The reason why investors made big losses yesterday! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The reason why investors made big losses yesterday! 

A  A  A
In this issue:
» What drives stock prices?
» Indian corporates disappointed by RBI's rate hike
» Where is the telecom sector headed?
» What should India do to boost exports?
» ...and more!

What are the factors that influence earnings and stock prices? Broadly we can divide all factors into two categories- internal and external factors. Internal factors would mean the company's operations, the products, management quality and so on. These are factors over which the management has significant control. And then there is the external economic environment. Given that a company is nothing but a cog in the larger macroeconomic wheel, the external environment does have a substantial impact on the company's fortunes, and also its stock price.

Let's consider the macroeconomy. It is an intricate web of relations and interactions between millions of microeconomic factors. But there is one factor that clearly has a very major influence on the economy. And that's the government! By controlling both fiscal and monetary policy in an economy, the government becomes the single most powerful agent that gives direction to the economy. It then naturally follows that government action is very closely monitored by investors, economists and experts.

So the anxiety and excitement surrounding announcements and comments by policymakers are understandable. Especially if the policymaker is the Chairman of the most powerful central bank in the world!

If you recall, Ben Bernanke had commented some months ago about a likely tapering of the quantitative easing program. Since then, many fellow members of the Federal Open Market Committee (FOMC) had on many occasions hinted at a probable taper from September.

So everyone was waiting for that historic moment on September 18 when Bernanke would finally announce the taper plan. But to everyone's surprise the taper did not happen. In other words, the US Fed would continue its money pumping program. Reacting to this, the world stock markets rose sharply.

But many investors ended up burning their fingers. Needless to say, they were those who had taken Bernanke's comments too seriously and invested accordingly.

Something similar happened in India too. After the Fed announced it would maintain its easy monetary policy, many speculated that the RBI would ease its hawkish monetary stance. But that didn't happen too. In his very first monetary policy review, newly appointed Governor Raghuram Rajan took the unpopular decision of tightening policy rates. Lo and behold, the markets tanked yesterday.

And here comes the important question- Should investors make their investments based on what policymakers say or the anticipation of certain policy decisions?

The answer is a big no. As the two examples above have shown, macro policy decisions are very dynamic and uncertain. It would be unwise to make investments based on expected policy outcomes because if things don't take the course you expected, you are going to burn your fingers.

Do you think it is wise to invest based on expected policy outcomes? Let us know your comments or post them on our Facebook page / Google+ page

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01:30  Chart of the day
One of the most daunting problems that has arrested India's growth trajectory is the poor state of infrastructure. And high power deficit has been a spoke in the wheel of the India's economic growth. As per an article in the Economic Times, 400 million people in India have no access to power. That's almost one-third of India's population.

Today's chart of the day shows the hydro power generation capacity of major world economies. It is evident that India lags far behind the other BRIC economies. Currently, hydro power capacity comprises 17.5% of the country total power capacity. In fact, China's hydro power capacity is more than India's total power generation capacity! It is high time the government hastens reforms to boost power generation in the country.

India lags far behind in hydro power capacity
Data Source: The Economic Times

A long time observer of the Indian economy can't help but notice that the services sector now accounts for close to 60% of our GDP. And the way the trend is moving, the share will only increase from here on. But is it reflected in the way we analyse stocks? The answer is a big no we believe. Most service sector companies rely on human capital but the attention given to this metric is woefully inadequate. And even if any attention is paid, it does not go beyond calculating revenues per employee or net profits per employee. Simply because there is a widespread belief that what matters in any company is how its revenues and profits will shape up and not these other irrelevant factors. However, a new study has shown how wrong this assumption is. As per this study highlighted in, a couple of metrics based on returns on human capital investment are much more powerful indicators of long term share price movements.

What exactly are these metrics? Well, they are 'Return on Human Capital Investment' and 'Human Capital ROI ratio'. The first is arrived at by dividing total cost of workforce to net operating profit. The second on the other hand divides revenues net of non-workforce expenses again by the total cost of workforce. One close look at these ratios and it is clear why they are so effective. Rather than treat human capital as a mere commodity, they actually measure how productive the workforce is. And just as capital productivity is important to a stock's performance in the long run so too is human productivity we reckon. It thus makes perfects sense to incorporate these ratios into one's analysis. Especially when the firm under consideration is human capital intensive. Worth pointing out that in the US a fund has been formed with the objective of investing in companies with great human capital management. And how has it done? Well, last heard, it had significantly outperformed the S&P 500 index.

The Indian government was hoping for some free lunch. Ben Bernanke's resolve to keep the liquidity tap open gave it exactly that. The assurance that cheap money will keep flowing in from the West offered some temporary relief to India's politico. Having unsuccessfully dealt with the falling rupee and bloating deficit for past few months, this was their only hope. The fact that the incumbent RBI governor was a newly minted one was another plus point. Little did the government expect Dr Rajan to show his true colours so soon. However, it was not just the government that was hoping for some generous streak from the RBI. India Inc. was party to it too. And the RBI's latest and unexpected move has left it thoroughly disappointed to say the least. At a time when both growth and profits are elusive, cheap funds were their only hope of sustenance. It now seems that for companies unprepared to deal with yet another conservative RBI governor, it will be trial by fire!

Post 2008, the telecom sector fell out of favor of the investors. Hyper competition, the subsequent tariff war, regulatory issues were some reasons for this apathy. Subsequently the margins of even the best and biggest telecom operators came under pressure while their balance sheets continued to get stretched. But in recent times, the telecom stocks seem to be coming back on the radar for most of the brokerage houses. Most of the euphoria has been based on TRAI's recommendation to cut the reserve price for spectrum in the upcoming auctions. Leading brokerage houses have been upping their views on the telecom stocks as well. Most of their positivism is based on improving regulatory outlook and expectations of tariff hikes. In our opinion if investors get swayed in the favor of telecom stocks just on these reasons, then they would be committing a grave mistake.

