2009 – There’s A New Bull in Town – His Name Is Bond: Government Bond

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

THAMASOMA JYOTIRGAMAYA

November 30th. 2008



'Take us from darkness to light'; from ignorance to awareness; from incompleteness to totality ... Let that be our instinct... But let us not forget the self... the omnipresent'

The above is for the unsung heroes who protected, defended and some who gave up their lives so that we could live to see another tomorrow

Yes I know that it’s been a long time since I wrote a small piece but personally was not up to it and intellectually did not know what to write since events predicted earlier were overtaking me faster than I could say I told you so. To quote the and from the Alchemist, when he appears to Santiago in the form of an old king "when you really want something to happen, the whole universe conspires so that your wish comes true" – well all that I can say is that somebody conspired but personally this is not what I deserved, maybe professionally I did – does that make sense – to me it does

A bird does not sing because it has an answer -- it sings because it has a song. No point wasting precious time writing and you reading unless there is something to say / read. Well let me start my birdie song on the current state of the bewildered investor: How did he get there!!!!

Then:
You found yourself behind the wheel of a large automobile
And you found yourself in a beautiful house, with a beautiful wife
And you never asked yourself-Well...How did I get here?
& Now:
And you may ask yourself
Where is that large automobile? (it’s the bank’s stupid)
And you may tell yourself
This is not my beautiful house! (it’s the bank’s stupid)
And you may tell yourself
Where is my beautiful wife! (you’re broke have you forgotten that!!!)
And you may ask yourself-Well...How did I get here?-Inspired By “Talking Heads, David Byrne lyrics to Once in a Lifetime”

As the economic crisis continues to unfold, a sense of uncertainty has begun to pervade the market. Even dyed-in-the-wool risk takers admit that they don’t know what to think anymore. Inflation, deflation, recession or depression – there are so many vagaries that it appears to be anyone’s guess what will happen next.

Despite the current, volatile environment, though, I maintain my core prediction that there will be continuous deflation in asset prices i.e. real estate (30-40%), share prices (20-25%) and even in currency, I also maintain my stand that a highly inflationary cycle in real commodities is not far off and that my dear friends should be the start of the bottom for our markets.

The way I see it, the swift, far-reaching and mostly ill-conceived reactions from most of the world’s governments under the leadership of two apprentice sorcerers (Bernanke and Paulson) have until now resulted in a widespread run for an exit to nowhere, a deep credit freeze, and total and indiscriminate mistrust in the market and all of its players.

It is wholly rational and necessary that the end leads to a great deleveraging and economic recession. It is unavoidable that institutions withdraw from the market holding tightly to their “paid for” assets.

Investors, who played the carry trade both in USD and the YEN, are being forced to sell foreign assets for local currency and buy dollars/yen to repay their debts. Even major corporations are repatriating funds from abroad to meet the domestic dollar/yen cash demands.

However, when the deleveraging subsides, the inflationary effects of massive developed nations stimuli, will take effect and show through rampant inflation. The dollar is then likely to stall and even plummet. Indeed, it is possible that facing depression, President elect Obama may devalue the U.S. dollar drastically against gold, just as his 'mentor' President Roosevelt did in 1934 (only after confiscating all privately held gold from American citizens).

The over-valuation of the dollar has been of the global economy's most serious problems for the last decade. The high dollar led to an unsustainable trade deficit that peaked at almost 6 percent of GDP in 2006. By definition, a trade deficit means that domestic savings is less than domestic investment. This means that (barring an investment boom, which we have not seen) there must be a large government deficit, low private savings, or a combination of the two. None of these situations are desirable or sustainable, at least over the long-term. While the trade deficit has consistently been far larger than the budget deficit over the last decade, it has received far less attention from the media. The only plausible way to bring the size of the deficit down to a manageable level is by reducing the value of the dollar. A lower dollar is especially important in the wake of the collapse of the housing bubble. Without a continued improvement in the trade balance, spurred by a falling dollar, there is little hope that the U.S. economy will escape a prolonged downturn.
The governments are now, thanks to the fiat money system creating liquidity out of thin air, all it takes is a few approvals and pen strokes. At last count the developed countries (read as rich and broke, ironical isn’t it) had created close to $ 15 trillion of bailout packages and we are not even through Phase ONE of this crisis. The IMF and the World bank under the eagle eye of the US of A insist that emerging economies increase spending domestically to bail themselves out of this crisis which will put paid to their ambition of becoming a developed nation and ensure that the emerging economies get poorer rather than richer .The cost will then be passed on to the taxpayer via higher taxes (that is provided they can tax losses), so the alternative - diluting the purchasing power of their money. It's not as though there's going to be a revolution over it. It's 2008, not 1870 when if the government tried to rip off the public in this manner, they would have found themselves hanging from lamp posts outside their offices. (It’s time we did it don’t you think)
“When the facts change, I change my mind. What do you do, sir?” -(John Maynard Keynes ).

