The end of fear? - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
The end of fear? A  A  A
18 JULY 2009

Remember October, 2008?
Or March 2009?
Or the days and weeks in between?

At the start of the calendar year 2008, the world was obsessed with soaring prices of oil, wheat, rice, and metals. High economic growth in many countries around the world had created the possibility of high inflation. With the US printing dollar notes, it was expected that the US dollar would weaken.
And a weak dollar would automatically boost the prices of all these commodities simply because they are priced in US Dollar: it would take more of the paper currency to buy the same kilo of any commodity.

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By October 2008, the world had changed.
Oil prices had collapsed by over -60% from their peak in July, 2008; the price of rice, wheat and metals had also begun to decline by -40% to -70% from their peak levels.

Lehman Brothers went bust on September 15, 2008 and the Indian stock markets - hostage to short term gambling money from P-Notes and hedge funds - saw a -50% decline within weeks of this bankruptcy.

Graph 1: The BSE-30 Index recovers but needs to rise +50% to match previous peak
 The BSE-30 Index recovers but needs to rise +50% to match previous peak
Note: from January 1, 2008 to June 30, 2009

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).

Table 1: India played catch-up on May 18th
(all % returns in US Dollars) Jan 1 to May 15 Jan 1 to May 18 Jan 1 to June 30
India, BSE-30 Index +24.50% +50.60% +53.30%
Brazil, Bovespa +36.40% +43.60% +52.00%
China, Shanghai Index +41.00% +41.40% +57.70%
Russia, RTSI +49.80% +51.90% +60.30%
MSCI Emerging Markets +25.60% +29.30% +35.70%
MSCI World +3.70% +5.60% +9.40%
Source: Bloomberg.

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.

Table 2: India outperforms MSCI Indices and will continue to attract capital over the long term
    2001 2002 2003 2004 2005 2006 2007 2008 2009 YTD
Foreign buying (USD bn) 2.8 0.8 6.9 8.96 10.9 8.0 17.2 -13.1 5.0
BSE 30 Index (INR) -17.90% 3.50% 72.90% 13.10% 42.30% 46.70% 47.10% -51.80% 50.90%
BSE 30 Index  (USD) -20.50% 4.10% 81.80% 18.70% 37.30% 49.30% 65.20% -60.10% 53.30%
MSCI Emerging Market Free  (USD) -4.90% -8.00% 51.60% 22.40% 30.30% 29.20% 36.50% -53.50% 35.70%
MSCI World  (USD) -17.30% -20.50% 31.60% 13.30% 8.80% 18.80% 9.60% -41.90% 9.40%
Note: YTD is from January 1 2009 to June 30, 2009.

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".

Table 3: Equity/Gold mix of 80% to 20% has helped so far.
Asset class Your investment on October 27, 2006 Return till June 30, 2009 your gain was
Quantum Long Term Equity Fund 80% +17.70% +14.10%
Quantum Gold ETF 20% +21.10% +4.2%
Total 100% +18.30%
Bank / Quantum Liquid Funds - your 6 to 24 months of cash on hand. What you kept aside in cash +4.00% You did this to sleep well, not for the return.

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.

Table 4: Clear views despite the fog.
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 don`t assume that markets go only up - they do not! There could still be some bad news (a failed monsoon, a muddled government policy) and it is unclear 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 purchases
Fixed income Don`t lock in your money because of high interest rates being offered - investing in equity and gold may be better.

Note: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt Ltd and Quantum Asset Management Company Pvt Ltd.. 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. To write to Ajit, please click here.

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10 Responses to "The end of fear?"


Sep 8, 2009



Ajit Dayal

Aug 22, 2009

Your are right, Soham Das, all investment is eventually a "gamble"; a guestimate; an expectation...but the mismatch occurs in time horizons...(Pls see the October 4 2008 Honest Truth)...I am willing to "gamble" that in the next 10 years, India will be a richer country than it is today....and there are others who are willing to gamble that India will be richer/poorer in the next 10 minutes...the mis-match occurs when people who are trying to save money and invest for the long term (gamble for the long term) are held hostage by those gambling for the next 10 minutes...i am a firm believer that financial policies must be in place after we know and define our end objective as a country, the economic policy....
If India wishes to build a power plant, should it accept 10-minute hedge fund money for that power plant or should it accept 10-year long term money?
Both investors are "gambling" that the road will be built and the people will pay for the power.
One gambler will decide the "price" of the power plant every 10-minutes leading to a more violent price shift, another gambler will evaluate the investment maybe once every few months leading to a more gentle price shift. The argument is not about who is a better gambler...but about which gambler India needs...

