August 3, 2007
Dear Sirs / Ma'am
As I write this to you the feeling I have today is that of watching a massive car pileup on a highway but in slow motion. There does not yet seem a sense of panic on the streets but still hope .
It’s been over a month and a half that we have been suggesting to our clients to book profits and stay out of the markets and yes the markets in that period have proved us wrong - FII inflow in from the Middle East and elsewhere coupled with a cartel of bulls but wrong we were. Our average exit has been around 14500 – 14600 levels and yes we have seen a 5-6% increase in indices , maybe in certain stocks to the tune of 10% but not in Mutual Funds.
The Question then is were we playing for an additional 5% or were we satisfied with the 30% - 80% gains provided by the markets to our clients . The latter it was.
There is a time when you fundamentally have to look at markets and our mandate is very clear – DO NOT ERR on the side of CAPITAL. There seems to be a natural tendency in markets for past successes to lead to more risk-taking, more leverage, more funding, higher prices, more collateral and, in turn, more risk-taking. Such cycles inevitably end when fundamentals have been overpriced.
For the last 45 days we have noticed a few clients feeling deprived of not having participated any further in this rally and we hope that they are smiling now or maybe there are still a few who believe that we could have got more . Honestly we have no defence for that question except that the following fundamental facts that we had based our judgment on and are playing out now collectively.
1) THE SUB-PRIME PROBLEM IS NOW PRIME - The sub-prime problem in the US of A is finally blowing up in the face of the financial system globally and effecting normal credit which is likely to lead to further delinquencies and tightening of credit. Turbulence in the credit markets has already claimed several casualties - from highly leveraged hedge funds to mortgage providers whose lenders have cut them off. But the fallout could get worse The debt crunch could squeeze underperforming companies that have, until now, been able to finance their way out of trouble - and trigger a wave of corporate bankruptcies - please read this as the beginning of the slow down effect. And yes if there are a few out there who believe that it is not contagious I just hope that they are right and we are proved wrong.
2) Bernanke caught in a dilemma - USD Dollar Index hits a 13 year low. i.e. if you had bought the dollar in 1994 you would be negative value on the purchase of the same today. So does the US Federal Bank chief cut interest rates immediately to spur growth , if he does that then the USD depreciates further or does he hold off and chances are then accentuated for a US recession. The implication of a rate cut are huge at this juncture (although we do believe that he would cut rates somewhere in December this year) since the dollar would shrink further in value and has many implications which may be worse than anyone can anticipate - we are still researching in the same.
3) Reversal of Yen Carry Trades - Now this is something that we have been saying since the Yen touched a 124 against the US Dollar. The YEN today trades at 117.55 against the US dollar- a move of over 6%. We are now expecting for certainty a BOJ hike on the 23rd August which shall put more than enough pressure on the carry trade. This has to be done since the Australian Federal Reserve is likely to hike interest rates by 25bps this Wednesday, and before the ECB i.e. the European Central Bank hikes interest rates in September once more and the Bank Of England in November or December of this year. Easy Liquidity seems to be a thing of the past.
4) Over leveraged positions in the Domestic Market – unlike March this time it’s over INR 70,000 crores. A small sell off can trigger a largish fall. Smart Money has already exited the market or the same is hedged.
5) My Fundamentals are Intact or so you think dear Watson –The S&P CNX 50 trades at 20 times on a trailing 4 QTR basis (which includes this last supposedly fantastic quarter) The CNX Midcap trades at 17X, The Nifty Junior trades at 18X, The IT index trades at 27X and the Banking Index at 18 X. It is important to note that the above multiples have been taken including the “other income” component of most corporate which vary from 10% to 35% of Profits and is one time in nature. So ask yourselves what happens to earnings of the next Quarter. On a forward looking basis we are at approximately 18X FY08.
When you split things up one would realize that a Bharti trades at 40X, an L&T at 30X, BHEL at 30X and a Reliance at 22X and an ONGC at say 10X (not checked on this one ) basis. So in times of uncertainty on what basis do we give such multiples .. does one price in 2010 earnings today or for that matter 2009 just because research analyst talk about earnings visibility in certain stocks.
Please do remember as Keynes once said “in the long run everyone’s dead” and change is immenent. GDP numbers, corporate profitability can change on the trot … so please look revise and read quarter on quarter results and reassess the risks involved every quarter.
So where does this take us –
Could the turmoil in the markets in the past few weeks be the precursor of a full-blown credit crunch that could force the U.S. and global economies into a recession? Some observers think that the markets are exhibiting classic signs of a so-called "Minsky moment," when overleveraged borrowers must finally pay the piper for their euphoria. The result, they say, will be a credit shortage that could bring down even innocent bystanders in their wake.
We are not pronouncing the end of the world, however one only has to go back three years to see how equity was being priced, as if there was no risk at all, and go back one year when there was perceived risk (at that time it was only one commodity hedge fund called AMARANTH which lost close to USD $ 6 Billion).
