Outlook for CY 2009: Fog on a rainy day - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
Outlook for CY 2009: Fog on a rainy day A  A  A
5 JANUARY 2009


Forecasting what is likely to happen in calendar year 2009 is a tough proposition.
We are driving in heavy rain - and there is a dense fog all around us.

Looking back at where I pictured the world to be - and India within it - I can say this with certainty: where I had imagined we would be in December 2007 is not where we are in December 2008.

And it is not a pretty picture: every sector within the stock market has taken a beating. What a difference from the scorching performance of the year 2007.

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Table 1: What a difference a year has made
  Year ended
Dec 31, 2007
Year ended
Dec 31, 2008
INR 100 invested
on January 1,
2007 would now
be worth
Index returns in INR 1 year return (%) 1 year return (%)  
Quantum Long Term Equity Fund +45.8% -47.0% Rs. 77
BSE-30 Total Return Index +48.8% -51.8% Rs. 72
BSE 30 +47.2% -52.5% Rs. 70
BSE 200 +62.3% -55.9% Rs. 72
BSE 500 +64.9% -57.6% Rs. 70
BSE Small Cap +95.8% -71.9% Rs. 55
BSE Mid Cap +70.5% -66.4% Rs. 57
Sector Index returns (%)      
BSE Real Estate na -81.9% Rs. 18
BSE Metal +125.4% -73.6% Rs. 60
BSE Consumer Durable +96.1% -72.2% Rs. 55
BSE Capital Goods +119.0% -64.8% Rs. 77
BSE Power +122.1% -59.4% Rs. 90
BSE Auto +4.3% -56.0% Rs. 46
BSE Oil & Gas +118.0% -54.0% Rs. 100
BSE Technology +10.7% -50.9% Rs. 54
BSE Banking +62.9% -51.5% Rs. 81
BSE PSU (govt companies) +77.3% -49.2% Rs. 90
BSE Health Care +17.9% -32.1% Rs. 80
BSE FMCG +22.7% -12.6% Rs. 107
Source: Bloomberg, www.bseindia.com

From greed to bust
While I did expect business models built on greed and irrationality to crumble - and hedge funds and derivatives to be risks to the system - I did not expect companies like Bear Stearns, Lehman, and Merrill would implode. Or that banks and insurers like AIG, Fortis, RBS, Wachovia, and Washington Mutual would themselves collapse.

Closer to home, I have long considered banks like ICICI Bank as dangers to the Indian economy. For many, ICICI Bank has been the "poster boy" of Indian banking. To me, the aggression of these "new age" banks was a threat to the Indian banking system. Banks are meant to make money on the loans they give, not brag about how large their loan book has grown. Largeness is what people discuss in bars, not what heads of banks should advertise - or what film stars should endorse. While Indian banks were saved from the horrors of insolvency and the global credit crises, ICICI Bank was the only bank whose name kept cropping up as a bank in trouble. Luckily for all of us, ICICI Bank survived this scare - as it has survived past scares. Maybe a more chastened management will learn from its past mistakes and behave more like a bank. Maybe.

The Honest Truth: ICICI Bank v/s Bankex v/s Sensex
Source: Bloomberg

Secondly, while I did expect the US economy to be in a recession, I predicted the Indian economy would be largely sheltered from this. The jury is still out on this prediction. But, if the vote of the stock market counts, then the decision seems to be that India is very much coupled to the fate of the US economy. The battering of the Indian stock markets is in line with its global peers. That was not what I had expected.

Table 4: A global storm drenches all - including India
(all in USD) % Gain/Loss in
calendar year 2008
% Gain/Loss since July 31, 2007 (when
the Bear Stearns funds were in trouble)
India - BSE-30 TRI -60.8% -47.6%
Brazil - Bovespa -55.3% -44.7%
China - SHCOMP -62.4% -54.8%
Russia - RTSI$ -72.3% -68.1%
MSCI Emerging Market Free -53.5% -47.5%
USA - S&P 500 -37.0% -35.9%
MSCI World -41.9% -39.9%
Berkshire Hathaway -31.8% -12.2%
Gold +5.8% +32.8%
Oil -50.5% -38.5%
Source: Bloomberg

And, finally, while I was frightened by the prospect of short term capital flows that had entered India via the P-Notes and was concerned what their "unwinding" could do to share prices; I was taken aback at the extent of the relentless unwinding. Foreign "investors" have been net sellers of Indian stocks for 154 out of 243 trading days in CY 2008. For the year, they were net sellers of USD 13.1 billion. Data from www.equitymaster.com indicates that FIIs have never been net sellers in any previous calendar year.

