Change is here

Nov 8, 2008

In this issue:
» The week that was
» The US basks under new-found hope
» Massive rate cuts across the globe
» Playing by the Book
» ...and more!

  Change is here
Change is the only constant they say. And the last 11 months have shown us how. You name it and it has shown, not a negligible, but a drastic change in the past few months. Trends have changed and governments, policy makers and experts have changed their opinions, actions and visions.
The change has been ubiquitous.
From double digit economic growth prospects to recessionary trends.
From inflation to deflation.
From irrational exuberance to unreasonable pessimism.
From leveraged consumption to forced savings.
From investment in futures and options to fixed deposits and bonds.

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The newly elected President of the United States said the obvious - 'Change is here'. And he was applauded. What he did not say was whether the change was for the better or the worse. Our experiences of economic, political and social turmoil in the past have brought about changes that have shaped the destiny of people and economies.

Take the case of India. The currency crisis of 1991 brought about the economic liberalisation that ushered us into the high economic growth phase. The tech bubble burst showed us the outcome of irrational exuberance. And eight years later, meltdown in global housing prices have once again brought about changes. Real estate prices, interest rates and commodity prices have all taken a U turn that no one had envisaged. The biggest lenders globally have gone with their begging bowls to central banks or succumbed to the crisis. The once 'happiest' economy - Iceland - has gone bankrupt. And the key benchmark indices globally have touched their multi-year lows.

Gold and crude prices have also been pretty volatile this year. Gold prices started the year at around US$ 850 an ounce. As crude oil prices started to climb and experts began predicting that oil might hit the ominous US$ 200 a barrel mark, gold quickly shot up to over US$ 1,000 in March. Post that, the metal retreated and began bouncing around in a trading range of US$ 850 to US$ 950 before dipping back below US$ 750 in September. During the past week, crude oil prices corrected by 4.5% to touch a low of US$ 61 a barrel while gold regained some favour (up 1.6%) on the back of depreciation of the US dollar.

The week gone by saw important changes on the political and economic front. The US elected its first Afro-American President. Central Bankers the world over, went on a massive rate cutting spree, something they had not done in years. Our very own conservative RBI also joined in. What is more, the central banks have not ruled out a further reduction in interest rates due to concerns of a deeper economic slump.

Amongst global markets, the Asian indices drew some respite from the additional liquidity and managed to close higher. The benchmark BSE Sensex gained 1.8%. The European markets, however, with exception to UK, continued to languish in the red. The US markets lost as much as 4.2% of the market capitalisation with reports of further job losses and earnings downgrades from corporate heavyweights.

Change is certainly here. And investors need to acknowledge the same. But that does not mean they need to change the way they invested for the long term. The principles of investing in fundamentally strong companies for the long term remain the same. And investors must continue to use the 'Four Filters' (as recommended by Warren Buffett and Charlie Munger) to fortify their portfolio against all such crisis. That is - when buying companies they should look for understandable businesses, with enduring competitive advantages, accompanied by reliable managements, available at a bargain price.

 The week's biggest news

The US basks under new-found hope
This week, the citizens of the most powerful nation on earth settled a debate on the most turbulent political battle in recent times. After eight long years, a Democrat is set to step into the White House. Barack Obama will take over from George Bush and will become the 44th US President, the first ever African-American to do so. Although the US Presidential elections are one of the most watched global events, the intensity had increased manifold this time around as it coincided with a financial crisis of epic proportions.

Just to put things in perspective, a survey by the International Herald Tribune (IHT) revealed that 6 out of every 10 voters cited the economy as the most important issue during the elections with things like the Iraq war and health care being put firmly on the back burner.

As far as its impact on India is concerned, many experts are of the opinion that irrespective of who moves into the White House, Indo-US relations are only likely to strengthen given the global geo-political climate and economic power shift that is currently underway.

The RBI's liquidity pumping effort
The Reserve Bank of India (RBI) announced multiple measures to add liquidity to the system early last week. As a matter of fact, it was for the first time since 1997 that the RBI deployed all three of its main tools - CRR, SLR and repo rate - to perk up the credit markets and enable growth.

The Indian central bank reduced the CRR by 1% to 5.5%, the repo rate by 0.5% to 7.5%, and the SLR by 1% to 24%.

These announcements from the RBI came after inter-bank lending rates climbed to as high as 21% on the back of dwindling cash in the banking system. This was due to the continued large scale FII pullout and RBI's actions of stemming the rupee's decline by selling dollars. The FIIs for instance have pulled out almost US$ 12.8 bn from Indian equities this year after the US$ 17 bn investment they did in 2007.

  Best of this week's 5 Min. WrapUp - Playing by the Book
That stocks on Dalal Street have been beaten and hammered out of shape is probably old news. But allow us to put some numbers to it. As per an analysis on most actively traded stocks (1,600 to be precise) published in a leading business daily, around 55% of the stocks are currently being valued by the stock market below their book value! What this essentially means is that if one buys into the complete equity of these companies and sells the assets in the open market, one could take home a pretty handsome profit. The study further reveals that the discount to book value increases as the market cap decreases. In other words, there are quite a few mid cap and small cap firms that are trading at a steep discount to their book value.

While the current opportunity to buy into stocks with attractive growth prospects is indeed once in a lifetime, we would like to add that book value could be a misrepresentation of the true value of the company in quite a few cases. For example in companies with technologically obsolete plants, actual book value could turn out to be a lot less than what the balance sheet might imply. In other cases where companies have a lot of real estate bought many years ago, book value could turn out to be a lot more understated. Similar study needs to be conducted on other assets like inventory and receivables. Thus, while investing in a company based on book value, don't just go by the book.

  Weekend investing mantra
"I think that one should recognize reality even when one doesn't like it -- indeed, especially when one doesn't like it." - Charlie Munger

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