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Will the global deflation affect your stocks?

Jul 28, 2015

In this issue:
» Is China going the Japan way?
» Will global pharma M&A impact Indian pharma firms?
» Indian e-commerce heats up!
» ...and more!


00:00
The global economy is in a state of deflation. What do we mean by this? Quite simply we mean that rampant consumerism in developed nations is coming to an end. People in these countries are no longer spending their money; at least not as much as they used to. Why is that? The simple reason is that they didn't have a lot of money to spend in the first place!

They were buying on credit. Their governments encouraged them. Their central banks encouraged them. Tax breaks were given to speculate in real estate. Low interest rates fueled massive credit card driven spending. Developed nations borrowed to the limit. As we know, this party ended in 2008. The aging citizens of the developed world, fearing the loss of job security, put a stop to their runaway shopping spree. As a result, prices started falling. But did this stop governments and central bankers? No it did not.

For the last six years, they have tried every trick in the book to boost consumption again. It has not worked. What has all the money printing and stimulus really done for these economies? Absolutely nothing! The only impact of these measures has been a huge rise in asset prices. Stocks, bonds, commodities, and real estate; you name it. All assets benefited.

But it was artificial, a mirage. It could never last. Solving a problem caused by debt with even more debt is foolishness. Today, debt levels globally are no longer sustainable. A lot of it will not be repaid and will have to be written off. This phenomenon called debt deflation is what we are seeing now. Central banks seem powerless to stop it.

The results are there for all to see. Commodity prices have crashed. The currencies of commodity producing countries like Canada, Brazil, and Australia are under pressure. The twin bubbles in China (property and stocks) have burst. The whole world now knows how desperate the Chinese authorities have become. The only beneficiary has been the US dollar.

Could the global debt deflation impact the Indian stock market? Yes we believe so. While falling commodity prices are good for India's economy, FII sentiment is a completely different matter. Any adverse global event could see foreign flows into India reverse, at least in the short term. If FIIs flee to the perceived safety of the US dollar then Indian stock markets will fall.

But what about the long term? We have no worries on this front. We believe Indian investors don't have much to fear if they take a long term view. The great thing about the Indian markets is that there are so many opportunities. In our travels we have discovered several great businesses. These firms are driven less by global factors and more by the Megatrends currently driving the Indian economy. This gives us comfort that as long as we stick to a bottom-up approach to picking such stocks with sound fundamentals, we will do quite well.

What do you think? Are Indian firms which are benefiting from Megatrends protected from global deflation? Let us know your comments or share your views in the Equitymaster Club.

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02:30
To add to this point, we believe there is a strong possibility that China could be going the Japan way. It is surprising just how similar the situation in China resembles that seen in Japan in the late 1980s. Japan as we know suffered two ‘lost decades' following the bursting of massive bubbles in stocks as well as real estate. The same seem to be the case in China right now. Both nations enjoyed many decades of debt fueled growth based on exports. When Japan's bubble popped, the authorities were powerless.

As per an article in Bloomberg, history could be repeating itself, this time in China. The country faces a deflationary downward spiral. We have not seen much that would convince us that the Chinese authorities are on top of the situation. Just witness their disastrous attempt to prop up a falling stock market. We believe if China does not move quickly towards a more market based consumer driven economy (as opposed to a state controlled export driven one) it will repeat the mistakes of Japan.

03:40
 Chart of the day
In one of our recent editions of the 5 Minute WrapUp, we had discussed how Indian pharma companies have been looking to grow globally through the inorganic route. And now there is one such big ticket acquisition announcement that has come from the world's largest generic company, Teva Pharmaceuticals. The company has acquired the generic drug business of Allergan Plc for a huge US$ 40.5 bn! This makes the deal one of the largest in recent times in the global pharma space. Today's chart of the day shows the largest deals in the global pharmaceutical space in recent times.

Top global pharma deals in recent times
*- Consumer care business; # - Non-US markets

This deal will further strengthen Teva's position in the global markets, as it gives the company a way bigger gap as compared to Sandoz, the second largest generics maker, and much larger scale of operations. Also, as reported by Reuters, this business is seen as a better fit than Mylan's (the company Teva was pursuing earlier this year) as it would improve Teva's distribution channels and access to profitable injectable drugs.

As reported, Teva earns about 60% of its revenues from the American market. Lupin and Sun Pharmaceuticals earn about 45% and 50% revenues from the US market.

