Sudip Bandyopadhyay’s Blog

In the Hindi blockbuster movie Gajini, the lead actor suffers from a disastrous aliment “Short-term Memory Loss”.  The current market euphoria across the world reminds me of a similar mental state for investors across  asset classes who are unable to grasp the toughest lessons of last year’s global economic crisis.  The crisis was predominantly about unsustainability  of macro imbalances – imbalances within and between the nations as well as flaws in policies, regulatory structures & risk management practices that allowed these imbalances to take the world to the brink. Many of these structural issues haven’t been adequately addressed yet. The macro  imbalances continue .In the midst of a very lukewarm recovery in few economic indicators, the recent rally in almost all asset classes is baffling.The current market upswing is being driven by huge surge in liquidity, consequent upon biggest ever simultaneous liquidity injection by the governments across the world. The danger of the current euphoria is apparent with a very clear writing on the wall regarding forthcoming acceleration in inflation numbers across the globe.  This is driving the gold prices which are hitting record highs.  Even oil & other commodity prices are  showing steady rise &  the unprecedented  liquidity is keeping the equity markets  buoyant.

Confused investors are seeking answers and searching for  appropriate asset classes for investment .  They are clinging on to gold.  With looming inflation in the horizon I don’t see any fault in this logic of buying or holding on to gold except the fact that the appreciation in gold may not be significant  in the near term considering the fact that it is already at record high.  But for long-term purposes gold will continue to remain an attractive investment avenue. Jim Rogers the renowned commodity bull recently mentioned ” I can’t say what will happen to Gold tomorrow..but if you ask me whether Gold will go up in the long term…I would say yes .”

Oil as an investment avenue is a bit complicated and at present avoidable  for the general investors. Inside every Oil bull beats the heart of a brooding pessimist. Crisis , turbulence & disasters enable Oil prices to shoot up.  Apart from demand/supply dynamics, geopolitical issues play a significant role in determining the price of oil. Geopolitical tensions around the world are currently showing signs of cooling down with more mature US policy response to the various issues. While the economies  of China, India and few other developing countries are on their recovery path, the same is not true for the European and US economies.  Subdued global economic activity depresses demand for oil and consequently  its prices. Popular belief that holding  oil as investment can act as a hedge against forthcoming increasing inflation will not hold true  unless & until economic activity around the world significantly picks up.

Thus, in spite of nervousness around the world regarding sharp rise in prices of Equity Shares over the last six months, investing in stocks will continue to remain attractive.This is specially true in case of India. During the boom of 2007, the rate differential  between the GDP growth of US, Western Europe and India was around 3-4 per cent, as India was growing at around 8 per cent, whereas these economies were growing at around 4-5 per cent. Conservatively India is expected to grow at around 6 -7 per cent during the next few years, whereas US and Western Europe will either show de-growth or grow marginally.  Thus the GDP rate differential  has only moved up to 6 per cent, making India more attractive as an investment destination.  India will continue to attract significant long-term FII fund inflows ensuring that there is ample liquidity in the market. Domestic savings will also continue to get channelised indirectly through the Mutual Funds & Insurance companies. The trick would be to identify the right sector and right company in these sectors.  With the economy growing at 6 – 7 per cent, and expected inflation of around 4-5 per cent, the nominal growth will be 10-11 per cent.  In such a scenario, the performing Indian companies will definitely provide a CAGR of around 15 per cent over the next 5 years.

It is also very important to remember the cardinal principle of investment…don’t try to time the market..be in the market for a time. Today’s stock market levels are much closer to the 2007-08 peak than the bottom of 2008-09 & in the short term market movements will be volatile &choppy. The world economic scenario is still not very rosy & liquidity levels may fluctuate wildly based on entry or exit of FIIs. However the medium to long term projection for Indian equity markets are very encouraging & Investors with similar time horizon should definitely look at equity investments for building their wealth.

