New Lows all over the world .... see further slide in India ....

As we have been maintaining time and again, we are still to see the worst. The bulls will have to wait for at least another six months before they can really assert themselves.

There appears to be only one solution left to the Central Banks across the world to get out of this mess - print more currency. With inflation likely to remain in control, they will find enough support of the economists to justify printing more currency. Otherwise interest rates will start rising putting more pressure on an already beleaguered financial and economic system. The problem gets postponed to another time, another government and another set of people.

India appears to be a bit insulated from the problems and that gives us reason to be optimistic of a turnaround SIX months from now - a timeline that we had originally indicated in July 2008.

We mentioned two stocks last week - Reliance Infra and Bartronics. Reliance Infra has now declined to more attractive levels and is likely to be available at a good price in the next few days. Bartronics is good, but the problem is its weak balance sheet. And that probably is the reason why it is available at a low PE multiple. It is a stock that one should keep in radar, to be bought after the markets have bottomed out. It also has a substantial US exposure, which could present all kinds of problems in the near term.

Reliance Industries is another stock that has been strong - thanks to the KG basin news flow. However, rumours have also been going around about the huge losses that the group has incurred in the derivatives market. We don't know how much truth is there in this, but there is generally no smoke without fire. So here too one can wait for a while before taking the plunge. It is a much safer buy closer to 1000 levels or after a few months, when more bad news gets priced in. If there is any truth here, it has to come out pretty soon.

The conservatism of the Indian banking system is paying off for us. The crazy derivative instruments created by the over smart investment bankers are finally devouring the banks. The debt and equity markets provide different risk return profiles. Unfortunately, the investment bankers have left no difference between the two - debt has become as risky as equity and that too for marginal returns. The government has played into their hands by keeping interest rates too low - no reward for saving. All investments became risky and this is the price that has to be paid. We are seeing the same thing happen here as well. The only fortunate thing for us is that we don't have a deep derivatives market. A simple blunder that continues to be perpetrated in the name of economic revival - so the problems will keep recurring every now and then.

Vivek Bhargava

US Stimulus package through ... Interim Budget today ... nothing much to go after this ....

The stock markets have been rallying so far on all kinds of false expectations being built in the minds of investors. Several stocks had been pushed up sharply prior to the Railway Budget and see what happened. Same thing has been done for the Interim Budget, which is to be presented today. And the result will be the same.

The US, European and Japanese markets have been struggling and the possiblity of a big sell off when crucial support levels are breached will create panic here too. The $787 billion bailout package will not be enough according to most analysts. No one wants to talk about the price at which toxic assets should be taken out of the system. At current prices, most of top US banks would turn insolvent and a higher price will be difficult to justify to the tax payers. Interest rates in the US have also become difficult to handle. Most economists expect US to print currency, which will be highly inflationary, and only postpone the problem by a few more years.

The restrictions on H1-B hirings by US companies that seek government funding is likely to negatively impact on our software business. Why this restriction, beats us? The loss of jobs is mostly in other skill-sets, and this restriction is not going to be of any help, but then a mix of politics and economics is what compounds problems. Also, H1-B visa hirings ensure spending in the US iteself. If this move were to encourage more off-shoring, then it would be even worse for the US economy.

The decoupling theory has come back again. Chinese market has risen by 35% or so from the bottom and our markets too have been holding. One can certainly say valuations are cheap for the small and mid-cap companies, but to say that valuations are cheap in the large cap companies is definitely not correct. In the small and mid-cap companies the major problems are illiquidity, transparency, poor information flow, accouting issues, weak balance sheets, etc. The ones that do not have these problems aren't really that cheap. The operators are at play, and they are using rumours and volatility to their advantage to lure investors.

On company specific front, Reliance Infra and Bartronics attracted our attention. Reliance Infra announced another buyback program for purchase of Rs. 700 crore worth of shares over the next two months at a maximum price of Rs. 700. They seem to have enough confidence about their liquidity position and that's a big positive in this environment. Bartronics has bagged a project from Delhi MCD to set up 2000 kiosks on a BOT basis, from which it expects to earn revenus of Rs. 5000 crores over the next 9 years. It is an interesting project, which might be emulated by other State Governments throwing many more opportunities. Both these stocks present a good investment opportunity on declines.

The markets are poised at critical resistance levels. An extremely bad Q3 had to be followed by some semblance of recovery - both in price and volumes. This is what we have seen from the January data and it has helped the markets to stabilize and regain some of the losses. But sustainability of these numbers may get questioned again when the February data starts to come out in March.

We believe that there is still time and a fall is imminent sooner than later. This is the time to start working on your shopping list for the next discount sale!!.

Vivek Bhargava

Frauds make money for investors .......and it's not just companies that do them.....

Well, this is another way of looking at it. As we have mentioned in our earlier articles, fraud is always behind every bull market. Satyam may have been at one extreme end, but is there any doubt that it made money for the early investors. Is there any doubt that the dotcom fraud, in which both the entrepreneurs and analysts and big investment bankers were equally involved, was a windfall for the investors who got in early. The commodities boom, especially the last stage in which the fraud was perpetrated by the analysts and investment bankers, was also a windfall for the early investors. The real estate story was another joint effort of the promoters and the market players. Promoters used shady accounting practices and market players invented new models to justify crazy valuations.

Greed is at the core of capital markets and that's why frauds are an intrinisc part. In an earlier piece, we had warned readers to wait for frauds to get uneartherd during bear markets. when the abitlity to carry on the fraud becomes increasingly difficult.

During bull markets it's very normal for promoters to fudge numbers to show fantastic growth and profits. That's when they want to sell shares, either from personal account or from the company - most of them don't care whether the money comes into their account or into the company. It's theirs - that's how they view it.

