Monday, April 30, 2012

The Paradox of Being an Equity Investor

Friends, sorry for not posting any articles for a long time. As equity investors, we are all facing one of the most difficult economic climates around the world now. Recently I read two articles one discussing why there is going to be a global financial crisis and the other discussing why India will not have one. As investors we all want to make money in stock market and on the other side we also want to protect ourselves from a potential disaster. We are experiencing a paradoxical investment environment where investors who matter the most (FII’s and DII’s) are positive one day and become negative in no time though not without reasons. I will present some of the important points from those articles and relate how it can affect retail investors.

First Article: 22 Red Flags Indicating Serious Doom Is Coming For Global Financial Markets (Contributed By Michael T.Snyder)

One of my Investor friends shared this article with me and thanks to him. Important points from those articles are given below and my views are in the parenthesis.

• There are signs of trouble at major banks all over the planet. (Not really in India though. European Banks are in deep trouble and all the banking and financial institutions which have exposure to this region will be in trouble too. But terming this as “Global” financial crisis is little bit exaggerated when top Indian banks have shown above 30% growth in the recent quarter (ICICI, AXIS, HDFC AND YES BANK) while reducing the NPA level and Indian banks don’t have significant European business or connection.)

• The greatest global debt bubble in human history getting ready to burst, and when that happens the consequences are going to be absolutely horrific. (True if this happens. But how do we know this is going to happen for sure and when? There is risk in everything we do. We don’t know the bus we are boarding in has a good brake or not. Of course there are red flags about the safety of Government run buses, Indian railways or for that matter even Indian army. What are we doing about it? The same thing can be applied here too. By that I mean the investors who are planning to invest can wait for more clarity. But the investors, who have huge exposure already like me have only two options, ride out this journey or jump from the bus. We just can’t do things based on probability and if that’s the case FII’s might have already pulled out billions. Retail investors are in a catch 22 situation for sure.)

• According to CNN, the level of selling by insiders at corporations listed on the S&P 500 is the highest that it has been in almost a decade. (This is a warning for us. But sometimes when we are in fear we see tiger in a cat)

• Home prices in the United States have fallen for six months in a row and are now down 35 percent from the peak of the housing market. The last time that home prices in the U.S. were this low was back in 2002. (Not really. Florida is the worst affected market in the US and the home prices have increased in the last few months. Lot of people have changed jobs from my company which means there are opportunities out there.)

• It is now being projected that the Greek economy will shrink by another 5% this year and the budget deficit will be 7% of their GDP. (This can be true. If major economies of Europe does not support, Greece will even default.)

• Interest rates on Italian and Spanish sovereign debt are rapidly rising. (This is true. European nations as a whole are reaping the rewards for being reckless over a long period of time)

• Spain, Portuguese and Italy are in trouble and they might need bailout. (How funny? All these countries have become developed countries on borrowed money and now they are trying to protect their interests on bail outs. This is like a legal Ponzi scheme where you go on paying the debt through refinances. These countries also face huge unemployment.)

• Many experts are saying things could become bad again and there are dark clouds over the global economy. (Terrible thing to hear. But why were they projecting rosy things few months back?)

• A recent IMF report admitted that the current financial crisis could lead to the breakup of the Eurozone like Soviet Union. (We read this almost every day. What we don’t know is whether the governments are taking any action or not? Whether those actions will prevent the collapse or not? How bad the situation is? How much money involved? Can any expert answer?)

• A member of the European Parliament, Nigel Farage, stated in a recent interview that it is inevitable that some major banks in Europe will collapse. (Even though, Indian banks have no significant exposure, stock market might crash on FII selling if this happens. I shudder to think of that happening.)

• The IMF is projecting that Japan will have a debt to GDP ratio of 256 percent by next year.

• The 9 largest U.S. banks have a total of 228.72 trillion dollars of exposure to derivatives. That is approximately 3 times the size of the entire global economy. It is a financial bubble so immense in size that it is nearly impossible to fully comprehend how large it is. (If this happens, you and I will lose every penny but at the same time it might provide greatest opportunity that has ever existed.)

• The financial crisis of 2008 was just a warm up act for what is coming. The too big to fail banks are larger than ever, the governments of the western world are in far more debt than they were back then, and the entire global financial system is more unstable and more vulnerable than ever before. (Wow. So what’s in store for us? All you can do is to pray the god that nothing catastrophic happens in next few years.)

Second Article: Seven reasons why India’s economy won’t collapse as feared (Contributed By Jonathan Anderson)

• Credit bubble is not that bad. In terms of peak five-year increase in the overall domestic credit/GDP ratio across emerging market (EM) economies, India sits near the bottom of the pack, far removed from the "true-blue" credit bubble countries in eastern Europe. India is simply light-years away from the kind of numbers that normally point to trouble.

• The feared investment collapse does not exist. India does have a slowing economy, and real investment spending has shrunk. Still, India is investing between 30 per cent and 35 per cent of its GDP – the second highest investment ratio in the emerging universe, after China. No collapse in domestic savings either.

• Growth has not disappeared completely. If you look at the investment and production figures on a sequential rather than a y/y basis, you will find that levels have already recovered visibly over the past few months, even if we are not talking about a massive recovery here.

• Inflation is worse but it is on par with other emerging economies if you compare using GDP Deflator inflation. (GDP Deflator: nominal GDP divided by real GDP multiplied by 100).

• Cost of capital is not that alarming. While RBI has had to adjust reserve requirements to ensure continued liquidity in the system, that's about it. While short-term rates have been rising as a result of policy rate hikes, long term funding rates have been unchanged in the last couple of years.

• The myth about overseas borrowing by Indian corporates and repayment crunch is overdone.

• There was no rupee sell off last year. It was on par with other emerging economies.

What do we take home?

The truth is nobody knows exactly where we are heading and it will remain so no matter what. There are some true concerns and there are some exaggerated ones in these articles. To me it appears that the US is not really that bad for the time being considering the increase in home prices and reasonable job market. While India has so many macro issues because of government inaction and policy flip flops, she is still growing at a decent rate of 6.5%. If you consider banks are the back bone of an economy, then top private sector banks have shown more than 30% growth in the last quarter. Other sectors like Infrastructure, Power, Metals and gas are down in the dumps and it will stay there till government gets it act together. European Union is the major problem at this point of time and if it fails, then FII’s are going to flee Indian market (Not because of problems in India) and I can’t imagine the impact to retail investors.

Retail investors have not got any returns for the last 2 years. Only people who have invested in December 2011 lows might have made some money. If you are one of those guys who invested in 2010 and start of 2011, then you would be down by at least 20% and there are not many safe options at this point of time. But I have listed whatever options available and you just have to accept the reality and use these as a guideline according to your own situation.

• Remain invested and ride out the trouble if something bad happens.

• Keep good stocks and sell those that you don’t think worth having in your portfolio when there is a relief rally (if at all there is one) and restructure the portfolio by adding defensive stocks.

• If you are someone who can’t see the red, exit totally from the market when there is a relief rally and wait for the right opportunity to enter the market which means enter the market when there is no European union.

Relief rally a probability?

Warren Buffet says that we need to buy stocks when there is lot of pessimism and I do believe this is a market with lot of pessimism. Mid and small cap stocks offer cheap valuations even now. In that sense I do have the gut feeling that the (Though data and information supports otherwise) market might rally before something happens and that’s the risk that we need to live with.

Kumaran Seenivasan.



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