'All assets appear overvalued' - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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'All assets appear overvalued' 

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In this issue:
» Bill Gross sounds the alarm bell
» Long term returns in Indian stocks still attractive
» An admission of the rare kind
» Curious case of Indian telecom companies
» ...and more!


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00:00
 
The voices are getting louder by the day. And these do not belong to some ordinary gentlemen. After Jeremy Grantham's decidedly bearish undertones yesterday, it's the turn of Bill Gross, arguably the most powerful money manager in the world, to play the Cassandra. In his monthly letter, Gross has made a scathing observation that almost all assets appear to be overvalued on a long-term basis. And according to him, this is not only true in the present environment but the US and most other G-7 economies have been significantly and artificially pumped up by asset price appreciation for decades. In other words, people kept borrowing against these inflated asset prices and kept stimulating the economy artificially.

Gross has very convincingly argued that over the long-term, asset prices should follow the growth in GDP of an economy but the excessive use of leverage and creation of sophisticated financial instruments like derivatives in the 1980s, led to a period where asset prices outperformed growth in GDP handsomely and this continued for nearly two decades. Infact, at its peak in 2007, return on all US assets was 100% higher than what it theoretically should have been. Thus, while some of the excesses were corrected in the recent financial crisis, the US policy makers are trying to once again push the asset prices higher so that the GDP can once again return to its pre-crisis growth levels. While it remains to be seen whether they succeed or not, as far as stocks are concerned, the current rally is not sustainable and over the long-term, a growth of 4%-5% is what that can be obtained from investing in US stocks at best.

00:55
 
Will the above statement hold true for India as well? Not really we think. Unlike the US, growth in India is not asset price driven as leverage is still very low and use of derivatives extremely sparse. And secondly, nominal growth in India's GDP is likely to remain in the region of 12% - 15% over a reasonably long period of time. Thus, at the current P/E multiples, it will not be wrong to say that Indian stock markets should return in the region of 12%-15% from a long term perspective.

Of course, these are aggregate returns and there could be individual stocks that could potentially earn greater returns, like in the region of 20%-22% for a sustained period of time. Needless to say, they have to be available at attractive enough valuations and have to be very good quality companies. Click here to know about such companies.

01:26  Chart of the day
The IMF, in its most recent WEO report (World Economic Outlook) has revised upwards the projections for the world GDP growth. Apparently, the better than expected economic performance during the second quarter of the current calendar year prompted the IMF to take such a step. It now expects world GDP to clock a growth 3.1% during the calendar year 2010 as against its earlier estimates of 2.5%. Needless to say, India and China are likely to emerge as the fastest growing economies as they have been doing so consistently in the past.

Source: RBI

01:54
 
The Reserve Bank of India increased the frequency with which it evaluates the monetary and liquidity situation in the economy from half yearly to quarterly intervals a couple of years back. It is at these intervals that the central bank offers its view on the economic situation and an indication of the possible future movement in interest rates. However, given that liquidity and interest rates are short term variables, the RBI has been known to use its monetary policy tools (CRR, SLR, repo etc - rates which determine short term borrowing and lending rates) irrespective of the timing of the quarterly reviews.

Hence, notwithstanding the fact that the RBI monetary policy is an important economic event, it would be safe to say that the same is of minimal significance to a long term investor. For the investor who has already factored in a long term average of economic variables, such short term fluctuations call for no reason to review estimates unless they have long term implications. What however are important are the RBI's hints with regard to its concerns and comfort factors. The policy review this quarter for instance did a good job of highlighting the reflating bubble in real estate.

02:34
 
Continuing with the RBI theme, while the government of India could only pay lip service to the issue of CEO salaries , India's central bank and also the banking sector watchdog has decided to do a lot more to ensure sound employee pay policies for the banking sector. For starters, it is already working on Financial Stability Board (FSB) principles to formulate guidelines for the same. It is believed that highly unreasonable pay packets for CEOs of large financial institutions in the western world were one of the main reasons for the global financial crisis.

Apparently, the focus while arriving on the variable compensation was too much on factors like trading profits that led to these firms taking risks that were detrimental to the long-term health of the institution and ultimately, led to their downfall. The FSB report, which has also been approved by the G-20 nations, aims to correct this very anomaly and has proposed linking total variable compensation to the overall performance of the firm and maintaining a sound capital base. However, India's central bank will have to be also wary of market realities while putting into place employee payment guidelines. Otherwise, the banking sector might lose talent to other industries.

03:16
 
Can a soap company remain profitable by giving out the soap for free and charging for the bath? Highly unlikely, isn't it? However, a few months from now and the telecom companies in India may perhaps have to do exactly the same thing and still remain profitable. Of course in this case, the soap would mean voice calls and the bath would mean value added services like roaming, messaging, song downloading etc. As per a leading daily, local calls on mobile phones cost 40 paise per minute and they are likely to go still lower. Infact, low enough for the country to may be become the pioneer in the world of a concept that is known free voice calls.

