»5 Minute Wrap Up by Equitymaster

On This Day - 18 FEBRUARY 2010
"Don't ignore India," warns this noted analyst

In this issue:
» Analysts using 'embedded valuations' to justify high stock prices!
» Look who is buying a lot of gold!
» China dumping US bonds, Japan to follow
» It's birthday time for TARP
» ...and more!!

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"Don't ignore India," advices the noted investment analyst Marc Faber to international investors. In fact, he suggests that global fund managers can ignore India at their own peril. India's internally driven economy is what Faber believes will work in favour of the country over the long run.

Faber however does not see the Indian story without some big challenges. Notable among them is the significant pressure that India's huge population will exert on limited resources like water. Then there are the ongoing geopolitical issues between the country and its neighbour China.

But Faber concludes, "I should stress that I am far from certain about current stock prices providing an ideal entry point; however, given the country's size and economic potential, investors who either have no exposure to India's economy and vibrant corporate sector or are massively underweight Indian stocks should gradually become more involved in this promising country."

While we agree to most of what Faber believes, we see poor governance and corruption as key issues that can delay India's rise as an economic superpower. International investors generally have these things on the top of their minds before looking at any country.

Overall, while India has all that it takes to reach the pinnacle of economic leadership, the time taken can be longer than what most expect.

 Chart of the day
Today's chart of the day lists the number of stocks that are traded in India and four other key world markets. And the Indian count leads by a big margin. The BSE has around 5,000 stocks listed as compared to less than 1,000 listed on the Chinese exchange in Shanghai. Now, while that gives Indian investors a lot of options to choose from, there are also pitfalls given that a large number of companies in India are very small and family owned businesses with a dubious track record of financial performance and corporate governance.

Data Source: World Federation of Exchanges; Data for January 2010

Other than the IPOs, one more bull market excess is back in vogue. The art of using 'embedded valuations' to justify high stock prices! The Economic Times reports that there has been a rise in broking houses using embedded valuations or sum of the parts valuation method to justify higher stock prices to their clients. Well, we see nothing wrong in this trend. After all, a business can have a profitable segment or a subsidiary whose value is not reflected in its share price. It is only fair that analysts bring that out to the notice of the investors. That is why they are paid in the first place.

But there's a huge problem if those hidden assets are valued to the sky, like it happened during the peak of the last bull market. Because when a bear market sets in, the apparent hollowness of the sum of the parts method gets exposed and investors in these stories could suffer huge losses. As one brokerage house rightly pointed out that the contraction in valuation of embedded assets contributed meaningfully to the previous market meltdown.

So, please be careful of a research report that justifies a very high price for a stock from the current levels based on sum of the parts valuation. It may have a hidden asset that could actually turn out to be a huge liability during a market sell-off!

Indian stock market had a weak outing today. Sentiment was also soured by the release of inflation data. India's food inflation inched up to 17.97% for the week ended February 6, 2010. The BSE-Sensex was trading lower by 100 points (0.6%) at the time of writing this. Mid and small-caps toed the line of their large cap peers. Energy and metal stocks were at the receiving end today.

Amongst other key Asian markets, while Japan was the lone gainer (up 0.3%), selling was seen in Hong Kong (down 0.3%) and Singapore (down 0.6%). Gold is also trading weak in the international markets. The price of an ounce currently stands at US$ 1,099, down almost US$ 8 from its previous close.

While stockmarkets try to find their ground (now) amidst the fear of failing countries, loud voices can be heard of investors seeking shelter in the safety of gold. While some like Marc Faber are asking everyone to buy more gold, there are others like George Soros who are up on the act.

Yes, you read that right! George Soros, the man who 'broke the Bank of England' by betting against the Pound in 1992, has in fact more than doubled his holding in the world's biggest gold exchange-traded fund (ETF) - SPDR Gold Trust. His fund now is the fourth-largest investor in this ETF. And these holdings were at around US$ 660 m at the end of 2009.

Ironically, while these latest figures are as on December 31 2009, Soros had proclaimed publicly last month that the yellow metal is an 'ultimate asset bubble'! His act of adding gold to his fund's portfolio thus leaves a few tongues wagging. However, this makes it amply clear that even he treats gold as a hedge against the future crisis that central banks are setting up for us.

A company with a massive balance sheet size cannot sustain its business if it does not have the ability to service its massive debt. The same logic applies to economies as well. The US economy's current status being the ideal case in point. Despite being the largest economy in the world, its status as the largest borrower is not doing any good to its fragile economic revival.

Concerns over the fate of the US dollar now seem to be at its peak. Its biggest lender China has dumped billions of dollars of US Treasuries (government bonds). As per reports, China, which is the biggest holder of US Treasuries, has recently offloaded US$ 34 bn worth of the debt papers.

Predictions that the US fiscal deficit would rise to US$ 1.6 trillion in 2010 and stay above US$ 1 trillion for three years seems to have sparked the selloff. What is more, Japan, which now holds the maximum value of US Treasuries, is contemplating a similar move. The impact of the selloff may range from gold being touted as a safer hedge, to the US losing its AAA rating. Difficult times indeed for a nation that has so far been used to living lavishly on borrowed money!

Anyways, yesterday marked the completion of one whole year since the US$ 787 bn stimulus bill (TARP) was announced in the US. The stimulus program had one major aim. To pull the economy out of recession. But while US stocks have most certainly seen a pull back, the average US citizen still seems to be hanging in the lurch. The unemployment rate continues to be at a distressingly high rate of 9.7%. Small business establishments too continue to see some very hard times. Thus, while the large stimulus is still to achieve any substantive results on the ground, the seed for high inflation rates in the years to come may have already been sowed.

 Today's investing mantra
"Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts... Slug it out one inch at a time, day by day, at the end of the day - if you live long enough - most people get what they deserve." - Charlie Munger

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