Like India, like China and more...
(Jul 8, 2008)
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In this issue:
» Global markets bogged down
» It's rollback time!
» Banks under pressure in India and China
» Big Pharma's changing strategy
» ...and more
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Stockmarkets around the world continue to reel under shocks that first began with the subprime crisis in August last year and were followed by rising inflation on account of soaring crude and food prices. The US stock markets by definition have entered a 'bear' phase as the indices have plunged 20% from their peak. The credit crisis set in motion the US economy's slow and painful fall into a recession. Add to this the prospect of declining profits of corporates around the world, rising inflation and interest rates and the scenario looks grim indeed. Oil prices continue to touch new highs fuelled by geopolitical tensions in the Middle East paving the way for disruptions in supply and speculations in the oil market.
||Global markets bogged down
Against a backdrop of rising inflation and interest rates, corporates will have to brace themselves for a likely slowdown in net profits. And there could be added pressure on companies to hike wages especially if the latter is not growing in tandem with inflation. This would most certainly dampen profitability of companies in the future.
These are testing times for central banks around the world and most of them have accorded priority to bringing inflation under control by raising interest rates at the cost of their respective economies facing a slowdown in growth. Case in point is the interest rate hikes undertaken by the RBI and the European Central Bank. While the US has not gone in for a hike in interest rates till now, it certainly seems to have halted its rate cutting exercise for the time being.
Also read - Emerging markets need a Volcker
...though not from the Finance Minister as you would have imagined. Global investment banks have been cutting their Sensex (BSE-30 index) targets for this year and the next. In its latest report, HSBC Holdings Plc has cut its estimated Sensex target by 20% for 2008. The target now stands at 14,000 levels for the index, down from the bank's previous target of 17,500. Further, HSBC has also lowered its FY09 target for the index from 21,000 to 15,000, a cut of 29%!
||It's rollback time!
So what are the reasons behind such big cuts for the ubiquitous Sensex, which till half a year ago was the cynosure of all eyes? "There is risk of price-earnings multiple contracting in the case of further monetary tightening," says HSBC justifying its assumptions.
As far as our view on the ubiquitous Sensex is concerned, we never had one in the past, and do not intend to have one in the future as well. How does that matter when one is following a stock-specific approach to long-term wealth creation?
One of the fallouts of a democratic set-up in a country (for good or for bad) is the need to arrive at a 'consensus' to do (not do) things. And we as the biggest democracy in the world have been following the consensual approach for ages to arrive at decisions to do (how not to do) things. Be it for the investigation of a scam, or for the creation of a dam, we require a consensus. And, at most times, the consensus is so large, that we fail to arrive at a conclusion, the very basic premise for which the consensus was required!
Something similar is visible when one considers investing in stock markets. When the markets are buoyant and everything that you pick up rises in value in a short span of time, participants (investors and speculators) tend to form a consensus that the euphoria will not end soon. This is what was seen when the Sensex was at the 21,000 levels. Many had formed the view that the next target will be 25,000. And all were proved wrong again!
More importantly, small investors, who (usually) follow such a consensus approach to investing, are the first to fall prey. Now, when the BSE-Sensex has reached near the 13,000 levels, the next 'consensus' target has been set at 10,000! Why?
Whatever could have gone wrong with respect to economy, politics, stock markets - has already gone wrong in India since the start of this year. The country is reeling under double digit inflation, large government deficits and rising interest rates. Foreign investment is fleeing, the rupee is falling, and the stock markets are down almost 40% from the year's high.
While the concerns are for real, we do not expect them to have a very prolonged impact on India's economic growth and the robust long-term earnings visibility of Indian corporates. The current situation and its impact on stocks only reminds us of the past events in the history of Indian stock markets in which investors who took advantage of the mis-pricing of risks eventually reaped the benefits of patience and foresightedness.
Fear among investors that the worst in the credit malaise is yet to come reared its ugly head once again. And the two companies to cast this pall of gloom were none other than the US' largest buyers of home mortgage namely Freddie Mac and Fannie Mae. The stock price of these two companies plummeted by 18% and 16% respectively in just one day amid concerns that they would need to raise billions of dollars in fresh capital. As a result, Asian markets too languished in the red, as this news did not go down well with investors in this part of the world too.
||In the meanwhile...
Indian stock markets were at the receiving end falling by 1%. As per Bloomberg, oil prices rose by US$ 1 a barrel following reports that production at Mexico's biggest oilfield declined and the first hurricane formed in the Atlantic Ocean this year would disrupt output. The dollar continued to weaken against the euro and the Japanese yen. Yahoo reports that a falling dollar has helped boost oil prices by 50% this year as investors buy commodities such as oil as a hedge against inflation when the dollar weakens. Taking cues from the US and Asia, the European indices too have opened proceedings on a weak note with most of the key indices reporting declines of 2%.
