How to tackle the bear run

Nothing is going good for the economy (whether India or the world). The markets are down and no one knows where it is heading. But there is one common view. The markets have bottomed out and there is little downside from here. However, no one knows when is it going to revive. The levels of 21000 seems fantasy at this point.

Analysts are jobless and are considered a liability to the erstwhile employers who used to flaunt a research division not more than 4 months ago.

But it is said that if there is anything that comes for free in India, it is advise. So here I am, giving free advise. I know I wont be paid foir it anyways ;-)

Seven ways to tackle the bear run

• Stick to stocks of large companies
• Look for debt free companies
• Search for businesses that are insulated (well, relatively) from the slowdown
• Look for companies that largely depend on domestic revenues
• Search for value stocks (generally cash-rich companies)
• Have an investment horizon for at least 2-3 years
• In case of mid-cap stocks, choose companies that are market leaders, are niche players and possibly belong to sunrise sectors

-adapted from the Businessworld, 17-nov-08 issue
You may also apply a set of financial filters:

• PE Ratios below 16
• Debt-Equity Ratio below 1
• Net profit growth and operating margins of over 10% in the last three financial years as well as in the 1st half of FY 09
• Average 3 year return on equities above 20%

So you may follow the advise and invest based on this. But standard disclaimers apply. You wont give me a share if you profit, dont blame me if you lose either.

RBI Bulletin Nov 2008

"India, with its strong internal drivers for growth, may escape the worst consequences of the global financial crisis. Indian banks have very limited exposure to the US mortgage market,
directly or through derivatives, and to the failed and stressed financial institutions. The equity and the forex markets provide the channels through which the global crisis can spread to the Indian system. The other three segments of the financial markets - money, debt and credit markets could be impacted indirectly. Risk aversion, deleveraging and frozen money markets have not only raised the cost of funds for Indian corporates but also its availability in the international markets.
This will mean additional demand for domestic bank credit in the near term. Reduced investor interest in emerging economies could impact capital flows significantly. The impending recession
will also impact on Indian exports.

Even EMEs which do not have direct or significant exposure to stressed financial instruments and troubled financial institutions are
experiencing the indirect impact of the financial crisis, and this impact is by no means insignificant or trivial. Indeed, it could intensify in the months ahead".

- Extract from RBI Bulletin November 2008 ["Lessons from the Global Financial Crisis with Special Reference to Emerging Market Economies and India" - D. Subbarao, Governor, Reserve Bank of India]

Click the links below for the entire bulletin and/or segment breakdown

RBI Statistics
Click here to downLoad: Reserve Bank of India - Bulletin (November 2008) (full bulletin 17.26MB)

Click here to downLoad: Contents

Click here to downLoad: Editorial Committee

Click here to downLoad: Statement by Dr. D. Subbarao, Governor, Reserve Bank of India on the Mid-Term Review of Annual Policy for the Year 2008-09

Click here to downLoad: I. The Real Economy

Click here to downLoad: II. Fiscal Situation

Click here to downLoad: III. Monetary and Liquidity Conditions

Click here to downLoad: IV. Price Situation

Click here to downLoad: V. Financial Markets

Click here to downLoad: VI. The External Economy

Click here to downLoad: Lessons from the Global Financial Crisis with Special Reference to Emerging Market Economies and India* D. Subbarao

IMF on Emerging Markets

Until recently, emerging markets were one of the few bright spots left in a world economy hit by massive deleveraging, failing banks, and corporate profit warnings. But now, the crisis is spreading beyond the advanced economies where it originated, with emerging markets all over the world suffering from the squeeze in global financial markets.

In terms of equity prices too, after more than a year of relatively small spillovers from the financial turmoil in advanced economies, equity prices in emerging markets succumbed to the dramatic worsening of financial distress in mid-September 2008.
Still, in early October, despite their steep and abrupt declines, emerging equity prices as a group were still well above their level at the beginning of their rally in the early part of this decade.

Moreover, unlike in past crises, the size of the spillover has not been uniform, reflecting the deepening of these markets, the different economic fundamentals among emerging market economies, and the growth of South-South cross-border investment, which helps insulate them from investor concerns in mature economies. The equity price declines, however, are likely not over.

IMF has projected that world growth is projected to slow from 5 percent in 2007 to 3¾ percent in 2008 and to just over 2 percent in 2009, with the downturn led by advanced economies. IMF has already trimmed the growth projections of India from 7.9% to 7.8% in 2008 and 6.9% to 6.3% in 2009.

