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Thursday, July 3, 2008

Yes… No… Maybe… Wait –Investor’s dilemma

"Give me a one-handed economist” Harry Truman, an ex American President once frustratingly remarked. "All my economists seem to say; On the one hand. On the other…”

The financial world too suffers today from an overload of information, many of which is pointing to conflicting directions. And depending on which of them you choose to rely on, the world appears to be sitting on brink of disaster (Economic, social, environmental… you take your pick) or as wall street historians would have you believe the fire sale of Bear Stearns was the bottom of the market and the worse is behind us.

The views are so divergent and sentiment so skittish with conviction levels low all around, that the world markets move up one day on a better than expected retail demand in the US and move down the other on falling employment or a weaker dollar and increasing crude prices.

2007 was the year of the Bull Climax. The world could just get nothing wrong. US, Europe, the shining BRIC economies, Japan showing signs of recovery at the end of a decade of difficult times. The rally across the world on real estate, commodities and stock markets had made people across the world have the illusion of being richer.

In July the cracks in the fairy tale came up with the mortgage loan-related losses being disclosed by financial giants. For a long time, the problem was thought to be much smaller and, in the subsequent months stories of spectacular debacles started emerging from the largest banks in the world.

When on their rampage, bulls tend to ignore reality and amidst rising discussions of the financial sector collapse in the US with "experts” falling over each other to put a number… $200 billion… $400 billion… $600 billion. With new losses being reported every day and banks which are pillars of world finance scrambling to raise capital to stay afloat; the collapse of confidence was near total and fear of recession in the US, a fed which had pushed itself into a corner by cutting rates to the bone and the ugly head of inflation raising its head along with a weakening dollar.

With the benefit of hindsight it is apparent that the Indian and Chinese markets completely ignored this reality; drunk on the theory of "decoupling” based on the strong domestic story in both markets. The BSE Sensex which was hovering around 15700 levels in July’ 07 had a gravity-defying ride to 21000 in January completely ignoring crude crossing $100 a barrel, world financial markets in disarray, real estate prices across the world correcting sharply, commodity prices, food prices. After all China and India seemed to have not only decoupled from the world, they also sadly decoupled themselves from reality.

India woke up on 18th January ’08 fresh from the hugely successful Reliance Power IPO and stock market pundits and fund managers went to office discussing the next high of the markets completely unprepared for the day that was to alter their reality for a long time to come. The market plunged 687 points; a minor blip; most dismissed it. It followed it through on 21st January ’08 with an all time high record fall of 1408 points and horrifyingly plunging to an intra-day record loss of 2273 points on Jan 22nd with BSE suspending trading within minutes of opening after the sensex reached the circuit of 10% fall in a day, the market recovered a little but still lost 875 points from the opening.

Suddenly the world; which till very recently could get nothing wrong, is now unable to get anything right! Crude jumps to $137 a barrel with a $11 increase in a single day. The predictions of doomsday are now out in full strength. In 2009, crude will reach $250 if you believe the Russian Oil Producer Gazprom, $200 if you are a Goldman Sachs fan and in three weeks it is out to cross $150 if you prefer Morgan Stanley research.

Food prices which were not even a matter of discussion in the world economic agenda all these years except in subsidies and starving African children is all of sudden center stage. The world just does not have enough food and since we have to find a theory to justify for the moment lets blame it in rising consumption in India and China.

India and China now seem to be re-coupled with a vengeance, a sneeze from Wall Street and we are under treatment for pneumonia! Just as water finds its lowest level, money has found play in commodities so logically commodity producers are in play. Sell India and China and Buy Brazil and Russia – both commodity producers.

From a benign inflation of around 4%, all of a sudden we are now staring at a double- digit reality! Infrastructure is not keeping pace, Fiscal deficit of center and states are now at 10% levels. Policy responses of not passing on crude price increase, the farm debt waivers, which will affect long-term credit discipline, and a reality where interest rate increase may not be the only solution to tame the hydra-headed inflation monster.

In between these crisis, I suddenly found this video given below, which is in little hilarious tune, but worth watching it with the tune of a famous song and the Wall street meltdown, to give my readers a little relief getting through this article.

Corporate growth in India peaked in December ’06 and the Indian companies have done a great job managing growth quarter on quarter but, on a rising base and fast escalating costs, the percentage growth is likely to slow further somewhere north of 15% which is very admirable but will bring the valuation of the market lower.

There is still one bubble left in this story, which must either be pricked or will burst causing greater damage – ‘The Real Estate prices.’ In the US, Ben Bernanke still warns of a possibility of 10% reduction in House Prices; which means a peak to trough correction of 25%. The cost of doing business in India is already paining retail and entertainment – two of the biggest consumers of commercial space, and houses are getting beyond reach as the gap between rising aspirations of the middle class and affordability is widening. Infrastructure in terms of roads, public transportation, much has got talked about, little has been done. This means that cities like Bombay are unable to expand, as time taken to commute gets unrealistic with distances. Across residential and commercial properties there needs to be a countrywide correction to align to reality. The stock markets have a better and more transparent system of price discovery while the real estate markets are opaque and the waiting game between holding power of builders and staying power of buyers is on. But, in the end real estate prices will have to wake up and smell the coffee.

From the romantic stories of the Bull, we have now moved to the grizzly reality of the Bear. From greed to fear, the pendulum has swung. While in the short-run the markets may still have some venom in them and may keep testing the bottom, each decline will provide an opportunity to buy sound stocks with good management at prices that will justify the risk taken to invest in them at these times. There will be no miracles and going back to the valuations we have seen is a long time away.

The FIIs are selling out, the bear drumming says. Numbers do not confirm this. Out of $250 billion, net sales are only in the region of $5 billion hardly substantiating the perception that is generally being built. Domestic Mutual Funds rushed in after what was generally thought to be the bottom post the January fall but it turned out to be a false one and now most of them are sitting on cash.

Governments across Asia are swinging between denial and despair as inflation in China, Vietnam, Indonesia, India, already far above the central banks tolerance limits is now galloping out of control – and mind you, governments in China and India have not passed on the full price of oil increase. This with the obvious signs of growth slow down is building up to a stagflation possibility. In Asia, unlike the west, wage price spiral is exacerbating the challenges. Central banks are buying time with monetary accommodation by keeping short-term interest rates below the current inflation levels. GDP growth, Interest Rates, Inflation and Currency Price Management are all said and done the most difficult to manage in these uncertain times.

The market as it stands today is still in a narrow trading zone with a negative bias as it is very close to various technical levels which if breached can take the sensex lower by 10% from these levels. The market may have to move sideways and consolidate before it finds momentum to go up. All in all, the markets are likely to continue being rough as they seek direction and confidence to trend directionally; everyone is nervously watching the cat walking on the narrow ledge looking for signs on which way it is likely to jump.

By: Asim Dhru, MD & CEO of HDFC Securities

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