Are you mesmerized by rising stock prices?

Jul 27, 2009

In this issue:
» Keep an eye on companies, not stock prices
» Power of BRICs shows up through IPOs
» Bank nationalisation (and not RBI) has saved us, says the FM!
» What to expect from RBI's monetary policy
» ...and more!!

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00:00
 
As we read from newspaper reports, most companies that have reported their results so far have surpassed the broking community's estimates. But comparing to what we saw till about March, we can assume that what this means is that the current reported earnings have been 'less bad' than what brokers had projected in the face of fear.

Anyways, the words that best describe their (brokers') explanation of India Inc's June quarter results are - "Better than expected!" What they are simply saying is that they are happier than they had been before the start of the result season.

But you know this community has always been in the business of cheer leading, even when there's really not much to cheer about. And in these times, it wants you - the investor, and its client - to think positively, on the assumption that positive thinking can be a self-fulfilling prophesy. After all, isn't it that if investors begin putting more money into the markets, the markets will automatically rise, leading more investors to put in more money? While the rally might end subsequently because nothing has fundamentally changed in the real economy, the brokers would have made their commissions by then?

See, we understand that if the economy improves, corporate earnings will follow. It is also true that stocks will turn up before businesses do. But it is very important for you to understand carefully what you are advised in the form of a stock/company whose earnings are said to have been 'better than expected'.

As we have seen from corporate results so far, what's pushing earnings is not really a growth in sales, but largely cost cutting - be it from cutting staff, or shutdown of capacities, or general cost rationalisation. If a firm cuts its costs enough, it can show a profit even if its sales are still in the doldrums.

But you might not be made to see through this as you remain mesmerized by rising stock prices. If yes, our suggestion to you is - Keep your eye on the real economy and companies' businesses and valuations before taking the plunge. It's dangerous to buy stocks just because everyone else is buying, and because the entire market is rising!

01:19
 
In the meanwhile, equity markets in the BRIC nations have come a long way in a surprisingly short time. Here's some interesting statistics for you. China's Shanghai Composite Index and Brazil's Bovespa Index have soared 89% and 45% respectively this year. Back here in India, the BSE-Sensex has climbed 59%, while Russia's RTS Index has gained 64%. In contrast to that, the Dow Jones in the US and Japan's Nikkei indices have risen by just around 4% and 14% respectively, a pittance compared to the gains in BRIC markets.

Data Source: Yahoo Finance

What is more, IPOs in these nations too have come back with a bang. China State Construction Engineering Corp. recently raised US$ 7.3 bn, making it the largest IPO in the dragon nation in the last 16 months. In Brazil, VisaNet pulled in US$ 4.3 bn in June this year. India too seems to be warming up with Adani Power's IPO (starting tomorrow) planning to raise about US$ 681 m.

Barton Biggs, former chief global strategist for Morgan Stanley, feels that the world's two biggest IPOs this year coming from China and Brazil are nothing less than a reflection of the 'growing power' of the BRIC nations. Seems like being a developing country is fast becoming more of a positive than a negative in the face of this global crisis.

02:09
 Chart of the day
How decoupled (or coupled) are emerging nations from the developed world can easily be seen in today's chart of the day. It shows the change in annual industrial production over the years, with the same falling off the cliff since April 2008. In fact, the worldwide fall in industrial output this time around is being compared to the situation during the Great Depression of the 1930s. The good news, of course, is that the policy response is very different. The question now is whether that policy response will work in reviving the world industrial system.

Data Source: IMF's World Economic Outlook 2009

02:37
 
Clearly, the FIIs are excited about the recent election results. But Finance Minister Pranab Mukherjee is trying his best to change. It may be recalled that during his budget speech he praised the late Prime Minister Indira Gandhi's decision to nationalise about 40 banks, which he believes saved India from the global financial crisis. He has now reiterated his stand over the last weekend. As per a leading daily, he said, "We survived the economic meltdown because of this step. In the world's leading countries, the finance sectors have crashed but we are still surviving because we nationalised our banking sector."

In our opinion, the wise men at the Reserve Bank of India (RBI) and not Indira Gandhi should be given the credit for India escaping the financial meltdown. They made sure that the lending practices of Indian banks were not hijacked by fancy 'financial innovations'. The difference in praising the regulator and not the government through its presence in the banking sector is vital because India needs well regulated free enterprise and not the disaster that the license permit raj and mai-baap sarkaar was.

03:18
 
Anyways, the RBI will announce its first quarter review of the 2009-10 monetary policy tomorrow. Given the macro-economic picture, the bank is expected to play out a balancing act - between the need to grow the economy while keeping prices under check. Remember, while prices (measured by inflation) are under check currently, the huge fiscal deficit of the central and state governments have the firepower to ignite high inflation in the future. Anyways, the consumer price inflation is already ruling at high levels given the spike in food prices over the past few months. Now, with monsoons playing truant, these prices are set to rise even further, thus making RBI's policymaking even difficult.

We will not try to hazard a guess on what Dr. Subbarao will say tomorrow. These are difficult times for guesses anyways!

03:47
 
There are no signs of drought in India despite below-normal monsoon rains, claimed India's meteorological department very recently. Now with the northern state of Uttar Pradesh declaring 27 more districts as drought-hit (taking the total to 47), these claims are biting the dust.

Whatever the Indian economic experts say, the Indian economy remains highly dependent on the vagaries of monsoons. With more than 60% of population dependent on agriculture and allied activities for their livelihood, it will take a long time for the country to decouple its economy from agricultural performance.

See the chart below for reference - the years when India's food grain production has declined, the GDP has taken a knock. While the impact has reduced over the years due to pickup in other sectors of the economy - services and manufacturing - the Indian economy has still not reached a level of a major decoupling from the growth in agriculture. Now, with weak monsoons and subsequent fear of lower agricultural production this year, will GDP grow by 5-6% as is being widely predicted? We don't have the answer!

Data Source: RBI

04:31
 
Stocks in India were trading weak at the time of writing. The BSE-Sensex was trading around 40 points down, led by selling pressure in stocks from the oil & gas and auto sectors. The BSE-Midcap and BSE-Smallcap indices were however trading amidst strength. The Sensex was, in fact, the sole loser in Asia, where gains were otherwise seen in the benchmark indices of China (up 1.9%), Hong Kong (2%) and Japan (1.5%). European stocks have also opened this week on a positive note.

04:49
 Today's investing mantra
"The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator's primary interest lies in anticipating and profiting from market fluctuations. The investor's primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell." - Benjamin Graham

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4 Responses to "Are you mesmerized by rising stock prices?"

abhishek

Jul 29, 2009

good news but i expect more from the point of view of the consumer.

Like 

Maanoj Rakhit

Jul 28, 2009

Very good.

Like 

mj singh

Jul 28, 2009

no mesmerisation, price rise even on good results of the coys is not appreciable.DO WE EXPECT SENSEX TO TOUCH TWENTY?

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sameen ahmed

Jul 28, 2009

great insight will like to hear from you more often

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Equitymaster requests your view! Post a comment on "Are you mesmerized by rising stock prices?". Click here!