Thursday, May 31, 2012

5.3% GDP : Numbers not being interpreted correctly, recovery is intact

The latest GDP number of 5.3% caught many people, including myself, by surprise. Looked at in isolation, this number does sound very disappointing and many analysts and economists have been quick to come out with comments on how the India growth story is probably over and how the government is killing growth.

In fact, here’s what an ET story had to say: “HSBC labelling the nation as a ‘gasping elephant’ while Credit Suisse said latest numbers will send ‘shivers down’ the spines of coalition politicians of ruling UPA.”

However, when interpreted the right way and along with other macro numbers, the GDP numbers actually show that the recovery process is intact and the economic growth engine is chugging along just fine.

And this conclusion assumes that the GDP numbers don’t get revised upwards. The credibility of our government for data accuracy is a bit suspect given the numerous mistakes detected in the past with IIP, exports and the GDP numbers themselves.

The right way to look at the quarterly GDP numbers is to simply look at a chart of GDP (in Rs Cr) over time. Take a look at the chart below. What does it show? That the economic growth engine is chugging along just fine or that the economy is trouble? I rest my case.

 

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It’s not always right, and sometimes outright dangerous as in this case, to draw conclusions based on a single year-over-year growth number. This apparently low 5.3% growth number is driven by the high base effect of the last two years, when there was a growth spurt after the 2008 slowdown.

In my previous analysis, I argued that the recovery process as well as the India growth story is intact. Does it mean that we are back on a high-growth path and that everything is hunky-dory? No, not at all. The pace of growth is no doubt slowing down and there are concerns around a possible rupee fall, inflation and fiscal deficit.

However, there is nothing at all alarming in any of the macro numbers declared so far. All that is happening is that we are going through a very normal business cycle. After a burst of growth in 2009-10 and 2010-11, the economy is taking a breather, so to say. The economy continues to grow, but at a slower rate.

What about the negative growth rate in the manufacturing sector? Refer to my analysis of the latest IIP numbers for April 2012 which came in at minus 3.5%, year over year.  I had shown how the IIP numbers actually show a recovery taking place and not a contraction. It’s the same case with the manufacturing sector. It continues to grow, but at a slower pace.

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One of the strongest indicators of growth is the corporate profitability numbers which have been showing a steady rise for the last two quarters. This strength in the corporate sector is borne out by double-digit salary hikes, good bonuses, increases in hiring and high attrition rates, which are indicators of an expanding economy, not signs of a moderating economy. Going forward, the fears and paranoia surrounding a possible Greece exit and other global issues are likely to prove to be a blessing in disguise for India because of the impact on commodity prices and inflation.

The bottom line is that the economy went through a moderation phase in the second half of 2011, is now on a recovery path and is very likely be able to maintain growth rates in the 8% range, governance and reform issues notwithstanding.

I’ll end this one with a nice quote on data analysis I came across sometime back. “Conducting data analysis is like drinking a fine wine. It is important to swirl and sniff the wine, to unpack the complex bouquet and to appreciate the experience. Gulping the wine doesn’t work.” Daniel B. Wright (2003).

Saturday, May 26, 2012

GDP downgrades: Be wary of research house estimates - India growth story intact

I came across a slew of reports, where major research house, including the likes of Goldman Sachs and Morgan Stanley are reducing their 2013 GDP growth estimates to less than 7%, in some cases these have been reduced to around 6.5%

Here’s the key point to note - These research house reports are not meant for use by retail/ long term investors and going by past trends, Goldman and many other would very likely get their 2013 estimates horribly wrong, due to a clear bias towards overestimating negative impact.

Their primary audiences are fund managers, who need to hit their benchmarks every month. India growth story is very well intact and in-fact reiterated by these very same research houses in some of their other reports. The audience and purpose of these quarterly / yearly kind of estimates is very different.

Here're how accurate Goldman and Morgan have been in past.

FY10 Actual GDP around 7.9%

Goldman Sachs April 2009 Estimate - 5.8%

Morgan Stanley April 2009 Estimate - 4.4%

FY12 Acutal GDP around ?? (it'll probably come in around 6.9%)

Goldman Sachs Dec 2010 estimate - 8.70%

To give them credit, they have been accurate too sometimes, but there is no consistency. However, as far as overall accuracy of projections goes, they have a hit rate around 50%. That's more like a coin toss. Every expert would be wrong a certain percentage of the time, and that's to be expected as projections are probabilistic estimates and not crystal ball gazing. But a 50% hit rate doesn't really inspire too much confidence.

Again, I don't mean to rubbish these kind of estimates, but they are meant for a different audience and a different purpose, and not really meant for a retail investor.

My detailed analysis’ posted over past few months, shows that India growth story is intact. Key points summarized below:-

- Double digit salary hikes, increases in hiring and high attrition rates are indicators of an expanding economy, not signs of a moderating economy.

- My analysis of IIP data showed how the numbers are not being interpreted correctly. IIP numbers are actually tracing a pattern of recovery, not a contraction.

- Quarter on Quarter corporate profit growth till Dec’11 has shown an uptick. Trend is expected to continue with the March’12 results too.

- The fears and paranoia surrounding Greece exit is likely to prove to be a blessing in disguise for India, via its impact on commodity prices and inflation

- The transaction patterns of FII’s seem to show that overall they continue to remain bullish. There has been no exodus, even though they have been net sellers. Overall, for the whole of 2012, FII’s have been net buyers to the extent of Rs 38000 Cr, while being very minor sellers in April (Rs 1600 Cr) and May (till 24th May -Rs 1600 Cr).

My analysis shows that India growth story is intact, and after a strong bounce in the economy post 2008, we went though a dip in 2011, that dip has ended and we are now on  the next leg of recovery.

Be wary of Marc Faber’s public forecasts

Here’s what Marc Faber is reported to have said in an interview in CNBC and reported in MoneyControl.com

“I think we could have a global recession either in Q4 or early 2013." When asked what the odds were, Faber replied, "100%."

Marc Faber interviews are a must read for the many fresh perspectives they offer, however be wary in relying too much on his projections, as the overall accuracy of his projections is at around the 50% level. This is also true for many other Gurus by the way.

I love reading Marc Faber interviews. He's one of those folks who don't pull their punches. He has strong opinions and I have always found some new perspective in each one of his interviews. In this same CNBC interview, his point of view is that a Greece exit is likely to be bullish for markets - that's a beautiful point and well supported by the bond market behaviour too.

However, as far as overall accuracy of projections goes, they have a hit rate around 50%. That's more like a coin toss. Every expert would be wrong a certain percentage of the time, and that's to be expected as projections are probabilistic estimates and not crystal ball gazing. But a 50% hit rate doesn't really inspire too much confidence.

Let me clarify - I don't really doubt his ability to make money, based on what I read in the media. My focus is only on the projections that he gives out publicly.

By the way, he does not have any shortage of correct forecasts - he did call the 2008 crash and the ongoing correction accurately; however I couldn't find any level of consistency over a period of time.

Here are excerpts from some of his interviews - (I have restricted my self to reports published in Moneycontrol only for now, but over a period of time I have carried out many internal reviews for self consumption, for many gurus, over many publications).

What he said about US markets (March 2009):
"But I don't think that right now we will make new lows before 666 levels. We may have a rally until the end of April and a total collapse at the end of the year, when it becomes clear that the economy is a total disaster."

What actually happened: US markets went on a bull run and the US economy posted a strong economic recovery.

What he said about China (March 2009)
”I think it is out of the question that China will grow by 8% this year. In fact, I don't think it will grow at all. I think the Chinese economy is in recession.”

What actually happened: This was one of his more outrageous statements. I am not sure that he actually believed what he said and maybe it was said in jest. I mean, China has never posted an annual GDP growth rate of less than 10% for the past decade at least.

What he said about global recovery (May 2009)
"My sense is that the markets will correct now and they will correct for a variety of reasons partly because it will become obvious that the global economic recovery is not very strong or not taking place at all."

