Is the Q3 GDP growth rate of 6.1% a good or a bad number?

The short answer to the question: It depends on your viewpoint. Such a GDP growth number can not be seen in isolation, but in comparison with what has happened before and what is happening elsewhere.

Here are a few reasons why the number is good, and a few more reasons why the number is bad. The idea is not to confuse readers, but to provoke thinking and debate.

Reasons why Q3 GDP growth of 6.1% is good

If you look at the growth figures in some of the developed economies – particularly those in the Eurozone where even a 2% growth figure is considered good – a 6.1% growth figure should be celebrated with fireworks and champagne. The stark difference in growth figures is one of the reasons FIIs are investing big sums in our stock market.

High growth usually leads to inflation and therefore, high prices for goods and services. A more moderate growth figure has helped to tame inflation to a certain extent.

The Q4 GDP growth figure is unlikely to be much higher, but things are likely to improve from here on as there is usually a spurt in spending by the government sector to utilise left over funds from the previous year’s budget. In other words, the economic cycle may be bottoming out – which it usually does a few months after the stock market bottoms out.

Reasons why Q3 GDP growth of 6.1% is bad

This was the lowest growth figure in nearly 3 years, and almost 35% lower than the heady figure of 9.5% growth seen 5 years back.

There is evidence of economic slowdown everywhere – particularly in the manufacturing sector. Even services sector is slowing down. If growth doesn’t pick up soon, the FIIs may just pull out their money and invest it elsewhere.

Government’s fiscal deficit target for the year has already been exceeded in the first 10 months. That, coupled with the rise in oil prices, means that inflation may rear its ugly head again. The RBI may feel constrained to leave interest rates at the current high levels, or reduce it only marginally. That in turn will lead to slow growth in the next financial year.

Stock Index Chart Patterns – S&P 500 and FTSE 100 – Jan 20, ‘12

S&P 500 Index Chart

There was no stopping the bulls as the S&P 500 index chart comfortably scaled the 1300 level, and maintained its bullish pattern of higher tops and higher bottoms. All three EMAs are rising, and the index is trading above them. The bulls are back in the drivers seat.

The technical indicators are reflecting the bullish condition. The slow stochastic is deep within its overbought zone, where it can stay for a long time. The MACD is above its signal line and rising. The RSI is in its overbought zone. The ROC is positive but sliding.

The index has risen too sharply this month, and there are negative divergences visible in the MACD (lower top) and ROC (series of lower tops). A correction may be round the corner - which should be welcomed by the bulls. It would restore the health of the nascent bull market and provide an entry point.

The US economy continues to flash mixed signals, as it slowly gets out of a downturn. Industrial production increased by 0.4% in Dec ‘11. Last week’s initial unemployment claims came in much lower at 352,000. NAHB’s Housing Market Index rose to 25 – still low but the highest since mid-2007. Core inflation is decreasing but service sector inflation is increasing – so a deflation is unlikely. Rail traffic dropped sharply in Jan ‘12. The Baltic Dry Index has dropped by more than 50% in the last three months – close to the lows of 2009. That means, global trade is slowing down.

FTSE 100 Index Chart

The FTSE 100 index chart defied gravity and continued its bull rally last week. The index just about managed to get past its Oct ‘11 top, and formed a bullish pattern of higher tops and higher bottoms. The imminent ‘golden cross’ of the 50 day EMA above the 200 day EMA will technically confirm a return to a bull market.

The technical indicators are bullish, but showing signs of weakness. The slow stochastic is inside its overbought zone. The MACD is positive and above its signal line, but has stopped rising. The RSI is above its 50% level but sliding down. The ROC is barely positive, and touched a lower top as the index rose higher.

The UK economy is lagging behind the stock market. But there was some good news. Inflation fell to 4.2% in Dec ‘11 from 4.8% in Nov ‘11. This may pave the way for expansion of Bank of England’s Quantitative Easing programme. Luxury car manufacturers like Bentley, Jaguar and Land Rover (no longer British-owned brands) can help the country’s GDP growth, thanks to the healthy demand from China.

Bottomline? Chart patterns of the S&P 500 and FTSE 100 indices are back in bull markets, even as the US and UK economies continue to stumble on their way to recovery. This looks like a rally driven more by liquidity than by fundamental strength. Be prepared for sharp corrections, but use them to add. Looks like the world may not come to an end after all.

5 reasons why this is a sucker’s rally and not a change of trend

P. T. Barnum, a 19th century American circus owner, had apparently said: “There is a sucker born every minute.” Translated into English, that means that the world is full of gullible people. Any idea, however ridiculous and unbelievable it may be, is sure to find a few takers.

Crazy ideas - from ‘the world is flat’ and ‘the sun moves around the earth’ to ‘Suzlon is the next GE’ and ‘RJ is the Warren Buffett of India – follow his portfolio if you want to become rich’ – always find believers (a.k.a. ‘suckers’).

So, what is a “sucker’s rally”? It is a sharp price rise in an index or a stock without the support of fundamentals – usually during a bear market. Here are 5 reasons why the current rally in the Sensex and Nifty indices is a sucker’s rally:

1. There is a ‘gut feeling’ among small investors that the worst is over. Gut feelings are seldom right, unless the guts belong to some one called Warren Buffett. Even Buffett is known to make mistakes. Keep your guts where they belong. Use your brains instead. The problems in Europe haven’t been solved yet. China’s economy is struggling with slower growth. The worst may not be over yet.

