Stock leaders on bumpy economic road, no double-dip

Mid- and small-capitalization stocks often serve as a leading indicator for the direction of the US economy. So what does it say that they they are down roughly 15 to 20 per cent?

As the US economy throws up dismal economic data, putting the ominous possibility of a double-dip recession at the top of Wall Street's talking points, money managers are saying that assessment would be premature

"Right now the market is responding to this fear, and double-dip is in the air... but is it verified in the statistics? And in that case we are saying 'No, there is no double-dip,'" said Milton Ezrati, senior economist and market strategist at Lord Abbett, in Jersey City, New Jersey.

"Particularly in an environment like this it is very dangerous because the market picks up the talk and it will give a lot of false signals," Ezrati said, referring to the influence grim economic data can have on stock markets and vice versa.

Risks of a double-dip have increased, managers admit, as employment and housing have failed to rebound, and, akin to the eternal chicken vs. egg debate, corporate earnings estimates are being revised downward in anticipation of sluggish growth.

"We are in a transition period where small and mid-cap stocks will face headwinds as they face the question of whether earnings projections will be reduced by a more sluggish global economy," said Martin Sass, founder of New York-based investment advisory firm MD Sass.

Sass believes it is premature to declare a double-dip recession is at hand, but notes that earnings estimates are now being revised down rather than up.

In fact, the mean change in aggregate earnings estimates for the third quarter for the S&P SmallCap 600 index fell 1.1 per cent in the last 30 days, according to Thomson Reuters StarMine Professional data.

That is still slightly less negative than the 1.4 per cent drop in the last 30 days for revisions to S&P 500 aggregate earnings estimates.

DOWN SHARPLY

Stocks have tumbled from their late April peak, entering deep into correction territory even after a strong rally on July 7, when most major stock indexes rose over 3 per cent.

According to Canadian investment firm Brockhouse Cooper, over the prior five US recessions, small-cap stocks have outperformed large-cap shares by 4.5 per cent, on average between the market trough and the end of the recession. In the first year of expansion that out-performance is 13.7 per cent.

The S&P 600 SmallCap index is down 16 per cent while the S&P 400 MidCap index is off 15 per cent from April 26 highs.

That may be worse than the 13 per cent drop in the large-cap S&P 500, however, since the March 2009 market trough, mid- and small-cap stocks are up well over 80 per cent versus a 58 per cent rise in the S&P 500.

"We are not forecasting a double-dip, no, just a slow growth environment. Very slow. We think (small-caps) are going to underperform a little bit, more just because of the relative valuations," said Bernie Williams, the head of USA's private investment management division based in San Antonio, Texas.

Williams says he sees shares in a trading range, although he remains "cautiously optimistic."

"If earnings come through and we don't double-dip, we could end up in positive territory for the year," he said.

As a result of their run-up, on a valuation basis, the S&P SmallCap 600 has a forward price-to-earnings ratio of 14.24 per cent versus the S&P 500's 11.6 per cent. The Russell 2000 index of small-cap shares is even higher at 15.74 per cent, according to Thomson Reuters data.

While valuations may be high in mid- and small-cap stocks, one fund manager sees the correction as a buying opportunity.

Aram Green, co-portfolio manager of the Legg Mason ClearBridge small-cap growth fund, says cash is piling up on corporate balance sheets while firms go through a "digestion phase of assimilating people back into their employment base."

That is perhaps one reason for the lull in hiring, which is feeding into market trepidation.

"I think we are going to need more data points, and I think that is why the market is pulling back. They are waiting for that next set of data points," said Green.

"I like the stock market here. These are very attractive valuations and if there is any sort of digestion period, we are talking about a minimal impact in terms of the earnings power of these companies over the next 12 months. At very attractive valuations we are putting money to work."

Investor sentiments as fears of a double-dip mount

With the global economy slowing, interest rates about as low as they can go, governments getting austere and banks being investigated for stress, it is getting harder for investors to keep putting on their bullish faces.

Heading into the first full week of the second half, investors are still committed to riskier assets such as equities and high-yield bonds in their portfolios, but are being battered with questions about whether this is the right stance.

Reuters asset allocation polls for June showed investors cutting stocks a bit, but retaining a long-held overweight bias toward them. They also moved into the riskier end of bonds, seeking yield. But markets themselves are telling another story.