( ** this is the transcript of the weekly column I write for Economic Times )

Alan Greenspan in his book The Age of Turbulence commented that ‘Fear is an automatic response in all of us to threats to our deepest inbred propensities.  It is also the basis of many of our economic responses.  It is difficult for investors to imagine when markets veer from rational to irrational, from euphoria to fear and back again’ The stock market is ruled by powerful emotions and desires – greed, fear, hope, uncertainty  which  control the behaviour of stock markets and investors.At the start of the year there was talk of a Great Depression.  By March, that had become the End of the World.  In April, however, the global economy faced merely a stiff recession. May has now ushered forth expectations of a self-sustaining recovery.  At this rate the boom will be back by summer.  The Bernanke, Fed Chairman, now expects to see a recovery by the year’s end, albeit a weak one.

The strong rally in global equity markets continues to confuse and surprise most market participants.  A continuing stream of better than expected economic data is forcing investors & fund managers  to reposition portfolios, and this act of repositioning is driving up markets to levels that  may  no longer seem attractive from a valuation perspective.  Having gone through a very tough 12 months, investors are naturally worried about not taking further losses, and are thus loath to chase this rally.  Fund managers  are damned if they do and damned if they don’t.  If they buy now and the markets fall, they are bound to get asked questions on chasing the market, and if they do not participate they will be questioned on underperformance. India is currently part of this global rally, and for us to break out on either side we will have to wait for the election results. Markets will cheer the emergence of any stable political structure post the elections. Such structure will assure that the reforms agenda of the central government will proceed without any major setbacks.

The economic reform agenda of the new government  amongst others should include large scale reforms in the Commodity space.  Financial markets have witnessed reforms regularly and to a great extent our capital market systems are world class and robust.  However, unfortunately the Commodity Trading space, both Spot and Derivatives including the related infrastructure haven’t  yet received  the required attention.  Organised development of the Commodity business will surely  create a virtuous  cycle which will significantly benefit the farmers, manufacturers, users and consumers across the country.  Commodity market needs a strong regulator  and  this needs to be addressed  urgently either by empowering FMC or creating a single regulator for the markets .From the point of view of commodity marketscompetition is important among exchanges.  But to compete efficiently, they must have products which differ in features and benefits or even if these parameters are the same, they must be distinguishable in service quality.  Without any product differentiation, the market gets segmented, leading to efficiency losses when the same product is traded on more than one exchange.

The  Indian  capital market in the last week remained buoyant largely on the back of aggressive FII buying in the cash segment.  Despite high volatility in the week gone by, both benchmark Indices Nifty and the Sensex registered hefty gains. The current trend suggests that the economic data is likely to keep improving slowly on tle margin as  restocking of inventories begins and confidence creeps back among corporates.The results of the U.S. government’s stress tests for Banks were in line with expectations. However, 10 out of the 19 banks under review will need to raise further capital of about $75 billion by end of CY2010. On the domestic front, Inflation rate witnessed a mild jump for the third straight week to 0.70% from 0.57% earlier due to a large increase in prices of food articles.

In the coming week markets are likely to decouple from global developments and would be eyeing political developments more closely. FIIs have already turned cautious. With elections results slated for end of the week, markets may witness extremely high volatility and may see some unwinding of positions.  With the political scenario post election still cloudy, fresh build up of positions and sustained upmove looks unlikely.