What actually happened: There was a strong global recovery, with US and emerging markets leading the way.

What he said about India (May 2009).
"But in general in the case of India we went from less than 8,000 to 14,000. I wouldn't be surprised to see something like 10,000-12,000 in a correction but maybe it won't happen. All I am saying is the risk reward today of buying equities is obviously not as favourable as it was in March."

What actually happened: The Indian market went up by more than 50% in the next one year.

What he said about India (June 2009) India
"There is little potential to grow very strongly. So, there will be disappointments in terms of earnings in the second half of 2009. The gravy is a bit out of markets. India was below 8,000 on the Sensex and has gone up almost 100%. I don't think it is a very good time to make an entry into the markets except for traders.”

What actually happened: The gravy was still there in Indian markets, as it went up by more than 50% over the next one year.

What he said about the financial crisis (Oct 2009)
"So, I think enjoy your ride in asset classes as long as it lasts but I think we are seeding the next crisis and it may happen in the next three months, maybe tomorrow, maybe five years, maybe only in 10 years"

What actually happened: Is there really anyone out there who believes that there won’t be any crisis in the next 10 years??

In summary, do read his interviews for the many new perspective that they have to offer, but be wary of his publicly made forecasts.

Thursday, May 24, 2012

Party time again: Time to buy panic for the Sensex ride to 80000

With fear starting to take over the stock markets on one hand, and recovery in the Indian economy progressing well on the other, this seems like a party time for professional investors to accumulate equities. After a great accumulation opportunity towards the end of last year, it seems Mr Market is offering another one on a platter.

I continue to stand by my forecast of Sensex reaching 80K (min 45K) by 2016. I made the first version of that forecast in March 2008 and have not yet seen any reasons to revise it. In fact, as part of the same forecast, I had also projected that we would go through a major bear market first, before the ride to 80,000 begins. The subsequent bear market and the lows made in October 2008 are, of course, now history.

Coming back to the present, markets are likely to continue to be spooked by the Eurozone and Greece’s minuscule economy, providing some great entry opportunities.

Investing literature, and quotes from the likes of Warren Buffett, are full of descriptions for times like these. The one I like is “Buy fear, sell greed,’’ although I don’t remember who said it (probably Buffett).

And this, to me, seems like one of those times to buy fear.

Take a look at the following charts of P/E and IIP data for the past six years. P/E’s are already in the undervalued zone and are about to enter the extreme undervaluation zone. Meanwhile, the IIP seems to be northward bound, as if the sky is the limit.

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And what about global markets? Well, I believe the long-term professional investor must be looking at a time frame of seven years or more. In that time frame, does it make a difference whether the Eurozone remains or melts down, let alone Greece?

Even from a short-term perspective of the next year or so, my analysis shows that global recovery is intact. This notwithstanding the latest PMI numbers for the U.S., China and the Eurozone released today, which on a superficial basis might cause further fear. A deeper analysis reveals the recovery is intact.

Coming back to the projection of 80,000 (minimum 45,000) for the Sensex, that number, is really not that terribly large, if we keep in mind that the Sensex was at around 3,000 just a decade back and at around 6,000 about seven years back. As for growth estimates, I am not even banking on a 10% range of GDP growth and a 20% range of EPS growth. My growth estimates are far more conservative, but that is probably better covered in another story.

I’ll end this story with another one of those nice quotes: “What we learn from history is that people don’t learn from history.”

U.S., China, Eurozone PMI Drops: Global Recovery Still Intact

The latest economic numbers point toward U.S. economic growth taking a pause and economy contracting in China and the Eurozone.

What does that imply?

The immediate impact is likely to be fear, with stock markets taking a sharp dip. However, a deeper analysis shows that, except for the Eurozone, global recovery is well underway and at worst is taking a pause. Any panic selloff in equities would be a good opportunity for professional investors to accumulate equities.

Markit’s flash PMI numbers released today point towards a slowdown of manufacturing growth in the U.S. and contraction in China and the Eurozone. U.S. durable goods orders and jobless claims, released today, indicate a flattening trend.

How on Earth do I then say that global recovery is intact? Here’s how:

Recovery is never in a straight line. There are dips and there are plateaus. The U.S. is going through a plateau and China is going through a dip, with a bottoming out process underway. The Eurozone is in a league by itself and is in the middle of a full-fledged recessionary cycle, except for Germany, which is slowing down sharply but has been able to dodge a recession cycle so far.

Now let’s take a look at the graphs which bring out the trend better than just the latest monthly numbers.

The U.S. flash PMI for May, although showing a drop, is still slightly higher than a few months back and is actually tracing a flattening pattern. Take a look at the chart below. Does it look like a downward trend or a flattening trend?

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Now take a look at the graph for China’s PMI. What does it show? An increase in downward momentum or that the downward momentum has been arrested?

 

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Japan’s latest PMI numbers have not been declared yet, but it is in a sharp recovery mode with first-quarter 2012 GDP having gone up 4.1%.

Together, the economies of the U.S., the Eurozone and China comprise more than 50% of global GDP.

Europe, comprising around 25% of global GDP, is no doubt in trouble. Its major economies ­– Germany, France and the U.K., comprising nearly 15% of global GDP – are just about dodging a recession or are in a minor recession. But the remaining countries in Europe are in the midst of a major recession, and they comprise just 10% of the global GDP.

The Eurozone has been in a slowdown mode for many months, but its impact on the rest of the world economy has been minimal until now, except for causing intermittent panic attacks in stock markets. Going forward, I expect a recession in Europe to have only a minimal impact on the rest of the world.

If we look at the size of these economies and the current stage of their business cycle, my conclusion remains the same as before, that global recovery, except for the Eurozone, is intact. At least, that’s what the data says.

Wednesday, May 23, 2012

Greece Exit: Imminent Now?

With the latest news that is coming in around Greece, it now seems that Greece’s exit from the European Monetary Union (EMU) is imminent.

CNBC, quoting Reuters, reports Euro Zone Officials Agree to Prepare for Greek Exit Scenario.

“Each euro zone country will have to prepare a contingency plan for the eventuality of Greece leaving the single currency, three euro zone sources said on Wednesday, citing an agreement reached by officials. The consensus was reached on Monday afternoon during an hour-long teleconference of the Eurogroup Working Group (EWG). As well as confirmation from three euro zone officials, Reuters has seen a memo drawn up by one member state detailing some of the elements that euro zone countries should consider.”

This is in line with my argument a few days back that the latest runs on banks in Greece might very well be the beginning of the end.

And, what are the bond markets saying? It almost seems as if the bond markets are ready for a Greece exit and might even be hoping that it happens! Spanish and Italian yields have been going up the past few days but are still much lower than the highs made a few months back. The yields are going to rise, of course, but the fact that they have not even crossed the highs made a few months back shows that bond markets are not too worried.

It seems that Nouriel Roubini, who predicted the 2008 crisis right down to some uncanny details, seems to be getting this one right, too. Roubini has been predicting a Greece exit and an eventual meltdown of the EMU for a long time now. In fact, his recommendation for a long time has been that Greece Should Default and Quit the Euro.

"The recent debt exchange deal Europe offered Greece was a rip-off. If you take into account the large sweeteners the plan gave to creditors, the true debt relief is close to zero. A return to a national currency and a sharp depreciation would quickly restore growth and competitiveness, as it did in Argentina and many other emerging markets that abandoned their currency pegs," he said.

As recent as a few months back Roubini’s view was that Situation in Europe is a ‘Slow Motion Train Wreck’.

With the Greece re-election dates just a few weeks away, the economic and political dynamics surrounding the Eurozone are evolving at a very fast pace.

Greece has dug itself into a hole from which it is nearly impossible to emerge without a severe battering. With debt at 160% of GDP, an economy in severe recession and a quarter of the population unemployed, an exit from the EMU is starting to look more and more like the best option.

Petrol Price Hike: What Could Go Wrong?

