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Graph 1: The BSE-30 Index recovers but needs to rise +50% to match previous peak
The economic world was now faced with a new set of challenges: a global depression; massive unemployment; failures of financial institutions; and a complete lack of confidence in the ability of governments and central banks to bring sanity to the global economy.
Green shoots emerge?
From September 2008 till February 2009, while governments and central banks were doing their fair share of printing money or increasing their spending plans, the mood amongst consumers, businesses, and investors was one of utter despair.
President Obama`s historical inauguration was matched by other historical events: the plunge in global stock markets and the spurt in the price of gold.
But there was a renewal of confidence from March 9, 2009.
The mood changed.
People began interpreting data in what is called the "second derivative".
Let`s say a company was to fire 1,000 employees out of 10,000 employees: that is a 10% cut in its workforce. But next month it fires 450 out of the 9,000 employees left: that is a 5% cut in its workforce. It is still firing people, but at a slower rate: first it let go 10% of its workforce and then it let go 5%. Note that the company is still firing people - suggesting that it is not seeing any good business prospects. But the fact that it laid off at a slower rate was considered to be a 50% improvement!
This rate of change in the rate of change is the "second derivative".
The patient may be dying a little more slowly - but he is still dying!
So as the global mood got better on this flawed argument of statistics based on the "second derivative". Money flows to stock markets around the world - including India - increased.
But there was a problem: India still had the general elections and the results were not due till May 16th. So, while the Indian market did benefit from the flow of foreign money into the global stock markets, it still lagged the performance of the stock markets in Brazil, China, and Russia. India was behind its peers in the BRIC group by about 20% since January 1, 2009.
Foreign money was nervous to fully commit to India.
The election results changed that: on May 18th in 36 seconds of trading for the entire day, the BSE-30 Index surged by +17.2% - and the Indian Rupee strengthened. The gap with Brazil, China, and Russia was now a lot less (see Table 1).
Actually, are those weeds?
But that was then.
Now, the owners of foreign capital are wondering whether the green shoots are actually weeds.
And they are coming to realise that the global economy is still in a mess. While the "second derivative" - the rate of it getting worse - may be better, the fact is: it is still pretty bad out there. The patient is still on the death bed.
The US, Germany, UK, France, Japan and other economies of the developed world are still in a hole. And sinking deeper. Maybe they are sinking less slowly, but they are still sinking. Governments in all these countries are trying their best to spend out of the mess but the losses in the portfolio of the banks are still unknown - and large. In the boom days, the banks had given loans to companies and individuals against the assumed value of their existing businesses, their future profits, or the value of their homes.
All those assumptions on assumed values are now worthless.
At the other end of the global spectrum, you have economies like China, South Korea, Singapore, Taiwan, and Mexico whose engine of internal economic growth was to provide the goods and services required by economies like the US - which consumed anything it wanted and printed US Dollar bills to pay for it. China gave real goods to consumers in the US for pieces of paper - obligations of the US government in the form of US currency notes or government bonds.
Russia is very dependent on oil for its revenues as a country. And oil prices are a function of speculative demand (the hedge funds again) and real economic activity (which is pretty stuck in weeds for now).
Brazil has oil and iron ore. But all that iron ore only has value if it eventually gets converted to steel. And a lot of steel was needed to build cars, washing machines, and refrigerators for sale in USA. Now the US is buying a lot less.
India: still standing
The green shoots may exist, but right now there are still a lot of pretty well-entrenched weeds.
India is neither a US (a big borrower and consumer) nor is it a China (a big producer of goods for export that created jobs and boosted China`s economic growth). So, while I remain nervous about where the world is, I continue to believe that India has a good chance of being less impacted than most other countries in the world. And while the market has reacted very negatively to the budget (silly, in my opinion) and is nervous about the monsoon (we should be), the trend of India`s GDP remains upward.
Many popular and well followed (not necessarily correct) economists working with well known groups were busy "downgrading" India`s GDP for much of 2008. Since the election results, they have been busy giving massive upgrades to their "thoughtful" forecasts.
Whatever their forecasts may be, an increase in economic activity is generally good for stock market returns over the long run.
Lesson of safety
As we outlined in our January 5, 2009 note (click here to read "Fog on a Rainy Day") the world is still an uncertain place.
And the best way to deal with uncertainty is to have enough money kept aside to meet 6 months to 24 months of your must-have, known expenses. And, any extra cash left after that, should be 80% in equity markets (the Quantum Long Term Equity Fund) and 20% in gold (the Quantum Gold ETF).
This is what we wrote on October 27th, 2008 (click to read "Preparing a Buffer").
Yes, we know the Indian stock markets have done well since their recent lows - and we believe that there is a case to be made for the market to reach a new peak of 21,000 by June 2010. But, don`t chase that +50% possible surge in the market by losing sight of safety. Nervous reactions to any negative news in the global or Indian context could see sharp falls in the stock markets.
India is still hostage to flows of short term money from hedge funds. Our policy makers continue to give priority to their desire to have any capital flow in compared to the "right" kind of capital. There is nothing wrong about having hedge funds or other short term pools of capital buy Indian shares - but be prepared for wild swings.
Interest rates will inch up
On the fixed income side, we expect interest rates to increase. The government`s higher fiscal deficit (it is spending more than it earns, as usual) means it needs to borrow more. But don`t let these fiscal deficits worry you. The rating agencies may start "downgrading" India. But before that they will need to downgrade the state of California to junk grade and the US government to junk grade. India is a far better credit risk than the state of California or the central/federal government of USA.
Honestly, I ignore what these rating agencies say. It was these same rating agencies that failed in their duty and misled investors about the quality of the mortgages they rated. Economic policy should not be held hostage to what rating agencies want. India will have a fiscal deficit for the next 20 years: it needs to. There are many poor people who need to be brought up the economic ladder. I worry more about what the government is doing with the borrowed money. If that money finds its way to rural India, I applaud. For such flows will help the poor. If that money finds its way to politicians and their goons with bank accounts in Swiss, Dubai, Singapore, Hong Kong, UK, or US - then that is not good.
Stay with the 6 to 24 months cash on hand and 80% to 20% in stocks and gold.
The allocation has worked well and given investors a +18.3% return over the past 8 months (see Table 3). We see no reason to change our view. An 80/20 split between equity mutual funds and gold is still the safer way to invest. After you have kept aside the cash you need for the next 6 to 24 months. It is too early to assume that "Happy Days are here again".
Our views don`t change much. Our conservative nature kept many of our clients away from structured products and real estate funds that were the "hottest" things being sold. Investment is not about fashion - you don`t need to change for the sake of being "with it". For the sake of doing what our neighbour does. Choose your level of comfort in the risk-return world - and stay with it.
Your approach to investments should not be comparable to the models that sell you the instant gratification of a chilled Thums Up to quench your thirst. Don`t confuse why you should invest with the emotions that the Thums Up ad has stirred.
Meanwhile, keep the two-pronged approach: keep some money aside to live comfortably - and invest the balance in equity mutual funds and gold.