After a brief rally early last month, world stocks have fallen almost steadily. What was shaping up to be a gain on Friday was only the second up day in nine sessions that have seen stocks lose around 8%.
At the same time, bond yields are painting a picture of deep concern about the future. Citi’s composite world bond yield is only 1.8%, while short-term US and euro zone yields are only 0.6%.

“There is growing concern over the possibility of a double-dip recession in developed markets ,” said Rob Carnell, chief international economist at ING Commercial Banking.

“In consequence, people want to keep their money as liquid as possible in case things start to turn down.”
Just about everything has been turning down from bond yields, to stocks, economic indicators and the Baltic Freight Index, a proxy for world trade.

ARMAGEDDON?

There are two implications from this. Either investors banking on a stock revival are wrongly positioned or bond yields are wrong pricing in something approaching an investment and economic Armageddon.
Fred Goodwin, the “Mr Macro” analyst at Nomura, leans to the latter. He says that once a recovery has begun to take hold, as now, double-dip recessions are very rare. The one in 1980-82 , he reckons, only came about after the Federal Reserve had raised interest rates closer to 10%.
“Positioning (now) for the double-dip , a Japan scenario, or a Depression does not offer compelling risk-reward at these levels of bond yields,” Mr Goodwin said in a note.
Others are similarly unimpressed by the idea that another recession is on the way, particularly when it comes to corporate earnings performance, the main driver behind stock movements.

“A number of factors have been in place preceding previous global earnings recessions including an inverted global yield curve, excess inventories and unsustainably high profitability . None of these factors are apparent now,” Citi equity strategists said in a note.

That said, it is hard to see where investors would find grounds to be bullish if the current recovery slowdown — epitomised by the latest manufacturing surveys — starts gain momentum.
Reliance on Chinese and other emerging market growth could hardly be guaranteed if their main commercial markets started to retrench. 

And deflation fears are growing enough to prompt investors such as those at HSBC’s absolute returns team to buy 25- and 30-year bonds. They want to grab a near 4% yield they expect will soon fall as demand drives the price higher.
STRESS
The week ahead is not likely to offer much that will help investors make up their minds about the future.
The Bank of England and European Central Bank hold separate meetings, but both are likely to keep interest rates on hold.
Germany will also auction some 10-year Bunds on Wednesday. Some auctions have been disappointing because record low yields have put people off. But this auction is expected to attract plenty of buyers because of a massive amount of cash that will be returned to Bund investors the same week from other maturing German issues.
Austria might provide a better stress test, when it auctions € 1.3 billion of benchmark bonds on Tuesday. The country is highly exposed to debt-stricken Hungary and is seen by markets as riskier than Germany and other core euro zone sovereigns.
Investors, meanwhile, will also be looking for any early results from the European Commission’s stress tests on European banks, designed to see how they would cope with crises.
Results for some of the biggest banks will be given to EU finance ministers on July 13 but leaks or announcements could come before then, especially about German regional and Spanish saving banks. 

Shape of Things to Come

This is the editor's note that appeared in the September issue of Wealth Insight magazine. The cover story, 'Recession is Dead', argued the case for the recovery that the global economies have effected from the meltdown position they once were threatened with, especially focussing on the position in India.

Our cover story is a cheerful one. I firmly believe that at this point of time, there’s a lot more economic good news than there’s bad news. As our article points out, the recovery has defied the most pessimistic expectations and has been rapid and sustained. For equity investors, the bonanza has been tangible.

It’s not quite one year since the global crisis broke. It is clear now that last year’s collapse of equity prices had two phases. There was a ‘normal’ bear phase that started in January and lasted till August. And then there was the all-is-doomed phase in which people seriously doubted the survival of the world economy and the capitalist system and so on and so forth.

It is important to note what exactly we are recovering from. To a great extent, we’re all over-relieved at the turn of events. I freely admit that articles like our cover story are an over-reaction to the actual degree of up-turn that has happened. However, they’re also justified. We may be seeing just the beginnings of the much-cheered green shoots, but that’s a big relief from our biggest fears of last year. There are plenty of dark spots on the horizon, but none of them look like show-stoppers, and that’s very good news indeed.

The important question that then arises is how accurate is our analysis. It would be customary for a magazine editor to defend his articles and claim that they represent the best possible forecast, but I’m not going to do that. This stuff is not that certain. Some days back, while reading an article in Scientific American on the science behind economic boom-bust cycles, I came across an interesting comparison between science and economics. Economists, the article said, suffered from ‘physics envy’. Economics is not physics. Physicists have three laws that can describe 99 per cent of the world. Economists, in contrast, have 99 laws that can describe three per cent of the world. Predicting, or even recognising, recessions and recoveries is not just an inexact science, but not a science at all. We can see some signs that indicate a certain outcome, but we could easily be missing others that may be indicating quite the opposite.