I believe that, over the long term, economic growth does lead to earnings growth, which does lead to an appreciation in stock markets and the share prices of companies that have shown a growth in earnings.
I have not said that economic activity was dead till March 8th and then suddenly picked up on March 9th....there is an underlying economic activity (up or down) every day...and the various "gamblers" (the 10-minute hedge fund kind and the 10 year kind) are all reacting to news....stock markets on a daily basis move for all kinds of reasons...stock markets, in my opinion, do not lead economic growth, they reflect economic activity...somtimes with a huge time lag...sometimes with a smaller time lag...
And, while I am the first to admit that we know very little, I also believe that we make mistakes and if we learn from those mistakes and try not to repeat them, we can improve as fund managers.

Just one factual correction: we were buyers in March 2008 (and the months before and after that) but not sellers in Ocotber 2008...we continued to stay invested and suggested that it was a good time to buy shares see the Honest Truth of Oct 27th 2008...but also that investors must have a well-balanced portfolio and cash to set aside for their daily needs for 6 to 24 months...

There is a saying that the only other profession that makes investing sound respectable is weather forecasting! I agree with that and I believe that the financial services industry is the most overpaid and useless (calculating the relative contribution to society compared to what it gets paid) industry. The world will be a lot better place when engineers, doctors, teachers begin to earn 2x what financial people earn..


Soham Das

Jul 29, 2009

Two things. You have often been scathing in your comments about P-Note and Hedge funds. Terming them as "gambling money".
You honestly are further away from the truth, than I assumed you to be. What makes you think, you are better than those "hedge funds" and dont gamble? You invest, because you think something is gonna go up, which means you are speculating, which means you are no better than those P-Notes.
And lets not forget, P-Note, I don't support because of its lack of transparency, but foreign money, your so called hedge fund money? Oh you bet! Else, we are not gonna see a new business cycle emerging.

Secondly, you hinted sane economic activity leads to stock market growth, isnt it? Are you sure?
So in your words 9th March 2009 was the day, economic activity shot, and till 8th it was in dumps?
Its the opposite thing, my dear friend. March ended in bittersweet note in terms of earnings. Yet the stock market rallied. And almost after 4-6 months, the earnings have started picking up.
Lets keep, fundamental jargons, out of the view and question the bs fed to us.I dont blame only Mr. Dayal but almost all, the Mutual Fund managers. They bought in March 2008, only to sell in October 2008. What a laugh!



Jul 29, 2009

Ajit, is there something called ‘dishonest truth’? If the answer is no, then there cannot be an ‘honest truth’ too. Some suggestions that you can consider to change the title - ‘Triumph of Truth”, “No-masala truth”, “Nothing but the truth”, “Kadwa sach”, “Sweet lies, bitter truth”



Jul 26, 2009

what do we make of this article if we read it along with the one dated 17th may (Sensex at 21000). Isn't it confusing??


Satyajit Hazra

Jul 19, 2009

Dear Sir,
Please keep up the good work on giving good advice to the readers. Your articles help keep the sanity in check when things are too pessmistic or too optimistic.
Thank you,
Satyajit Hazra


Anil Mehta

Jul 18, 2009

I am a great fan of this column. Author has rare wisdom and unconventional and orginial thinking. This is one very useful column for those small investors who don't understand or don't have time to study and understand stock / commodity market. Thanks


rafat merchant

Jul 18, 2009

Very informative Sir keep up the good work hope we gain some thing out of it



Jul 18, 2009

You appear to be an Indian BULL amongst your World BEAR. Lets see..



Jul 18, 2009

a very balanced article. i admire your conservative
approach to investments especially in these times. but
you have gone hopelessly wrong in saying prices of
rice,etc have declined. over the last one year and
especially after the elections prices of rice, wheat,
cooking oil, pulses have increased to crazy levels
(close to +50%) please dont quote figures from
commodity exchanges. go out on to the street and find
out for yourself. if this trend is not arrested soon, I
reckon that we will have a food crisis on our hands in
India. And the Inflation rate put out by the govt is a
'cruel joke' on us.please get ur facts right.

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