Financial Services

2010

anoopkg — Mon, 01 Feb 2010 03:56:00 +0000

There is an artificial feel to the stock market rallies that we’ve witnessed over the last six months or so. The rally would have been normal if it had covered the same amount of ground over two to three years. The primary contributor to the rally is the amount of cash in the market rather than a dramatic change in fundamentals.

For example, in 2008, the Indian stock market closed 60 per cent lower, an unprecedented high-to-low movement in one single year. Despite a poor monsoon the market dashed ahead furiously from Mar 09. The rebound played out in thanks to three complimentary events; shoots of recovery in global markets, positive political outcome at the Centre, and finally the earnings upgrade cycle.

How long will the rally continue? A month into 2010, almost all of the analysts agree that the Great Depression and a 60 per cent surge are both not in the horizon. The general consensus is that despite the huge gains seen in 2009, the overall trend would remain positive in 2010. I wouldn’t be very optimistic about an encore of 2009 in 2010. As a cas in point, current predictions for the Sensex keep it at 19,000 and 21,000 by December 2010.

I believe that the market will continue on the upward trajectory, albeit at a slower pace, if earnings visibility, global recovery, and the extent of government reforms follow through the last quarter’s performance. The dampener is the withdrawal of the stimulus, both on the monetary and fiscal front; after effects can include GDP slow down, inflation.

Having said that, I think it will be a stock pickers market. According to a report by Morgan Stanley, "A high market effect, high sector correlation and middling micro factors such as valuation, fundamental and return dispersion sets us up for a better stock picking environment in 2010." Most of the market returns last year came from a PE re-rating. This year, the key driver of returns will shift to earnings and hence distinctive stock related factors will play a strong role.

Loss avoidance

anoopkg — Wed, 27 Jan 2010 03:55:00 +0000

The management of a factory in China asked consultants to design a better incentive bonus system. Most of the consultants suggested fine-tuning the amount of bonus, but two behavioural economics researchers worked purely on the language of the letters through which workers were informed about their bonus.

As an experiment, one group was told that if they met certain targets, they would get a certain amount of money as a bonus. Another group was told that they had provisionally been awarded a certain amount of bonus based on their capabilities. However, if their work fell below certain targets, then they would lose the bonus. In reality, the two schemes were identical.

As researchers had suspected, workers who had been given the provisional bonus were much better at meeting the targets. The fear of losing something you already have is much stronger than the motivation to gain something new. This loss-avoidance urge is well-known to behavioural researchers in other areas like investments.

The loss-avoidance urge is not a fringe phenomenon. It is absolutely central to what makes a good equity investor. The idea that some of the money you have earned may go away at any point is difficult to accept.

Dollars aplenty

anoopkg — Tue, 19 Jan 2010 03:46:09 +0000

Every news article that talks about recession trumpets the impending resurgence of the world economy. Though the verdict is still out on the specific reasons for the rebound, and more importantly whether what we see today is in fact a rebound, the major market players are all bullish about the rebound. I have a different question to ask. How long before we experience the next crisis? Specifically, are the measures that the major economies employing today to counter the effects of recession sowing the seed for the next big bust.

I believe so. There isn’t adequate information (and attention paid at the moment) to assess the impact of the enormous cash infusion that the U.S. government is bringing into the world. I believe that it can cause a bigger problem that the one we just faced (or facing, depending on whom you speak to). Early last month, China’s chief banking regulator made an uncharacteristically blunt statement that highlights the problem. To quote, he said “The continuous depreciation in the dollar, and the U.S. government’s indication that, in order to resume growth and maintain public confidence, it basically won’t raise interest rates for the coming 12-to-18 months, has led to massive dollar arbitrage speculation,” and that this had “seriously affected global asset prices, fuelled speculation in stock and property markets, and created new, real and insurmountable risks to the recovery of the global economy, especially emerging-market economies.”

This statement followed the Fed’s announcement around keeping the interest rates in the US at almost zero levels for the foreseeable future (read as two years). What we need to realize is that the massive amount of money that is poured into the U.S. economy is making its way around the world into all kinds of assets (commodities, real estate, stocks, etc). This is a sure recipe for asset price inflation. This will eventually lead to a vicious circle of easy money, rampant speculation and higher prices.

In summary, I think this is the same sort of problem that led to the crash from which we are still trying to recover.