Correlation - Dollar and Stocks

An eventful week has passed by. The Dow has seen a strong rally not seen in decades and Mumbai has seen its deadliest terrorist attack. The patience of Mumbaikars is wearing thin and the country has rallied to comfort Mumbai. Hopefully and finally, we may see action to stop this type of senseless violence.

Markets -

The BSE Midcap is now 28% of the all - time high, seen at the beginning of January 2008. The SENSEX is 42% of its all-time high seen almost at the same time.

The relative outperformers have been the Healthcare companies (such as Pharma Companies and Hospitals-they fell only about 38%) and FMCG companies (such as Britannia, Colgate, ITC etc -they fell only about 25%).

The Aut, IT,PSU, Metal,Realty and other sectors fell significantly and are the underperformers by a wide margin. Here companies got hit by the fall in demand,leveraging. They were also significantly overvalued and had to give up their excesses. Another practical way to look at the differences in performances is because the Healthcare and FMCG companies were well established companies which were, with exceptions, sticking to their knitting and conservative in their approach to expansion. The underperformers indulged in excesses - borrowing and spending recklessly (since this happened even during the time when the boom was clearly coming to an end-remember Tatas?).

A look at the markets across the globe reveals that this recklessness was widespread. The evidence that we have in India will look like a reflection of what has happened elsewhere. All this is known today.

The interesting question is this - if India was turning attractive in the last few years which explained the high share prices, then why the great fall in share prices? A plain practical (cynical?) answer is that this is the business cycle, the boom and bust of stock market. But, unlike earlier episodes, the economy has also kept up a nice growth rate. Indeed, until 2008-09 brought upon us the problems from faraway lands, policy makers were talking about grabbing double digit growth.

However, I think this time it is different. I mean the growth story is for real (though it may have been sown by excesses or it may have sown excesses!) and the Corporate sector has become better (as I keep saying). It is different because of increasing local demand and this potential is being well protected as the Government comes out with fiscal and monetary steps. The economy is still promising.

At the current levels of stocks the PEs are about 11 while dividend yield is getting closer to 2 pct. Both are recent low and high respsectively suggesting a bottom is close.

Meanwhile, the currency markets are exhibiting diverse behaviour - the dollar has strengthened back to its recent highs while the Yen (that carry currency) is trying to regain strength. An attempt at reversal of the dollar strength is now visible on the charts. This coincides with a few other reversal attempts and thus demands our attention - the money and credit markets are showing some signs of life, the Dow had one of its large rally in decades(in percentage terms). Across the world fiscal and monetary steps are being taken and these are market friendly.

For India, a small additional evidence is in the form of the decreasing sales from FIIs. This indicator has been very important. So, if the recent behavious of market is analysed from the perspective of FII activity, a bottom can now form given the other positive conditions. Of course, these are still in embryonic stage. Similarly, with the worries on US fiscal coming into the open, the dollar seems to be getting into a top.

Cheers!

The Second Tsunami wave is Coming?