Equity prices affect growth
Such global spillovers on emerging equity prices can, in turn, affect domestic private consumption and investment, although the links between financial markets and the real economy tend to play out more gradually than those within financial markets. The IMF analysis found increasing evidence of the so-called "wealth effect" of equity prices in emerging market economies, although not as pronounced as in mature market economies, where consumption and investment have long been affected by changes in equity prices.

Building resilience
To help withstand abrupt price fluctuations, emerging markets could help build and sustain resilient capital markets. Specifically, the policies that could help to make markets more resilient in the long run include:

• Fostering a broader and more diversified investor base to help deepen markets. Encourage a variety of investors, including institutional investors, such as pension funds and insurance companies, which tend to have long-term investment horizons. Longer-horizon investors can provide a buffer against any reversal of foreign equity inflows.

• Aiding price discovery. Remove impediments to price discovery by avoiding artificial delays in revealing prices or limiting price movements.

• Supporting financial infrastructure development. Adopt legal, regulatory, and prudential rules that conform with international best practice.

• Developing stock exchanges. A well-functioning exchange environment and supporting financial infrastructure for trading equities and new financial instruments can help price discovery, foster liquidity, and generally improve efficiency. Careful implementation, however, is important at every stage. Enhancements and financial innovation need to be properly timed and sequenced, with appropriate oversight in place, so as to reap the full benefits of innovation, while managing the risks to financial stability and ensuring the proper functioning of markets.

“Sail with the tide” is the apt phrase for those who talk about the economy, markets you name it. Except for those who did not invest in India, every one talked about the fundamentals and the growth rate projections for India’s GDP went as high as 15% by some eminent global analysts. Now when the markets have come down, every one has become an astrologer in retrospect. Every one is saying that India was overvalued and this downfall was obvious et al.

India’s GDP growth accelerated to an average of 9.3% during the three years ending March 2008 compared with an average of 6.6% and 6.0% in the preceding three and five years, respectively. “The most important driver for this acceleration in growth above potential was the sharp rise in capital inflows” – believes Chetan Ahya, Managing Director, Morgan Stanley.

Capital inflows have risen dramatically over the past five years. India received an average of $10 billion per annum between 2000 and 2002. During 2003-2005, capital inflows jumped more than two times to an average of $21.3 billion, followed by an increase to $38.5 billion in 2006 and to $98.3 billion in 2007.

Contrary to general belief, the direction and magnitude of capital inflows have been highly influenced by global macro environment rather than emerging markets’ long-term fundamentals. Very often we hear the argument from investors that capital inflows were drawn into India because of attractive growth opportunities and, therefore, this trend will continue unabated. However, trend for capital inflows into emerging markets have been dependent on global risk appetite, which has been driven by liquidity and growth environment in the developed economies.

During 12 months ending March 2008, India received $108 billion in capital inflows. Of this, $29 billion were portfolio equity inflows, $42 billion were debt borrowings, $15.5 billion were net FDI, and the balance was other inflows. Over the last few months, with the reversal in global risk appetite, we are seeing a sharp fall in capital inflows into India and emerging markets. As estimates of Morgan Stanley, capital inflows into India have on an annualised basis slowed to $30-35 billion in April-August 2008. India has seen portfolio equity outflows of $4.3 billion from April to August 2008, in line with the emerging markets.

It has been observed in the past that FDI inflows into emerging markets and India tend to lag the portfolio inflows by a year. A large part of the rise in FDI inflows into India was in the form of private equity inflows, real estate, and acquisition of stakes in Indian companies by multinationals. There has not been any significant increase in FDI into green-field manufacturing activities in India. Hence, a large part of the FDI inflows will likely follow the mood of the capital markets.

“In the current global financial market environment, countries with the twin macro-problems of high current account deficit and tight banking sector liquidity is likely to suffer a major deceleration in growth”, says Chetan. He believes India will be the most affected after Australia. First, unlike the rest of the region, India runs a large current account deficit, and its balance of payments surplus has been driven by capital inflows. Most other countries in the region have large current account surpluses. Second, India has had a strong credit cycle over the last four years. It has been a beneficiary of a virtuous cycle of large capital inflows — major liquidity infusion — pushing up domestic demand. India’s credit growth has averaged 28% over the last three years.

There is not much scope for a quick policy response to a further slowdown in domestic demand. The government has already been running a pro-cyclical fiscal policy stance. Indeed the burden of higher oil prices, the government’s announcement of a wage hike for its employees, and write-off of farm loans have pushed government’s deficit, including off-budget items to 10.2% of GDP in year ended March 2009.

Analysts don’t expect a quick monetary policy response either. It is believed the RBI is unlikely to cut policy rate again until the March-April 2009. The RBI will hesitate to cut policy rate until we see deceleration in WPI inflation closer to RBI’s comfort levels of 5% from the current double digit levels. Moreover, the RBI’s policy rate decision is also likely to be weighed against the weakening exchange rate.