2. A general consensus among market players is that RBI may start reducing rates soon; even if the interest rate remains where it is, there is likely to be a cut in the CRR to increase liquidity. The RBI has not indicated any such thing. They have only paused in hiking interest rates further. That means, interest rate remains just as high as it was a month ago when the Sensex and Nifty hit their lows. Stock markets can’t sustain in a high interest rate environment.

3. Though food inflation has started coming down, it may be more due to a high ‘base effect’ and seasonal availability of vegetables. Core inflation has moderated a bit, but still remains high. RBI has made it quite clear that controlling inflation is their top priority. Unless core inflation drops below 5%, interest rate cuts may not be effected. Inflation won’t come down as long as the government spends recklessly on various schemes to buy votes.

4. The government’s policy inaction will continue till the annual budget is announced in mid-March – thanks to the impending elections in five states. The only bit of good news for foreign investors in recent times has been the Supreme Court’s judgement in the Vodafone case, stating that the Income Tax department has no jurisdiction over a transaction between two overseas entities. But that judgement is more in the nature of removing an unnecessary irritant than paving the way for any fresh investments. The government has to be far more proactive on the policy front to change the commonly held perception that it is bureaucratic and inept.

5. Technically, both the Sensex and Nifty are in 14 months long bear markets. Bear markets (and bull markets) don’t turn around suddenly. They usually form some sort of a reversal pattern, which takes a few weeks to a few months to form. No such reversal pattern is visible as yet.

The recent spate of FII buying has begun to attract inexperienced small investors who don’t want to miss the bus. Technical indicators are looking overbought. The stage seems set for the big boys to get out. The suckers may get stuck with shares bought at higher prices.

Notes from the USA (Nov 2011) - a guest post

The US economy is slowly recovering from a massive downturn. To boost growth, interest rates have been maintained at near zero levels. Despite two rounds of Quantitative Easing, growth hasn’t picked up as expected. So, inflation has also remained low.

India has the opposite problem. High inflation has been fuelled by strong growth. To contain inflation, interest rates have been increased. But the inflation adjusted fixed income returns are negligible in both countries. In this month’s guest post, KKP gives his views on how to truly get rich by boosting your inflation-adjusted returns.

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Feel Rich Only with ‘Real’ Inflation-Adjusted Net-Worth-Growth

The 8^th wonder of the world is ‘% rate compounding’. In simple terms it means that growth in money based on money-making-money. In the US schools, I have taught kids how to become a millionaire by starting a part-time job at age 16 and putting $100 per month into an interest bearing account that multiplies money over the next 20-40 years of their life. On a side note, it is very interesting how many millionaires there are in the US, and in general, their profiles/habits/investment-styles (Google search for this info).

Well, the same effect of compounding works against us when it comes to inflation. In mainstream economics, the word ‘inflation’ refers to a general rise in prices measured against a standard level of purchasing power. Previously the term was used to refer to an increase in the money supply, which is now referred to as expansionary monetary policy or monetary inflation. Inflation is measured by comparing two sets of goods/services at two different points in time, and computing the increase in cost not reflected by an increase/decrease in quality. This is something that emerging economies grapple with during their entire growth phase, and we call that ‘growth pains’.

The inflation rate in India was last reported at 10.1% in Sep 2011. From 1969 until 2011, the average inflation rate in India was 7.99% reaching an historical high of 34.68% in Sep 1974 and a record low of -11.31% in May 1976 (strange but reported as negative). Many banks in India are offering 9% to 10% FD rates today, with corporate FDs getting much higher rates (at higher risk levels). Well, that is just a net 1% to 2% rate of return (after inflation). The chart below shows fluctuations in inflation within our Indian (a.k.a emerging) economy over the past three years. So, money is growing at a net-rate of only 1% to 2% in FDs or FMPs.

The US is about to move from a highly controlled non-inflationary environment into a high-inflation environment due to the non-stop printing of treasury bonds (no gold collateral is needed as everyone knows). Inflation basically makes you shell out more dollars to buy the same product (same quality and quantity assumed). So, one needs to earn more as a result - just to keep up with the inflation. Now, what really happens with inflation is a reduction in the value of the currency. So, as an example, one needs more dollars to buy an asset like a home, a gold coin or gallon of milk. See the chart below and study it for a couple minutes. Has the S&P500 really grown even though our Mutual Fund account might be showing net-growth-in-value? Maybe, slightly!

On the other hand, companies pay employees more every year to keep up with the inflationary environment, and over a period of time everyone feels good that they were earning $24,000 per year in 1996 or 2001, and now, they are earning $50,000 per year. But, when you measure it in terms of the depreciation in the dollar (caused by inflation), are they really better off with the higher salary? Or, would they rather have a no-inflation environment and get paid slightly more for their growth in experience and skills?

So, compounding effects of inflation in every economy around the world is really killing the value of the underlying savings that we hold, unless we keep growing that money ABOVE the inflation rate on a consistent basis. So, in India, if one had Rs 10 Lakhs in 2001, and now has Rs 21.58 Lakhs, then at the average inflation rate of 8% per year, their net-growth in wealth is a BIG ZERO. Same zero growth applies if one had Rs 1 Crore in 2001 and now has Rs 2.158 Crores. Yet, all of us feel good about the growth in the ‘total raw value of our accounts’.