So, does it look like a recovery is on its way? Yes it does. Is it a sure shot? Certainly not! However, that actually shouldn’t matter to us as investors. The collapse and recovery of last year should make it clear to us that no matter how dark the outlook at any point of time, it’s better to always be on the lookout for buying good stocks at good prices rather than be overly influenced by generalities of the economy and the global situation. To a considerable degree, choosing stocks and making investments is a relative exercise. It doesn’t matter how the whole picture looks at any specific point of time. What matters is that the actual investments you are making are better than other investments. Eventually, those companies will do well and when things turn around, you will reap the benefits.

This recession was feared to be an ‘L’ shaped one or at best a ‘U’ shaped one. In reality, it has turned out to be a ‘V’ shaped one. However, investors who try to move in and out of stocks by double-guessing stock momentum as well as the macro picture are more likely to end up with a series of ‘W’s or perhaps even ‘M’s. Or perhaps we need to look closer home. How about a IÉ or a ³? Do these shapes better describe the way your investments are behaving?

How Wall Street will kill the recovery

One year later, one of the key excesses that led our consumer-based economy into an historic downturn is being abused in the exact same way that got us $147-a-barrel oil last summer. Worse, many in the media are again getting the facts wrong on oil prices and demand—as if the oil and gasoline price explosion of 2005-2008 never happened—as one look at last week's oil report will verify.

Forget what Cambridge Energy Research Associates reported on Oct. 13. By its calculations oil demand actually peaked in 2005 among the industrialized members of the Organization for Economic Cooperation, while in the U.S. alone oil usage has dropped by 2 million barrels a day compared with 2005. But remember these facts: As of this writing, U.S. supplies of refined distillates, including diesel, heating oil
, and aviation fuel, are at a 25-year high. We have 29.56 million more barrels of oil in our inventories than we had the same week a year ago, and refined gasoline on hand is up 16.37 million barrels for the same period. And this does not include the 125 million barrels of oil that the Secretary General of OPEC says are being held offshore in tankers.

Skewing in Public In fact, the market is skewed by the high inventories of refined products. Last week, the Energy Information Administration showed that refinery utilization rates fell by over 4%, to 80.9%, yet oil jumped $2 a barrel on the news that our gasoline inventories fell by 5.2 million barrels.

That was the dark side of the futures market
making its move: Oil should have fallen just because, according to the American Petroleum Institute, refinery crude runs fell by 511,000 barrels per day (validating that 4% drop in utilization). In short, refineries determine oil demand, and in that week demand for more oil was off substantially—yet the market bid crude up.

It is true that this time of year usually sees some refinery maintenance. But, as Truman Arnold trader
Tom Knight wrote, "Though [refiners] say this is planned maintenance, we hear it is primarily motivated by very poor refining margins [and] the collapse of the sweet/sour crude spreads." Referring to "ongoing problems at the Delaware City [Del.] refinery," Knight gets the sense that this may be "the precursor to a permanent closure of that refinery." Basically, of course, overall demand for finished oil products is so weak and inventories so high that the "crack spread," or refinery profit, is virtually nil.

IEA Gave Us the Facts—Late This inconvenient truth is merely another strong indication that the retail market demand for refined goods doesn't come anywhere near justifying the market price for crude. Therefore, oil is back to being severely overpriced.

'Current market rally's not a sustained recovery'

By invite: Manish Chokhani

The current hype over ‘green shoots’ and the prevailing investor complacency due to abundance of liquidity tend to disguise a darker economic reality. The world economy and markets are merely rebounding after falling off a cliff; a bounce, therefore, should not be construed as a sustained recovery. A period of extended difficulty and volatility lies ahead as consumers, banks and governments deleverage their balance sheets.

Before I’m misunderstood as a prophet of doom, let me clarify that my natural instinct is to be optimistic. Indeed, last Diwali, at the height of the economic gloom, we at Enam published a “Flashback from Diwali 2009,” predicting a 74% rise in the BSE index from the lows of November 2008. At that time, it seemed like too bold a call. Today, with the benefit of hindsight, it seems to have been too timid! Indeed, markets have risen higher and faster than we anticipated.