Offsetting the wrong views with some right ones
But not all my predictions were incorrect. We had our fair share of good calls on other asset classes.

We had liked gold (gained + 5.8% in USD and + 30.6% in INR) and we were correct to be negative on the INR (declined -23.8% v/s the USD and -18.2% v/s the Euro).

We felt oil prices were too high and defied the fundamentals. Oil continued to climb and peaked at USD 146.93 per barrel in July, 2008 but finally ended at USD 35.35 per barrel; down -75.9% for the year).

And we thought real estate prices were too high - they still refuse to collapse but they are falling for sure.
We also believed that the share prices of real estate companies were too high - the sector is down -85.4% for the year.

The prices of commodities - steel, rice, wheat - had also risen excessively, we opined, they would decline. Happily, they have all headed south.

A case of a wrong asset allocation
Though we had these very good "calls", the net results show that we were caught in the floods. While we were not washed away, we were not able to stay completely dry on our island of rationality.

At the start of the year 2008, my suggested asset allocation was:

Table 1: Suggested allocation in Quantum Mutual Funds
  Quantum Long Term Equity Fund Quantum Gold ETF Quantum Liquid Fund
Why you should own it: An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% 15% 5%
Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"
Note: Ajit Dayal, the author is a Director in Quantum Information Services Private Limited and Quantum Asset Management Company Private Limited. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited or Quantum Information Services Pvt Ltd.
Mutual Fund Investments are subject to market risks. Please read the offer documents of the respective schemes before making any investments.

The high allocation to equities was a terrible call.
By the end of September 30, 2008 an investment in my recommended asset mix would have caused a loss of -24%.

Table 2: Some protection, but still some pain by September 30
  Quantum Long Term Equity Fund Quantum Gold Fund Quantum Liquid Fund Total
Allocation 80% 15% 5% 100%
Return since January 2008 -36% +25% +6% -24%
How did that do? Ouch! Yes! Good! Oh, no!

The Honest Truth: Quantum Mutual Fund Portfolio v/s Sensex
Daily Nav data of Quantum Mutual Fund Schemes, BSE Sensex daily closing data

By October 8th - jarred by the collapse of Lehman Brothers on September 15th and the complete freeze in the credit markets - I suggested a new way to look at the world.
And at a new way to look at one’s investment portfolio - what was left of it, that is.

My advice was: Review your need for "safe cash" - the amount of money you need every month to maintain your minimum lifestyle.
Figure out your risk tolerance and your ability to live with uncertainty.
While the central banks of the world - and the governments - are printing money, there is no guarantee that their efforts will have any immediate success. The world economy may recover but it could sink further before it comes out of its troubles.

I am an optimist - an ingrained characteristic of any equity investor - and believe in a better future.
But no one knows when this economic recovery will happen. It may be in calendar year 2009, 2010 or 2011.

So, depending on your ability to withstand turbulence and uncertainty, it would be a good idea to keep enough money with you to pay the bills to maintain your lifestyle for "some time". That time period can vary anywhere from 6 months to 24 months.

You can achieve this by not putting any of your savings into any investments for a while. This means that - from your monthly savings - you do not invest in stock markets. Automatically, your "allocation" to cash will increase. You may also elect to sell some of your investments - even at a loss - to build your reserve to your preferred level of "safe cash" to maintain your present lifestyle. And then add back to your investment kitty every month as you get your salary and monthly earnings.

Once you have kept your "safe cash" aside (the 6 months to 24 months of lifestyle spending), then invest the balance of your money in stock markets (80%) and gold (20%).

That advice on "asset allocation" was given in October, 2008. At the outset of CY 2009, there is nothing to indicate that you need to change that.

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Why buying some "about-to-go-bankrupt" companies
can be the best decision you ever make.
Read On.


Outlook for CY 2009: I can’t see clearly now
While global stock markets, including India, have recovered from their lows - the outlook for the world economy is still uncertain.