And now the reverse will happen. You can see promoters buying back shares, or companies buying back shares. To make investors sell them, they will now deflate the profits and even show losses for the next few quarters. That's the cycle that keeps repeating. As long as you work in this cycle, you will make money. The names keep changing, the investors become wise to old names, but new ones keep coming. These are the companies that give you maximum returns on the way up and take away everything from you on the way down.

So fraud, from any quarter - be it a company or a market player - will help you make super returns as long as you can recognize them for what they are. Atleast 500 companies would have gone public from Hyderabad alone over the last 15-20 years. How many good ones are there now?

Bear markets give you the opportunity to pick and choose the good ones at your own value and in your own time - so make the best use of it. This is where you can pick up good multi-baggers, but have patience. We are not yet through with the bear market.

Vivek Bhargava

Infrastructure .... is this the next scam to come out?

Infrastructure and IT were two sectors that were shunned by investors ten years ago primarily because the companies in these two sectors could easily fudge the numbers. Since then these two sectors have given the most fabulous returns to investors. Companies have grown at a terrific pace to attain unbelievably mammoth size, propelling growth all around. The Satyam fraud has opened a Pandora's box for the IT sector. Many more scams will get unearthed if the authorities were to look deeply.

Gossip in financial circles in Hyderabad suggests that the numbers in Maytas too may have been fudged by a huge margin. The reported turnover and net profit for the year ended March 2008 were Rs.18,739 million and Rs. 907 million. The grapevine has it that the actual numbers are far lower than this. We do not have a way to find out, but after Satyam, anything is possible. While here it may be a case of bogus turnover and profits, there is another scam of a different kind that may be lurking.

Most EPC contracts provide for a Mobilization Advance of 10-15%, which is paid at the time of the award of the contract. Look at the size of the contracts that are awarded these days - anywhere from a few hundred crores to a few thousand crores. The mobilization advance itself is a sizable amount. Many cash strapped contractors will now do anything to bid for new contracts at the lowest possible levels to win the contracts and lay their hands on the mobilization advance. By doing that they can defer their problems to a future point in time in the hope things will improve. This will be detrimental to the good quality players because they lose out on the opportunities.

Accounting irregularities are quite easy to manage for infrastructure companies. Cash transactions form a substantial part when compared with IT companies. Turnovers can easily be shown and so also profitability. Here again, our advice is to look for companies whose cash flow management has been superior to others. Look for companies that have low debt, normal receivables and a long history of integrity. None of these are difficult to check for the keen eye.

With Maytas too under close scrutiny, there is a good possibility of some scam being unearthed there too, which could play spoilsport for the entire sector. Unfortunately, there aren't any Infosys and TCS calibre companies here (other than L&T).

Vivek Bhargava

Q3 numbers .... bad numbers discounted ... good ones will be seen with suspicion ...

Other than a few companies, most groups and companies have always been looked at with suspicion. The numbers aren't going to be great for a lot of companies, especially in the manufacturing sector. The liquidity crunch during the last quarter would have impacted the business for most companies. The early birds generally come out with decent numbers. The problem is with the bad set of numbers that invariably get postponed to the last days of the month. The good ones will be seen with suspicion - from the point of view of both - genuineness and sustainability. The market may react positively to bad numbers if they are not as bad as expected!!

The Obama stimulus package is getting diluted with difference in views on how it should be structured. Economists do not favour tax cuts as there is no guarantee that these will result in creation of demand. They are more in favour of increased spending in infrastructure to meet the shortfall in consumer spending. The counter view to this has been that infrastructure spending will not help those who have lost jobs. All this is likely to delay the announcement as well as structure of the package. The uncertainty has led to a reversal of the rally in commodity prices.

Meanwhile, the problems for the banking sector are not over. Bank of America needed a substantial bailout package. Two more US Banks have failed last week. The auto industry will again run out of money in a month or so. Oil, after a brief spurt to $47 levels, has again tanked to $36 levels. The global scenario is expected to remain gloomy for most of this year. In India, Satyam episode has shaken the faith of investors. Elections are now a few months away. Once we enter a quiet period there, the Government's ability to support markets, through stimulus packages, will be doubtful.

On the positive side, inflation has come down. Interest rates have been brought down too. Liquidity has eased considerably. However we do not believe that this will help in a quick revival. The biggest uncertainty for the markets and the industry will be the elections. Whatever forecasts are available as of now, do not make a pretty picture. The two large parties seem to have little chance of getting more than 60% of the required majority on their own. So we are likely to have another khichri government (which may be weaker than the present one), and that can be a scary thing for the markets.

The best case scenario for the markets is to linger sideways. And the worst case scenario is testing the previous lows and possibly creating new lows. Given the weak global scenario, the second one is quite likely over the next three to four months.

Vivek Bhargava

Satyam fraud terminates the rally .... Hyderabad companies lose credibility ...

The markets, which seemed to be coasting along nicely, were brought to an abrupt and steep decline after Satyam news came out. The rally would have otherwise gone along for another week or two, but now there is no chance of it sustaining. Bear markets have this amazing feature of new developments that bring about abrupt and steep ends to bear market rallies. We had been talking about 10th January 2009 earlier and were even thinking that the rally might last a little longer than that, but it was not to be so.

The markets now have a fundamental problem that goes to the heart of valuations. Can we trust the earnings of companies, especially those that don't have a history beyond the previous bull market. Frauds are invetiable whenever the market foolishly (or sometimes through deliberate manipulation) values companies at ridiculous levels. The dotcom bubble was a fraud by the analyst / fund management community on the investors. Several corporates also were party to it. These are the hazards of investing in equity markets. Fortunately we have something called a BEAR MARKET which purges the system. We believe that is exactly what is going to happen over the next 12-24 months. The bear market may end in the next 8-10 months, but it will take much longer for investors to trust companies.

Hyderabad companies have taken another hit on their credibility. Other than a few companies, Andhra Pradesh has not produced comapnies that could grow over long periods of time to become large enterprises. There are likely to many more frauds / failures on the cards over the next four quarters as cash becomes tight and the business environment becomes tougher. Hyderabad companies will have to work that much harder to overcome this stigma.

