Inflation and the government

It has been long since my last post - however things have remained volatile on the bourses. This post discusses in brief the major changes in India polit

Bull runs have been intermittent, ebbed away by the larger bear market and profit bookings. Oil prices have taken a dip but has not impacted the stock markets significantly (except for oil intensive industries such as airlines etc).

On the other hand the UPA govt seemed strong and healthy after sweeping the vote of confidence; people seemed to believe that without the nagging left support reforms were round the corner. Much to our disappointment things turned out not-so-bright for the bulls. With Lok Sabha elections close by it is tough for the UPA govt to bring major reforms in the economy. To add fuel to fire, the inflation number have peaked their fourteen year high. Interestingly, the government has hardly taken any steps to contain the inflation, but rather adopted populist economic (or political!) policies. The forgoing of 60,000 crores of loan to the farmers have hardly impacted the needy farmers (they are unable to avail loans - as rural loan policies are dictated by local politics in each state) but have added to inflationary pressure. The avg hike of 21% of central govt employees (through the 1oth pay commission) was a kind of trade off. This would further add 30000 crores into economy thereby driving inflation higher. Only occasional interest rate hikes by RBI has failed miserably. In fact the worst is yet to come so far as inflation numbers are concerned.

I would attribute the bear market largely to the global credit crisis - the FII investments have been diminishing since the January crisis. Its only when these subside, that the Indian markets would take off. The losses incurred by various financial institutions will be accounted across a number of quarters (as I had already mentioned). Thus, we may see more institutions going bankrupt in near future. However, I do believe that the Indian growth story is intact and the very fact that the Indian equity is now trading at a lower P/E than the Chinese counterpart - the reversal / recovery would be faster on Indian bourses. Value picks and long term investments are tick of the day.

Real estate dilemma

There has been a drastic change in the real estate space - many of the bigwigs have touched their 52 week's low and some have gone doen below their listing prices.

Firstly, in the recent months post Jan 2008, if the major falls are observed they are preceeded by a crash in the real estate index. This may be due to some conceptions that the real estate stocks are trading far above their fair PEs. But I would attribute this more to the FIIs - almost all the FII have real estate stocks like DLF, Unitech, Parasvanath etc in their portfolio. These form a major component in thier portfolios and with these FIIs selling off the first indication comes on the real estate index.

Second being the fear that real estate prices would come down drastically in the coming months in Mumbai and Delhi (20-30% in topslap and 10-15 % in middle tier real estate assets). Yeah, this may be a possibility but the major real estate companies are mainly focusing on Tier B and Tier C cities as the development of a township gives far higher returns than some highly priced apartments in A+ cities).

In any case there is no justification that the stock prices falling almost 50%. However, these are more robust companies than any other because land remains the limiting factor in the Indian scenario. Infact the next craze would be REMF (Real estate Mutual funds).

The future of Indian equity market is not as gloom as it appears. Yes we had a fall of more than 500 points on the Sensex and many of the so called big corporated are reeling under selling pressure trying to gauge new all time low (or 2 week low) as the case may be.
But the story dosen't end here - lets analyze little things. The Indian economy is the same as it was a month or six months ago. No fundamentals have changed that much to have a drop of 50% or so. It just as good a concoted story as the 20k euphoria was.

The reasons - cited are a) rising oil prices , b) inflation, c) global equity crisis (this was supposed to have started with the sub-prome) d) lower GDP growth rate than forecasted.

Let's analyze them one by one:

a) oil prices - read my previous post. Also note that commodities is now at its peak undergoing a boom - similar to the equity market we had six months back. Like all things that which has gone too high will ultimately bust and even out. The question remains when ? Not too far from now - 3 months would suffice.

b) inflation - stupid indexes invented by morons have been used to gauge inflation. Its more of a number game - and some technical junkies use these to defend their statement. All such indices try to measure the inflation are grossly off the mark and many of these does not take into account seasonal changes niether do they discount abrupt price jumps of particular products.
Will post a detailed analysis in my next post.

c) Yes the US had a poor growth may be on the border line of what is defined as quote unquote "Recession". The unemployment rate has risen to 5.5%. But what the heck! Emerging economies provide far better return than the developed counterparts. What if the investment banks & insurance companies sell of in US ? Where the hell will they place that money ? Will they invest ? Yes. Where ? in growing economies and commodities. Aye no more in Gold ... Gold story is gone for the the time being. There you see the cycle - equitues, gold, commodities ...

d). GDP growth does have an impact - but its applicable only to the long term story. The nature of investment of FII is most cases do not adhere to such pronciples.

More to come later ...

Writedown of losses

The Article below explains how and why brokerage houses writedown partial losses over a period of time. The same applies to big banks and it is supposed that they would writedown the loses over a period of time (say for next 8 quarters). As a result there maynot be any significant bull run in near future.