Emerging economies give a lot of people a false sense of security that they have grown their income or assets by a huge amount over time, but one needs to beware of the 8^th wonder of the world working in ‘reverse’. India is going to generate the largest population of ‘middle income earners’, but one has to consider what a ‘real middle income level’ is, as inflation rate is eating away a lot of the increased income. As a result of the growth in the underlying Indian economy, a lot of low income earners will start feeling like middle-income-families, but for many it is a false sense of hope and feeling. Beware and generate a Return on Investment (ROI) way above inflation through a mixture of Stocks, Bonds, Real Estate, Commodities, FMPs and FDs.……That is the only way to feel rich and get truly rich!

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KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.

Spreading some good cheer in a gloom and doom market

You haven’t misread the title. I do intend to spread some good cheer on a day when the Nifty fell by nearly 100 points and the Sensex tanked by more than 300 points. Many large-cap stocks are sliding, which means the correction in the indices are not yet over. 

Many readers may think – specially after reading my recent posts and comments - that I am a perennial bear who advises caution during bull phases and staying away during bear phases. They won’t be too far off the mark in their assessment. Over the past five years, I have been a net seller in the markets.

But that doesn’t make me a bear – more a realist. After 25 years of investing in the stock market, I have learned from experience that a bullish stance causes more losses than a bearish stance. Warren Buffett’s two investment rules should always be remembered:

• Rule No. 1: Never lose money
• Rule No. 2: Never forget Rule No. 1

The trick to long-term wealth building is not to try and make a lot of money in a short time, but to ensure that your losses are taken quickly and kept to a minimum (through appropriate use of stop-loss levels) and profits should be allowed to run.

OK, enough pontification for today. Now, to the subject matter of today’s post. In a recent article in MoneyWeek,  author Cris Sholto Heaton made the following comments that may sound like music to the ears of small investors:

• India's inflation is too high. That's been caused by growth running too rapidly for the amount of spare capacity in the economy. So if you want to bring prices under control, you're going to have to curb growth for a bit.
• Ultimately, if EM governments are willing to act to slow their growth at this stage of the cycle, it's healthier for their economies in the long run.
• This is the normal cycle. Growth peaks amid rising inflation, slows as interest rates rise, and then can begin to pick up again as the central bank loosens policy.
• EM policymakers are likely to be able to declare inflation beaten for this cycle over the next three months or so. Most can then begin loosening policy. And as long as Europe avoids the very worst outcomes (a bad outcome is a foregone conclusion at this stage), EM growth is likely to pick up again within the year.
• It's been a tough five years for EMs. We've seen the global financial crisis and the eurozone crisis, both of which have encouraged investors to flee to safer assets. Yet over this period, the MSCI Asia ex-Japan is still handily ahead of the S&P 500.
• EMs wobble more when inflation gets high and interest rates start to bite. And they certainly sell off harder during a panic. That's what we've seen in 2011.
• But the other side of this is that they perform much better when growth is strong and they're likely to do better over the course of the economic cycle. So while the news is unlikely to get any cheerier in the next few months, it should be setting EM investors up for a much better 2012-2013.

I thoroughly endorse the authors views.

Investing strategies in inflationary times – a guest post

The business channels and pink papers have been obsessive about high inflation in the Indian economy and the consequent rise in interest rates – and well they should be. The government doesn’t seem too perturbed about the deleterious effect that high inflation causes – not just to GDP growth, but also to the wallets of common citizens.

During such times, savings and investments may be farthest from people’s minds as they struggle to make both ends meet. However, there are some comparatively less risky investment opportunities that smart investors can avail of – and Nishit discusses them in this month’s guest post.

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Inflation is rising, cost of loan repayments (EMIs) is going up and jobs are getting lost. How does a common man deal with such a situation?

Government bond yields have almost reached 9%. This means interest rates may rise further in the times to come. EMIs may go up if the RBI hikes the Repo rate, which is currently at 8.5%. In the case of loans, it is best to pre-pay some amount rather than letting the tenure increase. Many people will not get a tenure extension if their tenure has reached the maximum limit of about 25 years.

This is a good time to lock in your savings in high yield fixed investments. Non Convertible Debentures of L&T Finance gives an yield of about 10%. Other fixed income investments like Bank FDs should be utilized to avail of high interest rates. A SIP can be started in a Gilt fund. The interest rate cycle is about to peak soon and Gilt funds are likely to give good returns.

The recently increased limit in PPF investments from Rs 70,000 to Rs 1 lakh, and the higher rate of PPF return of 8.6% is a wonderful opportunity and should be made use of by small investors.

The markets are headed downwards. This scenario is likely to remain till interest rates start moving down. At every decline to key support levels, one can add blue chip shares to the portfolio keeping a 5 years horizon in mind. Supports for the Nifty are at 4700, 4300 and 3700.

Gold as an investment can be looked at only when the previous high of US $1900 per oz is taken out, or near the support level of US $1600 per oz.

For astute investors, cash is king. In a slow GDP growth environment, if one is willing to put down cash then real estate as well as automobiles may be available at good discounts. Plummeting car sales indicate that good cars may soon get sold at discounts just to clear off the inventory and keep the assembly lines working.

This is a great time for an investor to build an entire new portfolio. The portfolio should comprise of fixed income instruments, stocks, commodities and real estate. A proper balance of allocation to these assets will generate wealth going forward.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

Market celebrates RBI interest rate hike – why?