The crash of the financial industry is to do with the greed of the financial intermediaries. It is not a coincidence that the whole financial system is crashing down together across the world. The biggest culprits are the governments and central banks that have tried to use monetary policies that provided short term fixes and postponed the problems by every few years. What is happening is no different now. Pushing interest rates down to below inflation levels has created a scenario of negative real rates of return driving investors to take risks. The financial intermediaries have pounced on this opportunity and played around with investor money. The demand always is always to reduce interest rates and make credit easily available. No one wants to talk about reduction in prices, which are the real cause of the problem. Instead of allowing things to cool off on their own, the governments across the world have only been dropping interest rates and providing higher and higher money supply, thereby sowing the seeds for a bigger problem every time. The situation is the same all over the world.

The markets will bottom out as the increase in liquidity starts showing effect in a year or two and then we will have another bull run by 2012!!

Vivek Bhargava

Satyam Fraud .. unbelivable ... but not entirely surprising ...

Here is an excerpt from our 15 December 2008 commentary. We never expected Satyam to be the first one on our list.

"Every bull market has its share of fraud companies. They somehow declare fantastic results and manage to give the most spectacular returns on the way up. Investors typically chase them on the downturn because they appear to be cheap. These are the ones that do most damage to our portfolios. Fortunately, the bear market filters them out and you have a clean lot at the end of the bear market. Give another four quarters and you will know the difference between the good and bad. Till then stick to companies that are old with proven track record and have size and liquidity. "

It's quite normal for frauds to come out when the market stops supplying companies with easy cash. While there we always doubted the integrity of Satyam, even we are shocked at Ramalinga Raju's disclosures about the fraud in Satyam. He says the cash was never there. What does this mean?

We don't know, but here is what might have been done.

Entries were being passed to show fictitious revenues. To show receipts against these bogus billings, fictitious bank accounts were opened in the 'books' of the Company. Entries must have been passed to show that money was received from bogus clients and parked in these fictitious bank accounts. To ensure that auditors don't question these things, several documents would have been forged - bank statements, documents required from autorised dealers as paperwork for overseas remittances. Regulators don't get wind of these things because they were not even involved. It's unlikely that anyone is relating the data in the Annual Report to the data with the Authorised Dealers.


Perfect paper work would ensure that the auditors don't get wind of all this. The directors have no way of knowing all this. After all they are there only at Board Meetings and have to rely on the information given to them. Even in their wildest dreams they could never have imagined such a big fraud was going on under their nose. We can't blame the Directors or senior management team because the financial matters are based on the documents made available to them. Someone who has gone to a fraud of this extent would easily have fudged all the papers to the Board as well. When the auditors also haven't got a whiff of this fraud, how can one expect directors (who are not party to this) to have any idea about this.

Old timers in the market will remember similar frauds - Fairgrowth Financial Services Limited, Bangalore, which had been issuing bogus Letters of Credit and had been forging all the related paperwork.

This fraud may have gone on for more than a decade. The 1998-2000 period was a fatastic period for these companies. By merely selling a small fraction of their stake they could raise plenty of cash to make the balance sheets healthy and growing. As IT industry started losing fancy, the currency dwindled and it became more and more difficult to cover up the fraud. Many companies would have done this of the last four years - in the name of infrastructure, mining, etc. Whenever the market starts valuing companies beyond reasonable fair value, it makes fraud a viable business proposition.

There are only two criteria that can separate the good companies from the bad:
- how much tax are they paying?
- how much dividend are they paying?

Any company that pays a good amount of tax and has a good payout ratio, especially when the stock markets are down, is definitely generating good cash flows and deserves a premium valuation.

SATYAM FRAUD HAS CHANGED THE WAY INVESTORS WILL LOOK AT COMPANIES.

INVESTORS WILL NOW ASSUME THEY ARE GUILTY UNLESS THEY ARE PROVEN NOT-GUILTY.

Vivek Bhargava

A good start to the new year .... commodities will lead the way ...

The markets are gaining momentum especially with the strong gains in commodity prices. We will look at some of these things in greater detail over the next week or two, but here are some of the reasons that WILL provide a good rally in commodity prices and therefore a good jump in all the related commodity stocks:

• stimulus packages, especially the Obama package, which is quite substantial in size at around $800 billion
• likely weakness of the US dollar, because of too much supply expectations
• an extremely sharp fall in just 6 months that erased 3-4 year of gains almost without a decent and protracted bounce back
• near zero returns from debt markets again driving investors to seek opportunities to increase their returns
• human urge to do something all the time to make money

So, with a weak dollar expectation and with virtually no returns and safety of capital from debt investments, coupled with low risk after a steep fall in commodity prices and the possbility of good returns investors WILL flock to commodities markets as the stimulus package raises positive expectations. The commodity bulls will not let go the potent combination of these factors to ensure a good pull back in prices of most commodities.

We had recommended the commodity theme on 29th November 2008 and had again reviewed it on 15h Dec 2008 saying that there is a lot of steam left in the commodity stocks. The substantial jump in commodity prices since the last week of December suggest that we will see a good rally in the commodity stocks over the next two months to get closer to their 200 day averages.

The rally will peak out as the rise in commodities at some stage starts raising questions about the revival of demand and talks of recession resume. It will still be a bear market rally, but the duration is now likely to be longer seeking a higher target than before. It will pay to TRADE in stocks that lost the most in October fall and have a long history and still have a long way to recovery. We still do not advise a buy and forget strategy at this point of time.

WISHING YOU ALL THE BEST FOR A HAPPY AND PROSPEROUS 2009. IT IS BOUND TO BE A LOT BETTER IF YOU PLAY IT SMARTER.

Vivek Bhargava

Independent Directors Resign from Satyam Board ....