Have the facts changed ... do I change my mind... is the crisis over. The last 120 days has found me with my head buried under a heap of statistical data, lots of reading and meeting people who are by far more intelligent than an analyst like me and am yet to see some light at the end of the tunnel

There is a good chance that this is the play that advisors like us wait a lifetime for, but after the fact will bemoan their inaction due to fear. But the public and its policy leaders who all kept their heads buried deep in the sand during the cyclical bull market have now done the predictable 180, worshipping fear much as they worshipped greed just a short while ago in what now seems like a different life. Mania is mania and it works both ways. Smart people will fade mania.
I suppose it is up to the people who rightly saw this mess as overvalued and/or a disaster in waiting to move in and pick up the pieces. While we, along with several external experts, continuously review our assumptions and conclusions and encourage dissenting opinions and analysis to avoid biased conclusions, so far we keep returning to our views about what’s coming. That said, the hardest thing to predict is not what will happen, but when.

If there is ever been a time to think independently, it is now. I will end by quoting Friedrich Nietzsche (1844 – 1900) "The individual has always had to struggle to keep from being overwhelmed by the tribe. If you try it, you will be lonely often, and sometimes frightened. But no price is too high to pay for the privilege of owning yourself." “Happy Birthday” Dinesh

A Tribute to Dylan & Hendrix

(hope they do not turn in their graves)

There must be some kind of way outta here
Said the investor to the advisor
There's too much confusion...
I can't see no relief
Oils on a boil, boiling my blood
Asset deflation and Hyperinflation is pushing
my face into the mud
Bernanke did great or so the advisors thought,
By cutting interest rates he ensured your capital rots

Chorus :
And you Mr. Advisor ,
are interested in only your fees
Currently Pushing Capital protected notes
Just up my sleeve
Then what is your work Mr. Advisor
Is what one should ask
If the product protects my capital
When will you put your brains to task
End Chorus

No reason to get excited
Comsol kindly spoke
There are many here amongst us
Who felt that the erstwhile “Bull Market” was but a joke
But, uh...but you and I, we've been through that
And this is not our fate
So let us start talkin' reality now
Is it or Is it not time to unbolt the gate

All along the watchtower
Comsol stated it’s view
While all the advisors came and went
Television Experts , too
Outside in the cold distance
When the Bear finally did growl
22,000 was approaching
12,000 began to howl

Our clients sleep with a smile
Without a worry too (we hope)
They’ve left us the task to beat inflation
And make some moolah too

Inspired by the song "All along the Watchtower" (also known as "Joker & The Thief")– from the album "Wolfmother" for those who have never heard this song . It was written by Bob Dylan but made famous by Jimi Hendrix

Regards

Dinesh Khemlani

Circling Like Vulture’s

Falling stocks and markets are the favourite hunting ground for long-term advisors like me who look for stocks trading below their fair value. The Indian market rose spectacularly during 2003 - 2007. It also suffered an equally spectacular fall in 2008. Many likeminded friends of mine are beginning to think this market is moving below fair value.