RBI increased the repo rate (at which it provides short-duration loans to banks) and the reverse repo rate (at which banks maintain short-duration deposits with the RBI) by 25 basis points each. The repo rate is now 8.5% and the reverse repo rate is now 7.5%. The CRR has been left unchanged at 6%.

With inflation remaining stubbornly high despite 12 rounds of rate increases since Mar 2010, it was widely expected that the RBI will increase the repo and reverse repo rates by 25 bps (0.25%) today. The market should have already discounted the rate hike. Why the buying celebration then? Was there some good news that the market liked?

Apparently, there were three. First, and most important, the RBI governor hinted at inflation rate moderating to 7% by Dec ‘11, in which case there will be no further rate hike at the end of the year. Moderation of inflation and a likely pause in the rate hike cycle was considered ‘good news’ by the market.

Also, for the first time ever, interest rate on savings bank accounts have been de-regulated. That means banks have the freedom to offer any interest rate on savings bank accounts that they deem fit. Last, but not the least, banks have been given the freedom to open branches in Tier-II through Tier-VI towns without prior permission.

Let us look a little more critically at each of these pieces of ‘good news’.

How will inflation suddenly moderate to 7% in less than 2 months when it has remained uncontrollably high for the past 20 months? Will food prices suddenly fall? Will government employees get less salary? Will politicians become honest and stop their looting? The answer is: none of the above.

The moderation will happen due to the ‘base effect’. Inflation was already high in Dec ‘10. So the YoY increase in Dec ‘11 will appear to be less. Actual prices that we pay will remain almost the same as now. There is also a possibility that diesel and kerosene prices will finally be increased if inflation does moderate. So, we may get back to square one.

What about the pause in the rate hike? Well, that won’t help much either. Better than bad isn’t necessarily good. As per RBI’s guidance, the GDP growth rate has been revised down from 8% to 7.6% in year ending Mar 2012. There are already signs of growth slowdown, which will be exacerbated by today’s rate hike. Unless interest rates start heading downwards, stock markets are unlikely to go up.

Is the saving bank interest rate de-regulation good news? Certainly not for banks. Their business has already been hampered by high interest rates – due to which loans have become dearer and term deposit rates have gone up. If interest rate on savings bank accounts is increased, it will be a direct hit on bank bottom lines.

As per the Economic Times, if savings bank interest rate is increased from the current 4% to 5%, then all the banks put together may need to pay out an additional interest of Rs 15,000 Crores, which may reduce the entire banking sector’s profitability by 13%.

Look at it another way. Savings bank account holders will collectively receive an extra Rs 15,000 Crores. What will they do with the sudden inflow? Why, spend most of it. Will that stoke the fires of inflation or not? You tell me!

SBI has the largest percentage of savings bank accounts among all banks (Yes Bank has the fewest) and will be affected the most by an increase in savings bank interest rate. The CMD went on record that SBI will not increase the savings bank interest rate. He also said that de-regulation means rates can also be reduced.

What about opening branches in small towns? It may help in financial inclusion of people living in remote areas where no bank branches exist. But if there was a lot of business potential in Tier-II through Tier-VI towns, banks would have sought permission to open branches there by now. By removing the red-tape of prior permission, the business potential of remote corners of the country is not going to increase overnight. But opening branches will add to the operating costs of banks.

The ‘good news’ doesn’t seem so good, does it? What was the reason for the buying today? It was a combination of short-covering and index management – today being early F&O ‘expiry day’ because of the Diwali holiday. The broader markets didn’t participate much in the rally.

Both the Nifty and the Sensex are poised at the upper end of their respective trading ranges of the past 11 weeks – with the huge gaps caused in Aug ‘11 remaining unfilled. Tread with caution.

BSE Sensex and NSE Nifty 50 index chart patterns – Oct 21 ‘11

The battle between the bulls and the bears remained inconclusive for the 11th straight week, as both the BSE Sensex and the NSE Nifty 50 index charts consolidated within rectangular trading ranges.

The longer they consolidate, the stronger will be the eventual breakouts. The only problem is that we don’t know the direction of the breakouts. The probability of downward breakouts is greater, because the consolidations have followed prolonged down trends.

BSE Sensex index chart

On Mon. Oct 17 ‘11, the Sensex made a ‘reversal day’ pattern (higher top, lower close) that marked the end of the two weeks long rally from the low of 15745 touched on Oct 4 ‘11. RIL’s unimpressive result and outlook was the likely selling trigger. The good news from the bullish point of view is that the rising 20 day EMA provided good support to the retreating index.

The technical indicators are not bearish, but hinting at a downward move in the coming week. The MACD is above its signal line and positive, but has stopped rising. The RSI has slipped down before touching its overbought zone, but is just above the 50% level. The slow stochastic is still inside overbought territory, but about to drop down. The ROC is still positive, but has quickly changed direction to cross below its 10 day MA.

L&T’s not-so-great Q2 result was as per expectations, but their poor future guidance came as a big shock to the market. The strong selling in the counter dragged the index down on Fri. Oct 21 ‘11. A few more such shocks can break the resolve of the bulls to defend the 15700 level. Till then, more consolidation within the trading range is likely.