This was ‘Stage 1’ of the recovery. Following the collapse of Lehman Brothers and the seizure of credit markets, governments and central banks unleashed an unprecedented amount of fiscal and monetary firepower to prevent deflation and demand destruction. Their ‘brahmastra’ response prevented an economic meltdown and restored confidence. It had the desired effect of reliquefying trade channels and reflating asset values, thereby allowing businesses to start inventory restocking and banks to repair their balance sheets.

However, at some stage in early 2009, the astute ‘Mr Market’ sensed a new reality. The economic malaise was so deep that no country, including China, was willing to go against the status quo and assume the mantle of economic leadership. The world economy could not find an engine of growth to replace the US consumer. Hence, each country effectively allowed the US dollar to retain its supremacy, even as the Fed ran the currency printing presses as never before and the US fiscal deficits went into uncharted territory.

The reluctance of every major country to allow appreciation of its currency against the greenback allowed the creation of a new wall of liquidity and a massive wealth transfer to the US. (Note that Indian currency reserves have increased by about $50 billion since January 2008 even as, ironically, the rupee has depreciated from 40 to 48 in the same period).

This charade where everyone colluded in pretending that things are back to status quo and money remains cheap and freely available has led to a speculative frenzy centred on staple commodities (up 50%) and emerging markets (up 100%), the two areas where demand is expected to hold up, thanks to demographics and saving trends.

In the real world, despite ample liquidity, businesses find little reason to invest in new capital stock, as enough capacity exists to meet the one-time demand surge that’s being coaxed out of consumers by government handouts and stimulus packages. Indeed, the global demand outlook for the next few years is clearly anaemic as Western consumers save more. We may indeed get a brief round of ‘profit prop’, achieved through cost-cutting and restocking. But sustained earnings growth seems a long way off, thanks to a lacklustre operating leverage. At the same time, banks are shying away from releveraging their balance sheets. The green shoots have a few harsh winters ahead!

As ‘Stage 1’ of the recovery nears its end, the forces of economic recovery, government and central bank intervention and speculation are set to collide.

Welcome to ‘Stage 2’. In the coming months, the US Federal Reserve and other central banks in the West are on course to cease their
‘quantitative easing’ operations in order to prevent bond markets from panicking. In other words, they will soon stop buying what they are printing themselves and the current delusion of cheap liquidity will end. Real investors will have to be found for all new government treasury issuances. No less an authority than Warren Buffett has commented that these ‘Greenback emissions’ cannot be funded even to the extent of 50% if all the increased US savings and Chinese trade surpluses are invested in US treasuries! Whatever scenario one paints, Western liquidity is set to get tighter and asset prices must get relatively cheaper to attract investors. This means a combination of a cheaper dollar (or US asset prices) and higher interest rates in the months ahead.

Global liquidity is, therefore, seeking destinations such as India, taking into account its relatively attractive long-term outlook. However, as real investment demand remains muted, an asset price bubble in the property and the stock market in the immediate short term is a real possibility. We have already seen signs of this. With just $8 billion of FII inflows so far this year, selective stock and land prices are already approaching previous highs. Imagine the scenario if $4 billion of QIPs and IPO issuances had not partially met this demand!

Policy action holds the key to whether we can absorb enough liquidity to improve our fundamentals or whether we will passively go through another boom-bust phase. Faced with a record fiscal deficit and continued investor interest in India, the government has a golden chance to monetise large amounts of PSU assets, shares
, land, 3G spectrum and NELP VIII exploration rights to create a virtuous environment of non-inflationary growth, with a strong currency and low interest rates. While this may arrest the upward march of stock market prices in the short term, it is the scenario most consistent with improving our long-term fundamentals and creating a sustainable bull market.

This window of opportunity is limited for us in India. In the next few months, global bond and currency markets face an inflexion point as quantitative easing ceases. Record borrowing requirements must be met even as trade surpluses, consumption and profit growth weaken. Interest rates are set to harden and currencies are likely to turn volatile. At the same time, expect the speculative frenzy in commodities to climax as it faces a headwind due to unsustainable prices (e.g., in steel), lack of storage capacity (e.g., in oil) and higher carrying costs (interest rates).

As we head toward the climax, we in India may soon have to contend with the risk of inflation and a fat subsidy bill, thanks to a rise in prices of globally-traded commodities (oil, food grain, pulses, sugar, copper, etc.), combined with the pressure on prices emanating from the erosion of local buffer stocks because of the drought. In 2010, we could potentially face a repeat of the 2008 ‘high-inflation-weak rupee’ scenario that will force interest rates higher and GDP growth lower. While we cannot control international commodity prices or our rain gods, we need to move pre-emptively and use the current benign scenario to our advantage.

