"We have reached the extreme fear"
(Nov 26, 2008)
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In this issue:
"We've reached the extreme fear". These are the words of legendary value investor Jeremy Grantham, who the Economist recently called a 'Cassandra of the investment community' for his bearish and accurate ten year forecasts. It should be noted that Grantham had correctly predicted today's depressed market levels ten years ago. Besides helping formulate investment strategies for his investment management firm, GMO, which manages hundred billion dollars worth of assets, the legendary investor also writes a hugely popular quarterly letter. Recently, in what was touted to be his first ever television interview, Grantham put forth his views, among other things, on his methodology and the strategies to be adopted by an individual investor.
» The 'Cassandra' speaks
» Fed prints more money, much more
» Where have all the IPOs gone?
» China's slowdown
» ...and more!
The above comment was made in reference to the fixed income market, where according to him certain parts had become completely dysfunctional. On equities, for the first time in 20 years, his methodology was telling him that global equities had become reasonably cheap but not spectacularly cheap. However, he did suggest that investors who have the stomach to bear near term losses should start investing their money in stocks. And over a period of seven years, they would not regret buying stocks in the current environment. Infact, for his own firm, Grantham admitted to having already started allocating some portion to stocks. He, however, seemed to show a strong aversion towards marginal stocks, preferring instead to invest in blue chips as deterioration in global economics over the next one year or two would not harm them as badly as they would harm the marginal stocks. On the recent financial crisis, he put the blame squarely on the US Fed and called it the arch villain. Former Fed Chairman, Alan Greenspan, was particularly singled out for his thoughts on deregulation and encouragement for risk taking.
Finally, when asked if the age of permanent bullishness of equities has come to an end, he replied, "I certainly hope it's out. I'd like to say that in the short-term, we learn an enormous amount from these crises; and in the intermediate term we learn a little, and in the long-term we learn absolutely nothing." We do hope that what we have learnt from the current crisis stays with us forever, making us a much better investor.
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It's pouring money in the US. Even as a little more than half of the money to be utilized towards the TARP (Troubled Assets Relief Program) remains unutilized, the US Fed has unveiled two new plans, one to finance loan for consumers and a larger one to push down home mortgage rates. Taken together, the two plans are likely to cost as much as -hold your breath- US$ 800 bn dollars. US$ 200 bn for the smaller one that involves a program to lend money against securities backed by car loans, student loans, credit card debt and even small-business loans. The other and the much bigger US$ 600 bn outlay would go towards buying home loan debt guaranteed by government sponsored entities like Fannie Mae and Freddie Mac and others. The second plan is seen as another attempt to drive down mortgage rates further so that lending activity gathers pace. If the initial signs are any indication, it seems to be having the desired impact as interest rates on 30-year-fixed mortgage rates in the US fell almost a full percentage point post the announcement.
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The long term repercussions though seem to point towards a surge in inflationary pressure on the back of a virtually non-stop printing of money by the Fed. Indeed, it is a risk that the Fed is willing to take as not doing it is likely to lead the country into a full blown depression. Important to add that as per reports, the current plan swells the US government's direct and indirect financial obligations in the past one year to a record US$ 7.8 trillion, about half the size of the country's GDP.
"We are absolutely not assuming a scenario in which GM files for Chapter 11. I believe it's 100 per cent outside the realm of possibility" is what Mr. Osamu Suzuki, the chief of Suzuki Motor Corporation, said, referring to the situation of GM filing for bankruptcy. Interestingly, this statement comes after the cash strapped American automobile maker sold off its 3% stake in Suzuki Motor last week. While Mr. Suzuki has not justified the reason for this statement, the only logic behind it would be its repercussions on the already fragile US economy.
Crude prices have come down significantly and State run oil marketing companies have started making a neat profit on the petrol and diesel that they sell daily. But have they recovered fully the losses they incurred while selling the same commodities at subsidized prices when the crude prices were touching record highs? Unlikely. But this has not stopped the government from considering a downward price revision towards the end of December. Infact, had it not been for the restrictions imposed by the Election Commission in view of the recent assembly elections, the revision would have probably happened by now. While a revision would no doubt help ease inflation further, it will come at the expense of putting pressure on the long-term resources of the country. This is seemingly being understood by the Prime Minister and his economic team, who seem to be in no hurry to reduce prices. But with national elections just few months away, that certainly seems a very small price to pay for a wider faction of the ruling party! Once again a classic case of overlooking the essential for the urgent.