NSE Nifty 50 index chart

The weekly bar on the Nifty chart shows a higher top and a lower close – a ‘reversal week’ pattern that signals the end of the two weeks long rally from the low of 4728. The combined resistances from the falling 20 week EMA and the support-resistance level of 5170 seemed to overwhelm the bulls.

The technical indicators don’t look particularly promising. The ROC rose quite sharply, but could not enter the positive zone. The MACD failed to cross above its falling signal line in negative territory. The RSI is moving sideways just above its oversold zone. The slow stochastic failed to make much headway after emerging from its oversold zone, and stayed well below the 50% level.

Inflation has shown no signs of coming down. Another 25 bps rate hike by the RBI has been factored in by the market, though signs of slow down in GDP growth has prompted a few analysts to suggest a pause in the interest rate hike.

The myth behind the growth in exports has been exposed by a group of Kotak researchers. Bogus orders from dubious overseas entities located in tax-havens like the Bahamas, and over-invoicing are being used to funnel back black money into the country. This could be another huge scam that rival the 2G and CWG scams. No wonder the FIIs are in a selling mood.

Bottomline? The BSE Sensex and the Nifty 50 index chart patterns look all set to move down towards the lower edges of their respective trading ranges. More negative surprises from index heavyweights can trigger further selling. A Diwali rally appears unlikely. Stay on the sidelines.

Notes from the USA (Jul 2011) – a guest post

Michael Moore’s hard-hitting documentary, ‘Bowling for Columbine’, made an interesting point. The government and the TV channels do their best to keep Americans in a state of fear – so that they consume more! Remember the Y2K scare? Shelves of department stores were empty of water, canned food, torches, batteries, guns and a myriad other goods required for survival. People bought truck loads of the stuff. On Jan 1 2000 – nothing happened. No crash, no collapse. But a lot of goods consumed.

Following the economic downturn in 2008, a similar fear scenario played out across the USA. It was going to be worse than the 1929 depression. There would be riots on the streets. The US dollar was not going to be worth the paper it was printed on. Stock markets would crash and retirement benefits will vanish into thin air (a la Enron). Yes, unemployment is still high and the housing market is in doldrums. The doomsday theories have only led to a phenomenal rush to buy gold – but Americans are not getting fooled this time. They are tightening their belts – well some are – and digging in for the long haul.

In this month’s guest post, Kiran provides a ‘ground-zero’ report of the US economy.

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Global Growth Slow, But Continues…

The global recovery from 2009-10 has broadened to encompass more enterprises, more countries and more elements that show aggregate demand. Improving labour market conditions in high-income countries and strongly expanding domestic demand in developing countries augurs well for a continued maturity of the recovery that is more than two years old.

The recovery here in the USA has gained strength over the past 8 to 12 months and shows signs of becoming more self-sustaining, although all of it has happened in an atmosphere of disbelief that it is real. Of course, Aug 2^nd 2011 deadline for raising the debt limit being around the corner, makes this recovery a huge suspect in the minds of many without a Quantitative Easing – Part 3 (QE3). At this point, QE3 is not being discussed although Bernanke has hinted that he would be ready to pull it off if the situation warrants it. In the US, significant gains in levels of manufacturing and services activity, business re-investment and technology upgrades have helped improve conditions in U.S. labour and professional services markets. Most of the technology upgrades that we see are destined to either reduce labour costs, or reduce the current monthly expenditure (lower powered servers, more automation, VoIP, Telepresence, Call Center automation etc).

The recovery in Europe continues to face substantial uncertainty surrounding sovereign debt in several Eurozone members (code named PIIGS for each of the individual countries in huge debts). Germany and France have shown increasing strength; with unemployment in Germany now well below pre-crisis levels. In many other countries, growth is becoming constrained by fiscal consolidation programs, ongoing banking-sector restructuring and a skepticism regarding the financial sector. Perception is more important than reality, which is why gold is still trending upwards.

The horrible natural disaster and ensuing nuclear challenge in Japan will shape economic and human developments in that country for years to come. More importantly, all of the nuclear power plants in the US that are built similar to the one in Japan are under re-engineering to avoid a similar disaster. Despite the very real human and wealth losses associated with the crisis, its negative impact on GDP growth is expected to be temporary.

Overall, global growth is projected to ease from 3.8 percent in 2010 to 3.2 percent in 2011, before picking up to 3.6 percent in each of 2012 and 2013. The slowdown for high-income countries mainly reflects very weak growth in Japan due to the after-effects of the earthquake and tsunami. Japanese companies doing business worldwide are just starting to turn around and getting the business environment back to normal. Growth in the remaining high-income countries is expected to remain broadly stable at around 2.5 percent through 2013, despite a gradual withdrawal of the substantial fiscal and monetary stimulus introduced following the financial crisis to prevent a more serious downturn.

Contrary to the above, much of the rest of the world, meanwhile, is brimming with energy and hope. Policymakers in China, Brazil, India, and Turkey worry about too much growth, rather than too little. Rate increases in India and China are perfect proofs of efforts to curb inflation. By some measures, China is already the world’s largest economy, and emerging-market and developing countries account for more than half of the world’s output. The consulting firm McKinsey has christened Africa (part of the BRICA with the A standing for Africa), long synonymous with economic failure, as the land of “lions on the move.” That is an amazing turn for an economy – recall the pictures circulating on the Internet of kids who do not have water to drink and food to eat, and are just sitting there on the roadside. Well, a lot of that might be just a memory in Africa in the next decade.