The petrol price hike is a bold decision by Congress and a step in the right direction towards restoring the fiscal health of the country. The biggest thing that could go wrong is that Congress could have again got its political equations wrong and be forced to roll back the hike.

The bitter memory of the government opening up FDI in multi-brand retail and then reversing it after a few days is still fresh in the mind.

Opposition BJP and the so-called allies, Mamata and Karunanidhi, would definitely be plotting their assault on the government now. And, with the pain that all three have caused the government in the past, their capability to derail the price hike should not be underestimated.

However, it seems that this time Congress might have got its equations right. First Post did a great story yesterday, With Mulayam on its side, UPA won’t need Mamata anymore, identifying this change in the political equations.

Of course, political equations are very dynamic and uncertain, and one can never know what new equations could develop overnight.

But one thing is certain, if Congress is able to push through this price hike, that would mean a major change in the political landscape of the country.

Petrol Price Hike: Fantastic for the Economy

The massive petrol price hike of Rs 7.50 per litre, although causing a lot of consternation among citizens and non-Congress political parties, is a great piece of news for the economy after a long, long time.

Although in the immediate term the impact could be slightly negative, it’s the longer term implications that would prove beneficial. The government’s oil subsidy burden would come down, providing much needed relief on the fiscal deficit front.

The hike would also result in an improvement in oil companies’ profitability, deleveraging of their balance sheets and increase their free cash flows. This in turn would have a positive impact on capital investment plans of oil companies.

The hike would also ensure that those who consume a commodity are paying a fair price. After all, somebody has to bear the cost of rising international oil prices. Keep in mind that the drop in international oil prices is fairly recent, while the petrol price hike has been pending for a long time.

Furthermore, the price hike might actually help in halting the fall of the rupee, partly due to a short-term reduction in oil demand and partly by its impact on foreign exchange speculators. As I mentioned in an earlier story, never underestimate the power of the state.

And here’s the icing on the cake. If the price hike goes through, it gives out a loud and clear message that Congress is back in control. With that comes a high likelihood of the reform process restarting.

Of course, it would have been great if diesel and LPG prices could have been hiked, but that is, understandably, a very difficult bullet to bite given the impact on rural and lower middle class populations. The petrol price hike is probably cross-subsidizing the diesel and LPG prices. But something is better than nothing. And it’s likely that government, if it’s able to push through this price hike, would soon tackle diesel and LPG, too.

As for the immediate impact on the economy, it could be slightly negative, with a slight jump in inflation and a minor demand compression. However, going by prior experience, the impact would likely only be transitory. The hue and cry would soon die down and, in no time, people will have forgotten all about the price hike. Keep in mind that petrol prices were nearly half the current prices not so long back in 2008.

What could go wrong? Well, in many previous brave attempts, Congress fell flat on its face and had to roll back its decision within a few days. The decision to open up FDI in multi-brand retail, and its subsequent reversal in a few days, left a bitter taste all around that is still fresh in the mind.

Hopefully, this time Congress has got its act together.

Petrol Price Hike: Mulayam In, Mamata Out

One clear implication of the petrol price hike is that in the political equations at the centre, Mamata is out and Mulayam is in.

In my previous story, I had argued that, with the changing political equations, Reforms initiative would now be decided by Mulayam, not Mamata, nor Manmohan. First Post, I believe, was the first to identify this change in political equations with its great story: With Mulayam on its side, UPA won’t need Mamata anymore.

Of course, Mamata and Karunanidhi are not happy with the petrol price hike. They are all over the media shouting their heads off and have plans to request that the centre roll back the hike. With Mulayam on their side now, fat chance that Congress would roll back the price hike, except maybe a token amount.

What is also clearly a sign of changing times is that Mamata has immediately given a statement that they won’t be withdrawing from the government. Gone is the bravado and bluster she used to show around nearly all previous government decisions, with a subtle, and sometimes not so subtle, threat of withdrawing support. Well, now Congress does not care if she does withdraw. With the financial package for Bengal still hanging with the centre, Mamata has very little option but to fall in line.

As for Karunanidhi, he would mostly restrict himself to making the right political noises, and very unlikely resort to any serious action against the centre. How can he, with CBI cases against his daughter Kanimozi and key lieutenant Raja, and a possibility of a case being launched against his wife? With Kanimozi just out of Tihar jail after a long stay, I doubt Karunanidhi would be in any mood to take on the centre.

As for Mulayam, he very well might be the silver bullet that Congress has been seeking for a long time. No doubt he will extract his pound of flesh. But with a host of criminal cases against him, his family and his friends, he has a lot of opportunity for quid pro quo with Congress.

Of course, political equations are always very dynamic and uncertain, and one can never know what new equations could develop overnight.

But one thing is certain, if Congress is able to push through this price hike, that would mean a major change in the political landscape of the India.

Tuesday, May 22, 2012

Reform Initiative: Mulayam to Decide, Not Mamata Nor Manmohan

There is a great story on First Post: With Mulayam on its side, UPA won’t need Mamata anymore , which has correctly identified the changing political equations in the country. To quote from the story:

“ Indicatively, the Samajwadi Party has 21 MPs in the Lok Sabha and eight in the Rajya Sabha; the Trinamool Congress, on the other hand, has 20 MPs in the Lok Sabha and nine in the Rajya Sabha. But it’s not just about the numbers. As The Telegraph reported, citing Congress sources, having Mulayam Singh by its side gives the Congress much more elbow room on policy matters: for all the “samajwadi” economic philosophy that his party embraces, Mulayam Singh is perceived to be “more flexible” than Mamata when it comes to economic reforms.”

So what does that mean now for some of the major reforms and other governance measures that have been on the backburner?

Many of those measures are likely to go through, and that’s the silver lining in this whole thing. However, Karuna can still play the spoilsport, but only to a limited extent. CBI (Congress) has cases pending against his daughter and Raja, one of his key lieutenants.

Previously, it had been Mamata who was making the decisions (so to say) around all major initiatives. Now it will be Mulayam.

Mulayam is expected to be flexible. But why is that so? For the same reason that Lalu Prasad is flexible … all the CBI cases pending against him, his relatives and his friends, cases ranging from murder to bribery. Congress has done this kind of deal with Mulayam before, withdrawing a CBI case in return for support. That’s the kind of deal they must have worked out now.

Murder, rapes and lawlessness in UP are likely to continue, since Mulayam would now have the backing of the centre. All in all, Mulayam might be the silver bullet that Congress was looking for.

The Rupee’s Fall: Don’t Underestimate the Power of the State

Those who underestimate the absolute power that a state commands do so at their own peril. Ask Vodafone.

Those who talk about the inaction of the Reserve Bank of India (RBI) on the rupee probably fail to realize the power of a state. Just because the RBI and the government haven’t taken stronger measures, doesn’t mean they can’t.

Remember, the government has the power to change the goalposts mid-game. And these kinds of moves won’t get any opposition from Mamata, Mulayam and Karuna, probably because they would fail to comprehend the implications.

The RBI’s moves around export repatriation, although not having a major impact on flows, have more symbolic importance. It’s the RBI’s way of warning speculators “behave or else.”  If large companies playing the speculating game do not get the message, then the RBI and the government have a whole arsenal of tools to break the backs of speculators.

The fall might continue a bit longer. However, I don’t expect it to have any significant impact on corporate profitability. The reason for this is that, at some point, the RBI and the government will crack down hard on speculators and that would be the end of the rupee’s fall.

The RBI has already issued a veiled warning to speculative interests. The next set of measures would be far harsher.

Fuel Fuel price hike : Mamata, not Manmohan to decide

There is a story in The Business Standard about a fuel price hike. Here’s what it says:

With rupee depreciation leading to jump in oil import bill, Petroleum Minister S Jaipal Reddy today said there is an immediate need to raise fuel prices, but refused to say when the hike will actually take place. "It (price increase) is very essential but (before hiking rates) we have to talk to political parties,” he told reporters…

What he probably means is that the government would need to check with Mamata Banerjee to see if they can go ahead with the fuel price hike !

