Tuesday, March 31, 2009

Two Sides of a Story

We are just through with a week which has seen an upsurge of hope in investment markets around the world. All around the world stocks are up and there's talk that a turnaround is now visible. Every major index is up from anything between five to fifteen per cent over just a few days. So is this it? Are the dark clouds lifting? Is there a turnaround on the way which the markets have foreseen? It's possible but there are plenty of solid arguments against this view. Let's see what the arguments on both sides of the investments picture are.

 The Turnaround is here: It's true that the world economy is taking a severe beating, but equity prices have more than kept pace. In every equity market around the world, prices have fallen so sharply that there are plenty of great stocks available at ridiculously low prices. Sure, the economic downturn will impact many companies' profits, but eventually the profits will rise again. Such stocks will never again be available at such bargain basement prices. In any case, this is not about stock prices alone. From anecdotal evidence like Citibank's two profitable months to the improvement in the India's IIP to improving consumer confidence around the world, there's evidence that the global economic decline is not as bottomless as the doomsayers would have had us believe.

 They may have been slow of the blocks, but governments around the world have done a great deal to stave off the worst effects of the crisis. It takes some time for these actions to have an impact at the ground level, but the massive interventions of governments will start showing up strongly from now on. All things considered, there appears to be strong evidence that the worse is behind us and the turnaround is in sight.

 OK, that was one side of the argument, now let's hear it from the side that thinks that the worse is still ahead: Equities don't turnaround when they ought to turn around, but when investors start buying them in serious numbers. The evidence for this is still thin.

 The sudden upsurge in world stock prices is entirely the work of short-sellers scrambling for cover and short-term traders. In India, none of the constituencies of stock buyers are about to start pouring money into stocks. This holds for everyone from the biggest institutions (both domestic and foreign) to the retail investors. Moreover, the collapse in sales and profits has barely started showing up in corporate results yet. To think that the

impact on stock prices is over and done with is a mistake. What governments are doing is to try and re-inflate the same bubble, and what the cheerleaders are doing is to try and convince us that the clock is about to turn back eighteen months. If this downturn teaches one thing, it is that the situation is unpredictable. The markets are supposed to be foreseeing good times to come, but don't forget, the same 'markets' haven't been able to foresee anything correctly for almost two years now.

 Those are two sides to the debate and the logic for both is impeccable. Which one will appeal to you more depends on what sort of a mood you are in. That probably depends on how the downturn is affecting you personally. Which is where the key to understanding the situation lies. At this point of time, the real malaise is the tremendous loss of confidence in the future that has happened to individuals, businesses and institutions.

 Would you care to predict when that will get cured?

Thursday, March 19, 2009


There was a joke going around a few years ago that Alan Greenspan (then the U.S. Federal Reserve Chairman) would be remembered more for his phrase making than his monetary policy making. In 2005-06 he coined the term “bond market conundrum” to refer to the decline in U.S. bond yields in the face of Fed-induced increases in money market interest rates and rising U.S inflation.

Now we have Navneet Munot, CIO, SBI Mutual Fund, refer to it in our context of the RBI lowering rates and pumping liquidity as inflation, bank credit and industrial growth fall. “Bond traders like recession and deflation, conditions when bond prices move up. But alas! The widening government deficit is playing spoilsport and interest rates have actually moved up almost 200 bps over the last 2 months,” he says. Just today, bond yields once again rose ahead of fresh debt supplies this week. Early this morning (March 17), the yield on the 6.05% maturing in 2019 was at 6.48%, above the previous day’s (March 16) close of 6.40%. Munot observes that the “yield curve is in complete disarray with several 'illiquid bonds' offering massive yield pick-ups”. 

The market is clearly worried about the large borrowing programme of the government and is not responding to the indications given by RBI. At the beginning of FY 2008-09, we were expected to borrow 100,000 crore. By the end of 2009, government will be borrowing almost Rs 300,000 crore and for next year we are looking to raise Rs 360,000 crore a year, which is almost Rs 1,500 crore per working day. The size of the borrowing programme is unnerving investors. 

RBI’s recent rate cuts did not result in lower yields. On the contrary, we have witnessed RBI’s recent rate cuts did not result in lower yields. On the contrary, we have witnessed yields going up. Though the market is moving against the wish of the RBI, the central bank has many tools with which it can effectively get desired results. And there is no doubt that the RBI wants to bring down interest rates. 

Munot admits to the chaos but offers some advice: “There is lot of panic and gloom in the bond market. Yields may inch up a bit more but investors with some risk appetite should use that opportunity to move in.”

As of now, there are a number of factors favouring entry into income funds when the 10- year benchmark yield is at 7% levels: 

• Globally interest rates are nearing zero…Bank of England - 0.50%, ECB -  1.50%, FED: 0-0.25%, JAPAN: 0%.

• The WPI is expected to decline and become negative between May and September 2009

• Pressure of government’s borrowing programme will ease in the second half of March 2009

• Banks may turn buyers of gilts for year-end valuation. On December 31, 2008, 10 year G-Sec was valued at 5.25%. Today it is at 7% and banks are expected to reduce their mark to market losses as much as possible.

• RBI will take further action on OMOs and may give the rate signals.


Investors can look at entering income plans but should patiently remain invested… as they say patience pays….

Tuesday, March 3, 2009

Axe the tax!! Time to Act

As soon as realization hits that a new year is upon us, there is another one that lurks around the corner. And that is the start of a new financial year. Which means, you have till March 31 to complete your tax planning exercise? So if you have not completed your investments under Section 80C, you have a little more time to get your act together.

If one takes a look at the past year, what would seem more appealing would be the fixed return instruments like National Savings Certificate (NSC) and Public Provident Fund (PPF). After all, at least you are guaranteed a positive return there. The equity markets are in the doldrums and don’t look like they will be reviving anytime soon. But what investors tend to forget is that investing in equity is not a short-term investment. Even though equity has the potential of delivering phenomenally over the short term, the risk of capital erosion is also very high. To truly benefit from equity, one should have the patience to stick around for at least three years. But the ease of exit makes it virtually impossible for the investor to curb the natural instinct for flight in times of crashes. One mistake is to offload all shares and run when the market heads for a downturn.  

The other is choosing to avoid equity altogether till a recovery is on its way. The truth is one can never really say when the market is going to make a U-turn. But if one gets into the market with the intention of hanging on for a while, it will eventually pay off.

The good thing about an Equity Linked Savings Scheme (ELSS), is that it has the lowest lock-in period when compared to the other options under Section 80C. The minimum period of three years ensures that the investor puts in money that he will not need for a while. The other options start at a minimum of five years.

If we look at the ELSS category over the past five years, on an average it has delivered annualized returns of more than 12 per cent. This is much higher than the returns you will get on the other instruments under Section 80C, which will average between 8 and 9 per cent. The tax implications are also luring. You get a tax benefit when you invest in an ELSS scheme, dividends are tax free and when you sell the units after three years, you pay no tax (long term capital gains tax is nil). This makes it score higher than bank fixed deposits and the NSC. And, in terms of returns and lock-in, it scores over the PPF too.