Real Reasons for the current Stock Market Rally

Since mid-April 2013, the stock markets are going up. Whilst US Fed Chairman has warned about the bubble formation on 8th May 2013, the markets continue to ignore him.

As we hear during the bubble formation the market pundits and bulls says 'this time it is different'. If we notice, the stocks that participate in the rally are few.

At least in Indian context (to a great extent applicable in the USA) most of the stocks are not participating in the increase in stock prices. Only those stocks listed in index are moving up.

What are the reasons for the rally? Whilst the bubble formation is evident and there are lot of justifications, Financial Thoughts believe that the major reasons include the following:

1. It is evident that the financial and commodity markets in the world are controlled by a few power entities based in the west. The commodities may be produced in Asia or Africa or South America - but the price of major commodities is still fixed mostly by the traders in the West as in 19th century. They have powerful media backing them up - who throw out articles for world consumption. For instance, the newspapers and other media still rely on mostly Reuters or Bloomberg.

2. A few institutions and powerful people in the West decides which financial assets or commodities to rise in the next year and they invent reasons. For instance, they said Gold is good for uncertain times and they promoted gold to new heights - entire world participated in the chorus. However, was it uncertain times? Ask Warren Buffet and similar investors who did not even bought an ounce of gold - now the same people who have promoted the gold has turned bearish all of a sudden & they have shorted it and profiting on its fall. Well - the media around the globe is spinning stories why Gold is a bad investment.

3. After ditching the Gold, the funds has to find some investment opportunity. They turned to Equities. They also fear that if the Fed increases rates, then bond prices will crash - so they are also selling bonds - and they have a problem of where to invest. They are not happy with US treasury rates. So they have decided to create a bubble in equity markets. And this bubble will get over and the media will write stories how fools got into the bubble and got themselves destroyed!!

One of the common patterns observable in these manipulated market is that there is an inevitable jump in the equity index towards the end of the session. Even if the market is flat, during the last 20 minutes some of the index stocks - especially those with higher weightage - to the index will move just to show the public the 'manipulated rally' is still on.

This is very true in Indian situation. The fundamentals haven't changed much and the oil prices are still high - recent current account deficit has increased. Moreover, Indian rupee is depreciating  against dollar, which will result in imported inflation.

Although they say WPI is reducing, this is stated to be "'a managed number" by changing the mix within it. Ask Indian consumer who will say that he is experiencing price increase across the board - this is not a surprise. Since India is adding a population equivalent to Australia every year, the demand for all items - especially food - is on the rise. Any rumour of lack of monsoon or lower agriculture production sends the prices high. No wonder food inflation is around 10% - and big surprise that the WPI is still dropping.

Let the investors be warned - don't be hyped by the media or the FII driven rally. All FII hope to sell the stocks and indices at high prices to Indians directly or indirectly (read mutual funds, etc) and make their money and get out.




 

An Interesting Indian Story -

One of my friends has recently emailed me a story . Hence, the authorship belongs to someone else. Since it is interesting I am hosting it in this blog. 

Ant & Grasshopper

The Ant works hard in the withering heat all summer building its house and laying up supplies for the winter.

The Grasshopper thinks the Ant is a fool and laughs & dances & plays the summer away.

Come winter ,the Ant is warm and well fed. The Grasshopper has no food or
shelter so he dies out in the cold.

Indian Version

The Ant works hard in the withering heat all summer building its house and
laying up supplies for the winter.

The Grasshopper thinks the Ant’s a fool and laughs & dances & plays the
summer away.

Come winter, the shivering Grasshopper calls a press conference and demands
to know why the Ant should be allowed to be warm and well fed while others
are cold and starving.

NDTV, BBC, CNN show up to provide pictures of the shivering Grasshopper
next to a video of the Ant in his comfortable home with a table filled with
food.

The World is stunned by the sharp contrast. How can this be that this poor
Grasshopper is allowed to suffer so?

Arvind Kejriwal stages a demonstration in front of the Ant’s house.

Anna Hazare goes on a fast along with other Grasshoppers demanding that
Grasshoppers be relocated to warmer climates during winter.

Amnesty International and EU criticizes the Indian Government for
not upholding the fundamental rights of the Grasshopper.

The Internet is flooded with online petitions seeking support to the
Grasshopper (many promising Heaven and Everlasting Peace for prompt support
as against the wrath of God for non-compliance) .

Opposition MPs stage a walkout. Left parties call for ‘Bharat Bandh’ in
West Bengal and Kerala demanding a Judicial Enquiry.

CPM in Kerala immediately passes a law preventing Ants from working hard in
the heat so as to bring about equality of poverty among Ants and
Grasshoppers.