Is this deal likely to impact Indian payers? Lupin does not seem to believe so as they believe that this would rather impact the smaller players who are aiming to get a bigger pie of the US market.

As the M&A activity (written in more detail in today's edition of the 5-Minute Premium) has been heating up globally, the M&A activity in the Indian pharma space has been on the rise in recent times, albeit on a much smaller scale. As the global pharmaceutical Industry is undergoing a paradigm shift, the pharma companies have opted for the inorganic route to sustain their growth trajectory. With this increase in M&A activity, the question also arises whether there could be a probability of Indian pharma companies being targeted by such pharma biggies?

Now this is where the Indian pharma capabilities come into play. Abbott's acquisition of Piramal's domestic pharma business, Fresenius Kabi's acquisition of Dabur's oncology businesses are some classic examples. Robust portfolios helped these Indian companies fetch premium valuations. Hence, Indian companies which have strong product portfolios, lucrative product pipeline, low cost manufacturing abilities, low compliance issues in their manufacturing facilities and are approved by developed agencies, can become potential targets by these global pharma biggies.

04:05
Moving on from the deals in the global pharma space to the Indian e-commerce space, a bunch of big news came in from the latter in recent days. Flipkart has closed a Rs 45 bn capital raising deal, valuing the company at US$ 15 bn! As reported by the Economic times,"The 8-year-old firm has raised about US$ 3.4 bn from global investors keen on India's growing consumption and a rising young middle class more comfortable than ever with shopping online".

With projections such as India's Internet market to touch US$ 137 bn by 2020 from levels of US$ 11 bn in 2013, it is likely that a lot more money will be poured into this space in times to come. Not to mention the possibility of the country being a billion plus user base for this market. At the same time however, competition in this space is heating up too. With Amazon seemingly looking to up its spend in the Indian market - one which positively surprised its management - from an envisaged figure of about US$ 2 bn last year; the figure that it being spoken about now is US$ 5 bn for its non-US business. It would be safe to assume that a large chunk of this amount would be coming towards this part of the world.

Next up is that of Ola being in advanced talks with existing investors to raise about Rs 32 bn. As reported by the Economic Times, this deal could value the company at about US$ 4.5 bn.  So far, the company is believed to have raised US$ 676 m. It is reported that the company needs capital to invest in new business as well as sustain the discounts it is offering to customers.

In another development, Pepperfry - the online furniture store - has raised Rs 6.3 bn from Goldman Sachs.

These developments are only a testament of the strong boom that the Indian e-commerce sector is witnessing at the moment. While the opportunities maybe massive - especially in a rapidly increasing market size - the fact of the matter is that these companies continue to burn cash with an aim to retain or gain market share. Not to mention that with competition heating up, the possibility of the ‘heat' only getting bigger does remain.

What makes this development interesting is that Flipkart is now valued higher than a third of the Sensex companies. Ola on the other hand is valued more than Tata Steel and Hindalco.

We believe a good way to look at this is by playing the odds. Should one choose a business possessing real assets and good chance of not going out of business a decade from now? Or, rather go with those that have been around for a few years, have virtually no real assets on the ground and are prone to attracting strong competition in a rapidly changing market?

04:40
The Indian stock markets opened the day on a flat note and continued to trade on a muted note. At the time of writing, the BSE-Sensex was trading lower by 33 points (down 0.1%). Banking and engineering, stocks are trading in the positive territory.

04:55
 Today's investing mantra
"You pay a very high price in the stock market for a cheery consensus." - Warren Buffett.

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat (Research Analyst).

Today's Premium Edition.

M&A is heating up in pharma!

Teva's acquisition of Allergan shows that we could be seeing more of such deals going forward.
Read On...Get Access

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3 Responses to "Will the global deflation affect your stocks?"

SANKARAN VENKATARAMAN

Jul 28, 2015

good analysis. You can give names of some pharma companies which satisfy the norms you have listed out

Like (1)

Suresh Goyal

Jul 28, 2015

Thanks for sharing very nice and informative articles. You are doing a very good job.

Like (1)

K.P.N.Nair

Jul 28, 2015

I am not an economist. You are wright in your view points.
But as long as Indian rupee is pegged to to dollar, any changes in global deflation will definitely affect the Indian economy.

Thanks,
K.P.N.Nair.

Like (1)
  
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