With the New Year comes the annual tradition of predictions on how and where to make money be it in the capital markets, the housing market, the debt market or the commodity markets.
Since everyone is interested in “make my money fast schemes” the biased and debased commentary of most financial analyst’s and television hosts state that the worst is over, that we have bled enough – it is now time to be overweight in riskier assets.
The phrase, "blood on the streets," refers to economic panic. A wise old saying is that buy stocks when there is blood on the streets. This means panic. It refers to a final sell-off, when fear trumps greed. Ask yourself this question do we see that anywhere – in my humble opinion we are nowhere near that stage today.
There are certain indicators that I watch to give me inkling whether Dalal Street’s Halal has affected the now famously coined term “Main Street” - unfortunately not and here is why and these are some of my indicators:
• Restaurants and Pubs – business may be slightly affected but occupancy is not even close to the pathetic levels seen in 2001-2002
• Housing Demand has slackened but prices have not come off like they did during the period 1994 - 1997
• You still hear of your friends taking a holiday, so what if it is in a time sharing holiday scheme of the Mahindra’s in Goa and not at the Taj Exotica
• You still hear people talk about the Gucci’s and the Cartier’s and the Ester Lauder’s of the world so what if they are fighting to pay their credit card bills
• Lastly you still hear the word consolidation rather than cut your losses and run ( it is never too late)
Why can’t we admit that it is time to fire fight – A stock market bull would conclude that happy days are here again, and never really departed. "The recession / deceleration has been long, but it is not deep. It will be over soon." Wake up people - we are in the midst of an economic war unleashed through a fiat monetary system and we have to learn how to survive and protect our capital at the same time and yes earn.
I can't believe the news today
I can't close my eyes and make it go away
How long? how long must we sing this song?
How long can U hold for a term 5 year long
Empty bottles under traders bed
Bodies strewn across Dalal Street’s edge
But I won't heed the battle call
It puts my back up, puts my back up against the wall
And the battles just begun
There's many lost, but tell me who has won?
The trenches dug within our hearts
And families and peace torn apart
Wipe the tears from your eyes
It’s time to see the sunrise
Wipe the losses from Equity away
Fixed Income is where “Aye Aye Sir” I say
It'll wipe your tears away
Back it up with Gold is what I say
And it's true we are immune
When fact is fiction and TV reality
And today as the millions cry
We eat and drink while tomorrow they die
The real battle has just begun
A Nimble foot is needed on this re run
And Now I will heed the battle call
I’ll put my best leg forward and no longer my back up against the wall
(Inspired by U2 from the Album War lyrics of Sunday Bloody Sunday)
I am putting up a road map for investments at the start of the year but kindly be forewarned that it it is for the nimble footed only since I think everyone has learnt that buy and hold does not pay.
The route I foresee is
• Long Term Government Debt / Quasi Government Debt / “AAA: Corporate Debt (Better Known as Gsec Funds / Income Funds for retail subscribers) next 3 – 5 months
• Gold (In physical form or through ETF’s) now or after 2 months
• Natural Resources (In futures or last resort the producers of the same ) after 3 months
• Diversified Equity Shares after elections (yikes hopeful am I not!!!)
Since I have been talking about “Out of Equity” for the last one and a half years or so , I shall briefly talk about investment in Gsec’s / Income Funds and the reason’s thereof and if it does not make sense I would appreciate a response from your end so that I may learn a bit more and correct my facts.
Over the last six months the Reserve Bank has adjusted its policy stance from demand management to arresting the moderation in growth. In particular, the aim of these measures was to augment domestic and forex liquidity and to ensure that credit continues to flow to productive sectors of the economy. Notably, since mid-September 2008, the Reserve Bank has reduced the repo rate under the liquidity adjustment facility (LAF) from 9.0 per cent to 5.5 per cent, reduced the reverse repo rate under the LAF from 6.0 per cent to 4.5 per cent and the cash reserve ratio from 9.0 per cent to 5 per cent.
It is my belief that RBI shall cut further (between now and the next three months) and I would not be surprised to see a further reduction in
• The Bank Rate – am aware that it is only symbolic but necessary by 100 bps from 6% - 5%
• The Repo Rate – from 5.5% to 4.5% and
• The reverse repo rate from 4% to 3%
I would love to see an SLR cut but I do not see that happening since the new government in waiting (six months down the line) will have to ensure huge dollops of government spending on infrastructure and the said monies can only come by fresh issuances of government bonds since revenues (in the form of direct and indirect taxes) would have dried up by then (expect a CRR cut of 100bps points between June and October 2009).