Overall, for the cluster of developing countries growth is projected to decline from 7.3% to 6.2% between 2010 and 2012 before firming somewhat in 2013, reflecting an end to bounce-back factors that served to boost growth in 2010. The BRIC nations might have its own growth factors that are uniquely defined based on the organic growth within. Hence, their economies are more in the 8% to 10% GDP growth range, although inflation is a cause for concern in these hot economies. So, monetary tightening will continue to happen to temper the inflation.

Bringing it to today, perhaps for the first time in modern history, the future of the global economy lies in the hands of developing countries. The United States and Europe struggle on as wounded giants, casualties of the financial excesses and for the next few days, political paralysis. Economies of USA and Europe are shackled by heavy debt burdens with years of stagnation or slow growth in the offing and definitely a widening inequality – although they are not going to crash, contrary to emotional and eye catching dire predictions by some people. Analyzing the profile of family groups, and looking into their financial profiles, clearly shows the excesses in US from an income and asset standpoint. In the next one to two decades we will create ‘the haves’ and ‘the have nots’ even in these developed countries since the poor are getting poorer (with less and less government programs) and the rich will get richer buying more assets at low prices, for an eventual recovery. See below for a couple of interesting graphics:

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KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.

RBI tries a ‘shock and awe’ tactic to tame inflation

In what seems like a last-ditch effort to bring inflation under control, the RBI decided to use a ‘shock and awe’ tactic – even if it meant a slow down in growth in the near term – by raising the repo and reverse repo rates by 50 bps (i.e. 0.5%) each.

That may not seem like much, except that the consensus estimate in the market was a 25 bps hike. Some even hoped for a pause in the rate hike, as there were some signs of slow down in inflation and growth. The 50 bps increase came as a bolt from the blue, and the bears didn’t waste a moment in extracting a heavy toll.

Wikipedia describes the ‘shock and awe’ tactic as follows:

‘Shock and awe (or rapid dominance) is a military doctrine based on the use of overwhelming power, dominant battlefield awareness, dominant maneuvers, and spectacular displays of force to paralyze an adversary's perception of the battlefield and destroy its will to fight.’

Whether inflation will get tamed or not remains to be seen. But a 100 point drop in the Nifty and a 350 point fall in the Sensex may seriously hamper the bulls’ will to fight. However, the rate increase should not have come as a big surprise to readers of this blog. After the previous rate hike in June ‘11, this was my cautionary statement:

‘… without appropriate fiscal and policy measures to support the RBI's monetary tightening, inflation is not going to come down any time soon. … Which means more tightening and further increase in repo and reverse repo rates in future, while the governments 'addiction' remains uncured.’

I paid Rs 50 a kg for fresh ‘bhindi’ yesterday. People living in Mumbai and Delhi may laugh at such ‘cheap’ rates, but it is the maximum I have ever paid for a non-exotic vegetable in Kolkata. Now there is talk of allowing only 6 LPG cylinders per family per year at the ‘subsidised’ rate of Rs 405. Any additional cylinders will be billed at Rs 700 to mitigate under-recoveries of the oil marketing companies.

Even the current slightly moderated inflation rate – which the RBI is trying to bring down further with the 50 bps rate hike – is actually an artificially lower rate due to subsidised prices of diesel, kerosene and LPG. The actual rate is way higher.

So, be prepared for more rate hikes, more EMI payments, slower growth in the economy and a sliding stock market. The press conference of bank CEOs following the RBI announcement made one thing crystal clear. Things will get a little worse, before they get any better.

But there is a silver lining to every dark cloud. Shorter-term fixed deposit rates are likely to be raised soon. Time to take some profits off the table, and reallocate to fixed income. Looks like a very testing time for the bulls till Diwali.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – May 27, ‘11

Last week, the BSE Sensex and NSE Nifty 50 index chart patterns had thrown up bearish and bullish possibilities. The scales remain tipped in favour of the bears, in spite of the FII buying on the last two days of the week that ensured that both indices closed about 1.5% higher on a weekly basis.

Why? For three easy-to-observe technical reasons:

1. The down trend lines (in blue) from the Nov ‘10 tops are intact

2. Both the Sensex and Nifty are trading below their 200 day EMAs

3. Both indices have spent 4 straight weeks below their falling 20 day EMAs; the 20 day EMAs are below the 50 day EMAs; the 50 day EMAs have slipped below the 200 day EMAs – the dreaded ‘death cross’.

Are the indices getting ready for a bigger fall?

BSE Sensex Index Chart

All the signs are pointing towards a deeper correction. What should investors do? The answer will depend on what kind of a fish they are! The Anagatavidhatas should sell and preserve capital; the Pratyutpanyamatitwas may set a stop-loss 3% below the Feb ‘11 low of 17300; the Jadvabishyas will await their destiny.

The technical indicators are showing signs of life, but are still bearish. The MACD is deep in negative territory, but has moved up to touch the signal line. The ROC is above its rising 10 day MA, but both are still negative. Both the RSI and slow stochastic have emerged from their oversold zones, but are below their 50% levels.

Observant readers may notice the positive divergences. The Sensex reached a lower bottom of 17786 on Wed. May 25 ‘11. The ROC, RSI and slow stochastic made higher bottoms. Was the net buying by the FIIs on the last two days of the week a mere coincidence?