Well, at this point there is Risk to the tune of over USD $ 40 Billion (approximately USD $ 400 billion of DIRECT BANK exposure to subprime and mortgage markets, and we are assuming only 10% of that, not considering the fancy derivative’s which can and are played on top of these assets) , not withstanding approximately USD $ 60 billion of corporate deals which have not got funded , maybe these deals will get repriced which may make it expensive and not withstanding tighter credit norms which in turn will also affect the runaway growth we have seen in various economies including ours.
Hence risk, is simply being priced back in.
In my opinion RISK is a function of the ‘P’ of Price to earnings ratio. We are fairly sure of the earnings or so we think .. just change the multiplier and we shall arrive at a price for the future. For example (this may not be the correct methodology for calculating EPS but still) if one believes that the top 30 Companies In the Bombay Stock Exchange shall deliver an aggregate EPS of 840 in FY’08 then the multiple today stands at :
15200 (sensex value) / 840 (aggregate earnings of those 30 companies) = 18.09X
Now if you peg this to 17X = 14280, at 15X = 12600, 13X = 10920
If you believe that the aggregate earnings could be 865 then at
15200 we have a multiple of 17.57X, At 15X = 12975, at 13X = 11245
SO IF NO PERCEIVED RISK GIVE IT 20X, but if perceived RISK give it 13X, 14X or 15X – (in June of 2006 we were a touch lower than 15X on a trailing 4 QTR basis and approximately 13X on a forward P/E basis)
One question that will play at the back of your head – It’s the US of A not INDIA that is affected. I agree but what about the FII flows that get affected, Private Equity Flows that get affected, FDI flows that get affected (change in corporate plans), New Domestic Corporate IPO’s (there is approximately INR 75000 crores to be raised by domestic companies in the next six months) that get affected . We do not have anything to counter them except the USD $ 2 billion of MF NET INFLOWS this year which is miniscule.
So is the India Growth Story over – The answer to that is NO just look at the manufacturing sector, look at the domestic consumption story these are not over by any means. India will continue on it’s growth path at a notional rate of 13% (8% GDP growth and 5% inflation) inspite of higher interest rates but it is important for investors and advisors like us to be DISCIPLINED in the art of investing and not overly zealous both on the up and the down side. It is and will be important at all times hereon to take profits off the table and also minimize losses.
At this point in time given this correction, we would suggest getting into sectors and scrips which have shown resilience (obviously they are in favour with the big boys) .
We are still not suggesting a charge into the markets even at this juncture, but we can now start looking at investing into sectors and scrips of our choice given liquidity in hand. WE can start nibbling at these markets , lucheon’s and dinners can still wait.
At the end we would like our clients to sleep easy at night and not worry as to what’s going to happen the next day , especially to your money …
Regards
As I write this to you the feeling I have today is that of watching a massive car pileup on a highway but in slow motion. There does not yet seem a sense of panic on the streets but still hope .
It’s been over a month and a half that we have been suggesting to our clients to book profits and stay out of the markets and yes the markets in that period have proved us wrong - FII inflow in from the Middle East and elsewhere coupled with a cartel of bulls but wrong we were. Our average exit has been around 14500 – 14600 levels and yes we have seen a 5-6% increase in indices , maybe in certain stocks to the tune of 10% but not in Mutual Funds.
The Question then is were we playing for an additional 5% or were we satisfied with the 30% - 80% gains provided by the markets to our clients . The latter it was.
There is a time when you fundamentally have to look at markets and our mandate is very clear – DO NOT ERR on the side of CAPITAL. There seems to be a natural tendency in markets for past successes to lead to more risk-taking, more leverage, more funding, higher prices, more collateral and, in turn, more risk-taking. Such cycles inevitably end when fundamentals have been overpriced.
For the last 45 days we have noticed a few clients feeling deprived of not having participated any further in this rally and we hope that they are smiling now or maybe there are still a few who believe that we could have got more . Honestly we have no defence for that question except that the following fundamental facts that we had based our judgment on and are playing out now collectively.
1) THE SUB-PRIME PROBLEM IS NOW PRIME - The sub-prime problem in the US of A is finally blowing up in the face of the financial system globally and effecting normal credit which is likely to lead to further delinquencies and tightening of credit. Turbulence in the credit markets has already claimed several casualties - from highly leveraged hedge funds to mortgage providers whose lenders have cut them off. But the fallout could get worse The debt crunch could squeeze underperforming companies that have, until now, been able to finance their way out of trouble - and trigger a wave of corporate bankruptcies - please read this as the beginning of the slow down effect. And yes if there are a few out there who believe that it is not contagious I just hope that they are right and we are proved wrong.
2) Bernanke caught in a dilemma - USD Dollar Index hits a 13 year low. i.e. if you had bought the dollar in 1994 you would be negative value on the purchase of the same today. So does the US Federal Bank chief cut interest rates immediately to spur growth , if he does that then the USD depreciates further or does he hold off and chances are then accentuated for a US recession. The implication of a rate cut are huge at this juncture (although we do believe that he would cut rates somewhere in December this year) since the dollar would shrink further in value and has many implications which may be worse than anyone can anticipate - we are still researching in the same.