I can already sense some smirks on the above statements made by me but it has to be read in light of the fact that the entire developed world appears to be converging onto a zero rate interest policy never before seen in this life of mine or maybe even yours.
Would like to point out that the first four countries mentioned above are in recession and the balance three, are decelerating.
If one compares the Indian repo rate (not the bank rate which is symbolic in nature) and the US Fed Funds rate in the last decade or so, you would get a sense that the RBI’s tightening and easing policy follows that of the USA (for all practical purposes the engine of the world economy to date) albeit with a lag. I am in no way saying that we are copy cats and that we do not have our share of think tanks that do their own things but just maybe this is a coincidence and everything falls into place.
On an average the difference between the Fed and our rate is roughly 300 to 350 bps. That means that in the best case scenario our repo rate should come down to 4.00% - Yes you read me right I said 4.00%.
With Japan in a state of quantitative easing (since the last 15 years) followed now by the US of A and to be followed by BOE and the ECB it is not hard to perceive that rates will remain low for some time to come and hence may even require the RBI to make a much steeper cut than what it has already done so far.
I believe that the RBI will cut its rates for five reasons which I shall briefly touch upon.
• Future Petrol / Diesel price cuts along with deflation in producer prices shall ensure inflation at 3% or so by the end of March 2009, maybe near 0% by May 2009 and probably negative by September 2009, hence rate cuts would be needed to prevent real interest rates from becoming hugely positive, which would ensure that the Benchmark 10 year gilt dips closer to 4.00% (assuming that FY’09 -10 inflation average is closer to 3% if not lower).
• Lower Interest rates shall lead to the weakening of the Rupee against my basket of currencies something that I can afford at this point since my largest headache on my Trade Deficit is the import of oil, which is down to $ 36/barrel and thus try to give a stimulus to the exporting sectors hence try and prevent large scale unemployment
• The government can only throw caution to the winds and increase public spending only if it can keep it’s fiscal situation from going out of whack... a possibility if it can retire high cost debt and replace it with an increased amount of low yielding securities (a la 2001 – 2003).
• Current Credit growth rate figures of 24% are deceiving since it is my belief that currently credit off take by the said corporate’s is being used to either repay Foreign Debt or fund inventories. After a point the RBI shall have no other option but to cut rates to stop the deceleration of the economy and ensure credit targets are met.
• Lastly RBI has to ensure that beyond a point it will become unprofitable to be risk averse and this shall force the banks to start lending which shall meet the twin objectives of lending to productive sectors and maintaining growth
At the end I conclude that there is a Bull Run coming in Gsec/ Income funds. I would like to bet my money on Income Funds (which Invest in Gsec’s, Quasi Government PSU’s and AAA Corporates) rather than a pure GSEC Fund for one reason and one reason alone that is contraction in spreads.
For Example currently the spread between a 10 year Gsec and a Quasi Government paper is 300bps, and the spread is 400 bps if it is an ‘AAA’ corporate.
So if interest rates come down, in a GSEC fund one would get the benefit of the yield heading south and prices north hence you profit, but in an Income fund one would not only get the benefit of lower yields but also a contraction in the spreads of Quasi Government / AAA bonds Vs the GSEC. If this spread narrows, which it has to if you want growth (in 2003 this spread contracted to 60bps) one would get a huge upside in these income funds and returns could be mind boggling.
If no action is taken from RBI’s side then obviously all bets are off.
For my Equity friends (I have written enough on this and can be found on my previous posts) I have one thing to say -the bull’s think that the worst is behind us. But they cannot point to any sector of the economy and say, "That's the engine that will pull us out of the deceleration." There is a vague confidence that the market will rise, but no confidence that the sectors that provide job growth will rise. So, they want public works projects as a stop-gap. This is a replay of the Great Depression.
And to all those impatient people out there I have this to say - It has been said that the worst thing for a man is to see his neighbour getting rich. Investors simply fear being left behind in a bull market more than they do losing money. Most investors simply want to win with the group and then have someone’s hand to hold, for support, when faced with declines.
It is an easy scapegoat for financial advisors and brokers as you will never hear them boasting that your portfolio went up as result of a general market increase. No, they will always take credit for it. However, if your portfolio declines, the blame is simply shifted on the “bear market.” You are then told to hold for the long term – WHAT!!!!
I’d like to end buy quoting from a movie called “Dreamer” (which is based on a real story) “When you ran, the ground shook. The sky opened, and mere mortals parted. Parted the way to victory, where you'll meet me in the winner's circle—and I'll put a blanket of flowers on your back."
So take a step if you cannot run but ensure it is a step in the right direction – to victory.
Regards
Dinesh Khemlani
