Does first half of 2014 signal better days ahead? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Does first half of 2014 signal better days ahead? 

A  A  A
In this issue:
» Why the poor monsoon may not derail the buoyant market mood
» Hedge funds enter India in a big way
» Gold deposits as part of CRR/SLR?
» Global M&A deals at 7 year high
» And more!

00:00  Chart of the day
The Indian equity markets are clearly in a state of high optimism right now. In fact, one might even be tempted to call it euphoria. The run up which began well before the elections has resulted in huge short term gains across stocks and sectors. Consider this: India is the best performing market in 2014 so far. In the first six months of the year, the benchmark indices are up about 19%. This is the biggest six-month gain for the indices in the last five years. Over US$ 10 bn has entered the markets during this period. This huge inflow of foreign funds has even enabled the Indian markets to enter the top 10 in the world by market cap. Nearly 100 mid and small cap stocks from the BSE 500 index have doubled in the last six months. Do these figures convince you that the Indian stock market is the best place for your money? Your broker would certainly like you to think so.

Will India continue to outperform?

We believe that at times like these, it would be best if investors took a step back to assess the situation. It is true that that the Indian markets are not yet overvalued by historical standards. However, the fact remains that stocks are no longer available for sale cheap. Stocks in many sectors like infrastructure, real estate and capital goods have run up in anticipation of better days ahead. Nothing much has changed fundamentally on the ground for most of these firms.

Even from a macro point of view, things are not very rosy. As we have pointed out before, the new government faces the big challenge of pushing through tough reforms, many of which will be unpopular. The recent roll back in railway fares and the three month delay with respect to gas pricing is a sign that this government, despite its majority, may not have it easy. To add to this, the monsoon is expected to be deficient this year and this would result in higher levels of inflation. India also faces a huge fiscal deficit problem. But the markets don't seem too concerned about all these headwinds. In fact, most people have already set their sights on the budget (to be presented on July 10) as the next trigger that could push markets to higher levels.

Thus if investors were to make a basic assessment of the present economic situation, one conclusion will be quite clear. Market participants are just looking for reasons to buy! The reason could be anything: the budget, a reform announcement, a new proposed law. Anything that could justify higher stock prices based on sentiment alone. It is almost as if the markets believe that future growth in sales and profits will take care of itself. We would like to put out a warning here: a better future cannot be assumed just because everyone is feeling good today. In the long run, it is not sentiment but stable growth in earnings and profitability that will determine the fate of individual stocks as well as the markets. The run up in several stocks across policy driven sectors has made them expensive in the short term. If these stocks are to provide good returns from now, profitable growth will have to follow. This is far from assured. Any hiccup in policy driven growth stories like infra, power, oil and gas, mining etc could result in sharp corrections in stocks from these sectors.

We believe that the volatility in such counters will unnecessarily add to the risk in investor's portfolios. It would be prudent if investors do not go overboard when it comes to allocating money to such stocks. Do not get carried away by any high growth story that your broker tries to sell you. Remain invested in stable companies which have strong cash flows, which earn good returns of capital and are run by honest and ethical managements. These firms are your best bets for creating long term wealth.

Do you think that the first half of 2014 is indicative of the future as well? Let us know in the Equitymaster Club or share your comments below.

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The month of June has come to an end but we are yet to see the arrival of a full-fledged monsoon. Expectations of deficient monsoon has stoked inflation worries and hurt investor confidence. In fact, currently market experts deem monsoon as the biggest risk to the economy and thus stock markets.

However, quite surprisingly, an article in Business Standard points out how poor monsoon seldom influences market returns. Analysis of the past data by this leading daily reveals that whenever India received insufficient rainfall the BSE Sensex level at the end of the year was higher than the one that prevailed at the beginning of the year! And mind you this study has been carried out over a period of two & half decades. The length of the time period is long enough to eliminate near term aberrations and makes one conclude that rainfall has potentially no effect on stock market returns.

So, is this really correct? Well, not really. Rainfall does influence stock market returns. However, it is not the only factor that impacts markets. There are various other variables like interest rates, investment cycle etc that influence stock market returns. And over the last two decades as India gradually shifted from being an agrarian economy to a service oriented one the impact of rainfall on market returns has declined. Also, the deficit until now was not as severe to have material impact on market returns. But if the rain gods continue to remain in hibernation, the year end market return this time might not be in sync with the past.