Business Standard -
NBFCs of brokerages refrain from announcing one-time hit due to margin funding. A good number of non-banking financial companies (NBFCs) belonging to big brokerages are keeping themselves from announcing a one-time hit by losses arising out of margin funding following the market meltdown in the early part of this calendar. Instead, the broking houses are carrying forward these huge losses as loans under recovery, and announcing only minuscule bad debts. Through this move, say experts, these broking firms can avoid making huge provisions for losses and, to a great extent, neutralise a possible negative impact on their share prices. Stock prices normally take a hit if a company's provisioning or writedowns is huge, they say. It's surprising to know that provisioning and losses announced by brokerage houses do not form even 1 per cent of the entire margin funding business. Chartered accountants say brokerages can carry forward their losses for six to eight quarters, after which they will have to show it on their books.

However, they can avoid mention of any loan as loss, even after two years, if the matter is sub judice.'Typically, what most of them would do is make small provisions for NPAs every quarter, so the loss amount does not seem to be too big. Eventually, they would also try and offset these losses with their profits in the coming quarters,' says an accountant.In the last three years when the share prices were shooting up, the NBFCs of top broking houses made a killing by lending money to investors at an interest rate as high as 18-25 per cent.While the NBFCs earned high interest rates, their broking arms benefited from commissions earned from the share transactions. Conservative estimates put the size of the margin-funding market at Rs 10,000 crore during the market peak of 20,000-plus levels.The funding reached unparalleled proportions as brokers aggressively pushed for loans to small retail clients too. Investors typically bring in some portion of the money to purchase shares, while the broking outfits (through their NBFCs) finance the remaining amount. The shares are then kept in the name of the NBFC.In a rising market, when an investor chooses to book profits, he gets his portion of the contribution and the gains. The broking firm takes home its funds and the interest amount.This led to a bubble-like situation as investors were seduced into paying more for a stock than its fundamental value. Margin-funding trades were also responsible for the huge volumes generated in recent times. 'However, when the market crashed, the entire system collapsed like a pack of cards, leaving the broking houses with piles of bad debts,' explains a dealer, while stressing that the margin-funding business is now down by over 60 per cent.Currently, the brokerages have huge NPAs and bad debts. They're now moving the courts. 'Such cases drag on for years, and it will not be surprising if the brokerages do not announce any writedowns in some cases on the pretext that they are still in the court of law,' says the accountant.

Trading strategies - Technicals

There has been enormous research on trading methodologies to be pursued by any rational and intelligent investor. Volumes have been written but none provide a definite path. I believe that if a path did exist to make assured profits, then imagine a market where every investor follows the same pronciple! Will all make profit ? Who would sell when the theroy says one to buy? !!!

Non exists dear friend. W. D. Gann (one of the most controversial and successful traders) had charted out numerous predefined technical analysis. But they are so complex and incomprehensive (especially when you are not sure whether to implement all or a few of the rules laid down) that it is impractical to follow them.

Technical charts may provide you some guidance - resistance, supports and moving averages but they cannot be solely relied upon on deciding which stocks to pick and which stocks to sell.
Purchases should be made on a company's fundamentals or news (speculation). The later can give hansome profits or leave you nowhere!

But I would rather view Gann's principles from the philosophical angle - which advices one to show restraint on greed and be unnerved by losses. Stock market is essentially different from any other form of business - in other cases of life 'you' are the actor and your efforts get reflected; but in the market its too huge for any single participant to control ( leave out the stories of influencial people who can change credit policies or set the company rules ). Other forms of insider news is stictly unfair though they have significant impact on determining stock prices.

"... it turns out for all practical purposes there is no such thing as stock picking skill. It's human nature to find patterns where there are none and to find skill where luck is a more likely explanation ..." - William Bernstein, The Intelligent Asset Allocator

Soros and theory of reflexivity

Legendary investor George Soros was of the view that equities market was a total chaos - and the sooner one accepts it the better. He was of the view that its not always that the company's fundamentals determine the stock price (or equilibrate) but rather the stock prices can change a company's fundmentals in ways such as M & A. Stock prices being primarily a function of the perception people have, it is important to identify the inclination of the people towards a particular stock.

I would differ to some extent - in major index stocks its price is controlled/governed by the sal/purchases by QIB and HNIs etc. These being educated and rational woulf try to identify what rest of the markets think and conclude. Thus when each of the major entities think otherwise the common thinking may prevail. Its similar to a paradox. Let's illustrate - let the rational/intelligent participant be X and the rest of the market (excluding X ) be Y. Thus with X and Y together makes the universal set. X tries to identify how Y would interpret the market and accordingly steps counter measures - so if Y thinks stock A would perform X thinks its time to sell A. Similarly the other way round. But there are many participants who would think with the same logic - as a result we get the complementary set of expectations. Thus it would be really difficult to think as separate identity - i.e. there is no such thing like 'I' and the 'rest of market'. Its a sum total!

Monetary supply and Inflation

Government of India can print any number of notes.
There are two ways of generating Currency Notes, some may take physical form and other in the form of book entry.
One is through 'Deficit Financing' where the government of India's total expenditure exceeds total income from all sources - Income Tax, Excise duty, Central Sales Tax, Value Added Tax, Import duty etc. Supposing Net Expenditure for 2008 is say -80,000 crores. Since the GOI does not have money, it gives credit or print notes to the extent of Rs 80000 crores.

