On the brink of a rare global recession
(Dec 10, 2008)
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In this issue:
The chief economist of the World Bank has said that "...the financial crisis is likely to result in the most serious recession since the Great Depression," summarising the prognosis of the institution about where the global economy is headed from here on. And they see nothing in sight that can probably stop that eventuality. American consumers will probably not return to their notoriously extravagant spending habits for a long, long time. China, the previous shining star of the club of emerging countries, has also seen a very sharp fall in growth. Consumers in the perennially cash rich oil exporting countries from the middle east too have been hit hard due to the collapse in oil prices.
It has also forecasted in its report that developing countries will grow at an average of 4.5% next year. That would be a rate of growth that economists say will constitute a recession, given the need of developing countries to grow rapidly to generate enough jobs for their swelling populations.
» Most serious recession since the Great Depression?
» Buffett's sense of humor
» Abundance of cash bargains
» India's poor ranking
» ...and more!
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Most investors know Warren Buffett for his investing acumen. But few know that his sense of humor is equally legendary. The directors of his company, Berkshire Hathaway got a taste of the same a couple of days back when they received an email from the Oracle of Omaha. On learning that the US Treasury sold US$ 32 bn by way of 4-week bills at a yield of 0% - yes, you've read it right - he is believed to have said, "This should be bullish for Berkshire. With great foresight, I long ago entered the mattress business in a big way through our furniture operation. Now mattresses have become fully competitive as a place to put your money, and sales will soon take off."
|(Source: US Treasury)
Indeed, with investors getting virtually nothing from their fixed return investments by way of interest rates, putting once hard earned money under a mattress seems a far better idea than depositing the same in banks.
Most of the blame for the current crisis that has engulfed global economy has been put at the doors of greedy investment banks. Very few have questioned the role of ratings agencies, who we believe were equally guilty if not more in letting the crisis take place. In yet another instance of closing the stable door after the horse has bolted, India's capital market regulator SEBI is planning to come up with new norms that would ensure greater oversight of credit rating agencies.
Regulations for these agencies have been framed long time back and hence, with the emergence of new and more complex products, a relook has indeed become necessary. The outbreak of the financial crisis that had its genesis in faulty ratings on certain toxic instruments makes the relook even more imperative. The new plan is intended to have more focus on closer supervision and greater accountability. How well the lessons have been learnt by both the regulators as well as the ratings agencies? Only time will tell.
It is a match not exactly made in heaven. While one member of the alliance is brutally capitalistic, the other is a communist to the core. The stakes though are too high for both of them to ignore each other. If you haven't guessed by now, we are indeed talking about the biggest economy in the world, US and an economy that is widely believed to be its potential successor, China.
Although they haven't shared the best of relations in the past, being at each other's throats for their vastly diverse policies, the need to bury differences is more pressing now than it has ever been. And to his good fortune, President elect Obama will inherit a relationship that has never been as strong as it is currently.
And boy, does he need that badly. Roiled by the credit crisis, Obama plans to kick start a spending program that is touted to be the biggest since President Eisenhower. With both the US government as well as consumers broke, it will have to turn to China's vast forex reserves, which at US$ 2 trillion are the largest in the world and also its capacity to absorb more US debt for the financing of the same.
Although China does not need US as badly as the latter needs it, the former still needs to keep its manufacturing juggernaut chugging along at a good pace so that more jobs could be created and a big social unrest prevented. Thus, issues such as human rights violations, unfair trade practices and currency manipulation can wait. Getting out of the mess that it is in currently seems to be the first priority of the US.
Imagine buying a house and then finding all the cash you paid for it lying unattended in one of the rooms. You would certainly go ecstatic and immediately start thanking your lucky stars, wouldn't you? Well, something not that similar but equally rewarding is happening in the stock markets currently.
As per Bloomberg, stocks have been so badly battered this year that more than 2,200 companies around the globe are trading at market capitalisation that is less than the cash on their books. So if one were to buy a 100% stake in one of these companies by using debt, he will be able to repay the entire debt by using the surplus cash sitting on the company's balance sheet and still be left with some cash.
Furthermore, the person would be getting all the company's tangible and intangible assets, its working capital and also its investments, virtually for free. But most investors will not take anything of that. Their rationality seemed to have been completely overpowered by fear and near term concerns, not allowing them to realise the attractiveness of the opportunity.
Talking of opportunity, it is so big this time around that the list of companies that fall in the above mentioned category is eight times as large as at the end of the last bear market. Some value investors though are lining up to seize the opportunities on offer. It is a creed that firmly believes in the motto - 'Be fearful when others are greedy and greedy when others are fearful'. It is indeed time to be greedy.
If you have invested in any of these companies, get ready for a greater dilution of your stake. We are talking of companies like Pyramid Saimira, GTL Infrastructure, Hotel Leelaventure and GHCL that have decided to reset conversion prices of their FCCBs (foreign currency convertible bonds) after a sharp fall in share prices made conversion at the originally fixed price unattractive. The bondholders will now be offered an additional number of shares to make up the loss on conversion.
