Bulls, bears, sheep, moths, and the madness of herds - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
Bulls, bears, sheep, moths, and the madness of herds A  A  A
22 AUGUST 2011

The price of any product in the financial markets, it has been rightly said, is set at any point in time by the interaction of various emotions, thoughts, views, opinions, and reactions that different people have at that point in time to any known set of "facts" or new bits of "information".

But whatever that price set by the market may be - it does not mean it is right.

Take the case of US government debt.

On August 5, 2011 S&P - one of the 3 agencies that dominate the rating business - downgraded the debt of the US government from 'AAA' to 'AA+' with a negative outlook. They cited the political gridlock in the US decision making bodies on the need to take on more debt (to borrow more) and the how the US government was planning to fix its inherently weak economy where the revenues raised by the US government are less than the expenses and obligations it has committed to.

To quote from the Overview section of the rating report issued by S&P:

The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed.

And another quote:

Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a 'AAA' rating and with 'AAA' rated sovereign peers.

What S&P was saying, in plain English, was that investors could no longer fully trust the US government to repay its debt obligations on time. Any lender to the US government should be aware that the interest the lender is due to receive or the return of the capital is not 100% guaranteed. There is some risk of the US government not fulfilling its debt obligations to the lender. Hence, the "downgrade" by one notch from AAA - the best ranking possible that is still enjoyed by 16 sovereign nations - to AA+. As an aside, Moody's and Fitch - the other 2 rating agencies - did not downgrade the US debt.

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Hi, I'm broke, can you lend me more at lower rates of interest

Much of the debt in the world is priced off the "risk-free" rate of interest set by the market for US government debt, best reflected in the rate of interest offered on its very liquid 10 year bond: the US 10 year treasury. Given that "risk-free" was no longer "risk-free" - a severe jolt to the very foundation of the current financial system even if only 1 of the 3 rating agencies judged so - a rational investor would demand a higher the rate of interest for lending more to the US government.

In fact on August 19th, two weeks after the downgrade, investors were happy to invest in 10 Year US Treasuries for an annual rate of interest (the yield) of 2.0623% - far lower than the 2.5585% before the S&P downgrade.

If your neighbour took a loan from you at, say, 8% interest and a friend tells you later that your neighbour was having financial difficulties and may not be fully able to honour his debt obligation to you, would you lend him more money or less money?

And if you did lend him more money would you want a higher rate of interest or a lower rate of interest?

Well, the rational or logical view has been proven wrong by the market.

The market for US debt just got better from the government's perspective. The US government can borrow that extra USD 2.1 trillion approved by their politicians on August 1st - at a lower rate of interest.

There is, we are told, a "flight to safety".

Investors are so scared of what is happening in the world that they are fleeing to the "safety" of the US.

The bulls who believe that the US is the best place in the world to invest are buying, the bears who think the Eurozone and Asia will collapse are buying, the sheep who follow the crowds are buying and the moths who like to fly close to dangerous fire are buying.

Like the innocent dolphins in the heart-wrenching documentary "The Cove", the noise of sovereign debt busts in Europe is forcing investors to seek refuge in the comfort of owning more US debt. And like the hundreds of dolphins who are senselessly slaughtered by the Japanese fishermen in that deadly cove, my guess is that owners of US government debt will be slaughtered in time. A few lucky ones with the sweetest smiles may wind up at sea parks where they will be made to jump and do tricks for their survival.

Again we don't know how long it will be before this price bubble bursts - the tech bubble of 1999 lasted 12 months; the Asian Tigers bubble of the early 1990's about 3 years; the BRIC bubble of the mid-2000's about 2 years - but burst it will.

The US economy is in need of a massive overhaul. At one end of the spectrum, US companies are sitting on huge cash reserves of over USD 1 trillion. But the city, state, and federal governments are sitting on large potential liabilities in terms of retirement benefits and medical costs - with declining revenues due to low economic activity. It is estimated that the state of California alone has an unfunded pension liability of about USD 250 billion. With a 9% unemployment rate, unpaid credit card bills, soured housing investments, and lower salary levels, the US consumer needs to spend less. If the promised pensions are cut further - as is happening in Greece - the US consumers will have to save even more for their future retirement. And consume less.

Investment creates jobs - outside of USA?

Despite their cash war chest, the US companies are under no obligation to invest in their home country - they will go where the consumers are. Ford recently announced a USD 1 billion investment in India.

In India, as in many parts of the world with varying degrees, salaries are generally increasing. And while the cost of living - as measured by inflation and by our desire to live better lives and consume more goods - is increasing, we are still able to balance the growth in our levels of consumption with a 30% plus rate of savings. Sure, India has many challenges - creating 120 million new jobs by the year 2025 is one of them - and corruption is a big issue. But I would argue that many of these are addressable and we have started addressing them. And we still have time to reverse the undeclared strategy of relying on roads as a primary way to move people and goods (not a good idea because we import much of our oil) and stop the decay of our traditional joint-family system - a great blend of baby-sitting and old-age care rolled into one!

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But being positive on investing in India is the rational, long term view.

The bulls, sheep, moth, and dolphins have no time for that.

In a strange twist to the story, while the recent panic in global financial markets is being caused by fears over the US debt, it was the US debt that was a big gainer and was being priced as less risky! Lenders were willing to earn less interest.

Many stock markets around the world have been battered (Table 1). I can appreciate the fears over consumption levels in the western world and their impact on share prices of companies that cater primarily to those consumers. But we are in a broad sell-off, which could give rise to some interesting investment opportunities for us in India.