Further domestic demand growth deceleration is inevitable. Over the last 12 months, aggressive tightening in India’s monetary conditions has already slowed credit-funded consumption significantly. The increased tightening in the global and domestic financial markets is expected to further slow investment growth sharply.

With nothing going well for the global economy, one can just sit and watch what the global leaders do to rescue the global economies from the ongoing crisis.

References: The Economic Times Nov 10, 08 [Interview with Chetan Ahya, Managing Director, Morgan Stanley]

Obama, the new face of America

History has already been made by Barack Obama becoming President of the United States. The man of mixed ethnicity is considered to be the utterly representative of the 21st century America. He is expected to reverse (for the better, of course) the image of America abroad and refresh the spirits back home.

But we all saw that this was amongst the most sought after elections in the US. The passion of the elections in the US is understood, but why are we all here in India too were so curious about the elections in the US. One would say that we have become more globalised. Sure we have. But I guess there’s more to it. Our economy has developed deeper linkages with the US around increased trade, currency and investment. India Inc is one of the largest employers in the US as was pointed out in a recent FICCI report, on the back of recent acquisitions and investments by a large number of Indian companies like Wockhardt, TCS, etc. All this has significantly increased the risks and impacts of a US recession on our economy.

We just benefited for years due to the recession in the US economy. The corporates there outsourced their jobs to India leading to the Service sector being the highest contributor to our GDP growth. But now the biggest expectation for India from the new US President is the reversal of the decline of the US economy. He ha stalked about pumping in billions of dollars and tax breaks to the middle class to ‘kickstart the US Economy’. Our exporters should be preparing to take advantage of this coming resurgence of US demand and the government must ensure that our exporters are enabled to benefit from this opportunity.

“Indian businesses can look to broad changes in the outsourcing structure — with more emphasis on on-shore projects and investments by Indian companies with tax and other incentives to encourage this” says Rajeev Chandrasekhar, Member of Parliament and president of FICCI.

Obama has repeatedly talked about making the US economy competitive. This will redefine the strength of the dollar, which is currently at its strongest levels on back of flight to safety of the currency back to the US from across the globe. The US is also expected to be more aggressive in trade negotiations as he has also said “US will fight for a trade policy that opens up foreign markets to support good American jobs.”
India specially needs to be careful on this front. It is believed that Obama is anti-outsourcing but in order to “build a close strategic partnership” between US and India as he had pledged it would be difficult to take a call against outsourcing. Besides, he is not expected to come in the bad books of the corporates in the US who have been benefiting from outsourcing as a result of low costs. To keep his word, he may discourage the issue of H1B visa to Indians (outsiders for that matter).

The global slowdown is already being tagged as “Made in America”. One of the biggest negatives dragging down the world economy has been this growing sense of hopelessness and the vacuum of credible international leadership. Barack Obama has demonstrated both intellectual leadership and temperament that could turn this hopelessness into a positive view of the future. He is seen as the leader who is attuned to temperamentally, intellectually and emotionally lead the nation which leads (well, almost) the globe.

BT

I used to work for BT for 22 years and still feel quite loyal to them, though increasingly frustrated at the apparent determination to die. BT is a good company in many ways, dumb in others. But overall, it has missed out on the IT boom, and the share price has tumbled in recent years, so many of us loyal shareholders have lost a lot of money by staying optimistic about its future. In an industry packed with potential, it has consistently avoided capitalising on the many opportunities it has had.

BT has had a lot of CEOs over the years, and most have missed their main opportunities. Though I am sure some people would disagree, here is my take: Michael Heiffer came from the finance industry but completely failed to understand BT's potential to use its transaction management capabilities in the banking market. Peter Bonfield came in from the computing industry, but totally failed to understand the potential from telecomms-computing convergence, passing over lucrative opportunities worth tens of billions, while wasting tens of billions instead on 3g licenses and incomprehensible company purchases that almost took the company into bankruptcy. The less said about Cockburn the better. Finally, Ben Verwaayen was at least competent. He stopped the fall for a few years by selling off much of the company's most valuable assets, although he failed to dump the network when given the chance, which would have liberated the company to concentrate on what it does best. But although he was good at stopping the rot for a while against tough odds, he was never the right manager to capitalise on growth opportunities. But at least he had the good sense to go when he'd done his bit, to let someone else take BT into the growth phase. But once Ian Livingston was identified as the man likely to take over, there was never any prospect other than doom.