BJP wants Sonia Gandhi’s apology.

Pawan Bnasal in Rail budget allocates one free coach to Grasshoppers on

all Indian Railway Trains, aptly named as the ‘Grasshopper Rath ‘.

Finally, the Judicial Committee of SC drafts the ‘ Prevention of Terrorism
Against Grasshoppers Act’ [POTAGA], with effect from the beginning of the
winter.

Kapil Sibbal makes ‘Special Reservation ‘ for Grasshoppers in Educational
Institutions & in Government Services.

The Ant is fined for failing to comply with POTAGA and having nothing left
to pay his retroactive taxes, it’s home is confiscated by the Government and
handed over to the Grasshopper in a ceremony covered by NDTV.

Arvind Kejriwal calls it ‘A Triumph of Justice’.

Baba Ramdev calls it ‘Socialistic Justice ‘.

CPM calls it the ‘Revolutionary Resurgence of the Downtrodden ‘

Obama invites the Grasshopper to address the UN General Assembly.

..
..

Many years later…

The Ant has since migrated to the US and set up a multi-billion dollar
company in Silicon Valley ..

100s of Grasshoppers still die of starvation despite reservation somewhere
in India …
As a result of loosing lot of hard working Ants and feeding the
Grasshoppers, India is still a developing country!!!

GOOD NEWS - RBI CUTTING THE RATES & INDIANS REDUCE THEIR GOLD CRAZE

Finally the wholesale inflation in India is below 6%. Some critics say that this is nothing but a ‘managed’ inflation reduction by changing the reference data. It is ok to do so as long as it is not a blatant invention. Those who know how company’s announce earnings know that there is some earning management. Hence, when a sovereign releases its earnings equivalent economic data, some management is acceptable. Another bunch of critics say that these figures are related to wholesale prices & not the consumer prices. They point out that the consumer price index may still be above 10%. Well, what we want is rate reduction from RBI and if the reduction in wholesale inflation will help to achieve that, we ought to welcome it. Hopefully, consumer inflation will reduce in due course.

How much RBI will cut the rates on 3^rd May 2013? Stock market has rallied – Nifty has nearly touched 6000 level despite poor earnings by some corporates and low Indian growth rates. Some die-hard optimists predict 0.75% cut, a few brokers expect 0.50% cut while bankers such as Barclays, RBS predict 0.25% cut. Financial thoughts believe 0.25% is more reasonable as RBI has already reduced the rates by 1% already.

Will the markets zoom further? It all depends also on political risks- the mother of all risks!. It is a fact that UPA is a minority government and relies on outside support-which can be gone in day or two.

Ever since humans invented ‘private property’ encroachment of neighbours property exists and a form of greed. China is no exception as it clandestinely entered into Indian Territory.  They do it with all their neighbours – Vietnam, etc. China’s economic encroachment has left millions unemployed in several countries; however China did supply cheaper goods by ensuring that a significant portion of their own population worked under conditions of ‘near slavery’ or bonded labour. Whilst China’s economic encroachment is acceptable in the spirit of competition and capitalism, the border encroachments cannot be justified in any manner.

Any escalation is border-dispute with China and mini war could be yet another risk-well a sort of ‘black swan’ risk. Probability of this happening is negligible; but impact would be severe.

Indians Loose Billions in Gold

Forbes recently reported that hedge fund gurus John Paulson and David Einhorn who invested heavily into gold has lost more than USD One billion when the gold price became bearish during mid-April spooked by fears of sale of gold by Cyprus bank.

No one reported how much Indians as class of investors lost in this gold debacle. During the last one year, whenever I met Indian businessmen who frequents between Dubai and India, they mentioned the craze of Indians for gold. They lost trust in real estate (due to several scams), stock market and chit funds (again there are several scams). So the funds were flowing into gold. Even RBI or similar authorities have come out with a report saying that Indian bank deposits recorded slower growth because Indians pumped money into the gold instead. The result was that Indians imported gold in tons – over the last couple of years, Indians imported and horded gold worth USD 120 billion. So, Indian investors might have lost more than USD 10 billion when the gold prices tumbled sharply.

Manmohan Singh's Magic

Indian Economy was growing at a reasonable 6%-7% with petrol prices at Rs 50/- even when the crude oil prices hit USD 145/- during 2008. After 5 years, the oil prices are around USD 100/- but petrol prices in India has gone up by 20% to Rs 70/- thanks to poor foreign currency rate management by RBI. This resulted in imported inflation in a country with net imports.

Manmohan Singh and team, along with back seat driver (Congress President) made a mess of everything.