There is another interesting aspect that comes out from Jaipal Reddy’s statement. Since petrol prices have been deregulated, what’s stopping oil companies from increasing petrol prices? Is it the government (read: Mamata) again ?

PM Says Tough Decisions Would be Taken: Really?

In a story in The Economic Times, Prime Minister Manmohan Singh talks about making tough decisions. Excerpts from the story below:

"Difficult decisions have to be taken on both spending and revenue mobilisation", he said while speaking at function to mark the completion of third year of the UPA-II government. His statement comes in the backdrop of announcement made by Finance Minister Pranab Mukherjee recently in the Rajya Sabha that government would roll out austerity measures.

But these statements have to be taken with a pinch of salt.

Tough decision have been overdue for more than a year now and could not be taken due to political compulsion. What has changed now? In fact, with the Samajwadi party winning in UP and TMC in Bengal, the political compulsion has gotten worse.

And as for Pranab Mukherjee’s austerity measures, they relate to cost cutting in ministries—cutting back on air travel, foreign travel and the like. This might be worth a couple of hundred crores, while the fuel subsidy bill is supposed to have gone up by more than Rs 40,000 cr due to Rupee depreciation.

With this background, it’s a bit difficult to imagine what kind of measures the government is thinking about and how it’s planning to get them through.

OECD Report: Part truth, part scaremongering

The OECD’s latest Economic Outlook report, released today, has some great insights on the global growth trend. The report talks about healthy growth trends in the US and Japan, a minor recession in the euro area, and flattish trends in emerging economies. However, it is also full of dire warnings of what might happen to global growth if the euro crisis is not managed properly.

There is no denying that the euro crisis is serious. However, I believe that most of the points made regarding the euro area are scaremongering, though with the noble intention of driving world leaders to take the right kinds of steps.

Here’s what the OECD’s latest Economic Outlook report says: “The global economy is gradually gaining momentum, but the recovery is fragile, extremely uneven across different regions and could be derailed by the crisis in the euro area.”

It further states, “The OECD warns that failure to act today could lead to a worsening of the European crisis and spillovers beyond the euro area, with serious consequences for the global economy. Avoiding such a scenario requires action to be taken both at country and supranational level.”

However, analysis of global growth numbers to date has a slightly different story to tell:

  • OECD itself expects the US GDP to grow by 2.4% in 2012, up from 1.7% in 2011, Japan to grow by 2% (-0.7% last year), and China by 8.2% (9.2%). These three economies comprise more than half of the world’s GDP, and the OECD growth estimates themselves look pretty healthy.
  • As we go down the list to countries like India, Russia, Brazil, Korea, Canada, Turkey, Taiwan, and Hong Kong, we find that all of them are in various stages of bottoming out or recovery. All these countries together comprise around 70% of the global GDP.
  • The three largest euro area economies—i.e., the UK, Germany, and France—are expected to show a slowdown in growth, but not recession. These together comprise more than 10% of the global GDP.
  • The recessionary economies in the euro area comprise less than 10% of the global GDP, with Greece accounting for less than half a percent.

There is no doubt that the 10% representing recessionary or troubled economies would cause some pain. And if something goes wrong the stock markets very likely would take a nose dive, driven more by paranoia of fear than by anything real. But to extrapolate and imply that these economies would cause a global slowdown or have dire global consequences seems to be taking things just a bit too far.

Global recovery robust – Part II

Global Recovery Robust – Part II

In my analysis last week, I talked about how global recovery is robust and the fear is unfounded.

Two key points from that analysis were:-

  • Apart from the Eurozone, the major global economies, comprising more than 70% of GDP, are in various stages of recovery or bottoming out.
  • The fear factor due to the situation in Greece has become so prevalent that the likelihood of a robust global recovery is being overlooked.

There have been a slew of reports during the last few days that seem to confirm my analysis.

Jim O’Neill : US Recovery Improving

Here’s an interview with Jim O’Neill in CNBC Market ‘Freaking Out’ Over Greece, J.P. Morgan- O'Neill :

“After swinging through a cross-country tour of the U.S. last week, the London-based chairman of Goldman Sachs Asset Management said he saw an economy that is improving, despite what some of the indicators show.”

Reports : China Growth Stimulus Likely / 2012 GDP Growth above 8%

Here are some excerpts of a story in Bloomberg - Wen Growth Pledge Spurs Speculation of China Stimulus :

”Wen called for “putting stabilizing growth in a more important position” and didn’t mention concern about inflation in remarks published yesterday by the official Xinhua News Agency. China may announce stimulus actions in the near term, according to a front-page commentary today in the China Securities Journal, which is published by Xinhua.”

Of course, no stimulus has been announced till now, but it would be fair to assume, given its past track record, that China is likely to take decisive action to spur growth. And the consensus view amongst World Bank and research houses like Morgan Stanley, Goldman and J.P. Morgan is that China would be able to engineer a soft landing and maintain an 8% plus growth rate in 2012. And this comes after they pared down their growth estimates when China reported a 7.9% growth rate for the first quarter of this year.

GMAC : Continued Growth in Hiring During 2012 for Management Grads

Maketwire did this story based on a survey done by the Graduate Management Admission Council (GMAC) - Job Market for MBAs Improving; Pay Premium Remains : ”On average, companies in the Asia-Pacific region and the United States expect continued growth in hiring in 2012 for all management graduates, whereas European companies project that hiring levels in 2012 will be similar to what they saw in 2011.”

"These results provide strong evidence of the continued global market recovery, which is also matched with the feedback received from EFMD's business school members," said Eric Cornuel, director general and CEO of EFMD, a key partner in conducting the recruiter survey along with the MBA Career Services Council.

What about Greece?

My own analysis suggests that Greece, a minuscule economy with less than 0.5% of the global GDP, cannot take down the world.  Furthermore it almost seems as though markets are ready for a Greece exit and might even be hoping that it happens! (See - Greece bank runs : a precursor to exit?)

And these viewpoints about Greece now seem to be picking up momentum. Here’s a report in Bloomberg today: A Greek Exit? Euro Zone May Be Ready.

“It is increasingly conceivable that Greece may leave the euro zone, not just because of its own political dysfunction but also because the consequences of such an exit for the rest of the Europe and the global economy no longer seem quite so scary.”

There is no doubt that a Greece exit would have a negative impact on growth and markets, but I doubt it’s going to cause a global slowdown. My sense is that it would be really bad for Greece, bad for Europe, just a tiny bit bad for the U.S., but have near zero impact on global growth.

The bottom line is that major global economies are in various stages of recovery or bottoming out and it seems that the recovery would continue, Greece or no Greece.

Hiring & Salaries Going up - Where’s the Slowdown?

I have been coming across a whole bunch of stories in leading newspapers about double digit salary hikes, increases in attrition rates and increases in hiring. Those doesn’t seem like signs of a slowdown in an economy to me.

In fact, my analysis suggests that the Indian economy went through a moderation phase in the second half of 2011, is now on a recovery path and is very likely be able to maintain growth rates of 8% plus, governance and reform issues notwithstanding.

Consider this:

ET / 3rd May : India Inc. expects double-digit salary hikes this year: Survey : “TeamLease said double-digit salary hikes are likely this year and the average salary growth in India could hit near 20 per cent levels in 2012.”

ET / 22nd May : Boom time for MBAs continues : “…..Not only are the salaries higher but 88% of Indian employers plan to hire MBAs in 2012, in line with the 89% of Indian employers that reported hiring MBAs in 2011.”

ET / 4th Jan. : Employees to get 14% average pay hike in 2012: Experts: “Employees can look forward to an average salary hike of 14 per cent in 2012, up from 11 per cent last year, while hiring activities would be robust in various services sectors, such as banking, experts believe.”

