CONTENTS
The “Call”
The Big Picture
Technicals
Smoke Signals
The Good, The Bad, The Ugly
Investment Themes
Directional Spotting
Random Moorings
THE CALL
We rarely need to look at levels on the index or stocks to decide if we nee to sell or buy. The only question we may need to ask is “What are the odds?”. And usually you get the best investment answers by asking this question. For example, in December 2008-March 2009, what were the odds that you would make a good return no matter what. I’d say excellent. All the copybook “gloom and doom” was out there. But such collective bearishness is a sure sign most market watchers are going to miss the real points (and I mean points and not news). In June 2009, what are the odds you will make a good return? I’d say, I don’t know but I do know the risk I am taking now is way higher to get the same returns as I could have made by investing in December 2008-March 2009.
We may be suffering from a “narrative fallacy”. Using the Congress’s victory to find corroborative evidence to back the rise. While the victory is a good thing, we may want to consider the reasons the world markets collapsed in the first place. Those problems have not disappeared and may not disappear so soon.
The market is getting too bullish on what the Congress government can do or cannot do. But India may have a different agenda than the markets. For example, if opposition to layoffs or disinvestment grows or in the next 2-3 state elections, the Congress loses, they may go back into a shell. It is a real possibility. Because except for the past 2 decades where the congress has been in and out, it has been the ruling party in this country and does not have great shakes to show for that inspite of being in a majority. Infact, they got us into the whole socialist, public sector frame to start out with. What’s important is not whether the new government does what the market expects or not but are the odds high? I’d say odds are high that things are not going to go in ‘picture perfect” fashion (and that’s how the market is pricing things).
Infact, the only real divestment that has happened on the ground has been in the NDA government. So the jury is still out and the markets may be overdoing their jig.
THE BIG PICTURE
What really concerns me is that I am not sure I have all the information (or that the information fed to me) is enough to make an informed decision on where the markets will go. In the October 2008 – February 2009 period, the media got depressed and spewed out bad news after bad news (i.e focused on what was wrong). Then starting in March/April 2009, it started to tag the “green shoots” line. Not their fault at all. They are doing their job (i.e. following the most important stories). But investing is rarely about stories and the “most important stories” may have little or no investment value. Investing is about being able to figure out in our own thoughts what all the data, news means (and what has been missed out but is important). And lots is missed out. At the end of the day, its humans working at media houses and their decisions are tilted by their own thoughts and the pressure of competing thoughts or lines of thoughts from their peers(and now more than ever to go with the current prevailing wisdom).
The thing I worry most about is China. More than ever, I am convinced this is a big fat bubble waiting to burst. When, how etc I don’t know. The “odds” though are high. Infact, I find their data increasingly silly and worrying. In a time when the world economies came down to their knees, China reports a 33% growth in fixed asset investment (that along with a 7% drop in Producre Price index, a 4% drop in consumer price index). Does that sound real? If they were to collapse (or even swagger) economically, it may not hurt markets like India but it will take the mickey out of commodities etc. That may actually be great for India (we are still commodity starved). What China seems to be betting on is government spending now as a bridge till the world picks up. It’s the classic government response but in an “opaque” economy like China who knows who “checks and balances” such responses. I would imagine all their production is going straight into warehouses creating very large inventories across categories.
The third thing that concerns me on making investment decisions is the overwhelming focus on US economic news. They are at the end of the day 1/5th of India’s population and 1/4th of China’s population. Yet how much time do we spend reading up on US economic data and news as compared to what’s happening in China, Russia, Europe etc. Something is wrong in making investment decisions like this. While it may make good news copy, I don’t really care what happens to US housing if I was buying stock in India (it has an impact in some indirect convoluted logic but that’s about it). Or for that matter, it hardly matters to me (as an investor in India) whether the US employment rate is 6% or 9.6%. We have been programmed to look for such data though it may be completely irrelevant (note that I write this for sophisticated investors who need to do their own thing and don’t depend on news only to invest) .
Some of the currently popular benchmarks are absolutely archaic and of little investment worth and nothing but a historical legacy. Take for example Nymex crude. North Sea brent as a benchmark 30-50 years made sense. The Americans consumed most of the world’s oil and most of the North Sea crude ended up in refineries in the US. That’s not the case anymore. Oil production is way diversified (the Opec only controls 40% of the world’s production). World class oil fields and refineries (like Reliance) are not in the US. Yet we continue to use this historical relic as the oil benchmark. While business news can do this, we should do this only at our own risk if we3 are investing in oil or oil futures. Things are way too complex to make decisions on Nymex crude.
I also find difficult to believe surveys like “consumer confidence”, “purchasing manager indices” and other such confidence indices. We know for sure that confidence is the antithesis of good investment decisions. When confidence is at its lowest, it is usually the best time to buy because the downside risk in the market is virtually eliminated(what some call the “points of maximum pessimism”). When confidence is high, it usually means people are getting supremely confident about their own ability and that happens at the points of maximum optimism. Take a look at such confidence data just before Bear Stearns went under. It was (no points for guessing) high. What that means is that confidence is driven by how the market does and it is not the market that is driven by what a confidence index does. So while confidence surveys may make their sponsors money or fame, they are essentially meaningless in predicting where the markets are moving(on the other hand, the direction of the markets is a pretty accurate predictor of what confidence will be).