RBI Governer played a huge role - he started hiking interest rates when inflation was 9%. But the inflation continued to climb while Indian growth rate fell to 5% from 7%. http://www.financialstrategyonline.com/2013/03/discussion-on-rate-hikes-that-killed.html

I cannot help adapting a cartoon from the internet sources, which is given below

 

Are bank deposits safe? or are they high risk assets?

If you ask any financial advisor, they will classify fixed deposits as one of the safest financial assets that earns low returns. Well, low risk, low returns - as the theory says.

Those who support equity market related investment schemes would be quick to point out that the bank deposits are losers eventually - in terms of purchasing power. This is because of the fact in most cases the bank deposit interest rates are lower than the inflation and hence in the long run, the purchasing power of the bank deposits goes down.

But ask Cypriot depositors - they will tell you that the bank deposits are 'low return assets; but with high risk' - you can lose the principal invested in the deposits.

Yes, now-a-days the bank deposits have become high risk assets!!

Deposits of more than €100,000 at the banks of Cyprus would lose 37.5 per cent in money which would be converted into bank shares, according to a recent finance ministry decree. Depositors get some near worthless bank shares - usually it is the Governments who bailed out banks. Now it is passed on to the depositors.

Additional 22.5% cannot be withdrawn as it will be parked in a special reserve without earning any interest income till the banks complete the financial restructure.

This is a big warning sign - this new trend of asking the depositors to rescue banks will change how financial system works in many countries. Any deposits over and above the sums insured by 'desposit insurance' is liable to be confiscated. Let us have a quick look what is the maximum amount covered by deposit insurance in a few countries:


USA                       : USD 100,000
European Union     : EUR 100,000
India                       : INR  100,000

In your Scenario analysis, you may wish to add the following

- What would you do if your country's finance ministry confiscated your hard earned deposits to bailout the banks?
- What is the logic of asking you to take personal responsibility for poor lending practices of the  those banks?

At least it is better if they read and understand the principles of good credit (lending) risk analysis and management.
http://eu.wiley.com/WileyCDA/WileyTitle/productCd-1118604911.html

MASTER STROKE BY WARREN BUFFET

Recently, Warren Buffet hit the headlines again due to his acquisition of an ‘elephant’ along-with an investment partner. We are referring to Warren Buffet's acquisition of Heinz. However, the deal smacked something unlike of Warren Buffet. Why? Warren Buffet is known to be value investor or a bargain hunter. Well he was till late 1980s- however thereafter Warren Buffet changed his investing style. He began to ardently follow the advice of his business associate Charles Munger that it is better to buy a good company at a fair price than a fair company at a cheap price. This slight change in the investment philosophy has done wonders to the investment career of Warren Buffet.

Acquisition of Heinz was done at USD 28 billion. Warren Buffet and his Brazlian investment partner had paid 20% more than the market. There were criticisms that they overpaid for this acquisition. Did Warren Buffet overpay? Has Warren Buffet moved away from his investment principles? Financial Views will examine a few points below as to why did warren buffer pay 20% more than the market?

1.       Warren Buffet knows its trackrecord. Warren Buffett’s file on Heinz goes back to 1980. Heinz has been incredibly consistent over that time. During the last 5 years, the company have recorded strongest performance to date, with a ROE (return-on-equity) of 32%. Heinz has a nearly 60% market share in the U.S. ketchup market, but only 25-26% international market share. So, Warren Buffet has identified a company with potential to grow further in international market.

2.      Strong dividends: Warren Buffet may not pay dividends to his shareholders; however Warrant Buffet’s fancy for dividend paying companies is well documented (Recently Warren Buffet came out with a clarification whey he is not paying dividends to shareholders) Heinz’ dividend growth rate has increased over the last 5 years. This trend will accelerate after the company is taken private.

3.      Growth opportunity : Since late 1980s, Warren Buffet penchant for growth companies is well known. Warren Buffet likes increasing strength of Heinz’s in China, India, Brazil and other “emerging” markets. In this way, this investment by Warren Buffet has some similarities to his investment in Coco Cola Warren Buffet might also have noticed the Heinz strategy of buying local brands in these markets to speed up the access to introduce its own global brands.

4.      Paying for him first: Even if someone argue that there is overpayment, Warren Buffet has played the game in his favour. Warren Buffet (through Berkshire Hathaway) gets preferred shares (with warrants). The structure of the deal is favourable to Warren Buffet. Warren Buffet invested $4.12 billion in Heinz common equity, another $8 billion in preferred shares, (and gets warrants). 3G Capital contributed $4.12 billion of equity, the rest financed by $7.1 billion in acquisition finance, by Warren Buffett’s darling banks, Wells Fargo & Company (WFC) and JPMorgan Chase & Co. (JPM)).