Table 1: The trouble-maker performs the best: the wisdom of the markets.
The asset class or ecurity % change from August 5 to August 19 (in USD)
US 10 Year Treasury Bond 19.39%
S&P 500, USA -6.19%
FTSE 100, UK -2.57%
DAX, Germany -11.17%
MSCI World -5.30%
MSCI Emerging Markets -6.66%
IBOV, Brazil -1.62%
SHCOMP, China -2.82%
BSE - 30, India -8.68%
RTSI$, Russia -12.40%
Oil, WTI (USD/barrel) -5.32%
Gold (USD/ounce) +11.32%
Silver (USD/ounce) +11.89%
Source: Bloomberg, Quantum Advisors

I have often said that the price of Indian assets is determined by foreign investors, but the value of an Indian asset is determined by what happens within the Indian economy. That has not changed. Foreigners have sold some USD 1.5 billion worth of Indian stocks since so far this month. Their selling is causing the share prices to decline. But what is happening in the global economy may, in fact, help India. As the world slows down the price of various raw materials and commodities - from rice to oil to wheat - should keep declining and that will help the Indian economy.

But don't jump into the stock market because of the investment opportunity presented by lower share prices.

Any investment made, must be done with an understanding of your own situation including your ability to sleep well. You should recognise that the prices of many assets can - for long periods of time - be disconnected from what its estimated underlying value is. If you invest in stocks or equity mutual funds which decline by -50% from the time you bought it, you must understand why - and assess its impact on your needs. And then make a decision on what to do next.

And you should always re-balance your portfolio based on your changing needs. The bulls, bears, sheep, moths, and dolphins do what they do for they are who they are.

Investment is not a goal in itself - it is a way for you to get what you want over a period of time. Once you achieve your goals, get off the investment bus and use the money for the purpose you invested in the first place!

Though, my hunch is, many of us are still investing for our future needs and should evaluate the various investment opportunities that such dislocations offer us. I know that I am.

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Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.

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12 Responses to "Bulls, bears, sheep, moths, and the madness of herds"


Nov 26, 2011

Its been long since this article. When can we expect next one please?


Kiran bhat

Nov 25, 2011

I have come to understand thta you are a contrarion. When others are fearful you are bullish and vice versa. Agree with the comment that if you are selling your good/services to the neighbour you are likely to fund him lower rates immateial of his propensity to payback. After all business and economy runs primarily on one fuel optimism and forward trading



Nov 22, 2011

So Mr Dayal are we still aiming for Sensex 31000 in July 2012 that you predicted one fine day when you woke up from your Kumbhkaran like slumber?

As a professional, is it not expected of you to update us? Or will you only wake up in July 2012 and tell us it will now be 51000 in January 2013?


Hasit Hemani

Nov 7, 2011

If there is any Pulitzer prize for reviews on finance, investment and world economy you should be nominated, may be awarded. Prose of your treaties are so engrossing that it is utterly unputdownable.


Dharm Deo Sharma

Sep 28, 2011

Hi Ajitji, I admire that you are well read,wise and experienced and write very well.But, it is true that market play is quite complex and follows its own rules of uncertainty and risk.Wisdom lies in reducing the risks and finding way out of the uncertainties and of course, one must retire at a good destination found after a long effort and enjoy retirement, sharing wisdom earned with fellow beings.



Sep 24, 2011

Hi Ajit,

Your articles are interesting and thought provoking. It is a good guide for common people who do not understand technical terms.

I hope you have similar attitude towards people who subscribe to EM stock recommendations. In times like these where people have built long positions in markets based on your analysis,you should come out with monthly analysis
of all your recommendations to allow investor realign portfolios at lower price.
As always EM is mum when market is down and then would come up with recommendations to BUY when the price is high.
We buy your service to get your team's expertise otherwise Buying at High and selling at low does not require any consultants ..:))

Hope you listen to your customers or you will also be counted as CNBC like advisers who throw tips at roll of a dice...and.......




Sep 7, 2011

From the article -
If your neighbour took a loan from you at, say, 8% interest and a friend tells you later that your neighbour was having financial difficulties and may not be fully able to honour his debt obligation to you, would you lend him more money or less money?

And if you did lend him more money would you want a higher rate of interest or a lower rate of interest?


What if you earn or sell products or services to your neighbour? In that case, would you lend him to give him a chance to earn his position back??

Thats the situation rest of the world is facing with USA.



Sep 2, 2011

I think US will haul itself out of problems in the coming years... troops withdrawal from Afghanistan and Iraq....and subsequent contract wins for American business for rebuilding these countries will create jobs and kick up the economy in the home front...

Same is the model for UK & Libya....

Hence.. the price bubble...will be deflated with cost savings of not needing to spend any further for the war and revenues/profits from new business overseas rather than end up bursting...




Aug 26, 2011

The "Flight to Safety" to the dollar was not inspite of US itself being in trouble, it was to the world's reserve currency, which, today, happens to be the US Dollar. Witness that Gold, whose price rose even in US Dollars was a better "Flight to Safety". As long as US Dollar remains the worlds reserve currency, there is safety in it. However, once it changes, the situation will play out exactly as Ajit has predicted...senseless slaughter of US Debt holders.



Aug 23, 2011

Good sensible article Ajit, I like what you write except for those times when you start trying to predict the Sensex.

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