Are we finally out of the woods? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Are we finally out of the woods? 

A  A  A
In this issue:
» Is there a silver lining to India's performance currently?
» Government on the austerity path
» One of the world's best hedge fund managers is returning money to investors
» Realty firms are finally showing some stress
» ...and more!

It's amazing how fast things change. Not long back we were literally staring down the barrel. Our currency was down in the dumps. Stock markets were panicking big time and the economy was on a very weak footing. But events over the past days have significantly altered the landscape. First, the arrival of Raghuram Rajan breathed some life into the markets. Then the Government showed signs of waking up and finally smelling the coffee. And now we have the massive announcement from the US Fed that tapering, after all, may not take place in the immediate future. Thus, this is some turnaround in events we believe. And if you need any evidence, look no further than the stock markets. Clearly, investors seem to be falling over each other in order to buy stocks. Lest they would miss this bus of fast rising prices.

We believe their reaction here is the same as highlighted by the noted behavioural scientist Daniel Kahneman when he put a simple question before students from prestigious schools like Harvard and Wharton. When asked how much would a ball and a bat cost if both of them together cost US$ 1.1 and one is priced one dollar more than the other, nearly 50% stumbled, blurting out a wrong but a very popular answer that the ball costs 0.1 dollar instead of 0.05 dollar. You see, even the most intelligent out there don't take the mental effort required to make the calculation. Instead, they rely on their intuition and gut feel and end up giving the wrong answer.

This is pretty similar to what noted investor Howard Marks calls the lack of second level thinking. As per Marks, this lack of second level thinking is the biggest differentiating factor between a good and a bad investor. If it's a good company, let's buy the stock is what a first level thinker would think. However, the second level thinker would say, it's a good company but it's priced as if it's a great one. So the stock is expensive and hence, let's sell it. Likewise, if the first level thinker thinks the outlook is bad and hence, we should sell our stocks, the second level thinking would lead us to believe that everyone is also thinking the same way and thus, it could actually be the time to buy.

Therefore, the investors who are making a beeline to buy Indian equities are not exactly indulging in a lot of second level thinking we believe. Or as Kahneman has shown, are taking decisions based more on feel good factor and intuition. For if the investors would have done the second level thinking, they would have perhaps known that we are not out of the woods yet. Not by a long shot. The markets are just reacting to the news and no real action has happened on the ground. Even if it does and even if money comes to Indian shores, it may not be able to alter fundamentals which remain pretty weak. Thus, investors would be better off focusing on a stock's intrinsic value rather than reacting to near term price changes that are more liquidity and sentiments driven than anything else.

Do you think the Indian economy is out of the woods yet? Let us know your comments or post them on our Facebook page / Google+ page

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01:27  Chart of the day
Built wealth. There aren't many people who focus on this. But a certain consultancy who answers to the name of EC Harris measures just that for major countries across the world. Well, built wealth can be thought of as nothing but all tangible fixed capital investment, including infra investment, residential and non-residential construction, as well as investments in plant and machinery and also things such as land reclamation. It therefore is an indicator of the resources that a nation can draw upon to enable economic growth. And where does India stand on this in the global pecking order? Well, as the chart highlights India has the fourth largest base of built assets of all the countries in the world. Not bad for a country that hasn't seen much investments happen of late. However, if we have to grow in the long run, there is no denying that this stock of built assets will have to keep growing at a steady pace going forward.

Wealth in terms of built assets: India 4th largest
Source: EC Harris global built asset wealth report 2013

Time to keep some money under the carpet. Quite literally. If you think we are joking, one of the best hedge fund managers of our times is actually putting this into practice. The fund has returned money back to investors only once before in its 31 year history. And, as per Business Insider, it is set to do so for the second time very soon now. We are referring to Seth Klarman and his hedge fund Baupost group. Let us tell you that Baupost holds 33% of its assets in cash on an average. And its cash balance can reach as high as 50%. But given its terrific long term track record, one cannot argue that holding cash has hurt the returns of the hedge fund.

Of course, one needs to also keep in mind that Klarman is quite conservative when it comes to stock holdings. He has argued a lot of times that a stock should form no more than 5%-6% of one's portfolio. And only in cases where the confidence with respect to a stock is very high should the size reach 10%. Anything more than that and we are exposing ourselves to risk he believes. Besides, if a stock forms only 1% of a portfolio, then it is too small a position to make any meaningful difference to the overall performance as per him. Thus, despite such conservative views on stocks, his decision to return money back to investors is quite a warning signal we believe.