Gone are the days when companies with or without any fundamental strength to boast of could approach the capital markets to raise millions of rupees promising 100% listing gains. Fund mobilisation through initial public offerings (IPOs) has taken a major hit amid extremely bearish secondary market conditions since January this year. As per a leading business daily, barely 38 issues have come on the block so far this year to raise around Rs 170 bn. Compare this with 106 issues in 2007 which raised a staggering Rs 450 bn! Infact, this year also witnessed some large issues like that of Emaar MGF (Rs 54 bn) and Wockhardt Hospitals (Rs 5.6 bn) never seeing the light of the day after poor initial response.
According to data collated by Delhi-based research firm Prime Database, nearly a dozen companies have received SEBI approval to raise over Rs 130 bn going forward. Of these, Future Ventures and Adani Power are two large-sized issues with a combined size of Rs 83 bn. However, given the limited validity period of SEBI's approval (90 days) it seems unlikely that these issues will have a fate different from that of Emaar and Wockhardt Hospitals, due to the poor market conditions.
Citigroup has learnt the demerits of diversification the hard way. In what started out as a bid to diversify its asset portfolio, the bank ended up over-exposing itself to an asset class that was the subject matter of global speculation. The bank's CEO Mr. Vikram Pandit has identified the bank's unusually large exposure to real estate as being root to be cause of its woes; which finally led to it being bailed out by the US government. Citigroup has lost US$ 20.3 bn in the last year to subprime-related losses, and expects further losses from credit cards and other areas tied to the global economic crisis to pile up. The government last Sunday rescued Citigroup by agreeing to shoulder most of the potential losses from a US$ 306 bn portfolio of risky assets, and by injecting US$ 20 bn of equity capital. The guaranteed assets had a face value of about US$ 350 bn, before they were written down amid the credit crisis.
It is said that the only certainty is change. Commodity companies know this well. Still, timing the juncture at which conditions can change is not easy. Indian cement companies would vouch for that. After all, as per a leading Indian business daily, India's 205 m tonne cement industry has lined up capacity addition of up to 94.4 m tonnes at a time when the housing market has slowed down. It is easy to criticise commodity players in hindsight, but the fact is it is extremely difficult to forecast business cycles in advance.
How do you spot a bull market? It may seem like a silly question. Just look at the valuations and it is self evident, right? Unfortunately it rarely works that way. Luckily there are some tell-tale indicators. A spate of new IPOs is one. There is another - grand mergers & acquisitions. As per Mint, If RJR Nabisco marked the bull run in the late 1980's, the AOL-Time Warner merger marked the tech bubble. The recently ended commodity bull run had its own defining event - the hostile takeover attempt of Rio Tinto by BHP Billiton initially valued at US$ 147 bn.
The deal has been called off. With commodity prices plummeting, the deal stopped making economic sense for BHP Billiton, the world's largest mining company. Interestingly many regulators were worried that the merged entity would be in a position to corner the markets of several important raw materials. Unexpectedly the market forces came to their aid!
The financial crisis is taking its toll on the mighty dragon and at a much faster pace than what one could imagine. To give a perspective, the World Bank expects China's economy to grow by just 7.5% in 2009, the lowest level in 19 years! What a comedown, after logging in 11% plus growth rates for the past couple of years. Infact, this forecast is down from a previous estimate of 9.2% made by the World Bank. And the main culprit has obviously been exports which have considerably slowed down as the developed nations have been hit hard by the credit crisis. In such a scenario, it was expected that atleast growth domestically would provide some sort of a cushion. But that is not to be. Causing further angst to the Chinese economy is the fact that the deceleration domestically has been more pronounced. This has largely been attributed to the weakness in the housing sector. Of course the government is hoping that its plan to up its infrastructure spending would rejuvenate the economy. To what extent that will work, only time will tell.
Making further efforts to sustain growth, China's central bank today has slashed interest rates by the most in 11 years and also lowered reserve requirement for money, which the banks are supposed to park with it. The authorities are hoping that the rate cut along with the infrastructure spending would help it sustain high growth rate and also support the world economy, where most of the developed nations seem to be in a vice like grip of recession
In the meanwhile, News of Chinese interest rate cuts seemed to have a cascading positive impact on the Asian indices as most of them barring the Japanese benchmark ended the day in the positive. In India too, the benchmark, BSE-Sensex, edged higher by 4% mainly as China rate cut news raised hopes of a similar step by the country's central bank RBI. The European indices are, however, trading in the red currently.
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