BS /1st May: India Inc may see attrition rates as high as 31% : “India Inc. is likely to see attrition rates as high as 31% during the three months ending June, as employees unsatisfied with annual salary hikes would look out for better prospects, say experts.”

Economy in a Recovery Mode and Expanding

Double digit salary hikes, increases in hiring and high attrition rates are indicators of an expanding economy, not signs of a moderating economy.

Of course, the estimates and opinions differ a bit in terms of actual percentages, but that’s the nature of surveys, estimates and expert opinions in any case. The important point is that directionally all estimates point to a fairly robust growth in salaries and hiring in 2012.

That seems to tie in with my own analysis of economic data which suggests that the Growth story is intact, and slowdown fears are unfounded.

In fact my analysis of economic data of major economies around the world suggests that even the Global recovery is robust.

See the graphs below for IIP and PMI. Which is a better interpretation – that the economy is contracting OR that it is on a slow and steady recovery path?

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There is no denying that there was a moderation of growth in the second half of 2011, with Dec. 2011 GDP growth being at 6.1%, from a high of 9.3% in the June 2010 quarter, with corporate profitability and other indicators too showing a moderation.

But this growth moderation has to be viewed from the right perspective:-

  • Economies rarely, if ever, grow in a straight line. After a period of frantic growth, there is almost always a period of moderation. After all, economies need time to catch their breath too. And for a moderation period, a 6.1% rate of growth isn’t really too bad.
  • Macro indicators for the first four months of 2012 are now pointing towards a resumption of growth trajectory and a slow and steady recovery.

What about Governance Issues and Reforms Going on the Back Burner?

There is no denying that we have major governance issues, and there seems to be a general consensus that no major reforms are going to go through till the 2014 general elections.

However, I don’t see that getting in the way of the Indian economy touching 9% growth rates. The reason is simple – the Indian economy has already built up a base momentum and growth rates of 8% plus are the ‘new normal’ so to speak. In fact I recollect an insightful study done by RBI which talks about the new long term average growth rate being in this 8% range.

The bottom line is that the economy went through a moderation phase in the second half of 2011, is now on a recovery path and is very likely be able to maintain growth rates of 8% plus, governance and reform issues notwithstanding.

Saturday, May 19, 2012

Are the FII’s in a sell mode ?

 

This is a repeat of a story that I did a week back. And the answer still remains, not yet. The transaction patterns of FII’s seem to show that overall they continue to remain bullish. There has been no exodus, even though they have been net sellers since April 2012. However the selling volumes are minuscule. The next few weeks will shed more light, whether FII’s will provide support or go into an exodus mode.

Take a look at chart below – does it look like the FII’s are in exodus mode ? I rest my case.

FII investment

As the Nifty dropped by nearly a couple of hundred points from beginning of this month, FII’s have been net sellers of equities during this period. However the selling volume is minuscule.

Consider this :

Overall, for the whole of 2012, FII’s have been net buyers to the extent of Rs 38000 Cr, while being minor sellers in April (Rs 1600 Cr) and May (Rs 1200 Cr).

A few months back during Jan to March ’12 time period, when the markets were in freefall, FII’s started to provide support throughout the 4500 to 4800 range. It needs to be seen if they again step in to provide support or not.

How will we know FII’s are in exodus mode

On the other hand, how will we know if FII’s are going into a selling mode? Well, we don’t have to look too much in the past. FII’s started to exit the markets last year around Jan ‘11 – Feb’11 timeframe , right near the market tops, selling around Rs 8000 in each of those months with consistent selling on most of the days. We need to keep a close watch on FII numbers for the next few week – those tend to be better indicators than the FII interviews that are published in media.

In summary, the transaction patterns of FII’s seem to show that overall they continue to remain bullish. There has been no exodus, even though they are starting to get bearish. The next few weeks will shed more light, whether FII’s will provide support or go into an exodus mode.

Greece paranoia – a blessing in disguise for India

The fears and paranoia surrounding Greece exit is likely to prove to be a blessing in disguise for India, via its impact on commodity prices and inflation.

The sharp fall in commodities over the past few weeks is primarily driven by speculators making hay while the sun shines, or Greece related fear persists, so to say. Not to say that Greece related fear is the only reason. Of course there are a few others as we’ll see in the analysis below, but had there been no Greece factor, commodity prices might not have been making new intermediate lows.

With Greece’s blessings

All key global commodity prices are falling and making new intermediate lows. So, what’s causing it and what is likely to be the impact on the Indian economy and corporate results?

The fall is caused by growth moderation in China, slower than expected recovery in the US, large stockpiles of commodities with suppliers and last but not least, a speculative selling driven by fears surrounding Greece’s exit.

And what could be the possible impact for India? Given that India’s industrial recovery is progressing at a healthy pace, what it implies is that going forward inflation is likely to come down and corporate profitability will continue to increase. All because of blessings from Greece !

Let’s take a more detailed look at the points made above.

Commodity Prices Making New Intermediate Lows

The S&P GSCI Spot Index is on a sharp intermediate downtrend (chart from Bloomberg). The UBS Bloomberg CMCI composite price index also shows a similar trend.

commodity prices

Oil (European Brent Spot) is on a sharp intermediate downtrend. It is currently at around $107 after touching highs of nearly $130 a few months back. (Chart from Bloomberg).

coal prices

Coal has been in decline for a while (chart from Infomine.com) and is on a major downtrend.

coal prices

A similar pattern prevails across all other key commodities like copper, zinc, aluminium etc.

What’s Causing the Fall in Commodity Prices?

There is a very nice story in Dailyfinance.com by Eben Esterhuizen, Kapitall, The Motley Fool, which lists three key reasons:-

1. China is cooling down. Commodities are the inputs of all manufacturing processes. As economic activity slows down, so will demand for manufacturing inputs. As demand falls, so will the price.

2. The U.S. economy is struggling to heat up. Yes, the U.S. economy is recovering, but it has been a sluggish recovery. And as explained by reason No. 1, any slower-than-expected economic recovery will lead to lower demand for manufacturing inputs.

3. Suppliers of raw materials have overestimated demand for raw materials. As just explained, the economic sluggishness has come as a surprise to most suppliers of raw materials. Since they were overly optimistic, they increased their stock piles too rapidly. Now the sizes of their inventories are bigger than the demand for their raw materials, which further drags down prices.

The authors have hit the causes of commodity falls right on the spot. However I believe that there is a fourth reason too:-

4. Speculation driven by fear of Greece’s Exit. A large part of the fall is likely to be caused by speculators driving down prices to cash in on the fear and paranoia around Greece’s exit. The reason for this is that except for the Eurozone, global economies are in various stages of bottoming out and recovery. What about the future outlook for commodity prices? The prevailing view amongst commodity experts is that the fall is likely to continue, though some believe that the selling is overdone. I too tend to believe that the downtrend in commodity prices would continue, primarily driven by paranoid fear rather than any ‘real’ factors.

What Would be the Impact on the Indian Economy and Corporate Results?

The commodity fall couldn’t have come at a better time for the Indian economy. India is in a slow and steady recovery mode. Many folks seem to have been spooked by the negative 3.5% IIP numbers reported this week. But those concerns are largely due to their being driven by an incorrect interpretation. IIP numbers are tracking a very normal pattern of recovery, not one of contraction.

Here’s what I expect the impact to be over the next few quarters:-

- Inflation is likely to fall (vegetable price inflation remains a concern, but that’s another story.

- Falling inflation is likely to drive up real demand in the economy.

- A combination of rising demand and falling prices will result in Indian corporations posting strong quarterly sales and profitability growth. Quarterly corporate results are already on a rising trend. Year on Year quarterly results for Sept. 2011 showed a massive 21% decline in corporate profits, but then posted a sharp recovery with a 13% growth in the Dec. 2011 quarter; the trend continues for the March 2012 quarter with 12% profit growth (for companies that have declared their results to date).