The Chinese are preparing themselves for ‘Stage 2’. They’re diversifying their asset basket by buying up resources and have attempted to pre-empt inflationary pressures by stocking up on commodities ahead of a speculative climax. Indeed, they are already in the process of trying to prick their steel production and property/stock market bubble.

You, dear investor, must not get carried away into taking on more risk unless you are a savvy technical trader. My advice would be to construct a portfolio comprising companies that are well-capitalised, innovative, entrepreneurial and reasonably priced! Sectors to favour are domestic consumption; energy/utilities; insurance, and cost-competitive scale players in resources. Above all, I urge you to stay alert. The game is about to change.

(The author is a promoter-director of Enam Securities)

US economy has bottomed, to bounce back soon: Warren Buffet

Warren Buffett, Chairman and CEO, Berkshire Hathaway said the market were unlikely to fall any further and only a 9/11 kind of situation could rock the economy now. “The market sort of formed a plateau at the bottom right now but if you have got some horrible events, some of the 9/11 type of event or worse you could have something that could be really disruptive and start things all over again. We are past the critical point.”

Buffet said though the economy has not bounced back it has quit going down and it would soon come back. “I have never been able to tell whether it's going to be a week, a month or six months but we are on the mend.”

On the real estate front Buffet said, “We are certainly through the worst of our residential real estate in all probability and the reason is we are building a lot fewer houses than we are forming households, so that solves itself overtime than do it in a day or week, but it solves itself. Some of the toxic assets have been flushed through, there has been capital raised, we are measurably better off than we were a year ago.”

Beginnings of a Economic Recovery

The advance estimates for US GDP during the second quarter of 2009 (April-June) point to a distinct improvement in overall growth performance. The economy declined by a seasonally adjusted, annualised rate of 1 per cent. This was better than the consensus forecast of minus 1.5 per cent and a significant improvement over the minus 6.4 per cent recorded during the previous quarter. Of course, this is merely a first estimate, to be followed by one based on more complete information at the end of August. If the momentum that is responsible for the difference between these two quarters continues, the economy could return to positive growth in the third quarter itself, earlier than the fourth quarter transition that many forecasters have been expecting.

The factors responsible for the decelerating decline are many. Non-residential fixed investment and inventories both showed much smaller decreases than in the previous quarter. Non-residential investment had declined by almost 40 per cent during the first quarter but was contained to a 8.9 per cent decline during April-June. This indicates that both commercial real estate and investment in equipment are stabilising, while the inventory numbers suggest that businesses are able to finance larger inventories as a result of normalising credit flows. On the other hand, private consumption expenditure showed a downturn, decreasing by 1.2 per cent during the quarter after having risen by a modest 0.6 per cent during the January-March period. Both durable and non-durable consumer goods, which had increased during the previous quarter, declined during this one. The one significant component which is showing persistent negative momentum is residential investment, mainly construction of new houses, which decreased by over 29 per cent, only slightly different from the 38 per cent decline in the first quarter. On the trade front, exports of goods and services showed a much smaller decline than during the previous quarter, perhaps reflecting both better global conditions and dollar depreciation, while imports also declined by a much lower rate, which is reassuring news for export-dependent economies around the world. As in virtually all major economies, the one significant component that showed positive growth during the quarter was government spending, at the federal, state and local levels. This suggests that the fiscal package approved early this year is beginning to spread through the system and is contributing significantly to the reversal of the decline.

At the aggregate level, the fact that the US economy is recovering somewhat more quickly than earlier expected is very good news for the whole world. But the pattern of recovery highlights the challenges that most governments will have to face as the recovery strengthens. It is now hugely dependent on public spending. At some point, sustainability will depend on the ability of private spending to take on a leading role. The question is: will huge government programmes funded by borrowing “crowd out” a recovery in private spending? Higher interest rates and a turnaround in inflation do suggest that this is a risk.

Worst is over but complete recovery eludes

The government may ease curbs on foreign direct investment (FDI) and introduce an array of reforms to reverse a decline in industrial growth

witnessed in the last two fiscals. An indication to this effect was given in the Economic Survey, presented to Parliament on Thursday. However, the Survey said there were a number of positives such as a revival in power generation, an improvement in cement dispatches and higher credit offtake indicating that the worst may be over for the Indian industry.

