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Archive for January, 2012

Markets at 16000, again!

16000. The figure invokes a very strong sense of déjà vu. We’ve been at 16000 once in 2007, thrice in 2008, twice in 2009, twice in 2010 and four times in 2011. The level has acted as a support for the market many times, most notably in 2010 when the market rebounded sharply both times it hit 16000. Support is the technical term but what it really means that the market found enough suckers to buy the market at that level.  Someone who bought into the Sensex at 16000 in 2007 has made no money for more than four and a half years. This level is almost 25% below the Sensex life high of 21000. At such high levels, the logic which is sold to investors for long term investment is that one should not look at the trailing twelve month P/E but the forward P/E. The forward P/E projection is usually 20-25% higher which is used to imply 20-25% growth in value of the index.

Going by this logic, an investor should have got 20% returns YoY since 2007 instead of zero or negative. Why has this not happened?

EPS: an analyst joke

Ignoring market gyrations, I will simply state the most basic reason. The Sensex has been overvalued for the past several years. EPS growth has never been even close to the levels predicted by analysts. In Jan 2008, Citigroup said that the Sensex at 21000 was trading at 22 times forward P/E. Thus they were predicting a Sensex EPS of 955 for FY09 (by the way, they had a Sensex target of 23950-25000 for the year.) Even 1000+ estimates were made by some. The actual EPS after twelve months was 792. The funny part is that the figure of 955 is the current EPS of the Sensex according to bseindia.com(13 January 2012 with Sensex closing value of 16154.62 and TTM P/E of 16.91. The data from NSE suggests a higher Sensex EPS for the twelve months ended Sept 2011 at Rs.1013. Citigroup like many other analysts had projected extreme bull run conditions into the future.  This is a recurrent phenomenon which has been seen this year as well. Bloomberg consensus estimates for Sensex FY12 EPS were at around 1250. I would be surprised if it achieves 1050.

Conflict of interests

These consistent overvaluations are not a mistake but part of a very concerted plan to lure gullible investors who are stupid enough to believe in ‘finance experts’. The models of these experts are so complex and they consider so much data that they give themselves and investors the illusion of actually knowing the subject. Yet, their own traders are unable to beat the market and their clients lose money. Guided broadly by some fundamentals, the markets then rally mostly on sentiment. The job of the analyst is to disregard this truth about sentiment and to justify every valuation in the park, howsoever absurd. That is where the expertise of the analyst actually is needed. When the market fell to below 16000 in one day of panic selling on 22 January 2008, everyone on CNBC was shocked at the extent of the cut and advised ‘long term investors’ to enter into the ‘correction’. It was good strategy as people liquidating positions had to sell to somebody and these idiotic comments were as much denial as malice. These comments to buy petered out by the time 10000 was on the Sensex which was the actual level to enter. Why I call 10000 as the entry point instead of 16000 is simple. Sensex TTM P/E in end 2008 was 824. Even if we assumed positive earnings of 10% instead of the actual negative 10% we would have come across 900 forward earnings for FY10. At a forward P/E valuation of 15x, the Sensex should have still traded only at 13500. However, the figures of 15-18x are usually used in bull markets. By the PEG theory, forward P/E should equal EPS growth. This would have implied fair value of the Sensex at 10x or 9000. I wish I was smart enough to realize all this then and had bought bucketloads of stocks then. The point I wish to make is that the livelihood of the financial companies depend heavily on the capital markets. Market over exuberance is extremely profitable as it leads to tremendous growth of the financial services industry. Senseless valuations and forecasts are much more profitable than sober ones.

Ramping up prematurely

On fundamentals, the market should never have touched 21000. It did not deserve the level then and does not deserve it today. It did not deserve 18000 either. The move up to these levels has only benefited a few traders and financial ‘experts’, giving them the license to make idiotic charts that project irrational returns. In the long run the market has survived at neither of these levels.Even when the green shoots were clear in 2009-10, Europe was a concern that had the potential to explode any time. From this time to mid 2011, analysts once again utilized the opportunity to profit from gullible investors by selling them products at 18000 and 19000 Sensex levels by nicely showing them charts of twelve month returns. Of course at these levels neither the debt crises nor commodity based inflation was priced in. They were back to the forecasts of yore projecting 25000-30000 for the Sensex as the ‘India growth story’ is still intact. The India growth story has been a much abused term. It was responsible for the decoupling theory of 2007 that famously predicted that Indian markets would not at all be affected at all by the subprime crisis.

