the scope of key infrastructure projects two weeks ago was considered to be the much needed 'shot in the arm' for the ailing road construction sector. But the reality is that the scenario may not improve drastically. This is because of various reasons - interest rates remain high, construction companies are not in the best of health, land acquisition issues continue to be there, and financial closures of projects is taking longer than before, to list a few.

Funding and liquidity issues need to be addressed as well. Especially for those companies who won projects in the past, but have not managed to close the financial aspects relating to the same. And unless that happens, bidding for new projects would be difficult. More so, banks are unwilling to lend due to the difference in reports of the NHAI and the consultants. One should not forget that construction companies took on a lot of debt in the recent past to make their books asset heavy by taking on BOT projects. However, now, many of them are looking at offloading stakes partly or entirely to be able to raise money to improve their balance sheets.

04:00
 
The impending Greek elections were so far hanging like a Damocles sword over the Eurozone. With the possibility of Greece exiting the Euro looking more and more likely, the fate of the Eurozone depended a lot on how the elections would pan out. The contest was between the conservative New Democracy which favoured a bailout and the radical Syriza which opposed it. It appears that the former may narrowly beat Syriza. Little wonder that the Euro and stock markets began the day's proceedings on a bullish trend. But does that mean trouble for Greece is over? Not really. Even if a bailout package is agreed upon, it is most likely to prop up the economy in the short term. Serious structural issues still remain. Notably that of bringing the massive debt down and coming out with a sustainable growth policy. Unless these issues are urgently addressed, coming out of this slump will be an illusion at best.

04:35
 
In the meanwhile, after opening the day in the green, the Indian equity markets have dipped down into the negative zone. At the time of writing, Sensex was down by 194 points (1.2%). Stocks in the banking realty space are witnessing maximum losses. Among the stocks leading the gains were DLF Ltd and State Bank of India (SBI). The other major Asian stock markets have closed the day on a high note with Korea and Japan leading the gains in the region.

04:50  Today's investing mantra
'I don't look to jump 7-foot bars. I look around for 1-foot bars that I can step over' - Warren Buffett

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    Equitymaster requests your view! Post a comment on "Do bonds make more sense than equities?". Click here!

    2 Responses to "Do bonds make more sense than equities?"

    devendra

    Jan 20, 2013

    It appears in long run

    Like 

    Bondking

    Jun 18, 2012

    Predicting interest rate cycle is not that difficult. Interest rates are on a downward trend, there is no question of them going up now, so interest rates movements are not as volatile as equity markets. What you should understand is that change in yields can be broken up into: Yield curve risk (change in benchmark interests) and credit spread risk (change in yield of particular rating over benchmark). The second risk is much more important, as credit spreads generally expand in a depressive scenario, thus impacting bond prices

    Like (1)
      
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