The reforms could include allowing FDI in multi-format retail, starting with food retailing, raising FDI limit in defence industries to 49%, decontrolling sugar and fertiliser industry, limiting drug price control to essential drugs and creating an internet-enabled data system to help small and micro businesses, the survey said. It also suggested a review of labour laws to encourage economic activity.

One of the main reasons for the poor performance of the industrial sector over the past year was high raw material prices. In July 2008, Indian crude oil basked was priced at $132 per barrel. The persistent rise of crude prices impacted petro-based industrial inputs adding to fuel cost.

An increase in the prices of other commodities, particularly metals and ores, from the latter half of 2006-07 to the second half of 2008-09 also hurt the manufacturing sector. In fact, cost on account of consumption of raw materials rose by as much as 38% and 44% during the first two quarters of 2008-09, compared with 16% and 12% in the first two quarters of the previous fiscal.

A sharp increase in interest costs, especially from the third quarter of 2007-08, also added to the woes of the sector. The country is pinning its hopes of an industrial revival on a fall in raw materials prices. The decline in crude prices, low raw material cost and declining interest rates should help the industry to improve profit margins, which have been under pressure, the survey said. Lead indicators and other related information collected by various research analysts also point to an upward movement in terms of demand and supply, it added.

A sustained inflow of FDI points to foreign investor confidence in the Indian economy. The survey said India, on account of its market size, output generation and prices, would continue to be an attractive destination for foreign investment at a time when most industrial economies are struggling on industrial front.

The survey said that a decline in the number of strikes and lockouts indicated an improvement in industrial relations in the country. During 2008, Tamil Nadu experienced the maximum instances of strikes and lockouts followed by Kerala, Andhra Pradesh and Karnataka. Industrial unrest was concentrated mainly in financial intermediation, textiles, transport, mining of coal and food products.

The survey said it was imperative to facilitate the growth of labour-intensive industries, especially by reviewing labour laws and labour market regulations. The government, however, has always been cautious about proposing changes in labour regulations as labour is a sensitive issue and all state governments need to be brought on board.

Reading the recovery

The many signs of recovery across industries suggest that the earnings outlook for India Inc may improve over the next couple of quarters. However, it would be wrong to take this as a bullish prognosis for the stock market.

---

Aarati Krishnan

Investors looking for signs of recovery in India’s industrial landscape have been surprised by green shoots turning into flourishing foliage, in recent months. By now, some key sectors such as cement, passenger cars, two wheelers and durables have recovered sufficiently, to surpass the record levels of output clocked in March last year. Others, such as commercial or utility vehicles, after suffering particularly deep cuts last year, are climbing back from their lows. There have even been a few core sectors – power and steel- which have continued on a broad upward trajectory amid all this upheaval.

Short-lived contraction

Trends in the index of industrial production (IIP) — the widely tracked gauge of industrial activity, drive home the point that industry has gotten away with relatively minor damage from the global recession. The period of contraction, going by the IIP readings, lasted barely six months from April 2008 to October 2008, before the process of recovery started.

Average IIP readings (to even out seasonal blips) show that industrial activity for the first four months of 2009 has expanded by 3 per cent compared to the same period in 2008 and by 7.6 per cent over the year 2007. No mean feat, given the backdrop of the global recession and the recent credit crunch. A breakdown of the IIP into its key sub-segments shows that activity in most sectors now hovers above last year’s levels (see Table). Consider these numbers. Cement despatches have grown by a robust 10.3 per cent over last year in the first four months of 2009. Monthly passenger car sales have expanded by nearly 30 per cent, while two-wheeler sales have risen 46 per cent from their lows last year; both are back on the growth path.

What drove growth

These sectors have, however, been some of the out-performers within industry. Individual sectors in fact differed widely, in the extent of hit they took, and when they began to recover. The IIP itself declined by 14 per cent from peak to trough, but sub-groups such as capital goods (33 per cent fall), consumer durables (lower by 24 per cent) and mining (23 per cent), suffered drastic shrinkage.

The differing trends in IIP constituents suggest that the process of recovery was linked to three factors. One, sectors that relied purely on domestic consumers fared much better than those that relied on industrial or export demand. The severity of the slowdown in commercial vehicles, capital goods and textiles, even as passenger cars, FMCGs and consumer durables got away almost unscathed, buttresses this point. The substantial boost to the income levels triggered by the Pay Commission proposals may have been a key demand driver for consumer goods.