3) Reversal of Yen Carry Trades - Now this is something that we have been saying since the Yen touched a 124 against the US Dollar. The YEN today trades at 117.55 against the US dollar- a move of over 6%. We are now expecting for certainty a BOJ hike on the 23rd August which shall put more than enough pressure on the carry trade. This has to be done since the Australian Federal Reserve is likely to hike interest rates by 25bps this Wednesday, and before the ECB i.e. the European Central Bank hikes interest rates in September once more and the Bank Of England in November or December of this year. Easy Liquidity seems to be a thing of the past.
4) Over leveraged positions in the Domestic Market – unlike March this time it’s over INR 70,000 crores. A small sell off can trigger a largish fall. Smart Money has already exited the market or the same is hedged.
5) My Fundamentals are Intact or so you think dear Watson –The S&P CNX 50 trades at 20 times on a trailing 4 QTR basis (which includes this last supposedly fantastic quarter) The CNX Midcap trades at 17X, The Nifty Junior trades at 18X, The IT index trades at 27X and the Banking Index at 18 X. It is important to note that the above multiples have been taken including the “other income” component of most corporate which vary from 10% to 35% of Profits and is one time in nature. So ask yourselves what happens to earnings of the next Quarter. On a forward looking basis we are at approximately 18X FY08.
When you split things up one would realize that a Bharti trades at 40X, an L&T at 30X, BHEL at 30X and a Reliance at 22X and an ONGC at say 10X (not checked on this one ) basis. So in times of uncertainty on what basis do we give such multiples .. does one price in 2010 earnings today or for that matter 2009 just because research analyst talk about earnings visibility in certain stocks.
Please do remember as Keynes once said “in the long run everyone’s dead” and change is immenent. GDP numbers, corporate profitability can change on the trot … so please look revise and read quarter on quarter results and reassess the risks involved every quarter.
So where does this take us –
Could the turmoil in the markets in the past few weeks be the precursor of a full-blown credit crunch that could force the U.S. and global economies into a recession? Some observers think that the markets are exhibiting classic signs of a so-called "Minsky moment," when overleveraged borrowers must finally pay the piper for their euphoria. The result, they say, will be a credit shortage that could bring down even innocent bystanders in their wake.
We are not pronouncing the end of the world, however one only has to go back three years to see how equity was being priced, as if there was no risk at all, and go back one year when there was perceived risk (at that time it was only one commodity hedge fund called AMARANTH which lost close to USD $ 6 Billion).
Well, at this point there is Risk to the tune of over USD $ 40 Billion (approximately USD $ 400 billion of DIRECT BANK exposure to subprime and mortgage markets, and we are assuming only 10% of that, not considering the fancy derivative’s which can and are played on top of these assets) , not withstanding approximately USD $ 60 billion of corporate deals which have not got funded , maybe these deals will get repriced which may make it expensive and not withstanding tighter credit norms which in turn will also affect the runaway growth we have seen in various economies including ours.
Hence risk, is simply being priced back in.
In my opinion RISK is a function of the ‘P’ of Price to earnings ratio. We are fairly sure of the earnings or so we think .. just change the multiplier and we shall arrive at a price for the future. For example (this may not be the correct methodology for calculating EPS but still) if one believes that the top 30 Companies In the Bombay Stock Exchange shall deliver an aggregate EPS of 840 in FY’08 then the multiple today stands at :
15200 (sensex value) / 840 (aggregate earnings of those 30 companies) = 18.09X
Now if you peg this to 17X = 14280, at 15X = 12600, 13X = 10920
If you believe that the aggregate earnings could be 865 then at
15200 we have a multiple of 17.57X, At 15X = 12975, at 13X = 11245
SO IF NO PERCEIVED RISK GIVE IT 20X, but if perceived RISK give it 13X, 14X or 15X – (in June of 2006 we were a touch lower than 15X on a trailing 4 QTR basis and approximately 13X on a forward P/E basis)
One question that will play at the back of your head – It’s the US of A not INDIA that is affected. I agree but what about the FII flows that get affected, Private Equity Flows that get affected, FDI flows that get affected (change in corporate plans), New Domestic Corporate IPO’s (there is approximately INR 75000 crores to be raised by domestic companies in the next six months) that get affected . We do not have anything to counter them except the USD $ 2 billion of MF NET INFLOWS this year which is miniscule.
So is the India Growth Story over – The answer to that is NO just look at the manufacturing sector, look at the domestic consumption story these are not over by any means. India will continue on it’s growth path at a notional rate of 13% (8% GDP growth and 5% inflation) inspite of higher interest rates but it is important for investors and advisors like us to be DISCIPLINED in the art of investing and not overly zealous both on the up and the down side. It is and will be important at all times hereon to take profits off the table and also minimize losses.
At this point in time given this correction, we would suggest getting into sectors and scrips which have shown resilience (obviously they are in favour with the big boys) .
We are still not suggesting a charge into the markets even at this juncture, but we can now start looking at investing into sectors and scrips of our choice given liquidity in hand. WE can start nibbling at these markets , lucheon’s and dinners can still wait.
At the end we would like our clients to sleep easy at night and not worry as to what’s going to happen the next day , especially to your money …
Regards
Dinesh
No comments:
Post a Comment