Satyam drama has raised issues on corporate governance. Not surprising because the markets only focus on what they want. To us the crux of the issue is the role of Independent Directors. The media has taken-off on the independent directors of Satyam and most of them have resigned. Is the media justified in flaying the independent directors? Are investors right in assuming that Independent Directors will fight for the right thing?

The key is can Independent Directors be "motivated" and "independent" at the same time. If not, aren't the expectations too much from them?

Let's first see why people join the Boards of Companies to become Independent Directors - different people have different reasons - but some of them could be -

• adding to their status
• perks that help you get free business class trips to India.
• hope that they can leverage this position to further their own business
• in some cases, pretty decent income as commission on profits
• relationship / friendship with the promoters

Most of these goals are attained by "joining" and "continuing" to be on the Board. Since they have no financial gains from being on the Board, they really have no serious interest in the Company's affairs. The benefits they were looking for will keep coming to them as long as they are on the Board.

Now let's look at this from the Company's perspective. Why does it want "some people" to be on its Board as Independent Directors. Again many reasons, but some of them could be -

• Compliance requirement to have a minimum percentage of independent directors.
• Eminent members on the Board to increase the Company's stature.
• Professional advice.

The Directors are generally brought on to the Board by Promoters. The Promoters are happy to have people on Board so long as it doesn't cost much for them and they are benefiting from this relationship in some way or the other. And most importantly, as long as they are free to do what they want.

So both, the Directors and the Company, get what they want and do not want to rock the boat.

Bigger companies like Satyam may be following good Board practices (not the same as good Corporate Governance) - proper notices, Agenda, regular meetings, circulation of minutes, etc. Forget good corporate governance; there is a vast majority of companies that don't do any of these basic things.

The Satyam episode is likely to be a wake-up call to all independent directors who have till now assumed that they have nothing to lose. Several questions will come to their minds and make them rethink on their role as an independent director.

• why are they on the Board of the Companies?
• what benefit are they expecting / deriving from these relationships?
• what are the legal responsibilities?
• am I really competent and knowledgeable to help in key decisions that are taken by the Board?
• is it worth being responsible for something on which they have no control?
• is it worth taking the risk of being pursued by ED, ROC, Courts, Police, Media, etc?
• is it worth being hauled up in public or by media for actions of the Board, especially for decisions which they did not like but did not officially record as dissent to keep the good relationship going?

The media, investors and all regulatory authorities are of course right in expecting that Independent Directors will take the right decisions. After all it is their duty and responsibility. So what if they are not benefiting in any way!! Even If they have chosen to do this as a social service, they are still responsible.

ONE CANNOT AVOID RESPONSIBILITY FOR DECISIONS TAKEN AT THE BOARD MEETINGS WHERE THEY WERE PRESENT - THE RIGHT TO DISSENT WAS ALWAYS THERE - AND SO WAS THE RIGHT TO RESIGN.

THE CHOICE IS THEIRS. Most promoters cannot accept dissent and therefore it creates rifts and spoils relationships. After the Satyam episode many independent directors may choose to resign from Boards rather than create unpleasantness in their relationships.

AND IF THEY HAVE SOMETHING SIGNIFICANT TO LOSE, THEN THEY ARE NOT REALLY INDEPENDENT, ARE THEY?

Vivek Bhargava

Just when most people were turning bullish ... the market slides

This is the way of the markets and that's the reason why we believe one should not mistake this for a reversal. The market is still bearish and we are going to retest the lows sometime in next quarter, which is not too far away. Most of the positives are already factored in and therefore one should not become bullish based on them.

In an otherwise dull market, Satyam drama was one of the most intriguing ones from the capital market perspective. What were the Rajus thinking when they decided to use Satyam cash to buy their stakes in group companies? They have been fairly capital market savvy, and so it's hard to believe that they underestimated the market reaction. Perhaps it was personal greed that clouded their judgement. And god knows what their Board and Advisors were doing when this decision was taken unanimously!! It takes several years to build a reputation and very little time to ruin it. A good lesson for the others though!!

The markets are finding it hard to go up from the current levels despite several positive developments. So it is possible that we have seen the peak of this particular rally. Though we will see a bounce but it seems unlikely that we will cross it. We stand by our timeline of 10th January 2009 as a possible turning point where the ongoing rally will reverse. A solid bottom will be formed in the next fall.

Vivek Bhargava

More and more people turning bullish ....

The positive triggers keep coming to negate the effects of dismal news on any front to ensure that hope is kept alive and the markets don't go into a downward spin. In the last week of October we had said that the OCTOBER LOWS WILL HOLD IN NOVEMBER AND DECEMBER and the rally will continue till the second week of January 2009. We are now into the fag end of December and there is no danger of the lows being violated. The breadth has been good and there has been a lot of insider buying at lower levels. We expect this rally to continue upwards till 10th Jan 2009. The higher we go, the more dangerous it will become.

• Liquidity seems to be easing and interest rates are coming down.
• Inflation is going down as demand is evaporating.
• US has bailed out its auto firms for the time being.
• Japan has cut interest rates and is pumping funds to capitalize its banks.
• Indian government is releasing its stimulus package in instalments.
• Oil price has cooled off again despite OPEC production cuts. This is a big plus for the Indian Government because it has taken away the oil subsidy burden off its head for the time being so that it can take care of its other commitments.
• Rupee is appreciating and that is aiding investment flows into the markets.
• Obama is planning on a huge $850 billion stimulus package and also planning efforts to avoid 3 million job cuts.

The earnings for the current quarter will be pretty dismal. The outlook beyond that for the next few quarters is still uncertain and gloomy. This means that we will definitely see another fall, which could test the earlier lows, after the current rally has matured fully by pricing in all the positive news.

A lot of people are now turning bullish with targets ranging between 12K to 13K. The peak for this rally will be at a point when it almost makes you believe that the bear market is over and a bull market has begun.