How important are sentiments in the capital markets? Well, if you put this question to a handful of firms that successfully managed to raise large amount of capital recently, the answer that you will get is very, very important. As per a leading daily, two financial service providers and two mobile telephony companies have raised roughly Rs 11,000 crores through Qualified Institutional Placements (QIPs) in just the last 30 days. It should be noted that this was more than what was raised in either of the last two full fiscal years! What made this change possible? It's nothing but the expectations that the new Government at the centre would bring India back onto the higher growth path. Important to add that almost all the money has come in from overseas hedge funds and long term capital investors. And we may hardly be done yet. Lot many opportunities could be flowing into India in the coming months. Looks like we've entered the virtuous circle where growth attracts more capital which in turn leads to even more growth. However, investors would do well to ensure that the companies they invest in remain productive with the new capital at their disposal. In other words, they earn at least couple of percentage points more than their cost of capital.

Even when most banks in the country struggle to raise deposits, SBI typically has an enviable problem. How to deploy the deposit money profitably? The bank gets more deposits in one quarter than what a small bank gets in the entire year. Without enough avenues for lending, the bank therefore finds it difficult to retain margins. Moreover, given the size of its deposit book, the proportion of money kept aside as CRR is also substantial. The bank has been complaining about the CRR funds (4% of total deposits) being a waste of liquidity. This money is parked by banks with the Reserve Bank of India but it earns no interest. Similarly, even the gold deposit the SBI has gathered over the past few months is hardly being put to good use. The chairman of the bank, Arundhati Bhattacharya recently made some important recommendations to put the gold lying with banks like SBI to good use. According to Economic Times, she has pitched for treating a portion of gold deposits as part of the mandatory cash reserve ratio (CRR) or statutory liquidity ratio (SLR). Besides helping banks direct their cash balance to more productive assets, using gold as part of CRR will automatically release more liquidity into the system.

The data relating to global level mergers and acquisitions is a good proxy for sentiments. And going by the same, optimism seems to have been the mood for the first half of 2014. As per Reuters, the year to date (i.e. till June 26, 2014), global deal volumes stood at a whopping US$ 1.75 trillion; a figure higher by 75% as compared to a year ago. This is the highest level since 2007 when deal volumes stood at about US$ 2.3 trillion. However, what is different this time around as compared to 2007 is the quality of buyers. In 2007, it was private equity players that played a bigger role. In 2014, large blue chip companies have played the bigger role. The ample cash reserves on their books coupled with the ultra low interest rates in the developed parts of the world seem to be the main drivers behind this trend. As such, with the excess sitting on books earning low interest rates this may be better option in terms of cash utilization. However, with the stock markets at their all time highs, it remains to be seen how things will play out, in terms of the payback from these acquisitions, over the long term.

The Indian stock markets have been trading firm today. At the time of writing, the benchmark BSE-Sensex was up by 278 points (+1.1%). Majority of the sectoral indices were trading strong led by power and capital goods. Majority of the Asian Indices were trading in the green with China and Korea the biggest gainers. However the Hong Kong and Singapore markets are trading weak. The European markets have opened the day on a strong note.

04:55  Today's investing mantra
"An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business" - Warren Buffett
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2 Responses to "Does first half of 2014 signal better days ahead?"

M M Amalsadvala

Jun 30, 2014

Not necessarily. For India, Improved Economy, stable long term policies, removal of corruption & controlling channels of Black money would be the signals for better days ahead.
Commenting on the views expressed by Chairman A. Bhattacharya for use of Gold reserves with Banks as support towards Mandatory Ratios required to be maintained by Banks, at this stage is too premature.
Do Banks need Liquidity is a question worth raising in the forum. Banks can raise liquidity from their own resources by stringent Loan recovery measures. RBI should evolve steps by close monitoring of the issue by not just inviting periodical statistics but what effective steps Banks have implemented in increasing the recoveries and reducing the Bad Debts.

Like (1)


Jun 30, 2014

Equity master's observations and comments are very correct as stated above. In fact, several funds/brokers are calling by phone and asking for investing through them.

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