At the start of CY 2008, the Indian economy was plagued by high oil prices, high commodity prices, and high employee costs - along with a shortage of skilled labour. As we begin CY 2009, India has the advantage of lower oil and commodity prices - and a more stable labour pool that can be relied on to contribute to the growth of companies. Though I remain optimistic on the ability of the Indian economy to grow at 6.5% every year at an average, we have our own uncertainties.

Chart 1: GDP growth rate across governments has averaged 6.2% p.a. over the past 27 years
The Honest Truth: GDP growth rate across governments
*indicates coalition government: 5 of the last 8 governments have been coalitions

Despite a consistent record of strong GDP - probably second only to China’s growth - India is caught in its own tangles of bureaucracy, corruption, a lack of infrastructure, and mostly self-serving politicians. We need huge resources to improve the lives of the 400 million poor people in this country and few have worked out the cost - or the benefits - of building this India.

The continued terrorist attacks on Indian soil - there were 34 terror attacks in India - continues to expose the corruption and the inefficiency of the political and bureaucratic system. While mad terrorists with a desire to die can never be stopped, the ease at which they can terrorize is what is terrifying.

On the business side, Indian entrepreneurs have done well despite having a government, not because these entrepreneurs work in a supportive government framework. Most ministers who set policies are influenced by lobbies, not by a selfless national goal. And it is this lobbying that allows many socially destructive Indian business houses to thrive. They live off their political connections and political blessing.

And there continue to be managements - everywhere in the world, including India - who will be happy to take advantage of bad laws or the silence of investors to further their private wealth, at the cost of the larger shareholder base. There were 2 notable such events last year: Ranbaxy and Satyam. The government, as a majority shareholder in many PSU entities, is also guilty of using many listed companies to further its political objectives - and putting the price tag on the silent, minority shareholders. Expect more theft.

But the "India risk" remains - as it has for over 40 years - and you need to continue to navigate your investments in this environment.

The long-term GDP growth numbers will eventually show up in company profits - and in stock market performance. Though in the near term the stock markets - like the alerted cobra struck on its head by the snake charmer - are likely to be mesmerized by the flows of foreign capital and movements of the global stock markets. Note that fact, but don’t let it determine your (or your fund manager’s) investment actions.

Table 2: India outperforms MSCI Indices and will continue to attract capital over the long term
    2001 2002 2003 2004 2005 2006 2007 2008
Foreign buying (USD bn) 2.8 0.8 6.9 8.96 10.9 8.0 17.2 -13.1
BSE 30 Index (INR) -17.90% 3.5% 72.9% 13.1% 42.3% 46.7% 47.1% -51.8%
BSE 30 Index (USD) -20.5% 4.1% 81.8% 18.7% 37.3% 49.3% 65.2% -60.1%
MSCI Emerging Market Free (USD) -4.9% -8.0% 51.6% 22.4% 30.3% 29.2% 36.5% -53.5%
MSCI World (USD) -17.3% -20.5% 31.6% 13.3% 8.8% 18.8% 9.6% -41.9%

In conclusion
The speed with which the Indian stock markets recover - and decouple from the global markets - will be a function of how quickly we sort out our own "Made-in-India" problems.

Despite these uncertainties, we need to go through the exercise of "asset allocation" to understand how best to position our investment portfolios. And, if there are unexpected changes of significance as the year unfolds (as there were last year), then we need to factor those new unforeseen events and make the necessary changes in our investment portfolios.

For the moment, keep your mind at ease by keeping aside enough cash - and split any balance you have in an 80:20 ratio for investments between equities (individual stocks, equity mutual funds, and tax-saving equity mutual funds) and gold.

Asset class View for CY 2009
"Safe Cash" Keep some money aside to look after your needs for many months - you need to decide how many months gives you mental comfort
Equity Invest, but no clarity on when markets will turn - a lot of the bad news is priced in, but there could still be more bad news and it is unlcear when the good news will flow in - but equities remains the best long term place to invest
Real Estate This will crack - big time! Then buy the house you wanted.
Gold Keep buying, it is a great hedge just in case the world stays in trouble - or inflation gathers steam
Indian Rupee Will shuffle +/- 2% against a basket of Euro, USD, Yen, Pound - no dramatic moves like in CY 2008
Commodities In general, a good time to start buying on a 2 to 3 year view - but you have time to make your purhcases
Fixed income Don’t lock in your money because of high interest rates being offered - investing in equity and gold may be better.

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