It would be naive to assume that the CEOs of telcos in India were not aware of this fact. They indeed were and this explains their move towards trying to reduce their dependence on voice calls. It should be noted that more than 30% of the revenues and 50% of profits of companies that have existed in India for quite some time now already accrue to them by way of value added services. The others that have fallen behind will have to quickly play catch up. Otherwise, with the kind of capital intensity the sector demands, it will not be long before they start bleeding. While such a scenario will be good eventually as it will lead to the much needed consolidation in the sector, we will have to go through a lot more uncertain times in the interim. Little wonder, telecom stocks are being taken to the cleaners these days.

04:04
 
During a crisis of any sort, it is common to witness the blame game where nobody wants to really take responsibility for their mistakes upfront. Take the case of the current global financial crisis. Everybody right from the investment banks to the commercial banks to the rating agencies to even Alan Greenspan have been pinpointed as the architects of the crisis. Therefore when the head of the Securities and Exchange Commission (SEC) Chairman Mary Schapiro came out and said that regulators were as culpable as the others for the financial crisis blowing out of proportion a few eyebrows must definitely have been raised. She said, "Perhaps we bought into the fears about global competition or failed to appreciate the growing and concentrated risks. Either way, the right questions were not asked, nor were the necessary steps taken to mitigate the risk before we coasted to the brink."

Schapiro has had a tough year so far. As if the financial crisis were not enough the Bernie Madoff fraud only questioned the integrity of the regulatory body. The SEC certainly has a challenging task ahead of it to restore its reputation as a regulatory body that stresses on trust and transparency.

04:44
 
Meanwhile, Indian markets witnessed a quite volatile trading session today and the BSE-Sensex was down nearly 100 points at the time of writing. Stocks from the banking space were amongst the major contributors towards the weakness. Amongst global indices, while most Asian stocks closed in the negative, Europe was also under a spell of weakness.

04:55  Today's investing mantra
"A fast-changing industry environment may offer the chance for huge wins, but it rules out the certainty we seek." - Warren Buffett
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6 Responses to "'All assets appear overvalued'"

Shyam

Oct 29, 2009

Good article and very good read. I agree with the fact that the assets appear very much overvalued and it is surely in bubble and not sure when the bubble is going to burst.
We have seen similar burst in other countries like US, UK, Spain, Ireland etc and ended up prices getting to the rock bottom and starting fresh. In India, the prices seems to be holding far better and it is not good for the economy and the country to be artificially inflated because when the fall comes it will very steep and hurt people in a bigger way.
Like one of the observors, the price of property / land has gone higher by about 3 to 5 times within the last five years and has the salary and living standard increased soo much? Only time will say which direction we are moving on, right or wrong

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Venkat

Oct 29, 2009

Yes, prices of real estate has gone up very high. Land prices have to come down drastically. Government should faciliatate to reduce the land prices. This is the basic problem.

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kbr prasad

Oct 29, 2009

GOOD INFORMATION. THANKS FOR IT. PL. GIVE HEADING TO
EACH INFORMATION. PRESENTAION WILL BE MORE IMPRESSIVE
BY GIVING INFORMATION IN BRIEF GIST ALSO.

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R.Panneer Selvam

Oct 28, 2009

Highly informative and the comments by the experienced viewers are impressive

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krishnakumar

Oct 28, 2009

very good read.....a good synopsis of daily key events and some insightful observations. kudos to the team that puts this together every day and makes it interesting.

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Ashok Agarwal

Oct 28, 2009

You are talking of realty prices. These are unreasonably high. In 2003 Kharghar used to sell @ Rs 650 psf, and Chembur area/ Govandi was 1600 psf. Then in 2008 it went up to Rs 3800 and 9000, increasing more than six times in five years! What is the justification? In fact government body has contributed to this abnormal profit making. The mechanism has been like this.
When CIDCO took over land from Farmers in the new Bombay area, they developed it and returned 12.5% to original owners as developed Gaothan plots. Thus in every area while there were , say, 8 developed plots with CIDCO there was also one such plot with the original farmer. Now this poor guy made a deal with a builder by entering into an agreement that the builder will hold the rights to develop and sell the the property, in return for some small money or a flat or both. Thus in each area builders acquired control on many plots. Now came the CIDCO again for manipulation. They put a public tender for one of the plots in that area, these very builders quoted high and purchased it, and the land prices accordingly went up in the whole area. Thus flat prices were also increased. Now the fact remains that the builders probably paid high for only a small piece of land and all other plots were already under their control. May be CIDCO earned money. But is CIDCO supposed to act in this manner? Their job is development and also ensure fair price for customers. A middle income person is not only a part of the market in conventional sense, as a citizen he is the owner of all Government including CIDCO. However they have been treated only as a customer who is a to be used only for making profit.
Similar actions are being witnessed again on the part of CIDCO. This whole procedure of public tendering is highly manipulative and has the effect of increasing the real estate prices. The line up of governance appears to be repeating.
This is how prices were jacked up in New Mumbai. When new mumbai gets costlier, main mumbai prices will automatically increase. When Mumbai gets costlier, Delhi prices will also increase, and then Bangalore, Chennai etc will also go up. Thus CIDCO has been at the root of increasing all property prices through out the country and directly responsible for the abnormal situation mprevailing today. Somebody needs to take strong corrective actions. Of course we can hardly afford to get into rapid crash of realty prices, that will be US like situattion and harm the banks. But at least now onward prices should not be allowed to rise. Already housing has gone beyond reach of most people.

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