TECHNICALS
So what does one do? Sell? Buy? There has been exceedingly strong momentum. And momentum can run ahead of any fundamentals for much longer than we think. And just when we think, markets are running at a silly speed ahead of any reality, they may spike even higher (infact, get their highest gains at this point). However, I have rarely seen markets sustain momentum without reality over any extended period of time. So either reality will catch up with the markets or market will slow down to catch up with reality.
The probabilities I am looking at right now are as follows:-
Short Term Trend (7-30 days) – Neutral.
The Odds areo +20% gain: 20%o +15 % gain: 60%
o +10% gain: 20%- Intermediate Trend (30-90 days) – Bearisho +20% gain: 50%
o +5% gain: 30%o -10% loss: 20%- Long Term Trend (90 days +) – Bullish/Bearish (too early to make any calls)
o +20% gain: 30%o -10%loss: 30%o -20% loss: 40%
For a more detailed Technical Analysis, please see Ashu Dutt’s “THE CHARTIST’S ALMANAC”- June Edition
THE GOOD, BAD AND THE UGLY
THE GOOD
Tax collections have been robust. That’s a good sign
THE BAD
Over expectation from the Congress government and running ahead of the ground economic situation may cause severe dislocations. The higher we go, the more severe the dislocation.
THE UGLY
The Chinese are artificially stimulating commodity demand with their US$ 500 billion stimulus and hoarding commodities. Such unprecedented inventory buildup does not bode well for non ferrous metals.
“Estimates”. What do they mean? Specially from “experts” and “analysts” whose record of catching the “big swings” is lets just say “suspect”. So when we see US unemployment rate at 9.6% and markets move up saying unemployment rates were not as bad as analyst “estimates”, I wonder if we are “Alice in wonderland”. The whole reasoning is stupid. First we put weight in guys who never got it right to start with. Then, we buy stocks saying, “Oh the real data is better than what the extremely bad predictors predicted”. Does that sound right?
INVESTMENT THEMES
- The “map” is just that, a map. It is not the actual terrain. And we may just be looking at a “map” to decide on where we are on a terrain. What I am referring to is the overwhelming bias in the media (specially US and European business media) to focus and build up on any good economic news while selectively giving low weightage to news that may be relevant to investors but not fit into the neat directional bias that media usually suffers.- That’s precisely why the CDO crisis went unnoticed till it blew up in our face.- Global crude prices will be impacting “input” costs for a number of industries including those who use oil or oil derivatives as a raw material. That could put severe pressure on margins for a number of Indian companies in petrochemicals and other oil and oil derivative products.- The rupee should cross Rs 44-45 in the intermediate term (60-90 days). A gush of money into stock markets (both primary and secondary) may be the key driver but it could also be driven by speculation on the rupee’s potential rise.- By default, if the rupee goes to where I think it is headed, I would be wary of technology stocks.- I would also watch for pharmaceutical stocks not so much because of the rise of the rupee but because of increased input costs (pharmaceuticals use chemical products that are extremely sensitive to rising crude prices)
DIRECTION SPOTTING
IT - not looking good in the next 3-6 months, specially smaller IT companies (I expect the rupee to head to 44-45 and that’s what this based on).Pharmaceuticals – watch for crude prices. Chemicals with oil derivatives form a critical component of pharmaceutical raw materials.Oil&Gas stocks – waste of time. The government is not going to free this sector and these stocks will always live from quarter to quarter with variable raw material cost and regulated sales prices. Crappy sector to waste time on.
RANDOM MOORINGS
There are a number of ways to generate high returns while keeping risk low:- stocks are beaten way out of shape- stocks are undergoing structural shifts- stocks are getting into “asset class” behaviour- low priced stocks are going through a “mathematical illusion” ( its easier for a Rs 10 stock to go to Rs 40 and generate 300% returns than for a Rs 2,000 rupee stock to rise to Rs 8,000)- there is a distressed sale
Any other kind of market is resting on straw feet and its collapse will be steep and painful.
We had a short period of extreme craziness (late 2007 and early 2008) where the Baltic Freight index went up 4 times of what is its usual high, crude oil went up close to US$ 200 levels etc. But that’s what it was “crazy”. Before it reached that crazy phase, it spent most of its past in a range that is close to where have come back. It is almost as if we have forgotten the economic mess that caused the fall.
What I see now is a return of extreme craziness without the backup of any real economic reasons for such sharp rises (atleast not enough reason). So we may go straight to 20,000 on the sensex and then see a painful 50% or more retracement. I envisage this scenario.
“THE BLACK SWAN”
On May 18, 2009, markets froze up at 17+%. Would like to share a few learnings:- A 17% rise is a statistical number specially when no one gets to trade. The volume in the cash and futures markets added up to Rs 3,000 crores (US$ 600 million)- No one made money. No one sold. No on bought- When markets lose liquidity, they can crush anyone.- When markets enter “disequilibrium” i.e. either buyers or sellers tilt the scale, they can be downright dangerous- When buyers know sellers are trapped, nothing stops them from going for the kill- Don’t disregard opinion that does not fit your thought process. In the past 6 months, not a single analyst got the credit market collapse or the congress victory right. And anyone who would have given opinions like this would have been pushed to the side- The “unexpected” can happen more often than we think. Just because the chances are very low does not mean it cannot happen the next moment
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