Two, sectors that relied, to a significant extent, on rural and semi-urban demand were more resilient than their city-focussed peers. This trend is evident not only from sales of two-wheelers and FMCGs, but also from cement despatches, which rose on sustained rural housing off-take. And third, the three rounds of fiscal stimulus which gave a pre-election push to project completion, may have boosted demand for sectors such as cement, steel, power and engineering.

Will it last?

Having recognised that there is a recovery, can investors expect it to last? A prediction for the medium term is quite difficult to make.

However, lead indicators on industrial output do point to this recovery being sustained over the next few months. For one, the ABN Amro-Markit PMI (Purchasing Manager’s Index), moved back into positive territory in April and improved further in May. The index shows that purchase managers turned quite optimistic about output and employment driven by new domestic orders even though export orders remain weak.

Two, the index of core infrastructure industries, which tracks sectors feeding into industrial output, has delivered better-than-expected growth over the past two months.

Three, even if absolute numbers reflect sedate progress, investors can look forward to healthier year-on-year growth rates from the IIP and the sub-indices in the coming months, thanks to a favourable base effect. As April-August 2008 marked the trough of the cycle for many key sectors, delivering growth on that base may not pose much of a challenge.

Key triggers for sustained growth may come from accelerated public spending on infrastructure, the percolation of the deep interest rate cuts to borrowers and an improvement in the outlook for services, driven by an improving global economy. If the Budget manages to keep up the tempo of government spending, such industry-dependent sectors as engineering, capital goods and construction may see their fortunes revive.

Consumer-oriented sectors may be well-placed to sustain a recovery, on the back of higher incomes (boosted by the Pay Commission) and lower retail lending rates, which may allow room for spending on big ticket purchases. Sustainability of rural demand may hinge on continued public spending in rural employment and infrastructure and better access to agricultural credit. The looming risks to the ongoing recovery stem from the possibility of the developed economies (mainly US) slipping back into recession- throwing the services sector into disarray or a poor pace of implementation in public projects.

Good news for earnings

If the growth in IIP does sustain, will it result in a material improvement in the earnings picture for India Inc? Experience suggests that this is likely.

Trends in the IIP (despite its shortcomings) have had a strong bearing on the earnings performance of India Inc in recent years. A comparison of IIP growth with the sales growth of the CNX-500 companies for the six years from 2002-2008 (Refer article: “Does the IIP offer clues to corporate growth?” in edition dated April 6 2008), in fact showed a correlation as high as 0.79 between the two variables.

The analysis concluded that while the IIP’s direction does quite closely coincide with that of India Inc’s sales, the companies delivered growth that is far superior to the actual growth in output.

Assuming that this historical relationship continues to hold good, investors can look forward to better top-line growth from Indian companies in the current quarter, after two consecutive quarters of tepid growth. With input costs already well below last year’s peak and interest rate cuts likely to reflect in lower borrowing costs, an improving sales trajectory could well be all that is needed to pep up profit growth from here on.

While the earnings outlook for India Inc may have turned more positive on the back of the above factors, it would be wrong to take this as a bullish prognosis for the stock market. After its 80 per cent gain from the March lows, the stock market already appears to have anticipated and factored in a sharp improvement in the earnings picture for most companies.

In fact, valuations in sectors such as realty or commodities have moved well ahead of current fundamentals and appear to take a substantial recovery for granted. At this point, the room for disappointment, if the recovery makes slow progress, appears much higher than the potential for rewards, if IIP or earnings numbers surprise.

Investors lose crores in bid to get rich quick

At a time when companies are finding it hard to raise capital to fund their projects due to the global slowdown, thugs in India have successfully steered clear of the recessionary spiral. Beating global meltdown fears, they have cashed in on the ignorance of gullible investors, duping them of crores of rupees.

And with two such cases coming to light recently, an alarmed Delhi Police is planning to launch an advertising campaign urging people to be cautious against alleged fraudsters like Subhash Aggarwal and Ashok Jadeja. The latest case involves owners of BK Jewellers Rajesh and Chetan Mallik who are being alleged to have duped more than 300 invetsors of crores by assuring them handsome returns on investment.