FCCBs have emerged as a clear case of how things can completely reverse in a span of few years. When FCCBs were first issued by Indian companies way back in 2003, the move was greeted with much enthusiasm. This was a way to garner cheap capital to expand businesses. As for the investors/bondholders, this provided a fast route to participate in the India growth story. As such, issuing FCCBs was considered a win-win situation for both borrower and lender. Now, when equity prices have crashed and the conversion prices (at which FCCBs was transacted to be converted into equity shares) are far higher then current stock prices, both these parties are in a Catch-22 situation.
In fact, in some cases now, the outstanding amount on account of FCCBs is higher than or around the current market capitalisation of the companies concerned (Source: Business Standard).
Having witnessed one of the worst economic crises in the history of the US (the Great Depression) in early childhood, he is one of the few men in that country who believe that Americans have been living beyond their means for too long. Paul Volcker, the ex-Federal Reserve chief who fought a bitter but successful battle against inflation, has laid out a fairly clear outline of what he thinks is wrong with the present-day financial system and the government's management of the economy. Being an octogenarian has not stopped him from joining the economic team of US President-elect Barack Obama as a special economic advisor. And if the President-elect follows his advice on the current economic crisis, he can probably draw lessons from the vast experience and credibility of someone who has worked on economic recovery before.
Volcker has been a skeptic of modern Wall Street institutions, worried that the nation's entire financial system has evolved to a point that the government no longer has effective control over all of its important components. He believes that the financial sector has been at the mercy complex financial engineering that clouds the picture and reduces transparency for regulators. In his speeches he has called for tough regulations on securities markets, including oversight of hedge funds, in order to avoid the need for a bailout effort by the Fed ever again. It therefore seems likely that he will advise the Obama-led government against any further bailout packages.
The economic slowdown is showing itself up at the most unexpected places. After affecting sectors like construction, auto and housing, the sector that has now come in the firing line is FMCG. As per a business daily, leading companies like Godrej, Marico and Dabur have curtailed supplies to select modern trade retailers, following default in payments. Modern retailers are witnessing pressure on their working capital in recent times on account of higher rentals, aggressive expansion plans and demand slowdown. This has not gone down well with FMCG players who themselves work on tight credit cycles. Modern retail accounts for 3% to 4% of the FMCG sales and hence, the move could impact FMCG volumes in the near term.
The anti-corruption group, Transparency International's bribe-payers' index has revealed a startling pattern. It ranks the four emerging BRIC (Brazil, Russia, India & China) nations in the bottom five worst in terms of level of corruption. It claims that companies from these countries bribe routinely to win overseas contracts, especially for sectors like construction, real estate, energy, heavy manufacturing and mining. While the least amount of prevalent corruption was said to be from the IT, fisheries and banking sectors.
In terms of the best performers, Belgium and Canada topped the rankings jointly with a score of 8.8, while most of the other members of the Group of Seven leading industrialised nations scored more than 8.
The current global financial crisis has caused unfathomable pain to everybody around the world including India. Imagine for a moment, a broker in a financial firm, unable to deal with the stock prices plunging everyday, goes out for a smoke practically every one hour. In fact, there may be millions like him who are probably taking smoking one notch higher mistakenly believing that it will ease the stress.
Does this signal a bigger crisis in the making? It probably does. Believe it or not, as per a new report by the World Health Organisation (WHO), cancer will overtake heart disease as the world's top killer by 2010. More importantly, rising tobacco use in developing countries is believed to be a huge reason for the shift, particularly in China and India, where 40% of the world's smokers now live. Consider some more statistics on this deadly disease.
As stated by the WHO and published in a leading business daily, new cancer cases will likely balloon to 27 m annually by 2030, with deaths hitting 17 m. The rise in these numbers can be attributed to better diagnosing of the disease, downward trend in infectious diseases, which earlier used to be major killers in developing nations, an increase in population and of course a change in lifestyles.
What makes cancer such a dreaded disease is that the causes are not always known making the treatment of the same that much more difficult and expensive. However, most of the global pharma companies are increasingly focusing on developing new drugs in this field, which is amply demonstrated by the fact that this therapeutic area is currently one of the fastest growing in the world.
In the meanwhile, bargain hunting seemed to be the mantra in Asian stock markets today as most of them ended the day strongly in the positive. The Indian benchmark, BSE-Sensex, emerged as one of the best performers, closing in the green by as much as 5%. European markets, however, have opened on a negative note today. Red was also the colour of the day on the US stock markets yesterday as investors chose to take some profits off the table after a rally that saw the S&P 500 rise 21% in a few trading sessions. As far as crude oil is concerned, it edged higher on reports that OPEC would initiate another round of production cuts at a meeting next week.
"Just because the price goes up doesn't mean you're right. Just because it goes down doesn't mean you're wrong. Stock prices often move in opposite directions from the fundamentals but long term the direction and sustainability of profits will prevail" - Peter Lynch
|| Today's investing mantra
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