So be careful not to get caught in this rally!! It is a bear market rally.

Vivek Bhargava

Market Resilience signals continuation of rebound atleast till 10th Jan .....

On 28th November we had mentioned that the market valuations are attractive and the indices could rebound by 15-20% led by the commodity stocks. That has played out so far with stocks like Sterlite (+26%), SAIL (+17%), Tata Steel (+40%), Reliance(+15%) and Reliance Petroleum (+7%) have moved up significantly. Obviously it han't been a one way upward journey, but still the gains were pretty swift and substantial. The only ones that didn't gain from our list were the aluminium stocks and the reason is that they had already recovered 30% from their October lows. There is quite a bit of steam left and we think these stocks have some more distance to go.

The sensex is now at 9690.07, having risen about 7% since 27th November. Given the market resilience last week and particularly on Friday, we think the market will continue its upward journey atleast for another three weeks. Again it will not be a smooth journey, but in the short term the trend is positive.

There are several positive triggers that can help this upward journey continue:

• Bailout of the US auto majors - Ford, Chrysler and GM.
• Cut in US interest rates by another 0.5% on Tuesday.
• Second stimulus package by the Indian Government.
• Interest rate cuts in India.
• NAV propping by funds at the quarter / year end.
• Chinese government's decision to increase money supply to fight recession, which will give a further boost to commodity prices.
• Appreciation of the rupee to 45 levels as dollar loses value.
• OPEC plan to cut crude production in a bid to push up oil prices (meeting planned on 17th Dec).

There WILL be a lot of action in several midcap stocks, especially those in the F&O space. These stocks can give as much as 30-40 percent returns in the next four weeks.

Every bull market has its share of fraud companies. They somehow declare fantastic results and manage to give the most spectacular returns on the way up. Investors typically chase them on the downturn because they appear to be cheap. These are the ones that do most damage to our portfolios. Fortunately, the bear market filters them out and you have a clean lot at the end of the bear market. Give another four quarters and you will know the difference between the good and bad. Till then stick to companies that are old with proven track record and have size and liquidity.

Good luck!

Vivek Bhargava

DISCLAIMER:The views and opinions expressed here are strictly mine. In addition, my thoughts and opinions change from time to time. I consider this a necessary consequence of having an open mind. I do not undertake responsibility to update all my thoughts and opinions on this page.The information contained herein is from publicly available data or other sources believed to be reliable. I do not represent that the information contained herein is accurate or complete and it should not be relied upon as such. The user assumes the entire risk of any use made of this information.Investors should obtain advice from their own tax, financial, legal, and other advisors and only make investment decisions on the basis of the investor’s own objectives, experience, and resources.No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this page.

Will the Stimulus package stimulate??

Finally the stimulus package was announced by the government ... 30K cr or around $6B. The size is insignificant when you look at the packages announced by many other countries. RBI has also announced another repo and reverse repo rate cut by 1%. The idea is to make borrowing costs cheaper and also provide some relief to the industry. The thrust is on infrastructure spending, especially on the highways sector. The chances that it will stimulate demand are negligible.

Government spending is always a key factor in coming out of a recession. And how the government does that to make its spending most effective and also keep a check on fiscal deficits is the key challenge. If the government comes in too soon, it will exhaust its war chest before the real problem hits and the only beneficiaries will be the smarter players who can walk out with their money and profits. It would be fool hardy for the government to spend money on infrastructure when the commodity prices are still too high. Despite the correction most commodity prices are still fairly high since a part of the fall has been negated by the depreciation of the rupee. Creating infrastructure at competitive prices is important to maintain India's competitive edge. Doesn't it seem surprising that the benchmark for 1MW was Rs. 4 crore even in the mid nineties. And even after ten years it remains at pretty much the same level despite most costs having gone up quite significantly. No wonder India could never produce power at internationally competitive rates.

This recession actually provides the government an opportunity to adopt technology in a much bigger way than before. Apart from increasing the transparency levels, the bigger benefit will the higher multiplier effect that technology spending generates. The last five years are ample proof of that. The increased prospects of a buoyant economy will raise the prospects of capital inflows for infrastructure. Private sector spending will be far more efficient that government spending. The qualification norms for any type of direct spending should be stringent to ensure that only solid players are given the business opportunity. Otherwise it will mean money spent on nothing .. fuelling only the parallel economy.

The markets have gone up by more than 300 points. This has nothing to do with the stimulus package announced by the government. It's more because of the sharp jump in all Asian markets. We had mentioned about the commodity stocks sometime back. Their price behaviour subsequently has been in line with our expectations. Globally, the markets are looking for an excuse to give a rally. Further downsides will be likely only in the first quarter of next year. Till then a rally of 10-20% at the index level can be expected. The turning point is likely to be around 10-15 Jan 2009.

Vivek Bhargava.

DISCLAIMER: The views and opinions expressed here are strictly mine. In addition, my thoughts and opinions change from time to time. I consider this a necessary consequence of having an open mind. I do not undertake responsibility to update all my thoughts and opinions on this page.

The information contained herein is from publicly available data or other sources believed to be reliable. I do not represent that the information contained herein is accurate or complete and it should not be relied upon as such. The user assumes the entire risk of any use made of this information.

Investors should obtain advice from their own tax, financial, legal, and other advisors and only make investment decisions on the basis of the investor’s own objectives, experience, and resources.

No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this page.

Terror Attacks ... markets have become resilient

The frequency and intensity of terror attacks have been going up over the years and in some way markets are developing an immunity to these events. The negative effect, if any, will not last long. What's more important is the effect the terror that is in the minds of the financial markets from the past few months. And the culprits of those events are in that sense much bigger terrorists!! They have caused much bigger damage, including destroying lives of several innocent people.