( ** this is the transcript of the weekly column I write for Economic Times )

That people respond rationally to incentives, and that market prices incorporate information about the world, are not terrible assumptions.  But they are not universal truths either.  Much of what creates profit opportunities and causes instability in the global economy results from the failure of these assumptions.  Herd behaviour, asset mispricing and grossly imperfect information have led us to where we are today. Keynes went on to explain that economic understanding required an amalgam of logic and intuition and a wide knowledge of facts, most of which are not precise; “a requirement overwhelmingly difficult for those whose gift mainly consists in the power to imagine and pursue to their furthest points the implications and prior conditions of comparatively simple facts which are known with a high degree of precision”.  On this, as on much else, Keynes was right.   The legendary market man George Soros in his analysis of the crisis laments that in the financial markets we have to make decisions without having sufficient knowledge at our disposal .  He also states that  we have , to an extent gained control over the forces of nature& that makes us  powerful.  Our decisions have great impact on nature.  We can do a lot of good or a lot of harm.  However  we have not learned how to govern ourselves.  As a consequence, we live in great uncertainty and grave danger.  We need to gain a better understanding of the situation in which we find ourselves.  It is difficult to accept uncertainty.  It is tempting to try and escape it by kidding ourselves and each other, but that is liable to land us in grater difficulties.The prevailing paradigm for financial markets, that markets tend towards equilibrium anddeviations from it are random, is both false & misleading.He argues that only by exploring a new conceptual framework for how markets really work can we avoid disaster & economic ruin.There is a two-way connection between thinking and reality which, when it operates simultaneously, introduces an element of uncertainty into the participants’ thinking and an element of indeterminacy into the course of events.  George Soros  called this two-way connection reflexivity, and  asserted that reflexivity distinguishes unique, historical developments from humdrum, everyday event.

The present global financial crisis is not an account of market misconduct but the result of deliberate leveraging, mis-pricing of risk and asset bubbles.  Although several confidence-building measures have been taken, we may not have come to the end of the tunnel.  Fears of a US as well as global recession will not die down so soon.  It is important that this is understood and we should not get carried away merely by the performance of the stock market or the other emerging positive news and consider them as indicators of prosperity.  It is  important  now that we take a deep dive to clean up our own house by taking deeper systemic measures.

Globally markets continued their smart run on better than expected quarterly earnings numbers from several corporates  which  subdued the impact of emerging  gloomy economic data . Meanwhile Real GDP growth in the U.S. decreased at an annual rate of 6.1% in Q1 of 2009, following on from the 6.3% decline recorded for the last quarter of 2008. This marks  third straight quarter in a row that the US economy has contracted. The last time this happened was in the 1970s. However the US Federal Reserve in its recent policy update has maintained that it is seeing the first signs of bottoming out for the U.S. economy and has decided to keep the benchmark rates and discount rates unchanged.

Domestic markets continued to display strong buoyancy during the short truncated week gone by with both the Indices Nifty and the Sensex closing in positive territory. The sentiments continued to remain encouragingly positive on the back of continued strong liquidity momentum aided by the FIIs which resulted in  the upward rise seen in the markets. Momentum is clearly back in the markets. The markets uptrend has continued with added vigor during last week despite being a expiry week and of a shorter time frame largely on the back of strong buying. Total FII inflows in April 2009 has totaled Rs 5560 crores, reversing the trend in first three months of the Calendar Year 2009, during which FII outflow was as high as Rs. 6672 crores.  The Q4 FY09 earnings season by Indian corporate has been in line with market expectations, however strong inflows and improved sentiments in global markets have offset any adverse impact on markets. Meanwhile markets have risen up by almost 40% now and the rally is near the upper end of the range. Sustained follow-up buying is needed to take the Indices beyond the range.   More importantly in the coming week both domestic and global investors are likely to take cues from global markets where the markets are anxiously awaiting the results of the US bank stress tests to determine which banks are on the path to recovery and which might face pressure and will raise more capital, possibly through government funds. These results are expected soon.  Also domestic political uncertainty will continue to weigh heavily on markets in near term. Thus during the coming week while mild extension of gains are not ruled out, higher levels could be used for ‘Profit taking’. Very High volatility may be seen during this week.

