The Monsoon Worry...

India's southwest monsoon is likely to be below normal this year, which could impact the country's vital agricultural harvest. The forecast announced a couple of days back have further downgraded the weather bureau's April forecast of 96 percent of the average rainfall to 93 percent.

The agricultural sector reportedly contributes about 17 percent of India's GDP, and two-thirds of India's population depends on it and thus any delay in monsoon could lead to a serious problems of unemployment, falling taxes, a fall in spending from the rural side and consequently a rising deficits.

This is not only a bad news for the agriculture India but also a cause of concern for the Indian FMCG sector which depends heavily on the rural India for their growth. Companies like HUL, Colgate, Dabur, etc have more than around 35-40% rural exposure on an average and thus a bad monsoon could lead to a erosion in their profits too.

Signs of poor rains could also force the government to introduce more fiscal stimulus into the economy just as investors worry about the widening fiscal deficit and thus could also lead to a downgrade in India's sovereign rating.

Historically a poor monsoon for a 10 percent deficiency, we see a 1 percentage drop in GDP. This is significant in the present context. This will also lead to a increase in food prices and thus a higher interest rates and having a added slowdown effect.

Thus I firmly believe that if we have a bad monsoon, this will lead to a further correction in stock markets, no matter what the budget offers. The fertilizer, the FMCG, agri commodity sectors will be the worst hit.

Hence keep looking on to the skies!!

FREE Seminar on International Finance Qualifications (CFA,FRM,CMT,PRM)

Kredent Academy invites you all to a seminar on International Finance Qualifications and Career Opportunities organized by Kredent Academy in association with Pristine Careers, Mumbai on June 27, 2009 at Bharatiya Bhasha Parishad, 36A Shakespeare Sarani, Kolkata 700 017 from 2pm to 5pm.

The seminar aims to discuss on International Qualifications like Chartered Financial Analyst (CFA®), Financial Risk Management (FRM®), Professional Risk Management (PRM®) and Certified Market Technician (CMT®) and their career opportunities in India. The enlightening seminar is designed for you to understand each of these courses in detail and clarify any/all doubts from qualified professionals who have valuable experience in their respective fields. It is a great opportunity for students to talk to these professionals one on one and understand the career flowchart in the field of Finance.

Request you to let us know of your participation, along with that of any/all others who wish to accompany you to the seminar, either by way of a return mail or through a phone call/ message on 9748 222 555.

Be there, we will also be having a panel discussion on "Career Opportunities in the present turbulent capital markets"

The Reality of the IIP Data

Last week India declared its IIP numbers, the IIP for the month of April grew by an unexpected 1.4%, way above the street expectations. The people on TV were really cheering with this kind of IIP performance and even the president of FICCI Mr. Harsh Pati Singhania said “The overall IIP figures show encouraging signs of recovery and the stimulus packages may be having some impact. It is critical now to sustain this pace of recovery”.

However the reality of the IIP data is a little different which the media is trying to hide. Some the the key facts of IIP data are:

• Eleven out of seventeen industry groups showed a positive growth. (This was highlighted and indeed is encouraging)


• The industry group ‘Wood and Wood Products; Furniture and Fixtures
  ’ have shown the highest growth of 31.4%, followed by 12.6% in ‘Wool, Silk and Man-made Fibre Textiles’ and 10.2% in ‘Non-Metallic Mineral Products. Now the highest growing segment is Wood and Furniture; should this be encouraging- Definitely NOT


• the industry group ‘Food Products’ have shown maximum negative growth of 34.4% followed by 12.4% in ‘Leather and Leather & Fur Products‘ and 5.1% in ‘Other Manufacturing Industries’


• As per Use-based classification, the Sectoral growth rates in April 2009 over April 2008 are 4.6% in Basic goods, (-)1.3% in Capital goods and 7.1% in Intermediate goods. The Consumer durables and Consumer non-durables have recorded growth of 16.9% and (-)10.4% respectively, with the overall growth in Consumer goods being (-)


• 7% negative growth in capital goods is a pointer to industry confidence that they are not keen on spending on capex and intuitively they are not seeing a rise in demand.


• Growth in intermediate goods does not tell us story till it is clear for which products these intermediate goods are used


• Growth in consumer durables may be seen as encouraging


• Along with the Quick Estimates of IIP for April 2009, the indices for March 2009 have undergone the first revision and those for January 2009 have undergone the second (final) revision in the light of the updated data received from the source agencies


• This is the best part of it. So the final figures for April 2009, shall not be known till August 2009. How much would it differ from the quick estimates is any body's guess.

Thus I believe we are far from recovery and as I mentioned in my earlier post that given the bonds yield and earnings yield theory I definitely see Sensex at around 12,000.

Option ARMs Threaten Housing Rebound

An Option ARM is a adjustable rate mortgage, a loan popular during the housing boom for its low minimum payments before resetting at higher costs later. This helped a huge number of home buyers in US take loans with very low monthly payments initially and which allowed them to pay less than even the monthly accrued interest thus resulting in a "negative amortization", which means that the unpaid portion of the accruing interest is added to the outstanding principal balance.