- What about the impact of the falling Rupee? The fall in the Rupee is not driven by any flight in capital but by speculative selling. The fall might continue a bit longer, however I don’t expect it to have any significant impact on corporate profitability. The reason for this is that, at some point, the RBI and the government will crack down hard on speculators and that would be the end of the Rupee fall. The RBI has already issued a veiled warning to speculative interests. The next set of measures would be far harsher. Those who seem to underestimate the power of a state, do so at their own peril.

All in all, it almost seems that all this paranoid fear around Greece’s exit is likely to prove a blessing in disguise for India.

Rupee Fall: No flight of capital – only speculation

The prevailing theory doing the rounds is that the fall in the rupee is led by the flight of capital outside the country and that RBI and Government can’t do much about it. However the data and the past experience with power of state does not support such a conclusion .

Data seems to suggest that the sharp fall in the rupee is driven by speculation. Here are the key reasons:-

1. FII net investment in equity markets does not show any exodus.

2. RBI says so.

3. Economic growth numbers show recovery in progress.

FII Net Investment

Take a look at the chart below (Daily FII net flows into equities from 1st March to 18th May).  Which is a correct interpretation – FII in exodus mode OR FII flows moderating? I rest my case.

FII investment in equities

RBI Says So

The central bank has directed exporters to convert 50% of their foreign currency holding with banks into rupee balances within a fortnight. This move, although not having a major impact on flows, has more symbolic importance. It’s the RBI’s way of warning speculators, “Behave, or else….”  If large companies playing the speculating game do not get the message, then between the RBI and Government, they have a whole arsenal of tools to break the backs of speculators.

Here’s how the speculation works: whenever the rupee falls and there is an overall expectation of the fall to continue, exporters, including software companies, start to hoard their dollar reserves. They do it in two ways:

- By not converting their Forex reserves into rupees.

- By asking customers to delay dollar payments (this is a bigger one).

The RBI’s current moves give the appearance of targeting the first one, but it is actually passing on a message to the second one. Not only that, this is the RBI’s way of passing on a message to the whole speculator community.

Economic growth numbers show recovery in progress

The Market seems to have gone into a panic when it saw a negative IIP number. However it’s likely that most market participants are not interpreting the numbers correctly. My analysis shows that  IIP is tracking a very normal pattern of recovery, not one of contraction. Just take a look at the chart below – which gives a correct interpretation – that IIP is contracting, or possibly that IIP is in a recovery mode after a phase of moderation. Again, I rest my case.

IIP trends India

What about current account deficit, fiscal deficit etc etc

So what could be causing the majority of market participants to believe that there is something structurally wrong with the Indian economy?

Of course we have an issue surrounding the current account deficit; similarly we have issues with oil subsidies, but all those issues have been with us for as long as I can remember. Nothing negative of major importance has happened in the past few months, and definitely nothing has happened in the past few weeks.

My hypothesis is that the prevalent view is driven by one of the most common phenomena in equity markets – herd mentality. And yes, fund managers, analysts and economists are also prey to it. And of course, speculators are having a field day.

What’s the outlook

The fall might continue a bit longer, however I don’t expect it to have any significant impact on corporate profitability. The reason for this is that, at some point, the RBI and the government will crack down hard on speculators and that would be the end of the Rupee fall. The RBI has already issued a veiled warning to speculative interests. The next set of measures would be far harsher. Those who seem to underestimate the absolute power that a state commands, do so at their own peril. Ask Vodafone.

Greece exit a global catastrophe ?

I saw some media headlines about the potential Greece exit causing a global catastrophe, and decided to dig a little deeper into it.

The question I was trying to answer was – is anybody really talking about a global catastrophe if Greece exits from the EU?

Here’s what I found:

Nope – nobody – zilch!

Take a look at what Stephane Deo, chief European economist, UBS AG told CNBC-TV 18 in an interview

Q: “Do you think there is a choice of whether policy makers can choose to keep Greece inside, or do you think if Greece were to leave it could be a catastrophe and could lead to a sort of a Lehman moment in financial markets? Do you think it has that kind of potential, or do you think there is still a possibility that Greece may go out, you could have major write- downs, but it remains a possibility?

A: “It is a possibility. We again believe that it would be very difficult to manage the consequences that, if there is really an impasse between the TROIKA and the Greek government, at some point Greece might choose to leave the euro. I will combat with the argument that it is very bad idea that the Greeks are doing something that is not rational.

But if its politicians decide to do it, they will do it. So it is not impossible, but the fact that it is possible does not mean that it would not be a catastrophe. I think it would be really bad for the Greek economy and also very bad for the European economy.”

He does imply that there is a possibility that a Greece exit could cause a Lehman moment in financial markets and does not deny a possibility of catastrophe. However I don’t see him talking directly about the possibility of a global catastrophe. What he is upfront about is that an exit would be bad for the Greek economy and also very bad for the European economy. I agree with that assessment. There is no denying that an exit by Greece would be really bad for Greece and the European economy.

And What are Greek and European Leaders Saying?

Not even the Greeks themselves are talking about a global catastrophe. Some Greek politicians are talking about a catastrophe, but they mean a catastrophe for Greece and not a global catastrophe.

Not even the now ‘famous’ report from the Institute of International Finance (IIF), went on to the extent of implying that a Greece exit could cause a global slowdown. Its global slowdown theory is itself far-fetched, and is widely believed to be biased, but even the IIF did not talk about a global catastrophe.

My View

So basically, nobody, not even the biased parties, are talking about a global catastrophe. Of course there are lots of folks who are painting a very gloomy picture, and some of this negativity is definitely justified.

So, how much of this gloom is justified and what is likely to be impact of a Greece exit – can it really take down the world?

My own analysis shows that Greece can’t take down the world. The key points are summarized below:-

- The country of Greece is comprised of less than 0.5% of Global GDP! It’s not just small, but it is too minuscule to cause any widespread global impact. No doubt a Greece exit would cause panic and fear, and equity markets would crash, but the real impact on global growth would be near zero.

- If the 50% 'forgiveness' of Greece’s loan in March 2012 didn't cause any real blip on the global economy, how on earth will the default of the remaining 50% cause a global slowdown?

So what about those who are talking about CDO losses and the contagion effect and painting a gloomy picture?

Here’s my take:

Several banks and institutions will certainly go down (especially those who were greedy enough to write CDOs on Greece’s debt), and many jobs will be lost. I would think that in such a scenario, countless big-wigs in the banking and finance industry would no doubt be joining the hall of shame along with Alan Greenspan, Dick Fuld and many others. Some of these people could likely get prosecuted and possibly even join Maddoff’s ranks as well. The underlying issue is this – are business and political leaders really afraid of something else?

In summary, a Greece exit would be really bad for Greece, bad for Europe, just a tiny bit bad for US, but have near zero impact on global growth. As for global catastrophe, except in some media headlines, I couldn't find a soul who believes that Greece’s exit would cause a global catastrophe.

Wednesday, May 16, 2012

Will Jamie Dimon be joining the ranks of Greenspan & Fuld?

The $ 2B loss by J.P. Morgan has seriously dented the reputations of the hallowed institutions of J.P. Morgan and the larger-than-life persona of Dimon.

These kinds of incidents raise the larger issues of integrity, competence and leadership at the most senior levels of the banking and finance sector.

For instance, many of these complex instruments are created at a relatively junior leadership level. At a junior leadership level, they know what the instrument is composed of, yet they do not have the experience to understand the risks and future implications. Meanwhile the senior leaders, who have the experience to understand the risks, probably don't have the vaguest idea about how these instruments are structured. That's competency failure.

There is a failure at the level of top management to accept this ignorance and then do something about it. That's integrity failure.

Top leadership should have the competency to put in the right risk management structures, even though they don't understand the nitty-gritties of the instrument. That does not happen. That's leadership failure.

It’s these issues of integrity, competence and leadership that bought down Lehman Brothers and resulted in many iconic names like Citibank, J.P. Morgan and Goldman Sachs lining up at Capitol Hill with a begging bowl.