( ** this is the transcript of the weekly column I write for Economic Times )

Dubai must feel a little like Mark Twain, these days.  Upon reading his own obituary in the newspaper, Twain wrote: “The report of my death was an exaggeration.” Dubai has had its share of obituaries as it suffers from a property bust and contagion from the global credit crisis.  Headlines from Cairo to London to New York, laced with schadenfreude, proclaim its demise.  Newsweek said simply: “Goodbye, Dubai”. The emirate is certainly stumbling.  Many of its state-owned entities drown in debt.  Several high-profile property projects have wilted under tight credit, debt and corruption.  Its stock market has been in free-fall.   Still, news of Dubai’s death has been greatly exaggerated.  Its fundamentals as a regional hub of shipping, services, people, trade and capital have not changed, Disneyland Dubai has crashed but the core business model of Dubai remains sound. That business model predates modern financial markets and the hyper-globalisation of today.  It is not about lavish hotels, skyscrapers and manmade islands in the sea.  It is a simple model, reflected in the statement of Sheikh Rashid Bin Saeed al-Maktoum, the late ruler of Dubai. “What’s good for the merchants is good for Dubai.” Creating a hub for merchants has been an al-Maktoum family tradition for more than a century.  And it is those merchants and migrants, dreamers and entrepreneurs, who built Dubai, who deserve equal credit for its rise and who will help it grow again.  This openness to foreign talent will support Dubai as it faces today’s crisis. Speculations will leave but plenty will ride out the storm, including Arab professionals who have chosen Dubai as the place to achieve their drams and middle-class Indian mid-levels managers who make the city work.

To understand why Dubai will survive, it is important to understand its commercial geography.  It is not solely an Arab state – demographically or commercially.  It is a commercial and tourist hub for a region that encompassed the growing markets of south Asia, emerging Afica, oil-rich Russia and the Gulf states, Iran, central Asia and the Caucasus, Europe and China. And it works largely because of the heavy infrastructure investment made by Dubai’s rulers and the expatriate traders, service professionals, construction workers, bankers and techies who make up 90 per cent of the population.  Dubai was never, as one newspaper called it, “The Middle East’s economic powerhouse.” Rather, it was and remains a highly successful entrepôt in one of the richest and fastest-growing parts of the world. Like most entrepôts, it feeds from and fuels growth.  Dubai’s property bubble popped. Its core business model, however, did not. Property corrections and over-leveraged state entities can be fixed. Becoming a poor environment for trade would be far more dangerous. When the world growth engine restarts, city-states such as Dubai will flourish. In the meantime, Dubai will serve as a vital, if somewhat clogged, artery in world trade. The battered but still battling hub city will rise again.

Markets continued to witness strong buoyancy during the last week largely on account of positive global news flows resulting in Indices both Sensex and Nifty increasing sharply by 10-12% crossing the 10000 and 3000 levels mark on sustained buying from FIIs in frontline stocks and partly also from short positions being covered by market participants.

The main trigger provided was on the global front with U.S. government announcing a $1 trillion package to remove toxic assets from the Banks without further recourse to fresh government aid. This resulted in to U.S. markets bouncing sharply.  Sentiments also got a boost following more positive data on the U.S Economy pertaining to sales of newly built U.S. single-family homes, which rose by 4.7% in Feb 09.

On the domestic front, Inflation for the week ended March 14th tumbled to 0.27% yoy, the lowest levels in 30 years, from 0.44% previous week and is significantly lower than RBI’s projection of around 3% by March end.  Policy action from RBI is eagerly awaited by markets and the industry.