For example, if the borrower makes a minimum payment of $1,000 and the ARM has accrued monthly interest in arrears of $1,500, $500 will be added to the borrower's loan balance. Moreover, the next month's interest-only payment will be calculated using the new, higher principal balance.

"Shirley Breitmaier’s mortgage payment started out at $98 when she bought a three-bedroom home in Galt, California, in 2007. The 73-year-old widow may see it jump to $3,500 a month in two years"- Says Bloomberg. The reset occurs when the outstanding mortgage balance reaches a level of around 130-150% of the initial mortgage balance.

About 1 million option ARMs are estimated to reset higher in the next four years, according to real estate data firm First American CoreLogic of Santa Ana, California. About three quarters of those loans will adjust next year and in 2011, with the peak coming in August 2011 when about 54,000 loans recast, the data show.

This reset will lead to further foreclosures in US and will be a threat to the housing recovery. The more than 30-35% fall in the value of property will not help the borrowers to refinance their mortgage and thus the foreclosures are inevitable which will lead to a further slowdown in housing prices. This will also result in more write offs on the balance sheets of the large banks/ lending institutions as the payments are difficult to come across.

Thus the recovery in the US markets is a long way thing and hey don't think that we have decoupled.

For more information on Options ARM please refer to the following link: http://www.lynxbanc.com/optionarm.htm

I O U

On Tuesday June 9th the US Treasury gave approval to ten big banks, nine of which had earlier passed “stress tests” set by regulators, to allow them to repay money to the government’s Troubled Asset Relief Programme (TARP). These should be a combined repayment of around $68 bn.



Markets are really taking this news as a signs of a end of the worst for the financial system, however the US treasury secretary says "These repayments are an encouraging sign of financial repair, but we still have work to do,”



Do you know how have these banks which were in deep trouble 6 months back have managed to raise such money...? No no, not by being profitable, its just by selling their equity to public. Still, there is a long way to go. Paying off the first $68 billion is a healthy start, but western governments own roughly $450 billion in banks. If markets or the economy slump again, investors’ appetite for new shares will evaporate and these bank would be in blues again.





Even today in US, the things are not as good enough as it looks. The banks are using the life support systems provided by the government. Central banks provide generous collateral rules for borrowing, in an effort to provide banks with liquidity and the system needs to refinance some $25.6 trillion of wholesale funding by 2011. This is whopping 25 times or more than India's GDP.

Thus all this, which makes one think that we are completely out of woods needs some more deeper analysis. Stocks like L&T trading at a P/E of 34+ and Sensex up by around 85% in last 2 months. Do we still see more upside...? The answer is quite debatable.

Most of the companies/sectors have already gained huge on expectations that budget will be a panacea, hence even if budget does provide all the reforms (which is very very unlikely), the same is already discounted into the prices and we should see profit booking. If you all believe in short selling, the most probable losers (If Nifty corrects) should be: L&T, JP Hydro, JP Associates, DLF, Educomp, Reliance Power, the list is long. Would like you people to add some more on the list.

Sensex Earnings Yield Vs Gov. Bond Yield

Earnings Yield as per investopedia is defined as The earnings per share for the most recent 12-month period divided by the current market price per share. Under the same logic, earnings yield for Sensex will be the present value of Sensex divided by last 12 months EPS or we can be more forward looking and take the coming 12 months consensus EPS estimate.

Presently this earnings yield figure for our Sensex Index is around 5.9%. The yield on India's 10 year risk free bond is around 6.5%.

Classical theory suggests that investors in equities should demand an extra risk premium of several percentage points above prevailing risk-free rates (such as T-bills) in their earnings yield to compensate them for the higher risk of owning stocks over bonds and other asset classes. So here we have an amazing case where a risk free asset is yielding much more than a high risk asset. The best arbitrage is to short the Sensex and go long in the risk free bond until this spread becomes acceptable.

The reverse was precisely the case around 3-4 months back when the yield on Indian government bonds was just 5% and the Sensex earnings Yield was around 9.5%. That time also the spread was over valued. So the strategy global fund managers adopted was to short Indian bonds and long sensex. Due to shorting of bonds the Yield started increasing (Bond yield and prices go in opposite direction) and as sensex moved up the yield started coming down. But this spread was taken well above the justified levels.

Thus , we can accept the spread to again become acceptable and the only way this can happen is by sensex at the levels of around 12000, if no surprising changes happen on the bonds front.

The graph above clearly shows that the long term spread between S&P500 yield and 10 year US government bold yield have being fairly consistent and any deviations have led to the movement so that the spread converges.

This what investopedia also says regarding the same:

"Money managers often compare the earnings yield of a broad market index (such as the S&P 500) to prevailing interest rates, such as the current 10-year Treasury yield. If the earnings yield is less than the rate of the 10-year Treasury yield, stocks as a whole may be considered overvalued. If the earnings yield is higher, stocks may considered undervalued relative to bonds "