Nifty 50 Index Chart

There is every chance that the Feb ‘11 low of 5200 (or 5178, if you want to be precise) will be tested, if not broken. I’m not a gambling man, but if I was, I would put some money on 5200 level holding. Why?

Three reasons. First, despite all the negative news and lack of buying support from investors, the Nifty has not crashed. Second, the time-wise correction of the 20 months long bull rally (from Mar ‘09 to Nov ‘10) is almost over. Third, the MACD, the RSI and the 10 day MA of the ROC are forming bullish saucer-like rounding-bottom patterns. My guess is that the FII buying was triggered by these technical reasons.

Food inflation went up again. The proposal to allow FDI in multi-product retail – should it become a law – will not only help tame inflation, but provide huge job opportunities for semi-educated youth. The impending hikes in the prices of diesel and cooking gas, and the likely moderation in the GDP growth rate have already been discounted by the market.

Bottomline? The BSE Sensex and Nifty 50 index chart patterns have entered bear markets, and may face steeper corrections. There are signs of reversal of the down trends in the near term. Unless the down trend lines in both indices are convincingly breached, one should not go on a buying spree. This may be a good time to nibble into fundamentally strong stocks that have corrected a lot.

RBI raises interest rates – markets crash; what should investors do?

Regular readers of this blog should not have been too surprised by today’s selling, which followed the RBI announcement raising the repo and reverse repo rates by 50 bps (0.5%) each. In last Saturday’s analysis of the Nifty chart, I had mentioned the possibility:

‘The markets have already discounted a likely 25 bps interest rate hike by the RBI next week. If the actual hike is 50 bps, there can be more selling.’

The RBI governor had adopted a graduated raising of interest rates so far, taking baby steps of 25 bps on the past few occasions. Market players had expected a similar hike this time around, but were taken aback by the aggressive stance of the RBI. So, they decided to head towards the ‘Exit’ doors.

What signal is the RBI trying to convey? Inflation has now become a bigger concern than growth. It needs to be contained, even if growth slows down in the near term. Is that the right thing to do? What happens over the next few months will provide the answer to that question. Interest rate hikes take some time to percolate through the financial system.

The fact is, the earlier rate hikes of 25 bps at a time - in an effort to balance inflation and growth - has not really worked. Inflation continues to remain high, though it has reduced from double digits to single digit. The unrest in the Middle East caused a spike in oil prices that made the inflation situation even worse.

Thanks to the elections in a few states, petrol prices have not been raised. But they surely will be, once elections are over. Diesel, kerosene and cooking gas subsidies are huge burdens being borne by the oil marketing companies. At some point, diesel prices will need to be de-controlled. That will further stoke inflation.

The RBI governor decided to bite the bullet and tackle inflation with a heavier hand now. Higher interest rates will hinder the already slowing credit off-take and capex plans of India Inc. GDP growth in FY12 is expected in the 7.5% – 8% range. Not bad, but lower than earlier forecasts. Profit margins of India Inc. will reduce. That is why the sell-off happened today.

What should small investors do? Some times the best thing to do is to do nothing (and enjoy the extra 0.5% interest in your savings bank account that RBI doled out). Wait for the dust to settle, and the selling to subside. Then pick up some of the better stocks that may have been beaten up badly, and whose valuations start to look attractive.

Related Post

The Interest Rate hike was expected – why did the market fall?

The implication of high oil price for investors – a guest post

With oil prices ruling above $100 per barrel, India’s trade deficit is widening and inflation remains a major concern. In this month’s guest post, Nishit looks at the implication of high oil prices for investors, and suggests how we can benefit from this adversity.

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From a low of about $33, Crude Oil has now spiralled up to a high of almost $110 a barrel. Crude Oil is the lubricant which runs the world, so let us investigate why the rise in price and what are its implications for India.

Most of the crude oil deposits lie in the Middle East. Middle East has been racked by turmoil and unrest. Supply of oil has been threatened in Libya and other parts like Saudi Arabia. The price rise has been mainly on the back of supply concerns.

India imports 70% of its oil, and if the price rises it implies that it would need to spend more dollars to buy the fuel. A country earns dollars by exports, inward remittances by Indians settled abroad and also foreign investments into India.

We spend the dollars on imports. The difference between exports and imports is known as Current Account Deficit. As we import more than we export, we are always in trade deficit.

If Oil is pricey, the deficit widens, and India’s credit worthiness declines making it less attractive for foreign investors. Petrol price rise gets passed on to the consumer, thereby leaving him with less income to spend.

Subsidy on Diesel of almost Rs 18 to a litre weakens government finances leaving it with less money to spend on infrastructure and developmental activities.

In 2008, crude oil price rose and peaked at around $145 per barrel. All the time, as oil price was rising the equity markets did not react too much to the price rise. A month after the prices peaked, the markets tanked. This was aided also by the Lehman Brothers meltdown.

Now how do we play this as small investors?

We have oil producers like ONGC and Cairn. Cairn is a major beneficiary but now caught up in legal tangle over its acquisition by Vedanta, and ONGC has to bear the subsidy burden.

The legal tangle has no effect on its daily operations and hence I would still prefer Cairn to ONGC. Portfolio allocation could be these two companies and Gold. Average gold price per ounce is 15 times a barrel of oil. This implies fair price for Gold now is $1650 per ounce.