The pull-back in markets gained strength last week and was largely due to rally in global peers and the short squeeze witnessed ahead of ‘F&O expiry’. Indices have now closed above significant levels of 10,000 for Sensex and 3100 for Nifty. Activity was on the whole widespread and  visible in mid-cap and small-cap segment too. Volumes were also heartening and supportive of the rally. However markets may have now turned overbought and higher levels may attract traders to cash in on the gains. Also now with the elections round the corner, political uncertainty is likely to weigh high on markets.  A limited upside can be forseen during the next week with institutional activity and Global news-flow likely to swing the markets. The markets are likely to remain range bound and volatile.
( ** this is the transcript of the weekly column I write for Economic Times )

What is the future for credit ratings agencies and how should they be treated under the new system of financial market regulation evolving internationally? These questions have been hotly debated in recent months and a consensus is now emerging. The European Union is close to finalizing legislation to register and regulate ratings firms for the first time in the region, and next month’s G20 meeting in London is expected to affirm the need for a globally coordinated approach to overseeing ratings agencies. The starting point for these reviews is recognition that credit ratings of certain recent structured securities have not performed well.  At the same time, investors and policymakers appreciate that ratings - a common and transparent language for evaluating and comparing creditworthiness - remain important to the efficient functioning of capital markets. They provide useful information to investors about credit risk and help companies and governments access capital. To achieve the aim of restoring confidence in ratings, regulation needs to be globally consistent, based on broadly accepted standards. First, regulators should focus on overseeing ratings firms’ policies and standards for managing potential conflicts of interest. Ratings opinions and methodologies, however, should be free from regulatory interference. Second, ratings firms should be subject to robust, periodic inspections by regulators to check they are complying with their processes and policies. If they are found not to be, they should be subject to regulatory sanction.  Regulation should require high levels of transparency about ratings methodologies, models and performance, to help investors compare ratings and form their own view of the soundness of the rating analysis.

The meaning and use of ratings should also be clear, including their limitations and the level of risk inherent in the rating. Ratings on new, complex securities should be differentiated and consideration should be given to requiring issuers of these securities to disclose publicly information about these transactions that is currently provided to ratings firms confidentially. Ratings agencies must be accountable to regulators, which would provide the market with assurance that the ratings process has integrity. That should be the case whatever their business model, as all models - whether investor-pays, issuer-pays or government-pays - carry potential conflicts of interest and different levels of transparency. Policymakers should encourage competition between groups with different business models and investors should be free to decide on the credibility of ratings agencies according to the quality, integrity and performance of their ratings. Finally, governments must look at how ratings are used by regulators and investors. If ratings are used as benchmarks of creditworthiness in regulations such as Basle II, other benchmarks should be considered as well. That would help avoid inadvertently encouraging investors to depend excessively on ratings, rather than treating them - as they should - as one of many inputs in decision making.

Indian Capital Markets during the last week continued to trade in a narrow range with a positive bias.  Both the Indices Nifty and the Sensex closed moderately higher by around 3% following strong sentiments witnessed in the global markets which resulted in continued unwinding of short positions in the local markets.  On the domestic front, the good news came mainly from the inflation front.  Inflation has now touched a new 20 year low of 0.44%.  Going ahead it looks likely that the Indian economy could see inflation getting negative.   Reflecting the tough economic environment, IMF in its recent forecast has commented that the Indian economy is slowing down and the outlook for the next year remains uncertain.  The IMF expects India’s GDP growth would slow to 6.3% in FY09 and to 5.3% in FY10.The pull-back rally witnessed last week was largely on the back of FIIs, who turned net ‘buyers’ after 19 successive sessions of ‘selling’.  Last week in four trading sessions from 13 Mar 09 to 18 Mar 09, FIIs bought securities worth 975 crs in cash segment.  They were also net buyers to the tune of more than Rs. 2000 crs in F&O segment.  This has squeezed out most of the ‘shorts’ in the market.

Markets are likely to turn ‘highly’ volatile in the coming week, which also is the ‘expiry week’ in the F&O segment.  Large build-up of positions is hence not expected to happen, in view of ‘uncertainty’ due to general elections.  FIIs ‘action’ and Global news-flow is likely to drive the markets in the coming week.  Market is also now expecting further monetary action from RBI very soon.  Expectations are building around cut in benchmark rates and even CRR and SLR.  Positive action by RBI on this front will definitely cheer up the market.
( ** this is the transcript of the weekly column I write for Economic Times )