The last few days have seen continuation of announcements of steps to arrest the financial meltdown. China announced a steep interest rate cut in a bid to arrest the slowdown. European Union announced a $260 billion stimulus package to boost the economy. As we said earlier, the size of these bailouts only indicates the extent of damage that is being created. Just a while ago all the government were concerned about rapidly rising commodity prices and now they are worried about deflation. The shift has happened in just a few months - most commodities peaked in July 2008 - just four months back!!!

A look at this table will tell how some of the big Indian companies have lost in just two to three months. Tata Steel lost more than 70% in just two months, when the indicies hit a low on 27th October this year. Most of these stocks haven't recovered since then.

We expect the bailout packages to push up commodity prices a bit, which can push up these commodity stocks. And having lost as much as they have done in such a short time, the stocks may see a decent bear market rally, which can push the indices by as much as 15-20% in the next month or two.

We think the market has seen an intermediate bottom for the time being and new lows are unlikely for the moment. The markets may move sideways and move up gradually though it is unlikely to gain in confidence. The next turnaround date is likely to be around 10th January 2009. A fresh fall may start around that date till then it is going to be all right.

The risk of going long remains high. Avoid shorts for the time being. Look for shorting opportunities at higher levels.

Vivek Bhargava

Inflation declines unexpectedly to a six-month low of 8.98%.

Is it good or bad for the markets??

We think declining inflation numbers are bad news for the markets because the fall is entirely due to vanishing demand. Inflation upto a point had been good news for the markets because it always indicated strong demand unmatched by adequate supplies, giving businesses an opportunity to make extra profits. Rising inflation actually pushed up the indices and the entire rally of 2007 was due to inflationary situation benefiting corporates.

Now we are witnessing a reversal in demand, and supply suddenly seems to be too much, resulting in a crash in commodity prices and therefoe declining inflation. But we don’t think the downcycle has played out fully.

While, during the upcycle companies were announcing mega expansion plans, now they are being forced to defer / cancel those plans for two reasons: decline in demand and shortage of capital.

Declining inflation will certainly mean reduction in interest rates over a period of time, but that does not mean funds will be easily available. Companies which have strong balance sheets and have been prudent in their capex plans will certainly be benefitting, but companies that have overextended themselves will get into a big mess going forward.

We stand by our reading that the bear market still has a long way to go. The markets will turnaround only when no has any hope left and everyone is sure that the downturn will carry on for ever!!

Our good wishes are with you, and we hope that you will be able to tide over this phase comfortably.

Vivek Bhargava
(For taking this discussion further please contact me at wealthbridgeindia@gmail.com)

DISCLAIMER:

The views and opinions expressed here are strictly mine. In addition, my thoughts and opinions change from time to time. I consider this a necessary consequence of having an open mind. I do not undertake responsibility to update all my thoughts and opinions on this page.

The information contained herein is from publicly available data or other sources believed to be reliable. I do not represent that the information contained herein is accurate or complete and it should not be relied upon as such. The user assumes the entire risk of any use made of this information.

Investors should obtain advice from their own tax, financial, legal, and other advisors and only make investment decisions on the basis of the investor’s own objectives, experience, and resources.

No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this page.

Financial Tsunami reaching Indian shores ……

It’s now a few months since I wrote my thoughts about the markets and now I am being asked by a few of the readers whether we have now reached the bottom. As I said earlier, the beauty of a bear market is that bad news comes out of the blue just when you start thinking the worst is over. Who expected a virtual collapse of the financial systems in US and Europe? The problem is whom do you trust – because no one will tell you the truth. We will be too naïve if we expect the Finance Ministers and Central Banks to tell us that there are problems and things can go bad. Analysts? Most of the guys who come on TV are telling you one thing and probably doing another.

So what should one do now? While the indices have lost 50%, stocks have eroded by 80-90%. What should we do now – buy, hold or sell?

Cracks appearing in the Indian financial system ….
The drying up of liquidity in the Indian financial system is more out of fear than real problems with the banking system. Of course, during the economic boom over the last five years, banks and financial institutions would have made bad lending and investment decisions. And bad financial decisions show up over time, not immediately. And the deterioration accelerates when the economy cracks. US and Europe are clear examples of this. When growth is fed by asset bubbles, it is unsustainable and I think we are going to experience it going forward.

The urgency with which CRR has been cut by 2.5% and a liquidity package for mutual funds has been announced is a clear indication of things turning bad. I do not know if this is going to solve the problem, but I do know that the risk aversion is going to return in a big way and people will behave differently when that happens. And no amount of cajoling by the government and RBI will help.

The financial system and industry have got used to easy and cheap credit and have made big plans accordingly. Now equity and debt are going to be equally difficult to raise, creating financial problems all over the economy.

Working capital inadequacy likely to play havoc …
People in industry know what this means. Elongated receivables cycles, piling inventories, increasing risk of bad debts and most importantly the risk aversion of banks will take its toll on the growth of businesses and in some cases we are even going to see sharp decline in revenues and profits.

Falling commodity prices to create a deflationary environment …
After grappling with inflation (which was hurting the consumers), we are now likely to witness a deflationary environment that will negatively impact the topline and bottomlines of companies from price erosion. All companies that are in the commodities business will see declines in revenues because of shrinkage in volumes and decline in selling prices. The combined effect will be a steep decline in profitability. By commodity business I mean every business where the selling price is linked to its key raw materials.

Real estate bubble about to burst …
It’s been a while since people have been talking about it, but the prices have not really tanked yet. The builders, who managed to raise a lot of equity this time, were not desperate. But the funding options for real estate players are drying on all fronts. Equity is out. Loans from banks are out. And there is no easy foreign money available. They will now have to again depend on private financing, which generally comes at 24%+ per annum. Some of them are reported to have borrowed at such levels.

And where is demand going to come from? The software guys who led the end consumer demand at exorbitant prices are no longer preferred as there is uncertainty over their careers. Profits from stock markets which create demand at the peak of a bull market has vanished. Demand from real estate players who are flush with funds from earlier sales of property is down to trickle.