The tumble of the CITI stock and the questions being raised about the health of the Banking giant brings to memory the similarities with other collapses since September of this year. First the stock is jettisoned by traders amid a panic play. Then the risks that are held on and off the balance sheet are debated. Finally, the CEO's name is mud.
In this case, the cycle has been completed and its effectiveness can be seen from the way the Fed and the Treasury have been drawn into the drama. The CITI brand will be saved. What is unclear is what will carry that brand or how the animal will be transformed.
Clearly, the actions taken by CITI in the last one year have been ignored. The capital strength or its franchise/business value has been ignored. The CITI brand is valued at nothing. The fall in stock price by 50% in a week or to levels seen decades ago (when the organisation was smaller/more narrowly focussed) are attracting eyeballs. It appears that the fall in share price is driving the bank to the bankruptcy court or a merger. The enterprise value has been reworked.
There is clearly a warped sense of events here, even if one were to blame its portfolio of bonds and other instruments and assets. Except for the recent worsening of spreads on certain ABSs/Bonds etc, everything else on the balance sheet is/was the same? The fall in valuations, if it is due to genuine fresh issues/events/analysis must be the result of one or more of the following - a) the balance sheet got worse (possible due to the recession) b) fresh discovery of skeletons (speaks a lot about Auditors/Regulators) c) weak strategy (so much has been said on this, but with no clear majority or clarity of thought). None of these seem out of the recent history of ordinary in the financial sector in the world. CITI could not be suffering from more weaknesses than others.
You can see where I am leading you - the second "tsunami" wave is coming. Inspite of what CITI may do now (or may have done in the past) and inspite of all the capital that it may have (plus those billions in spare cash) nothing can stop the tsunami from running over it. If the first tsunami was linked to credit market the second one is simply a self-destructive, market generated panic that has now become omnipresent. If CITI has been targeted it is now easy to target so many other institutions - after,all they all had the same traders, risk managers and they operated in the same markets, they all paid fat bonuses and they are all listed.
Why do we have the second tsunami? I think it is just that while businesses are trying to come to terms and rescue themselves with friendly help from Government/Fed, the problems continue and the balance sheet does not get better: after all, capital can only pay for losses but unless it is deployed to expand business losses cannot be offset by fresh profits. Banks need protection from the second tsunami, not through provision of additional capital but through hiving off poor assets that have threatened to poison the entire balance sheet. Only then can the capital be put to use.
Can TARP be diverted for this purpose? Many more CITIes are in the line.

Recession is on (officially!)

So it is official. Atleast 4 of the major Economies are in recession - US, UK, Eurozone, Japan. Very soon, more will join this group. The urgency shown by the Governments and by Central Banks has shown little positive results so far.
I think the speed of this Tsunami has possibly left little time for Governments to think through. Eventhough rumbles in the nature of Bear Sterns and others hit the world before September, it seems that the post September 15 events (just about 2 months) were the watershed events-the letting go of Lehman must be rankling the Fed so badly. Until October the Fed has been grappling with the fallout of the Tsunami and as the US went through an election, it has been surprisingly inert, I mean on the fiscal side. Otherwise, what explains inaction on the Auto sector; the large employment is attraction enough for a politician to act.
The US also seems to have tied itself up with TARP. The freeing up of the Credit markets in itself can only push money market rates down across. Since markets expect the Fed to reach its zero rate (0.25%) what next? In the face of the phenomenal risk aversion and as more economies tumble down and demand is destroyed, why are Governments not taking fiscal steps?
The problem is that though the problem has built up over some years and has been assuming a shape and size in the last 15 months, the full force on the economy has been felt in the last few months. The size and the regularity of the problems have surprised Governments. Central Banks, with their clear heads (and objectives of growth, inflation, employment) have moved first, obviously with helpful prodding from Governments. But, what seems to be scarce is governmental action.
It would seem that Governments are so poorly prepared to deal with something like this, individually or collectively. But, if we were to step back and have a relook it is clear that every solution is itself quite complex. Since demand is yet to be fully destroyed, and employment has not really plummeted very severely, when recession is still at the shores of advanced nations, there has been such limited steps from developing nations. The developed nations themselves are unable to break free of their capitalism - they think the steps from Central Banks are adequate. The problem is of course, deeper. Developed countries have lived off the demand from developing countries. Since the latter are beginning to suffer GDP falls, developed nations will quickly discover that pushing the string will lead to nowhere. Until markets stay in a panic mode, funds flow into developing nations will suffer and consequently the vicious circle continues. It is my guess that the way out is going to take a few quarters.
Meanwhile, if you were to analyse the above, the following ideas must appeal -
a) the dollar is possibly close to a reversal
b) emerging market currencies would have to strengthen
c) export growth from emerging economies will have to suffer
d) fiscal health of all nations will worsen; but, as it happens usually, I suspect the developing economies will have to pay more for this
e) steeper yield curves will win respect

What may work and what has not been done yet.