Austerity is a word that has gained a lot of popularity since the dawn of the Eurozone crisis. Governments embarked on an austerity drive to cut down their deficits and debt figures. Interestingly deficit is something that has been troubling the Indian government as well. Little wonder then that the Finance Minister has announced austerity measures for the government as well. Some of these measures are - to freeze recruitments; not hold meetings in 5-star hotels; restriction on air travel by the executive class and freeze on buying new vehicles for the government departments. Another austerity measure is to limit the number of people going abroad as a delegation. Apparently these measures would help bring the fiscal deficit under control.

A question that we are forced to ask here is that are these measure too little too late. Would restricting these luxuries for government officials really help the fiscal deficit to such a large extent? If the answer to this is yes, then our next question is how much was being spent on these things earlier? Was the government's luxury and lack of governance the real culprits for the deficit trouble and not the populist measures? While the idea of austerity is certainly a plausible one, however we feel that its execution would be the key to actually controlling the deficit. Austerity has to extend beyond the government departments. It has to be exhibited even in the populist freebies that are being doled out to garner the vote bank. Only then will the deficit come under control.

The slowdown in the economy coupled with the high interest rates has hurt consumer demand. In light of this the retailers have not really expanded their footprint in the manner as what they were expected to do. As a result, real estate developers are burdened with idle capacity. Little wonder that the arrogance they showed towards the retailers has sort of simmered down. They are now offering something that they never did easily. Realty firms are agreeing to offer discounts on rents and are even agreeing to forego fixed rental payments in favor of revenue sharing with the retailers. And the result - most of the noted retail names are jumping to book their retail space for the coming years. Their reason for jumping to these discounts is different. Due to the tough operating conditions, new construction in the retail space has come down. So much so that the retailers think that there would be a major supply crunch in this space by 2015. Therefore, they prefer to avail the discounts being offered and fix their space before the discounts and space run out.

Thus, if we look at the retail side of realty, things do indicate that prices and rentals have cooled off albeit for the short term. The question now is when the same trend would take place on the residential side which would be a big relief for property buyers. Residential inventories are high. It can be inferred from the retail side that it is only a matter of time before realty companies offer similar discounts and offers on the residential side as well. But when would it happen and to what extent is anybody's guess.

India seems to be in an economic mess. All major macroeconomic factors- the fiscal and current account deficit, the Indian rupee, the economic growth, inflation rate, etc. point at the weaknesses in the Indian economy. The sharp fall of the rupee just highlighted India's economic vulnerabilities. But is it all gloom for India? No silver lining?

An article in Livemint has tries to find this silver lining. But it didn't seem very convincing. For one, the author states that the developed economies are in a relatively better state currently. We disagree on this. The reason being that whatever meagre growth the developed economies are witnessing is a result of excessive doses of money printing. In fact, the very fact that the US Fed has deferred its QE tapering plans says a lot about the so-called American recovery. The author's argument that even China is regaining momentum is likely to have been based on very short term data. It is highly unlikely that the Chinese economy will be able to match up with its past economic growth rate. So it would be highly presumptuous to say that the external environment is stable or improving. We should be ready for big negative shocks anytime soon. In addition, India's high savings rate, government divestments and the upcoming general elections are not adequate enough factors that could revive the fundamentals of our economy.

Meanwhile, indices in the Indian stock markets were on a tear today with the Sensex higher by 771 points at the time of writing. Stocks from the banks and capital goods space were seen enjoying the maximum gains. Other Asian indices also closed pretty strong today with Europe too witnessing strong gains.

04:50  Today's investing mantra
"What you have to learn is to fold early when the odds are against you or if you have a big edge, back it heavily because you don't get a big edge often. Opportunity comes, but it doesn't come often, so seize it when it does come." - Charlie Munger
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2 Responses to "Are we finally out of the woods?"


Sep 19, 2013

Excellent observations!! Basically the govt is in credit card mode. Spending before it earns. This is election year. No austerity measure will work. Thus it is in credit trap.

Indian markets also are not out of woods. We will see few more falls before it walks again.


Abhay Dixit

Sep 19, 2013

I would like to know the total amount of money Govt has spent on the heads now under aystirity drive in the last one year.

It is meaningless to allow IAS,IFS and IPS officers to go abroad for medical treatment four days before this move.

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