I believe the main problem in BT is accountancy drive. Accountants dominate many blue chip companies because the perception is that since the company exists to make money, people who can manage money ought to be able to run the company better than others, such as engineers. In some industries, perhaps that is true, I won't comment here. But in a high technology company such as BT, it is not at all appropriate. So I warned my friends to sell their BT shares when Ian Livingston was marked to take over. Since then, the price has fallen by about two thirds, proving I was right.

Accountants count beans, but usually only some of the beans. They look at those things that appear on the balance sheet, such as costs, and income, but don't look properly at things that are hard to measure, such as engineer productivity, creativity, or staff loyalty, and rarely look at potential revenue. So they put in place micromanagement systems that greatly reduce productivity by using up staff time to get small quantities of useful information worth a fraction of the costs of acquisition, but since those costs are not directly measured, they are ignored. The result is a very precise but very inaccurate figure for the numbers of beans.

They also have much less understanding than engineers of what it is that the company actually could do, what its skills are, or what the industry could offer. So while BT sits in a field full of promise, surrounded by gold, its focuses on headline cost reduction as the main route to profits, while splashing out heavily on low-potential investments such as BT Vision. Ignoring enormous revenue sources while putting too much effort into cost reduction is folly, but it is sadly a problem that has affected BT for many years. Its single strategy has been hiding in the corner, leaving new opportunities to other companies, while technology progress erodes the potential income from traditional sources, and then trying to stay in business by reducing costs.
This strategy hasn't worked so far and it won't start working in the future. It is long overdue for the scrapheap.

BT has a network that is very expensive to maintain, and is wholly inadequate to run modern services. Its strategy director was quoted in the weekend papers saying that she can't see why anyone would need more than 20Mbit/s to the home. Such comments will go down in the infamous quotation books alongside Bill Gates' comment than no-one could ever need more than 600k of memory in a computer.

The company must start to explore the modern telecoms and IT marketplaces, look around the find the services it could offer, quickly develop them, and then sell them at a reasonable price without its usual confusion marketing. This will cost money, but it will be a sound investment. Saving money ad-infinitum will eventually lead to a tiny company with tiny value. Investing heavily to create adventurous new products and services would create new income streams that will take the company to its full potential.

BT still has a lot of high quality staff, though many have left in recent years in management -induced despair, having offered the company the ideas it needed and having them rejected by accountants and managers with little or no real understanding of telecoms or IT. It is not too late yet, but it soon will be. Identifying key technology-enabled opportunities and financing them will lead to recovery. Counting beans will lead to oblivion. Livingston has to go, and go soon. In my opinion, he just doesn't understand the business he is in, and should never have been at board level, let alone CEO. Francois Barrault has gone as a scapegoat, but I think he had a far better understanding of BT's business than Livingston ever will. BT was once a great company and could be one again with the right policies. Sacking good people and over-promoting fools will not help. Nor will counting only a selection of the beans.

But I haven't sold my shares. I am hoping in spite of everything that one day, BT will appoint a CEO who understands the business, who is prepared to take risk and invest heavily in the right areas, with huge injection into R&D. With the courage to identify and remove some of the thoroughly incompetent managers dotted here and there, and to reward the better ones, BT could once again be a world leading company. But BT can only be a good investment in the long term, and it might not survive that long.

Very risky, but potentially a good buy for the long term.

Marks and Spencer share price decline

M&S used to offer the kind of clothes I would wear. I have no fashion knowledge, and effectively used to outsource that to M&S. I buy whatever shirt they have in stock, knowing I can go out in public wearing it without looking daft.

They seem to be in trouble with declining share prices and I wondered why. I hadn't been clothes shopping for a few months since my wardrobe was stuffed. But when we recently got a black tie dinner invitation, I took my wife there to get a new dress. We couldn't find one. We weren't being fussy, it's just that they only had three, all pretty similar. We searched the whole shop assuming we must have missed the appropriate section, but eventually gave up and went elsewhere. And come to think of it, I had the same trouble last year when I bought a new dinner suit, it took ages to find the right section because the layout had all changed, and when I did, there were very few choices. And I couldn't find the shirts I like either.

I think if this problem is a common one for their regular and loyal customers, it would explain why they are suffering. They have simply lost touch with what their customers want to buy, a potentially fatal problem if it continues. Too much trying to invent new styles and cater for new markets has left them alienating many of their existing customers, who want to spend money there, but can't.

Too bad. I'd like to help by buying stuff there, but they'll have to stock it first. My needs are simple - I just want ordinary everyday clothes that are reasonable quality, look OK, feel OK and don't cost a fortune. I suspect that's what the rest of their traditional customer base also wants.

Back to basics then.