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A Week after the Monday Market Crash...

Aug 31, 2015

In this issue:
» Spending on subsidies on a downtrend
» A fourth rate cut in the offing?
» DIIs go on an equities buying spree
» ...and more!


00:00

It's been a week since the BSE-Sensex shed a massive 1,600 points in a single trading session. The Indian rupee, too, tanked against the US dollar last week.

But you must see the market crash in the global context. On a relative scale, India turns out to be the least affected economy by the slowing Chinese economy and the yuan devaluation.

What makes India resilient to these global headwinds? Here are five key reasons...

  1. Unlike some other emerging markets, India's economy is driven largely by domestic consumption. Exports to China account for only 10% of our total exports.
  2. India does not compete with many Chinese manufactured products in international trade.
  3. The steep fall in commodity prices, particularly crude oil, is a big positive for India.
  4. More than half of the emerging as well as frontier economies are in bear market phase, unlike India.
  5. India's dollar debt is lower than other emerging economies. So, the risks emanating from the prospective US interest rate hike are limited.
  6. At a time when the global economic engine is struggling for growth, India appears to be one of the few bright spots.
In short, India appears well-geared to handle risks emerging from the global economy. And given that India is in a relatively better position than other major emerging economies, we may see global fund managers increasing their exposure to Indian equities.

Doesn't that sound like the perfect cue to send the BSE-Sensex soaring? Shouldn't you hurry and scoop up your favourite stocks before it is too late? Before you start seeing the Indian economy through rose-tinted glasses, let me show you the other side of the coin.

Remember, the fundamentals of the Indian economy, per se, haven't revived drastically. But because other emerging markets, particularly China, face worsening economic prospects, India's relative position has improved. Be warned, this consolation prize is not going to take us too far.

Do not take India's growth story for granted. We have many big challenges before us...

Take India's banking sector for instance. Typically, the lending activity of banks is a good proxy of overall economic growth. At 8.4% growth, bank lending is at the lowest level in 20 years (as per Economic Times). The massive build-up in non-performing assets (NPAs) is even more alarming. Indian banks have gross NPAs worth over Rs 3 trillion (4.29% of total loans). Add almost a similar amount of loans under restructuring...and you have Rs 6 trillion worth of stressed loans in the banking system. This is nothing but a reflection of the mess in the Indian economy.

When you invest, don't obsess too much over factors that drive stock prices in the short term...such as how Indian markets would react to a US interest rate hike...or how the weakening prospects of other emerging markets would shift liquidity to Indian equities...

In the end, it earnings, and earnings alone, that will determine the worth of your stock portfolio. Need I say more?

As an investor, what do you tend to focus on more - liquidity factors that drive stock prices in the short term, or growth and earnings, the real determinants of long-term wealth creation? Let us know your comments or share your views in the Equitymaster Club.

P.S. Want to know how to 'Crash Proof' your portfolio?

We believe we have found "5 Warning Signals" or "5 Red Flags" that show up in a business right before its stock price plummets.

In fact, ensuring that you're not investing in businesses which show these "5 Warning Signals" could potentially be the difference between creating wealth and incurring losses with your stock market investments.

Read more about it here

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------------------------------


02:30
 Chart of the day
'Give a man a fish and you feed him for a day; teach a man to fish and you feed him for a lifetime', or so goes the famous saying. As far as the administration of the Indian economy is concerned, one word that flies in the face of this wise saying has been 'subsidies'. That's because the subsidies doled out by the government achieve nothing more than very short lived relief to the poor. They do not in any way help in raising their status quo in a sustainable manner. In fact, they often do not even end up reaching the section of society that they are actually targeted towards. And as today's chart shows, the Indian government's spending on subsidies over the last 7 years actually exceeded even its spending on capital expenditure.

This is despite the fact that the latter, i.e. spending on capital expenditure, is what really helps in taking the economy and its citizens to a higher level. However, the good news is that after 7 long years of spending more on subsidies, as per budgeted estimates this year, the government is likely to spend an equal amount on creating productive assets during FY16. Further, if the recent trend of lower subsidies versus capital expenditure continues, it is likely to give a sustainable fillip to the economy. And commodity prices, if they remain low, will only further help the economy achieve this goal.

Productive asset building to finally take priority again?

03:05
It seems India Inc may be in for a pleasant surprise. In the year so far, the Reserve Bank of India has already slashed policy interest rates thrice. As per a leading financial daily, RBI Governor Raghuram Rajan has said that the inflation has come down to the comfort zone earlier than expected. Is this a hint that there could be a fourth round of interest rate cut soon? The central bank is keeping a tab on the inflation data to see if there is room to further ease monetary policy. What are the key reasons for the positive inflation data? One, a good monsoon... Two, lower commodity prices...

While the improving inflation scenario is indeed a big positive for India's growth revival prospects, there are many challenges that need to be addressed. Like we highlighted earlier, India's banking system is witnessing a huge build up of bad loans. There is no quick-fix solution for this. So while news of interest rate cuts by the central bank are seen with high enthusiasm, investors must understand that monetary policy, on its own, cannot guarantee revival of the economy. It must also be noted that the expected results from the rate cuts may not be immediate. Hence, patience and prudence are your best allies.

03:45
And in what may considered to be the opposite of patience and prudence, domestic institutional investors (DIIs) seem to be quite an excited lot these days. As per reports, DIIs poured a net of Rs 157 bn into stocks in the month of August. This is their highest monthly investment in more than six years! In fact, the last time they touched a figure higher than this was as far back as January 2008.

One big thing in common with January 2008 and August 2015 is that both months were witness to sudden and unexpected crashes in the stock market. If this is indeed what triggered the spurt in buying activity, perhaps it is time to step back and reflect a bit. For as we mentioned in one of the editions of The 5 Minute Wrapup last week, 2015 has so far seen stock prices and consequently valuations shoot up considerably. Thus, the recent correction has not necessarily made all stocks cheap. Many, if not most, remain expensive. And that is why we opined how we do not recommend backing up the truck on stocks right now.

04:45
The Indian stock markets were trading strong today on the back of buying activity in a majority of the index heavyweights. At the time of writing, the BSE-Sensex was trading up by around 60 points. Gains were largely seen in pharma and energy stocks.

04:55
 Today's investing mantra
"To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses - How to Value a Business, and How to Think About Market Prices." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Ankit Shah (Research Analyst).

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