Strategy of fooling long term investors

The analysts will never tell you that markets are not sexy. That would negatively affect their profession. The big investors, funds and brokerages always try their best to profit at the expense of the public. At the end of the day, the public is the one holding stocks at the highest levels. The brokerages quietly sell out in the rallies, the rallies themselves being engineered. As engineered rallies are costly to sustain, the the index retraces its gains after some time. Carefully observe the Sensex yo-yos in the last few years. You will observe a lot of trading ranges. These ranges have usually been broken on the downside in spite of consistent buy calls from brokerages. However, the public is left holding stocks from the highs of these rallies. If the institutional investors actually sold without creating artificial rallies, they would create precipitous declines. Instrumental in the artificial rally is the role of the momentum trader. No wonder that India’s stock market trading volumes are the highest in the world but the cash market volumes are in single digits. These artificial rallies have terribly low delivery volumes. When these rallies peter out, the value or long term investor is exhorted to save the skin of the large institutional investors who wants to sell without creating selling panic. These market manipulations are centuries old and still manage to find fresh losers.

The Future

If we assume 1150 as the Sensex EPS twelve months down the line, a valuation of 12x suggests fair value at 13800. Do I suggest buying at 13800? Yes, but only if you are not invested at present. Besides, a crack to 13800 could as well send the index crashing to 12000. My reluctance stems from the fact that Rs 1150 on a base of 13800 yields 8.3%. Risk free interest rates are at 9%+. Thus, unless we officially believe in monkey forces and the greater fool theory, there can be no justification for investing even at that level. I wholeheartedly believe in the greater fool theory as it has been the primary mover of Indian markets in the last five years but it is a theory only for traders, not for investors. The recent rally in the Sensex of 1000 points is in my opinion, nothing more than a suckers rally. Even if the index rallies to higher levels, there are no real fundamentals for an extensive bull run. A move higher would continue the long term bear market and draw more losers at higher levels (this is exactly the opposite of what a technical analyst will claim.) There has to be a change in fundamentals for a bull run. Look at the problems in Europe, US and now China. Every positive development claimed such as improvement in US GDP growth and unemployment numbers has only short term relevance as the underlying debt and related concerns cannot be wished away. China has had a huge real estate bubble and the voices of a soft landing following the bubble burst sound so 2007. I was a big bull from 2004-2008 but have been a net seller since May 2008. Secular bull runs start from compelling valuations, not from fair value or marginally overweight valuations. Bull runs are scripted in graveyards.


http://www.moneycontrol.com Sensex Target of 23950-25000 in 2008 – Citi http://www.dalalstreet.biz/investor/2008/01/sensex-target-of-23950-25000-in-2008/
Business Standard
Reminiscences of a stock operator by Edwin Lefèvre


Revisiting the Nuclear Deal

It has been three years from the time when the nuclear deal was making headlines every day. A deal important enough to destabilize a government and lead to unprecedented diplomatic activity is now dead as a topic. This is only natural but remember that the deal had permanent repercussions and quite a few of the fallouts could be newsworthy in the future, energy security for instance. It is true that every now and then a pale ghost of the era does manage its entry such as the recent clearance by Australia to supply nuclear fuel to India.

The need and the projections

As of November 2011, India had an installed power capacity of 185GW. However as 35% of the power generated is lost, actual power delivered is much lesser, around 110GW. The peak demand for electricity is expected to grow to 298GW by 2021-22 according to the 17th electric power survey of India report. This calls for a trebling of power capacity in around ten years. At present nuclear power meets 3% of India’s power needs with around 3.7GW capacity. NPCIL has called for a target of getting 60GW of nuclear power online by 2032. There has also been a revision of the earlier target of 20GW by 2020. Now NPCIL projects 22GW nuclear power by 2015. In fact Atomic Energy Commission has speculated on figures as large as 600-700GW by 2050 providing half of all electricity. First of all, I am amazed that these guys have the ability to project 40-50 years in the future. No doubt there are some Nostradamuses in the AEC. They are also intelligent enough to give enough time to the government to think of a few gigawatt excuses when these targets, inevitably, will not be delivered. However, even in the best case scenario, nuclear power would still be a small percentage of India’s energy pool in the next ten years.

 A shortage of fuel?

Our reactors have sharply decreased their capacity utilization over the past few years due to fuel constraints. This solution to this problem was one of the hallmarks of the deal.
Total uranium usage in 2006 was 478 tons. India’s domestic uranium reserves at around 80000-112000 tons could last us for several decades. I am not even talking about our vast thorium deposits athtw e are yet to utilize. Yet we have fuel constraints: why? I quote from Ashley J Tellis’ book ‘Atoms for War? U.S.-Indian Civilian Nuclear Cooperation and India’s Nuclear Arsenal’,  ”The present insufficiency of uranium fuel arises not so much from a lack of natural uranium reserves as it does from bottlenecks in mining and milling capacity.”

If breeder technology is used and it shall be used at some stage, perhaps very soon, spent fuel could be reprocessed for plutonium increasing the longevity of our reserves still further.Unfortunately no one has thought of the ramifications of depending on power derived completely from foreign sources. A sanction could cripple us anytime.  This is the same story as coal. We do not mine our own reserves but prefer to buy at high rates from abroad.