So we have a perfect scenario for our own meltdown in this market – exorbitant price levels, low demand, increasing supply and absence of easy credit. It’s about to happen any time now.

Cash is king…
The best thing to do is to hold on to your cash and not rush into making investment into stocks or any other asset class. Even gold will be vulnerable to declines as losses start mounting with declining asset prices. This is going to be a prolonged bear market and stocks will be available really cheap. I don’t know how people have forgotten that stocks were available at 3-4 PE multiples until 2003 and even large caps were available at 8-9 PE multiples. Are we anywhere close to those levels for some of the major ones yet – Reliance or L&T or NTPC? The answer is NO! So, given the overall economic environment, we may have a long way to go down before things turn around and confidence returns.

Vivek Bhargava
(For taking this discussion further please contact me at wealthbridgeindia@gmail.com)

DISCLAIMER:
The views and opinions expressed here are strictly mine. In addition, my thoughts and opinions change from time to time. I consider this a necessary consequence of having an open mind. I do not undertake responsibility to update all my thoughts and opinions on this page.

The information contained herein is from publicly available data or other sources believed to be reliable. I do not represent that the information contained herein is accurate or complete and it should not be relied upon as such. The user assumes the entire risk of any use made of this information.

Investors should obtain advice from their own tax, financial, legal, and other advisors and only make investment decisions on the basis of the investor’s own objectives, experience, and resources.

No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this page.

The Bear Attack ……

The beauty of a bear market is that bad news comes out of the blue just when you start thinking the worst is over. Ranbaxy and Infosys are classic examples. Everyone seemed most bullish on these two. Ranbaxy was holding out nicely while the whole market was tumbling around it thanks to the acquisition by Daiichi Sankyo. Infosys was expected to do well after a substantial depreciation of the Rupee over the June quarter. But the numbers just didn’t meet the market expectations and guidance was muted. The worsening scenario for the financial sector in US and Europe only made things worse. Both the stocks lost over ten percent in just two days.

Bad news follows declines ….
The problem in a bear market (which is backed by economic doom and gloom) is that even the companies that we talk to have little clue about what’s going on. They are not quick to realize the changes that are taking place in the larger picture. None of the companies focus on the bigger picture of the economy since they are mostly reacting to developments that are taking place from time to time. The guidance that they provide to analysts rarely takes into account the macro economic risk factors. Hardly any companies were bullish when the markets ran ahead of the fundamentals in 2005 and I can say that right now hardly any companies are bearish about their business outlook when the markets are going down. Mostly they are surprised at the valuations that are there today. To me it just means that the market expects the fundamentals to deteriorate going forward, even if the companies don’t think so yet. The market is telling us that the bad news is somewhere on the way.

Collapse of the US financial sector likely to impact IT business…
In a situation where India is now so closely integrated with the world, it’s getting more and more difficult to know everything that can affect our economy and businesses. The increased uncertainty means more risk and therefore lower PE multiples. It will be foolish to assume that the Indian economy will move strongly ahead while the world’s biggest economies are in a recession. Failure of financial institutions in US and Europe is bound to create problems for the IT companies that have heavy dependence on the BFSI space for their revenues. Most of them will have a substantial exposure. Whether it happens or not, investor must be cautious and not become overconfident even if the analyst con-calls don’t suggest any problems yet. Past performance is no guarantee for the future when there are dark clouds over the horizon.

Lessons from the collapse of Fannie and Freddie…

Fannie Mae and Freddie Mac have been in the news during the whole of last week. These two companies account for around 50% share of the US mortgage finance market. The problems with these companies are not new. Fannie Mae had reported a loss of $2 billion last year (2007) while Freddie Mac had reported a loss of $3 billion. The sub-prime issue has been in the news for nearly a year now. Bad news kept piling on to push these stocks deeper as the crisis kept escalating to a point where they are being considered by some experts to be technically insolvent. The US government has had to stand behind these two companies to assure investors only because they are “too big to fail.” The smaller ones like IndyMac face closure. Over the last twelve months, these blue chip stocks from the US have lost more than 85% of their value!!

So what do we learn from this?
The more you wait for real bad news to come, the more you lose.

1.The more you wait for real bad news to come, the more you lose.

2.If the clouds are really dark, rain will come. More bad news is inevitable if there are dark clouds on the macro economic front.

3.The third and most important take from this example is, never underestimate the power of a bear market. A lot can be lost. The post-dotcom bust had wiped out the second rung players. Most of the companies had lost more than 80-90% of the value, while even the blue chips like Infosys had lost more than 70% from the top. Even the recent crash of the realty stocks provides a similar picture with many of the smaller players losing 80% from the top, when the financial numbers haven’t even turned bad!!

History repeats itself …

History provides us a good time perspective on bear markets. A bear market typically takes anywhere from 12-18 months from the top to provide a strong bottom. We have just been 6 months into a bear market while some of the other markets have been in a bear market for a little longer than that. So what’s the hurry? We have a long way to go. Let things unfold themselves. As I mentioned earlier (July 7, 2008), the world needs to go through a structural adjustment phase in terms of commodity prices, equity markets, housing prices, currency rates, interest rates, etc, all of which are related to each other. And this process will take time. May be all this will get over by middle of next year sometime to provide a strong bottom for a sustained revival. Till then it is anybody’s guess as to what will happen and how much more we might lose.

The best thing to do…
The best thing to do is to wait out a period of 12 months from the top and then look for companies and businesses that seem to be on a sound footing. Investing at the bottom can provide you great returns with minimal risk.

Vivek Bhargava

(For taking this discussion further please contact me at wealthbridgeindia@gmail.com)

DISCLAIMER:
The views and opinions expressed here are strictly mine. In addition, my thoughts and opinions change from time to time. I consider this a necessary consequence of having an open mind. I do not undertake responsibility to update all my thoughts and opinions on this page.