Secondly through FOREX intervention. When the lot of dollars or other Forex currencies come to India, they need to be converted into rupees before they could buy stocks, bonds or make direct investment. The foreign investor has to buy Rupee from the market which will cause Rupee demand to exceed the demand, so the rupee appreciates. In this case, no currencies are printed. However, when RBI at the instance of GOI decides to intervene in the FOREX market to 'sterilize' Rupee currency's rise, it ask the Foreign Investor not to go to the market and buy the Rupee. Instead, RBI give special rate to the foreign investor to buy dollars in 'off market' and give him the credit to his current account with any bank (book entry). For instance, if Citibank approaches RBI to sell US$ 500 Millions on behalf of its Mutual fund customer, it will get better rate, say Rs 41 instead of market rate of Rs 40, so it saves about 2.5% on exchange. RBI then gives credit of Rs 2050 crores by buying US$ directly from the Citibank. This avoids selling of dollar and buying of rupee in the market, so rupee exchange rate remains same. Had Citibank sold $500 Millions in the market, rupee might have appreciated to say Rs 39 or it would have got 5% less than what it would have got by selling to RBI. In short, Money Supply (called M1) increases in the market. The book entry slowly gets converted into real money because when Citibank buys the stock, it has to pay in rupees, and that rupee will circulate in the marketplace. This is a suicidal policy; it does not increase the good, but merely increases money supply. The equilibrium between Goods and Currency in circulation is adversely affected as result of which 'Inflation' in the system increases.
This second type of practice is adopted by most Asian countries including Japan, which have highly inflationary effect.

One cannot pay Rupee to IMF to discharge the debt. The debt was contracted in US$, so you have to buy US$ by selling rupee in the marketplace to pay off the debt. If what you say was possible, practically every country will discharge its debt by printing more notes. USA is exception. Because it was used as Intervention Currency, or common currency, US government was encouraged to issue more notes and contract debts. Since the debt was issued in US$ or its own currency, it will pay off the creditors by printing more notes. This is what it is doing. It borrows from the world, and the President Bush go on giving Tax Rebates to its citizens at will, because he can afford to, because the world is foolish in giving more value to dollar.

Above should help you understand some basics of Monetary Management. Note there is no free market for currency in India.

Gold fortunes when markets crash!

Gold becomes critical when the stock markets crash - often it has become the norm that when markets crash gloablly the fund flows into to buy gold, thus driving the price of gold higher and viseversa.

Hence this posting on Gold - as now with the markets crashing people are flocking to buy gold and numerous banks are selling gold bars and mudras etc. It is important to understand the weightage price breakup.

Often people confuse in the conversion of 1 ordinary Oz & 1 Troy Ounce.

1 troy ounce ......= 31.10grams (Rounded off to 2 decimal)

1 Ordinary Ounce = 28.35 Grams or 1 Pound = 16 Oz = 453.6 gm

Current International Price = US$ 876 per Troy Ounce(1 Troy Oz= 31.10)

Price per Gram ................... = US$ 876/31.10 = $28.17

Price for 10 Gram ............... = US$ 281.70

Import duty@ 2% ............. = US$ 5.63

Importation Cost/Ins ........ = US$ (X)

Total Import Cost (CIF).......... = US$ 287.33

(ignoring X)Rupee Rate (Customers) ......... = Rs 41.02

Import Cost per 10 Gm in Rs........= Rs 11,786.28

Local Sales Tax @ 2% ..........= Rs 235.72

Bank's Profit Margin ..............= say,

Hence TOTAL SELLING PRICE ...............= Rs 12,022.00 + X + Y

Banks' Rate to Customer .............= Rs 13,500

Difference ........................= Rs 13,500 - Rs 12,022

Bank's Gross Margin ...............= Rs 1,478 (or 12.22%)

Even if we add the Bank's profit and Transportation cost of about 2.22%, the Bank's profit margin comes to 10%. Now, the difference between 1 Troy Ounce and 1 Ordinary Ounce = 31.10 - 28.35 = 2.75 or 9.70%.

USA PRACTICE: Visit American Precious Metal Exchange who charges normal international prices for the gold bar. However, if some one ask for Gold Coins or other form with Assaying certificate, the charges are significantly higher.IN APMEX, they also buy back the bar which trades at premium to international prices. So, if you want to sell, you also get the higher price.many cases you are a big loser. The moment you buy the gold, you are losing straight away 10% because they will never buy backIt is said that BUYERS BEWARE.

Crash in Indian viz Global Market

The current stock market crash was due long time back. This time it may have ridden the waves of subprime crisis - US slowdown and recession are just the tip. The most interesting thing is the situation has been kept under cover - even at present some banks (eg ICICI etc ) have not disclosed their losses. Same with major US and other global banks and i-banks. What seems that they plan to disclose their billion $ losses spread out over quarters.

Warren Buffet's prediction 'the recession is deeper than most people think' is an indicator in that direction.