This also means avoid the Auto sector, Banks and anything which is linked to rising Interest Rates. Rates will keep rising as government battles inflation and also seeks to raise more money to pay for oil.

Don’t like the petrochemicals sector? Long Gold and short Banks could be an interesting option.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

Related Post

Cairn India: an oil story worth betting on – a guest post

How much longer will the Sensex trade within a range?

That may be the question on the mind of many investors, as the Sensex has been trading between 17300 and 18700 for the past 5 weeks. The short answer is: I have no idea. It could be six weeks or six months. Buyers and sellers seem evenly matched. The post-budget rally appears to have come to an end.

What could be the triggers for the Sensex to move up?

1. The RBI may not increase interest rates on Mar 17. Since inflation remains a concern, another 25 basis points rate hike is being expected by market players. Ms K Morparia of JP Morgan said in a recent TV interview that she won’t be surprised by three more rate hikes of 25 basis points each. Not increasing the interest rate will be taken as a positive by the market.

2. Q4 results will hit the market in another 5 weeks or so. With higher commodity prices and higher interest rates, profitability of India Inc. is widely expected to take a hit. If results are flat, even if not better on a QoQ basis, markets may interpret that as a positive.

3. India is still dependent on good monsoons. Agricultural production gets a boost. That helps the rural economy to grow, and has a cascading effect on the economy as a whole. Signs of a good monsoon may shake the market out of its current gloomy sentiment.

What could be the triggers for the Sensex to go down?

1. Despite several rounds of interest rate hikes by the RBI, inflation continues be in double digits. Government spokespersons have run out of excuses. More rate hikes could bring the growth momentum to a screeching halt.

2. The unrest in North Africa and the Middle East has sent oil prices shooting up into three figures. Economic growth and high oil prices are a disastrous combination for stock markets. If oil prices remain high, India’s fiscal deficit and inflation may spin beyond control. As it is, artificially depressed kerosene and diesel prices is causing havoc to the finances of the oil companies. The real inflation rate is much higher than the published figure.

3. The FIIs have pulled out about $2 Billion from the Indian markets in 2011. This amount is less than 10% of what they invested in 2010. Still the Sensex lost 18% from its Nov ‘10 peak. The relative valuations of the US and Europe markets are cheaper. If the FIIs continue with their selling and pull out another $2 Billion, the Sensex could test its May ‘10 low of 16000.

Looks like the sideways consolidation in the Sensex may continue for a while longer. As I have mentioned several times before, investors should not get too bogged down by Sensex movements. When the market is unexciting and boring, it may be a good time to take a vacation and catch up on your reading. If you have already read books by Graham, Lynch, Fisher, Pring – read them again. You will understand many things that you missed when you read those authors for the first time.

Why is the stock market so excited about an unexciting budget?

These are the irreverent views of a non-economist. Take them with a pinch of salt.

It isn’t bad, so it must be good

There was a lot of uncertainty surrounding the budget this year. Rising inflation was not contained even after several interest rate hikes by the RBI. Higher interest rates were beginning to slow down Indian Inc’s growth momentum. Some tough tax measures were expected from the Finance Minister (FM). None came. The markets heaved a collective sigh of relief.

Shorts got trapped

The four months long correction in the stock markets had turned sentiments negative. All attempts at pullback rallies were getting sold into. The FIIs were selling heavily and redeploying in their home markets. Several experienced players were shorting the market. The unexpected surge in the indices on Budget Day was mainly due to short covering.

Auto sector gets an indirect boost 

A 2% excise duty cut was offered to auto makers a couple of years back as part of the economic stimulus. A roll back was discounted by the market. The FM left the excise duty unchanged. Feb ‘11 auto sales numbers have shown decent growth. Auto stocks soared on this twin good news.

Smart move from ITC

An increase in excise duty for cigarettes and other tobacco-related products was widely expected. In anticipation, ITC had increased the prices of some of its most popular brands prior to the budget. No such increase was announced by the FM. Don’t expect your pack of smokes to get cheaper. ITC’s bottom line will be a direct beneficiary.

Not so great for Mukesh Ambani

By transferring his shareholding in Reliance to a clutch of Limited Liability Partnership (LLP) companies, Mukesh Ambani ‘legally’ avoided paying income and other taxes (such as dividend distribution tax). LLPs have been brought under the purview of 18.5% MAT. Bad luck for big brother – he has to now pay taxes like a mere mortal! If only he had known earlier, he may not have built the ostentatious eyesore he calls home.

Reduced surcharge on corporate taxes

This would reduce cash outflows, and is a definite positive. Hopefully, the extra cash will get channeled into expansion activities and help to increase GDP growth. Investors may get rewarded with higher dividends.

Tax benefits for senior citizens

By reducing the qualifying age for a senior citizen from 65 to 60, several lakh tax payers will be able to avail higher tax exemptions. Some of the extra tax savings are likely to find their way into MFs and equity.

Does all this justify a 600 point rise in the Sensex today? Is the correction over? Should investors start buying again? Answers to these questions will become clearer over the next few days – now that the uncertainty about budget proposals are behind us.

Don’t let relief cloud reality. There has been little change in the global or local situations. Uprisings continue in the Middle East. Higher oil prices will further stoke the fire of inflation. Get set for another interest rate hike. FIIs were net sellers on Budget Day. The Sensex and Nifty are near strong resistance zones.

Stick to your asset allocation, and don’t get swayed by short-term index moves.