The information contained herein is from publicly available data or other sources believed to be reliable. I do not represent that the information contained herein is accurate or complete and it should not be relied upon as such. The user assumes the entire risk of any use made of this information.

Investors should obtain advice from their own tax, financial, legal, and other advisors and only make investment decisions on the basis of the investor’s own objectives, experience, and resources.

No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this page.

BSE Sensex down 35%.What to expect now?

Vivek Bhargava

A question that is on every investors mind is what to do now. BSE Sensex has tanked by 35% since the peak of 20869 on 9th January 2008 to a close of 13454 on 4th July 2008. The mid cap and small caps have lost a lot more, wiping out the gains made over the last two years. The problem is should one cut losses and get out now or just wait till things improve.

Deluge of bad news

Bad news has been coming from all directions to make things worse by the day. It started with the sub prime crisis in the US, which led to the collapse of the US financial system, compounded further by a steep rise in the price of oil by more than 50% over the last six months. The world is going through one of its worst periods and the Asian markets have also been caught in this mess.

Various market experts and economists world over have differing opinions on what’s going wrong, when things will turn around and what should be done to overcome this downturn. But there is almost unanimity in the belief that the US markets are in a recession and the world is caught in a stagflation putting the Central Banks of developed economies in a dilemma.

Key points
Any effort to contain inflation by raising interest rates is likely to put the economies into a deeper recession and keeping interest rates down is likely to stoke inflationary fires. Everyone is digging into historical references to evaluate and find answers. In all this one thing is sure, the world needs to go through a structural adjustment phase in terms of commodity prices, equity markets, housing prices, currency rates, interest rates, etc, all of which are related to each other. And this process will take time.

The key points that seem to come out of the various discussions may be summarized as under:

1. US consumer confidence, which is already low, is likely to dip further once the impact of over a US$ 100 billion US economic stimulus package, dissipates over the next quarter or so.
2. Housing prices are falling in the US and are likely to bottom out only sometime next year.
3. Falling housing prices will put more pressure on the banking system in the US and Europe.
4. Credit card institutions are seeing increasing delays in collections from its 52 million customer base whose average credit rollover is around $5000.
5. Most developed economies are believed to be or getting into a recession.
6. Asian economies, which supply goods and services to the developed economies, are also likely to see a much smaller growth rate going forward.
7. Oil prices have been projected to touch $ 200 a barrel by end 2008, but there are varying opinions on what really will happen.
8. With expectations of a high inflation, commodities seem to be the most preferred investment. Equities are definitely considered a bad alternative, while bonds are also likely to lose as interest rates are raised to contain inflation.

Indian situation
In India, we have added problems on the political front. This is the election year and it is widely believed that the government will try to fight inflation, which has already run away from 4-5% levels a few months ago to over 11% now, in every which way possible. Cement and steel companies are being forced to cut prices. Exports of key agricultural commodities have been banned to keep domestic prices in check. The subsidy bill of the government is likely to push up the fiscal deficit – directly or indirectly. Capital has become scarce and costlier. Government spending in infrastructure will get squeezed going forward.

Coming from a situation where corporate India has had an easy going over the last 4-5 years, the outlook must appear quite grim. Many of the companies that had announced major investment plans might be forced to defer them till a clear situation emerges. The increase in commodity prices has been hurting profit margins during the last two quarters and things might deteriorate further in the coming quarters. The crash in the stock market and the ongoing correction in the real estate market, coupled with scarcity of capital, may adversely impact the consumer purchasing power going forward.

Bear grip getting stronger
So whether we look at India or the world at large, the outlook has definitely soured over the last 6 months. The global markets have entered into a bear phase, and going by historical experiences, bear markets can take at least 12-18 months to bottom out. Since we are witnessing a global meltdown, this could be a longer bear market and therefore we might still be quite far away from a bottom.

Considering that the bull market had started in 2003, when the Sensex was around 3000 points in May 2003, we need to get the perspective right. The Sensex had gone up 7 times over a period of 4 ½ years and is still more than 4 times the level it was at just 5 years ago.

The market crash till now has only been on expectations of bad days ahead, but we are still to see the bad news hitting growth and corporate earnings. And when it does, the going for the markets will actually get worse. Bad news has a way of feeding on itself to bring down markets to new lows during a bear phase, and the second phase of the bear market is actually much worse than the first fall, which always seems like a bull market correction.

So what does all this mean?
The answer is never simple and I am not sure if any one can say with certainty. The only thing that is certain today is that the risk reward ratio is not favorable in the foreseeable future. The melt down will most likely continue as the risk appetite of investors keeps going down and the panic increases. This is obviously not going to be a downward sloping straight line. There will be technical bounce backs because of oversold positions and also because market may have declined ahead of the bad news or because the bad news is not as bad as it was expected!!

Having lost more than 20% in just seven weeks, where several stocks have lost more than 50%, the market definitely appears to be oversold for the time being. And it seems to be the case with most global markets. With the earnings season for the quarter ended June 2008 just about to begin, we are likely to see the markets reacting positively creating a fairly broad based rally across global markets and also in India. But let’s not get fooled by this rally. Investor would do well to take this opportunity to withdraw money from the equity markets. Cash is always king in a bear market!!

DISCLAIMER
The views and opinions expressed here are strictly mine. In addition, my thoughts and opinions change from time to time. I consider this a necessary consequence of having an open mind. I do not undertake responsibility to update all my thoughts and opinions on this page.

The information contained herein is from publicly available data or other sources believed to be reliable. I do not represent that the information contained herein is accurate or complete and it should not be relied upon as such. The user assumes the entire risk of any use made of this information.

Investors should obtain advice from their own tax, financial, legal, and other advisors and only make investment decisions on the basis of the investor’s own objectives, experience, and resources.

No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this page.