The nuclear deal aimed at giving us access to the Nuclear Suppliers Group (NSG) in terms of fuel and technology.  This objective has been realized partially with cooperation from quite a few countries(France, South Korea, Australia, Namibia, Kazakhstan etc.) So should Dr. Manmohan pat himself on the back?

 Too little Too Late

 He can but only a light pat. The odds are that nuclear power is hardly going to make a dent in India’s power requirements in the near future. The predictions of the distant future are so fantastic that they remind one of the more optimistic stories of HG Wells (I was also reminded of stock market analysts who predicted FY12 1350EPS, keep it up boys!). The government organizations are revising their targets steeply upwards as if it is going to create actual capacity. Their predictions and targets differ by tens of GW. Government estimates are usually hopelessly overoptimistic (remember the budget expectation of 9%FY12 growth?) it is likely that the 2015 or 2020 targets will actually be achieved several years later. Even going by their aggressive targets, nuclear power is not going to solve India’s energy problem; it is much more prudent to worry about our coal supply situation.

 A Grudging Acceptance

The US has clearly not cooperated to the extent expected. Ever since Bush left, they have begun dragging their feet on various issues. The primary deal has a clause that calls off the deal as soon as India performs a nuclear test, they have imposed CTBT on us from the back door. These guys are smart; once they can make India significantly dependent on nuclear fuel they know that India would be willing to do anything to prevent a disruption of supplies.It does not matter that the cancelling of the 123 agreement will not, prima facie, lead to cancellation of supply from other countries; US pressure will automatically ensure that. Further, restrictions and ‘safeguards’ on our nuclear facilities will remain in place permanently, deal or no deal.

Russia has always cooperated with India on nuclear power and irrespective of the deal we would have had cooperation from Russia. What would not have been possible without the deal was acceptance by the NSG of India’s status as a nuclear power.

This argument is weak and not just because of the NSG nations could not have permanently ignored the great loss of potential revenue because of their blacklisting of India. It is weak because even the hypocrites of the NSG would have been able to see that India could not be bracketed with North Korea, Iran and Pakistan. The US and Russia have enough nuclear weapons to destroy the earth many times over and have all sorts of weapon systems to deploy these weapons virtually anywhere. China has been responsible for the proliferation of nuclear weapons to Pakistan and North Korea. The other nuclear power states, if not anything else, have conducted scores of nuclear tests. Yet these countries always assume the upper hand and have us groveling at their feet whenever the word ‘nuclear’ is mentioned. Our behaviour is like that of the dark complexioned girls in the ‘Fair and Lovely’ ads. We feel permanently inferior have to be somehow endorsed by the fair.

Policy based on farsightedness?

There can be another stream of though here though. India could be smart enough to try to exploit the uranium reserves of other nations as its own are finite. Expecting such far sightedness from Delhi may be asking for too much but you never know. As it is, this is a positive from the deal.  In several decades, we should be able to get the necessary approvals and fulfill the procedures necessary to exploit our own reserves. Till then, let us drink our Indian cocktail of imported coal, crude and uranium. Long live our trade deficit. Hic!

P.S: There is no denying that our nuclear power sector will benefit from the deal in the long run. It is probable that India could not have been able to negotiate a better deal. It is just that the deal was shown so much as an achievement that I thought a little perspective is required. I could not take all that nonsense about ‘India being a nuclear pariah’ any longer.


Atoms for War? By Ashley J Tellis, 2006  http://www.carnegieendowment.org/files/atomsforwarfinal4.pdf





Should regulators decide for the consumer?

 In the movie ‘Thank You For Smoking’, the protagonist exposes the regulatory and social hypocrisy related to smoking and indeed regulatory policing quite brilliantly. He also indirectly raises another question: is individual freedom of action more important than moral or social guidelines? Regulators, be they in the government or in the church/temple/mosque, have their own ideas about morality, ethics, objectives, rights and duties. If one stands for a truly free society, it is imprudent for social norms to dictate free choice by dint of regulators and corporations. If the people have the democratic right to choose their own leader, they have the democratic right to choose their own lifestyle as long as this does not interfere with the freedom of others. Therefore a ban on smoking in public places is justified as a smoker impinges on the right of bystanders to clean tobacco-free air but a total ban of smoking impinges on private right and this is an instance of moral policing. The world around us abounds in the sinful. Cheddar is just one of those 21st Century temptations that are so dangerous in the long run but are still so deliciously irresistible in the short term. The consumption based free market economy will have to be traded for a Saudi Arabia type of setup to satisfy all moralists and regulators. No fast food, alcohol, cigarettes, loud music and bikinis.

Companies through intelligent product choices and effective but dubious marketing tools do manage to influence consumers for pecuniary benefit even when they know that their products are harmful. They sometimes even suppress information that could help consumers make informed choices for fear of falling profits thus laughing in the face of free choice. Therefore the government and the media have the right, even the responsibility of educating the masses and helping them take better life decisions. Nevertheless, let the customer have the last choice.   

Disclaimer:I do not smoke and neither do I recommend it.