A lot of importance is being paid to Monetary Policy in Emerging Markets. This seems misplaced as I will argue below.
Most emerging markets have seen destruction of export demand to a great extent. Their stock markets have sympathetically self-destructed aping the stock markets of G7 economies. Their currencies have weakened to account for the likely pressure on the balance of payments.
The monetary steps that has been unleashed addressed the demand for dollars from stock market investors who were withdrawing investments from the emerging markets. The policies provided liquidity that was sucked out as the economy produced goods but those goods were not purchased due to demand destruction. The intention was to provide liquidity to push the wheels and gears of production.
But, in the face of demand destruction, how does monetary expansion help? Yes, in the first stage it is necessary to smoothen the market action and help production to continue. But, where is the fiscal stimulus to boost demand?One can only hope that the Governments have been busy preparing for the second step silently and hopefully they will announce the steps. We need effective steps. In India, unfortunately, we have no sign of such steps.
Until these steps are announced, I am not certain that we will see a major recovery in the stock markets. For the long term, I would recommend taking exposures on stocks with good OPM, high Dividend yield (compared to historical trend of the stock or industry), low price to book value and low PEs. Of course, selecting the correct industry is a problem. The negative list would include Auto, Auto Ancilliaries, Cement, Metals, Real Estate, Media, Shipping etc. I dont have a yes list but I would use the above rules to pick my stocks in various sectors.
It is still a risky game - we dont know how many more skeletons are waiting to come out and we dont know whether the recession will last one or two years. It seems policy makers are talking about a recession that is 2 years long. Buyers beware!. Dont expect major returns and keep a large stop. Happy hunting!

A good week! - The tough week approaches

Global markets recovered about 12% last week. The recovery was well expected as Indices were at multi-year lows and a bear-market rally was unavoidable.
The chances of the rally fizzling out are bright this week. I base this on the following - No major CB or Government action was reported in the Western world during the last week that could have helped to push indices up further. The US became enmeshed in the final run-up to Presidential elections, the ECB more or less threw in the towel formally (a series of rate cuts are now well-priced in), the UK is preparing to welcome the recession. However, there hasb been action in the East - China and India along with other Asian countries delivered more liquity to markets as their governments fretted about impact on growth due to the disappearence of the Western Export markets. The mother of all has been ofcourse,the cut in rates in Japan - it dropped its rate almost by half!. The Japanese are going back to their favourite item on the menu - pushing the string, nevermind that it has not helped them in the past in delivering results.
As many commentators have begun to point out, the growth engines that are still spluttering are in Asia and the burden of saving the western world is now on the Asian Central Banks and Governments. While the glee of Asian commentators is hardly masked, it appears that Asia also believes its moment has now come. But is it possible that they are mistaken in their self-belief?. Have they forgotten that their recent riches have been rub-offs (ok, they may have been well deserved), from the growth juggernaut of the Western world (it is now very easy to divide the world into East and West - Japan has stopped contributing meaningfully, to the world GDP for so many years).
Since Asian economies have become more export oriented of late, how is it possible that they could not be impacted by the disappearance of those markets? Is it possible that they continue to chug along regardless of the trouble that the locomotive is facing? Their strong currency reserves position, their healthy fiscal position and their GDP have already weakened. In such a situation is it the right thing to fritter away these strengths or is it the time to conserve these?
The damage seems strong enough to impact these economies for some years. Have markets had a chance to analyse the impact of the measurs on their ecnomies? have markets estimated when the recession in the West would end and help the Asian economies to reestablish themselves?Should caution be ignored?In the steps that Asia is taking, do we see the formation of a local bubble driven by political expediency?
Markets are likely to have a relook at the above. I expect equity markets to remain lacklustre - in any case, volumes last week have been insufficient to pronounce an end to the recent crash of stockmarkets. Weak stocks must be offloaded in this phase.