5.      Future Cash Inflows: Warren Buffet obsession with cash is also well-known. So what does Warren Buffet will receive in return for his massive investment in Heinz? Assured $720 million (pre-tax) a year on his $8 billion worth of preferred shares with a 9% yield, and dividends on equity shares of $4.12 billion, which could fetch a dividend yield of 10%-15%. Hence, Warren Buffet could enjoy  a billion dollars inflow from this deal + capital appreciation possibilities.

 

At a time when US treasury offers just 0.25%, this deal has all features of a master stroke by Warren Buffet.

Discussion on rate hikes that killed Growth

Recently RBI Governor (RBI-G) D Subbarao addressed IIT-Kanpur Alumni and made some observations. http://www.moneycontrol.com/news/economy/5-6-growth-not-sufficient-says-rbi-governor_833324.html In fact RBI-G is admitting that his own policies since 2011 were wrong! Financial Thoughts(FT) have taken the key sections of the speech and provides some comments, which are captured below:

RBI-G:  “Growth rate of 5-6 percent is not sufficient for the economy, which has the potential to grow at double-digit rate provided some issues are addressed”

FT Comments: To achieve growth, proper monetary policy is needed. The interest rates have to reduced - which RBI had increased during 2^nd half of 2011. Since then the growth rate was on the downward trend. Correlation between rate hike and slowdown is well established.

RBI-G: “Pointing out some of the long-term challenges for the growth, Subbarao said there was a need for stable and predictable macroeconomic environment, removal of infrastructure deficit, skill improvement and job creation. He said there is also need for raising agriculture productivity, and improvement of social sector outcome.”

FT Comments: RBI clearly failed in this. Whilst RBI is supposed to be a guardian of foreign currency exchange rate, they have failed abjectly. Once $: INR was stable around Rs45/- now it has touched Rs55/- and it may fall further resulting in higher cost of fuel, which drives the economy. See the link http://www.financialstrategyonline.com/2011/12/rbis-smart-moves-taking-india-down.html On another blog post dated 21 Oct 2011 Financial Thoughts had screamed as follows:

“Those who support further indiscriminate rate hikes must go back to US in 2006 when US Fed was blindly hiking the rates in pursuit of a mirage, which achieved nothing but a fantastic economic collapse in 2008”

RBI-G: "We are quite happy that India is growing at 5-6 percent, but I must tell you that is not sufficient. That is much less than our potential ... unless we grow at 9-10 percent year on year for about 10 years we cannot pull hundreds of millions of people out of poverty," 

FT Comments: Totally wrong! In fact many Indians are unhappy in way things are mismanaged and brought to this level. 

RBI-G: "India consists of the largest number of poor people in the world. India has more poor people than the entire economy of South Africa," Subbarao, who is also an alumnus of IIT Kanpur, added.

FT Comments: For the sake of poor, put the economy back on track on 9% growth rate. Studies have proven that since liberalisation in 1991, the Indian Poverty has dropped because of the growth in the economy. Even slums in India have a TV set and two wheelers which during 1980s was the luxury of middle class. Post liberalisation, middle class migrated to four wheeler, however it becomes unbearable now due to the hike in fuel costs, thanks to RBI whose foreign currency management has exacerbated the issue. 

RBI-G: “Inflation is still high and stubborn. Balance of payments is under stress. Decline in investments is a worry. Investments not taking place today, that's a worry," 

FT Comments: Very sad to hear this as the interest rates were hiked in the first place to curb inflation!! Secondly investments will not take place if the debt finance is costly.  Thirdly with the slowing growth in India, there are other countries with better profitable opportunities as far as FII and FDI are concerned. FII and FDI deploy their capital not for charity; but for profit. Right now, India is not the second fastest growing economy but the third or fourth!

RBI G: "So people worry whether we have got derailed from the high growth trajectory. My short answer to all those questions is that the India story is still intact and India's growth story is still credible," he said.

FT Comments: Whilst Indian Growth story is still credible, we wait for a radical change in RBI policy or a new RBI Governor similar to Bimal Jalan to rekindle growth in the economy.

Financial Thoughts also believe that Narendra Modi, who has an excellent track record in ruling Gujarat must be given a chance to rule from New Delhi. Whilst many will point out to 2002, Financial Thoughts would like to point out to the role of congress leaders during 1984 massacre in New Delhi.  Financial Thoughts do not support any type of massacre or violence (as it reminds the chimpanzee past of humans!? Real humans are more evolved and sophisticated and do not indulge in violence – learn from Mahatma Gandhi or Martin Luther King)

With Modi at helm, the probability of India growing at 10% and becoming an attractive investment destination of the world would be a reality.