Greece bank runs : a precursor to exit?

Greece exit seems more and more likely now. The latest piece of news around a bank run in Greece might very well be the beginning of the end.

In a nicely written analysis Tim Duay argues why Greece is running out of time. Here’s what he says

-“ A bank run in the absence of a functioning government.  Is there anyone ready to push the button on a bank holiday with capital controls?  Or is this about to devolve into a free-for-all flight of capital?”

He cites Bloomberg which reports that:

“The level of funds in Greece’s state coffers has fallen below 1.5 billion Euros ($1.9 billion),”

My own analysis shows that Bond markets are not yet fearful. Spanish and Italian yields have shot up in the past few days but are still much lower than the highs made a few months back. It almost seems as if the bond markets are ready for a Greece exit and might even be hoping that it happens! Of course the yields are going to rise but the fact that they have not even cross the highs made a few months back shows that bond markets are much more ready now.

As for equity markets, the US markets did fall yesterday and Asian markets are down in the morning but the extent of fall is barely half percent. It seems that even the Equity markets are not too worried about a Greece exit.

Greece has dug itself into a hole from which it is nearly impossible to emerge without a severe battering. With debt at 160% of GDP, an economy in severe recession and a quarter of the population unemployed, it needs serious and painful therapy. Greek politicians, rather than take the blame by executing the EU plan, would probably prefer to exit EU and blame EU/ECB for the all the pain. 

Growth story intact, fears unfounded

An irrational fear seems to be taking over equity markets and investor sentiments. But then again, if we take a closer, more detailed look at some real data, it shows that a healthy recovery is under way and the fears are unfounded.

The analysis shows how key indicators like PMI, inflation, FII investments, Nifty Trends and corporate profitability all point to a healthy recovery process being underway.

And since the process of recovery is still underway, it is expected that there would be a few bumps and potholes along the way and in order for the growth to become robust, it might take a few quarters. Nonetheless, economic indicators highlight that an economic rock bottom has probably been reached and that recovery process is underway. Consider this:

My analysis of IIP data showed how the numbers are not being interpreted correctly. IIP numbers are actually tracing a pattern of recovery, not a contraction. See the graphs below for IIP and PMI. Which is a better interpretation – that the economy is contracting OR that it is on a slow and steady recovery path?

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The bottom line is that the growth story is intact and a healthy recovery is in progress. In fact, this scenario of good fundamentals combined with unjustified fears is an ideal situation for long term investments.

Greece Vs. EU catfights = good entry opportunities

The cat fight between the EU and Greece is likely to continue for a while, and the ensuing market dips should continue to provide good entry opportunities for long term investors.

Greece is already going into another round of elections early next month, and this is causing the markets to become anxious. Irrespective of the results of the election, that anxiety is going to continue. And each new bout of sparring is likely to cause a nice market dip and a good opportunity to make an entry.

Greece has dug itself into a hole from which it is nearly impossible to emerge without a severe battering. With debt at 160% of GDP, an economy in severe recession and a quarter of the population unemployed,it needs serious and painful therapy. Greek politicians, rather than take the blame by executing the EU dictac, would probably prefer to exit EU and blame EU/ECB for the all the pain.  Whether it exits or not, the cat fights and saber-rattling will continue for a long time to come.

As for global economies, barring Eurozone economies, most of the world’s economies are in various stages of bottoming out and recovery.

And what about India – well, India too is in a slow and steady recovery mode. Many folks seem to have been spooked by the negative 3.5% IIP numbers. But those concerns are largely due to their being driven by an incorrect interpretation. IIP numbers are tracking a very normal pattern of recovery, not one of contraction.

This scenario of good fundamentals combined with unjustified fears is an ideal situation for long term investments.

Global recovery robust, fears unfounded

Apart from the Eurozone, the major global economies, comprising more than 70% of GDP, are in various stages of recovery or bottoming out. However, the fear factor due to the situation in Greece has become so prevalent that the likelihood of a robust global recovery is being overlooked.

Consider this:

U.S.

Slow but steady and consistent recovery is underway. With the quarterly GDP growth rate at 1.8% for Sept. 2011, 3% for Dec. 2011 and 2.2% for March 2012 quarters, it is evident that the recovery has been progressing at a steady pace. In fact, this resiliency and recovery of the US economy has surprised many people. All other indicators including unemployment, housing prices and mortgage delinquencies are also showing a steady recovery.

China

China’s GDP and business activity, which were on a steady downward trend, are showing signs of bottoming out. The Dec. 2011 quarter GDP at 8.9% and March 2012 GDP at 8.1%, although of concern, have to be looked at from the perspective of improving manufacturing activities and PMIs in the past few months. The last couple of months of PMI data show a renewed growth in business activity, and a bottoming out in progress. The view of the World Bank is that China would be able to engineer a soft landing and maintain an 8% growth rate.

Japan

GDP rose by 4.1% in the first quarter of this year, compared with a 0.7 % contraction in the final three months of 2011. PMI data indicates that there is a very sharp recovery underway.

These three countries represent nearly half the world's GDP - and they are doing pretty well.

And if you go down the list to countries like India, Russia, Brazil, Korea, Canada, Turkey, Taiwan and Hong Kong - all of them are in various stage of bottoming out or recovery. All these countries together comprise more than 70% of Global GDP.

The Eurozone and especially the larger economies like the UK, Germany, Italy and France are no doubt a concern - but they comprise just 15% of the world GDP, and Greece, merely a fraction of percent of Global GDP!

IIP shows recovery, not contraction

IIP numbers for March 2012 showed a dip of 3.5%. Economists, analysts, fund managers and a majority of the financial community were quick to raise concerns about the decline. The question is- are the IIP numbers being interpreted correctly?

I don’t believe so. I believe that IIP is tracking a very normal pattern of recovery, not one of contraction.

Take a look at the graphs below for IIP and PMI. Which is a better interpretation– that the economy is contracting or that it is on a slow and steady recovery path?

image

image

Now here’s another interesting take- we were in a very similar situation three years back during the 2008 - 2009 period. The current IIP data on 2011 – 2012 is tracing almost exactly the same pattern as in 2008 –2009.

This is a pattern of recovery, not of contraction. Three years back, in 2009, markets broke out of the bottoming pattern, even as IIP was tracking negative YoY numbers.

Monday, May 14, 2012

Bond markets ; not yet fearful

Greece exit out of Eurozone is starting to seem more and more likely, but bond markets don’t seem to be inordinately worried.

There is no denying the fear factor across the global markets driven by anxiety around possibility of Greece exit from Eurozone.

Major equity markets across the globe have been on a minor downtrend since last week itself.

But what do the European bond markets say? Bond markets are definitely showing signs of anxiety but not the kind of fear displayed in Equity markets.

Spanish and Italian yields that have been inching up slowly over the past three months and are now in 6% range, but are much lower than the 7.5% levels reached towards end of last year. Of course, German yields are falling; and at 1.4%; are making new 52 week lows. That’s understandable as that’s likely to be driven by the flight to safety within the Eurozone.

It almost seems as if the bond markets are ready for a Greece exit and might even be hoping that it happens !

IIP numbers – economy continues to expand

I do have my doubts about the magnitude of March ‘12 IIP drop of 3.5% . However, a deeper analysis of IIP numbers show is that the economy continues to expand at a slow and steady pace, and the dip in IIP is driven by a combination of base effect and possible data error.

The IIP dip of 3.5% for March seems to have caught many folks by surprise. The first reaction from many economists and analysts is that it is another data error.

However, a quick analysis suggests that the IIP number seem to be directionally correct, even though I have serious doubts over the magnitude.

For instance, the fall in IIP numbers tie in with what the PMI and sentiment indices are indicating.

HSBC Manufacturing PMI’s has been showing a YoY fall of more than 5% for the period between March and April 12 and BlueFin’s spending sentiment Index for April 12 still remain in the pessimistic zone. Though month on month the sentiment shows an uptrend, my guess is that on a YoY basis, it’s also likely to show a contraction (YoY change data is not available, hence the guess).