It’s all about sentiments. Infact every facet of our life is ruled by sentiments and nothing can be more indicative of this than the stock market. The same market experts who were rollicking in a party mood a few days ago are now procrastinating doom

Suddenly today, all looks bad! The same issues of last 9 months – credit crisis, dollar crisis, tight liquidity, corporate earnings, global slowdown and inflation seem to have come back to the forefront in spite of best efforts to lock it in a closet and throw away the key (by Bernanke and gang, our own operators and P- Note subscribers and embedded value propagators).

The net result is that not only has this self-serving, world-wide spider's web of "investment professional" cretins tied up everyone's money for up to 3-5 years or more, at index levels that were at record highs, so that for the rest of your life you are derisively known around the office as "The man who wore the fools cap last", but they are also now running for cover – not lifting up your phones – if they do pick up your phones either it is OH MY God OR they are guaranteeing that you will make returns of 30% annualised in the next 3 yrs (first at least recover the 35% loss suffered in the last 6 months) as the TRISHUL raises its head or should I call it the rise of the TRIMURTI – the RISE of OIL, INTEREST RATES & Real Commodity Inflation ! The Long Pole is the demise of the dollar (read my August 2007 note wherein I had clearly stated that a cut in Interest rates will lead to consequences far beyond what one can imagine).

And you think that oil, interest rates, real commodities are NOT going to climb dramatically, handing huge, huge, HUGE freaking losses to any individual owning equity / debt that is so grossly, grossly, grossly over-priced? Do you actually, really, truly believe that interest rates will always stay below the rate of inflation? WAKE UP. On a lighter note now we know where the $ 100 billion given to the American Public as tax rebates was spent on - OIL.On a serious note Dr. Reddy is likely to hike the Repo Rate by atleast 25 basis points and the CRR by 50 basis points in the next 30 days.

The debt markets in the US and Europe have begun to flash warning signals yet again, raising fears that the global credit crisis could be entering another turbulent phase. There are now concerns that the Fed itself may be exhausting its $800bn (£399bn) stock of assets. It has swapped almost $300bn of 10-year Treasuries for questionable mortgage debt, and provided Term Auction Credit of $130bn – time for dollar to start its demise and gold to start climbing

The steep rise in swap spreads in the last 14 days is ominous; the deterioration is in stark contrast to what investors have come to hope since March. Banks are beginning to face waves of defaults on credit cards, car loans, and now corporate loans. We believe we're entering Phase IV. The liquidity crisis has eased a little, but the real credit losses are accelerating. The worst is yet to come.

The biggest threat to global stock markets lies in a combination of the continued unwinding of big bets that banks, hedge funds and others made on mortgage-backed securities with borrowed funds and a likely U.S. recession. A decline in growth will result in increased bankruptcies and defaults, higher unemployment and reduced consumer spending.

What's more, the process of weaning the global financial system and economy off the massive liquidity binge of the past decade will take one to three years and eventually cost $2 to $ 5 trillion,.

The looming recession in the U.S., the accompanying slowdown in global growth and the expectation of additional bank losses on assets other than mortgages suggest that stock markets have further to fall. Earnings forecasts also are probably too optimistic, given declining consumer sentiment. What's more, monetary and fiscal authorities seem unable to come up with a solution to the credit crisis short of injecting a huge dollop of inflation into the world economy.

The next wave will be in the form of a derivatives crisis: the oft-mentioned collateral debt obligations and credit default swaps. It is apparent that few people really understand what they are and how deep they go.

Do you all know how I know this – clearly evident from some of my friends who have got tired of me singing this song and are itching to get into the market but LACK the one good quality “PATIENCE”.

That is bad news. Because it means when the crisis hits, people are more likely to panic. Panics tend to be disproportionate to the problem, particularly when trust in institutions has disappeared, as is the case with banks today.

To put it another way, the war between inflation and deflation is still going on. Inflation is in the news so much that you might think it has won. Just look in the papers; you can practically see the victory parades and hear the music playing. Now that inflation has moved from asset prices into energy and food, then there is a real problem for those who were unprepared….e.g. INDIA

But deflation isn't giving up and isn't going away. Americans are deep in debt. And debts cause a man to pull back…to retrench…to downsize. We see that in the headlines too. Downsizing means spending less money. And spending less money means fewer sales…and lower incomes…and fewer profits. It means an economic slump - and, typically, falling prices.