True that in recent times most of the telecom operators have seen an improvement in realized rates. However this improvement has been attributable to cutting subscriber related costs and not to increase in tariffs. Moreover as the spectrum reserve prices are slashed, then there would be competitive bidding during the auction. This means that there is a big possibility that we can expect competition to flare up if the number of participants go up. In such a scenario, raising tariffs may not really be a viable option for the operators. Also, just because the regulator has given a positive comment on a few issues; does not mean that the regulatory risk for the industry has come down. Telecom is a utility for any country. And in India there is still a huge scope for both voice as well as data services. Therefore, the long term fundamentals of the sector remain sound. However, there are regulatory and financial pains for the operators that investors cannot ignore. Therefore, exhibiting over exuberance or over pessimism based on reports and news headlines would in our opinion be nothing but an overreaction.

Among a host of problems affecting the Indian economy, the rising current account deficit and the sliding rupee probably figure at the top. So far, the government has been focusing on reducing imports to narrow the gap. Many of these have been short term measures such as curbing gold imports for one. But the other solution is to increase exports and make them more competitive. In this regard, some efforts could finally be seen.

As per an article in the Economic Times, India is looking to tap certain sectors in the global market where China is fast losing its export competitiveness. China has largely been an exports driven economy. But rising wages in the dragon nation has meant that in certain areas it is beginning to lose its edge. And this is what India is looking to capitalise on. The other point that India needs to focus on is moving up the global value chain. For instance, the article states that India produces one of the best yarns in the world. But its apparel exports have largely been stagnating. Smaller countries on the contrary are being more aggressive and cornering more market share. Then there are other bigger issues that India needs to work on. These issues include rigid labour laws and problems relating to land acquisition and environment. Indeed, these issues, if addressed, will not only bolster exports but will have a huge positive impact on the domestic economy as well. So far a study has been commissioned to study ways of bolstering exports. We hope that this soon converts into action.

In the week gone by, barring China, majority of the global stock markets closed in the green. The rally was fueled by the US Federal Reserve postponing its decision to taper the QE program. Various emerging as well as European markets rose after the Fed's decision. However, the party did not last long. During the week's last trading day, various global markets witnessed selling pressure. One Federal Open Market Committee member signaled that the Fed could curb stimulus measures next month though this may not happen in September. The investors reacted to this uncertainty negatively and a heavy selloff was witnessed on Friday.

During the week, Fed Chairman Mr Ben Bernanke had announced that the Fed will wait for evidence of strong economic growth before taking such a step. However, the announcement of possibly curbing stimulus in the last trading session intensified selloffs in the US and various other markets.

As far as the Indians stock markets are concerned, while the Fed's decision earlier fuelled a rally, the new RBI governor announcing a 25 bps hike in the repo rate dampened sentiments on Friday. As a result, Indian markets sunk into the red. The RBI move was in line with the inflationary pressures that continue to plague the Indian economy.

Data Source: Yahoo Finance

04:50  Weekend investing mantra
"Warren is one of the best learning machines on this earth. The turtles who outrun the hares are learning machines. If you stop learning in this world, the world rushes right by you." - Charlie Munger
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5 Responses to "The reason why investors made big losses yesterday!"


Oct 2, 2013

In view of the two metrics suggested, I will have to re-evaluate TCS/INFY/Wipro/Tech Mahindra n two more next in ranks.(2) I think the initial success of China's economy will be slowly tapering off as the rulers there loosen the clutches on the people by giving little more freedom and the cost rises (3) It is always that not only the small investors exhibit the herd mentality but the cos. also (I mean the wolfs (wolves)and sharks )who are aided by so called anylist(paid news writers).So do not go by what others say. Apply ur mind and look at the basics.



Sep 30, 2013

The investors will continue to make big losses in future also , as long as these measures are not taken by the MoF / SEBI/ MCA ( Min. of Corporate Affairs ).
1. The Auditors of Companies are to be selected & approved by a majority of Non-promoter-shareholders , including MFs& Financial Institutions .
2. A ceiling on the present vulgar salaries , siphoned off ,by CMD/ his wife/ mistresses/ sister-in-law /close relatives , must be fixed . The ceiling will have a ratio of 10/ 20 /30 times the median/average salary ( CTC ) of the Company , according to the size/turnover of the Company & on Small/Medium/Big size of the Market Capitalisation & on the average of PAT of the last 3 years .This ceiling also must be voted by majority of the Non-promoter-shareholders.
3 . There must be a provision to arrest at once the socalled promoters of Companies that vanish in a year .
4. The Analysts who are in the Pay/Gift role of Companies must be exposed by the SEBI/Media . (Now even some newspapers are in this role of pimps for Companies .

Like (1)

Prof. N K Jain

Sep 22, 2013

The events referred were not black swan. The economic data before fed announcement were weak.
In case of India food inflation and general inflation figures were high. Dr. Rajan has done what he should done.
It was a case of reading too much in the statements of high and might.
Investors go overboard in building high expectations hence they suffer.

Like (1)

Umesh Sharma

Sep 21, 2013

The fundamentals should guide one for the safety of investment.However the methods adopted by different agencies vary.In India the market is greatly influenced by the foreign intervention.This has resulted at times in good shares getting beaten down.The few shares which the foreign investors fancy show a great appreciation in a short span of time.but they are highly risky and one is likely to loose substantially if investments are made in such shares.So the best thing would be to judge the mood of the market and make short term investments with a definite target in mind.One should get out as soon as the target is achieved

Like (1)

J. Muruganahan

Sep 21, 2013

When I do not know, what is going on in the market, I simply sit tight.

Like (1)
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