Now here’s a twist: month on month IIP as well as PMI numbers show an expansion while it’s the YoY numbers for March ‘12 that shows a contraction. And this contraction is due to a sharp spike in IIP of a year back, during March’11, which could very well be an uncorrected data error.

So, what does that mean? All that it means is that the economy continues to expand at a slow and steady pace, and as of now there is no need to get too bothered by the contraction in IIP.

Rise in inflation – what’s causing it?

The rise in WPI inflation for April ‘12 to 7.2% was a surprise. Or at least I was caught by surprise given that global food and commodity prices have started to moderate. My sense is that it is likely to be a combination of producer pricing power and data error.

The key commodity indicators i.e. spot copper prices; S&P’s GSCI Index and UBS Bloomberg CMCI Index are on clear downtrend since the beginning of April 12. It is the same case with FAO’s world food index which continues to moderate and fell by nearly 9% during April ‘12 year on year.

So what is causing the rise in inflation? I don’t know yet but I’m planning to dig down deeper on this one to figure out the reason.

However, I will go out on a limb and hypothesize that there are likely to be two reasons for the uptick in inflation:

  • Overheating in the economy, made worse by early loosening of RBI monetary policy (to be truthful, that’s benefit of hindsight).It seems that producers still command pricing power as there was an overall price increase after the budget in spite of global commodities prices coming down. This is now being reflected in the WPI inflation number.
  • Data error – the data errors and massive revisions in government data has become so common, that it’s very likely that the inflation number can be revised downward next month.

What’s likely to happen in future?  Well the global commodity indices have taken a very sharp downtrend in the first two weeks of this month. I would assume that the May ‘12 WPI inflation should come in sharply lower. If not, then the problem could be far more serious.

Are the FII’s in a sell mode ?

Well the short answer is not yet. The transaction patterns of FII’s seem to show that overall they continue to remain bullish. There has been no exodus, even though they are starting to get bearish. The next few weeks will shed more light, whether FII’s will provide support or go into an exodus mode.

As the Nifty dropped by nearly 340 points from beginning of this month, FII’s have been net sellers of equities during this period.

However during the past three days, even as Nifty dropped by more than 1% or nearly 70 points, FII’s have been net buyers on all the days. They bought Rs 355 Crs yesterday on May 14th along with Rs 159 Cr and Rs 317 Cr on 11th and 10th respectively.

Overall, for the whole of 2012, FII’s have been net buyers to the extent of Rs 38000 Cr, while being minor sellers in April (Rs 1600 Cr).

A few months back during Jan to March ’12 time period, when the markets were in freefall, FII’s started to provide support throughout the 4500 to 4800 range. It needs to be seen if they again step in to provide support or not.

On the other hand, how will we know if FII’s are going into a selling mode? Well, we don’t have to look too much in the past. FII’s started to exit the markets last year around Jan ‘11 – Feb’11 timeframe , right near the market tops, selling around Rs 8000 in each of those months with consistent selling on most of the days. We need to keep a close watch on FII numbers for the next few week – those tend to be better indicators than the FII interviews that are published in media.

In summary, the transaction patterns of FII’s seem to show that overall they continue to remain bullish. There has been no exodus, even though they are starting to get bearish. The next few weeks will shed more light, whether FII’s will provide support or go into an exodus mode.

Can Greece take down the world?

All of the current discussion about Greece causing a Doomsday is starting to sound more and more ridiculous (which is the funny part). Nonetheless, the underlying factors could be a far more serious issue. Here's why:

Funny aspect # 1

The country of Greece is comprised of less than 0.5% of Global GDP! It is pretty understandable that when the U.S. sneezes, the world catches a cold- after all, the U.S. is nearly 30% of the world’s GDP. But can Greece cause a global slowdown – I really doubt so.

Funny aspect # 2

There is a report from the IIF that was prepared to scare some of the hesitant lenders into signing off on the country’s bailout package. Through a series of 'well reasoned' arguments, the report discusses a global slowdown due to Greece’s default. Now, how all of this would be achieved by such a minuscule economy like Greece – which is less than 0.5% of the global GDP- has truly made the IIF report a hilarious read.

Funny aspect # 3

In the debt deal of February 2012, private creditors were quoted to have forgiven more than half of the Euro 200 Bn of outstanding. If forgiving more than 50% of a loan is a 'deal', then what in the world does a default mean?

Funny aspect # 4

Which brings us to the next aspect of our humorous stroll- If this 50% 'forgiveness' didn't cause any real blip on the global economy, will the default of remaining 50% cause a global slowdown?

Of course, if this were to really happen, then the economists would surely begin to discuss CDO losses and the contagion effect. This leads us onto the following serious issues:

Serious issue # 1

Several banks and institutions will certainly go down, and countless jobs will be lost. What will become of the bankers who are going to be held responsible for writing those CDO's on Greece? More importantly, what about the politicians who are going to lose power? Let’s think of them for a moment. I would think that in such a scenario, countless big-wigs in banking & finance industry would no doubt be joining the hall of shame along with Alan Greenspan, Dick Fuld and many others. Some of these people could likely get prosecuted, and possibly even join Maddoff’s ranks as well.

Serious issue # 2

Every economic crisis, including the most recent one beginning in 2008, clearly portrayed the lack of integrity and competency in the so called business leaders who are supposed to be examples of these very qualities. Furthermore, after every crisis, skeletons started to tumble out of the closet. Here are a few examples; they almost sound funny

  • Some of the rating agencies were later stated as saying that they had made mistakes in their excel spreadsheets and models, resulting in more than a few incorrect evaluations. Imagine that- a world crisis caused by a few excel mistakes; and the men who are responsible for those mistakes are supposed to be CPA's , CFA's, PhD's and MBA's. This calls not only calls into question the very competency of these professionals, but more so the leadership within the company.
  • Only the relatively junior level executives who created those CDO's knew what they were actually comprised of, yet they did not have the experience to understand the risks and future implications. Furthermore, the senior leaders- who had the experience to understand the risks- didn't completely understand how the CDO's were structured, so they preferred to count their bonuses, rather than to show their ignorance.

In conclusion, the question to ask is- can a minuscule economy with less than 0.5% of the global GDP cause a Doomsday effect, or are the business and political leaders really afraid of something else?

Monday, May 7, 2012

Recovery underway - fears unfounded

image Nifty Down more than 10% from its Feb high and GDP on a consistent Decline. Does it mean things are bad?
   
Unlikely. Check out the latest indicators, which show that a recovery has already begun.  
   
image PMI, which is a good leading indicator of growth, has shown a sharp uptick after bottoming out in Nov’11.
image WPI Inflation rates are on a clear downtrend
image Quarter on Quarter corporate profit growth till Dec’11 has shown an uptick. Trend is expected to continue with the March’12 results too.
image Are investors fleeing to the safety of Gold? Not at all. Gold prices have risen consistently till a year back on back of safe haven investment and speculation. But since the past one year, Gold prices have remained stable inspite of all the trouble in Eurozone
image Are the FII’s fleeing Indian markets?  Not at all. The tide of FII outflow started to turn around by Sep’11, and by the beginning of this years, FII were net positive investors.
image So what’s with the Index. Well, Nifty has had a decisive break from the lows of 4600 levels. The current decline is just a just a corrective move or an intermediate decline for now.

 

So What’s Next?

Towards the end of December ‘11, my analysis had suggested that Macro-Technicals point to a possible bottom. Today the macros are far better than a few months back. US, China, Japan, Brazil and Russia, comprising more than 50% of world GDP are in various stages of bottoming out and recovery. However, there is no denying that that the Eurozone economy is sliding into a recession and the worst is not over for EU.

I believe that the uptrend that started in Feb’12 will continue and the markets would very likely make a new highs over the next few months. Any shock caused by Eurozone would just continue to provide good entry opportunities for the long term investor.