In today's globalized world, that slump would have to reach worldwide proportions in order to have a major effect on key commodity prices, such as oil and grains. But that is probably coming.

The cure for high prices is high prices. You've probably heard that before. It describes the way markets work. Prices go up. The higher prices encourage consumers to use less…and encourage producers to produce more. It's not long before the supply increases…and demand falls. Then, prices adjust downward.

The Fed seems to be trying to create a situation whereby they are seen to be fighting inflation, simply by not lowering rates any further, This is because, while the Fed may have no interest in fighting inflation, they have a big interest in fighting what they call 'inflationary expectations'. In other words, they are more interested in fighting people's perception of the problem, rather than the problem itself.

Ben Bernanke may make a feint in the direction of fighting inflation - maybe raising rates slightly (in August perhaps). Oil will drop back below $120 temporarily. Bonds will rise. But consumer price inflation may still not go down; it may actually continue to worsen, as the global economy sinks further into a slump. Then, the next phase of the War between Inflation and Deflation can begin.

My advice - IGNORE the sensex levels is what I am saying since the index minus 5 stocks is trading at 13000 - 13500 levels YES you read correctly and by the time this is posted the latter sensex level should be at 12000.

Is it time to “SUPPORT” the market that I have ignored so far - Markets always look for support. This develops when prices fall to levels irresistible to buyers -- something quite aptly called vulture buying -- where investors wait for the market to reach its lows before they become buyers.

The Vultures are circling above – it may be time for the first course of a six course meal ... for the balance five one can keep waiting for – don’t be greedy yet to fill up your stomach.

The Whistling Wealth Manager

Does this tune sound familiar :

Buy,buy,buy,
Buy on Dips
Midcaps a bargain,
Largecaps are rising,
EPS & PE’s need revising.

Oil's at $ 115,
What’s that I ask,
Farmer, Fertiliser, Oil and Food subsidy bill ballooning
Lets take the taxpayer to task

Buy, buy, buy,
Inflation only a headline number at 7%
Reality Check : Staples and Veggies up 20%,
Milk up 50% Steels up 25%
Salary hikes a dream, Pink slips on the way
But hey domestic consumption story here to stay

Buy Buy Buy
Corporate Margins under pressure
RBI Governor adds fuel to the fire
FX Losses blow the cover
Downgrades around the Corner

Buy, Buy, Buy
Help Boost the Broking Community & Wealth Managers Fees
Bye, Bye, Bye
And Kiss Your Wealth Goodbye

When a market that has lost 30% or more in the past Quarter, gains 10% in 3 weeks, it's a "fabulous rally", always coupled with the tender question: "could it be that we have seen the bottom of these markets? Might it be the right time to jump back in?"

And, sure enough, you find a whole ballet of equity salesmen pirouetting through the various media telling you just that. Banks are cheap, Tech and Telecom the new leaders, All or more earnings in line with estimates (the estimates were so low anyway). Go bargain hunting. F & O positions are low . Time to think about coming back in. Don't miss the boat. Blah Blah Blah , Bloo Bloo Bloo.

Betting on rising stocks in a bear- market environment can be as dangerous as crossing a busy six- lane highway. Many investors take the risk anyway.

Motivating them, besides a whole host of wealth managers, is a desire to recoup losses from the three month decline in the equity market and memories of the bull- market run from April 2003 to October 2007, when investors were rewarded for buying on market dips.

I am not even arguing whether they might be right or wrong. I am just saying this: a car salesman will ALWAYS tell me that THIS is the right time to buy a car. Will always tell you that the car HE has is the one you must buy. That’s his job. That's the way he makes his money. It's the same with the Wealthmanagers. They make money by selling equities.Nothing wrong with that. It's their job. Or would you blame your fruit vendor for praising his alphonso mangoes ?

But it's up to YOU to decide whether and when you want to buy those alphonso mangoes. Same with equities.

Instead of adding to their holdings, investors should consider using the rallies as an opportunity to sell shares.

Regds

Dinesh Khemlani