Chinese banks are in a quandary. The steep plunge in the stockmarkets has caused the average Chinese man to shift his money to time deposits, which attract a higher interest rate. Given that the rising inflation has led the Chinese government to place curbs on the lending activity of banks, the latter will have to resign themselves to earning lower net interest margins. To add to its woes, weakness in the stockmarkets has curtailed mutual fund sales, which had helped banks increase earnings from outside their mainstay lending business. Chinese banks have been at the receiving end since April this year. Ever since inflation reached a 12-year high of 8.5%, the amount that banks can lend has been restricted to the same level as that in 2007. Plus, the proportion of deposits that banks must keep as reserves with the central bank has been hiked five times this year to 17.5%.
||Banks under pressure in China and India
Indian banks too have been feeling the heat. Inflation rising to 11.63% caused the RBI to adopt a two-pronged approach of hiking the cash reserve ratio (CRR) as well as the repo rate (rate at which the RBI lends to banks) by 0.5% each to suck up an estimated Rs 200 bn from the market. Indian bankers are of the view that while the liquidity situation will not be very tight even after the rate hikes, primarily because of the slower offtake of funds, they will necessarily have to offer better rates on term deposits and pass on the rate hikes to the advances as well. This may bring down the growth in advances (at 25% YoY in May 2008) and also put net interest margins under pressure.
Also read - RBI's move: Playing havoc with banks?
Europe, which had set a target for 10% of transportation fuels to be derived from biofuels by 2020, is likely to cut back its plans. This has largely been attributed to the rise in deforestation and surge in food prices. The International Herald Tribune states, "The current generation of biofuels reliant on crops like corn and soybeans helps drive up food prices by using agricultural land, aggravates deforestation and may be worse for the climate than conventional oil once the cost of production and transport are taken into account. The majority of biofuels produced in the world today are extracted from corn in the US, sugar in Brazil and both grain and oil-seed crops in Europe."
||Cutting back on biofuels|
Biofuels have been attracting considerable interest of late given the relentless rise in crude oil prices. Besides achieving greater energy security, countries are also looking to reduce the use of fossil fuels to lower greenhouse gas emissions and consequently improve air quality. At present, biofuels are being produced from food crops such as sugarcane and maize to produce ethanol and from vegetable oils such as rapeseed, soybeans, palms and others. To put things into perspective, IMF states that the global production of biofuels amounted to 45 bn litres in 2006, representing slightly more than 1% of global road transport fuels. Among the largest biofuel producers, the US used 20% of its maize production for biofuel, EU used 68% of its vegetable oil production and Brazil used 50% of its sugarcane for biodiesel production.
Also read - Food crisis: Growing worries
Global pharma companies continue to be beset by a host of problems. On one hand, research costs are rising with nothing much to show for in terms of new product launches. And on the other, rising emphasis by governments across the world to go in for generics in a bid to reduce healthcare costs has eroded their profits. The fact that the regulatory environment is getting complex and the US FDA has become very stringent in approving new drugs has made matters even worse.
||Big pharma's changing strategy
In such a scenario, global innovators are following the inorganic trail by either acquiring promising molecules or small biotech firms or generic companies. With Novartis successfully managing both a branded business and a generics business (Sandoz) and the Japanese innovator Daiichi acquiring Ranbaxy, buying out generic companies seems to be the latest fad that is likely to gain more prominence in the future.
India's mining industry is expected to touch around US$ 30 bn in the next four years accounting for around 2.5% of the country's GDP. The country is ranked among the top ten globally for having abundant deposits of iron ore, coal, bauxite, mica and manganese amongst others. India is rich in iron ore reserves and exports account for as much as 50% of its total iron ore production. These exports have increased from 31 m tonnes (MT) since 2000-01 to almost 90 MT in 2005-06, a compounded annual growth rate of almost 24%, with China accounting for 50% of India's iron ore exports. Because of this abundance, the Indian steel industry has an inherent long-term advantage over the international players and need not worry of regular raw material supply.
Also read - Ceding the iron ore advantage?
This is in stark contrast to coal deposits. Despite having strong reserves, India still has to import coal on account of delays in project commissioning, inadequacy of policy framework, inability to create appropriate infrastructure among other reasons.
"Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it." - Warren Buffett.
Also read - More lessons from Buffett
||Today's investing mantra
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