Similarly, Aggarwal, who has been arrested, allegedly lured people into investing Rs 10,000, promising them Rs 1,000 interest every month. In the same manner, self-claimed godman Ashok Jadeja in Gujarat also won the trust of a denotified tribe over a period of time and assured its members of tripling their investment. In all the cases, the alleged fraudsters won the confidence of the people they targeted through word-of-mouth publicity and by initially living up to their promise. While Jadeja allegedly duped people of Rs 1700 crore across 11 states, Subhash, who started three years ago, allegedly made away with several thousand crores, operating from his Aman Vihar residence. Both of them targeted people from the low-income group.

Cautioning investors, joint commissioner of police (crime and railways) Amulya Patnaik said: "If by any means or advertisement, e-mails, any person is offering returns which look very attractive, we appeal to investors to consider such offers with caution and verify the details about the company. We will issue a list of dos and don'ts through a series of advertisements.''

Explaining Jadeja's modus operandi, a senior officer of the Economic Offences Wing (EOW) said: "Jadeja targeted his own tribe. He invoked religious sentiments to milk his tribesmen who have traditionally been into the liquor trade. The tribe is very secretive and Jadeja knew that no one from outside the community will come to know of his designs.''

He was also aware that his tribesmen were financially illiterate and would never invest in mutual funds or any other financial instrument. "And that was the reason he had a free run for almost six months since January. His publicity was done through word of mouth and his tribesmen approached him from all corners of the country. His aunt, Manbai, advised Jadeja to inject a religious aspect into the scheme. She spread the word that Sikotar Mata had blessed Jadeja to help his community grow wealthy,'' said the officer.

Aggarwal, on the other hand, used the old trick of quick and fat returns. To win the trust of investors, he initially did keep his word. "Later he collected huge sums of money from investors and gave them cheques. But these cheques bounced and Aggarwal after two to three assurances disappeared.''

Investigators say that such complaints are very common. These people will always target a community or a region and would set up their base secretly. "Any person, coming out with unrealistically attractive schemes, knows his exit time and what it takes to create a base. In Jadeja's case, Ahmedabad Police has found that he started the money chain schemes in January. His scheme was more like multi-level marketing in which investors also become agents and spread the word,'' said another police officer.

Such scams are not new. "Delhi Police recently registered cases against Kanakdhara MLM Company for allegedly defrauding investors by drawing them into multi-level marketing. They promised a return of Rs 26 lakh on an investment of Rs 13,000,'' said an EOW officer.

Kanakdhara was started two years ago from west Delhi. Soon, the accused set up their offices in Mumbai and other parts of India and allegedly duped investors of Rs 10 crore. The Mumbai Police arrested the father-son duo of Bhupendra Singh Bakshi (54) and Gurkaran Singh Bakshi (24) in February this year. The police claimed the duo amassed wealth worth several crores, including several acres of land in Rajasthan. The Delhi Police also seized SUVs during the initial days.

Investigators cite many problems in probing such cases. "It becomes very difficult to trail the siphoned off money as there are no receipts. We have been taking help of forensic auditing in Kanakdhara case to determine the amount of losses,'' said a senior police officer. Another problem is that it's very difficult to link these men to any property.

How major factors influence each other on the way to economic recovery

Countries that are Least Affected by Recession

This world map shows a list of countries that are considered least affected by the global economic crisis.

International Perspective:
The countries perceived to be surviving the economic crisis the best, as voted by international businesspeople are:

Rank	Country
1st	Australia
2nd	China
3rd equal	India, Singapore
5th	Hong Kong
6th	Canada
7th equal	Japan, Qatar
9th	New Zealand
10th equal	Malaysia, Sweden, Vietnam
13th equal	Netherlands, United States of America
15th	Indonesia
16th	South America
17th	France
18th equal	Belgium, England, Korea, South Africa
22nd equal	Austria, Taiwan
24th equal	Czech Republic, Germany, Ireland, Lebanon, Russia, United Arab Emirates
30th equal	Brazil, Morocco, Philippines, Scotland, Sri Lanka, Syria, Thailand

FMCG Sector Stock Investment - Best in Times of Slowdown

The FMCG sector in India is one of the biggest in the world and growing at a scorching pace. In times of a global slowdown and recession (in some countries) the FMCG sector provides one of the best investment opportunities in India. This is one of the sectors which will be relatively less hit by the global economic slowdown. So good stock selection in this sector can gibve good returns even in bad times for the overall economy.

The Indian FMCG sector stocks have so far shown a lot of resiliance in the recent stock market meltdown. Most of the FMCG sector stocks have outperformed the Sensex this year and some stocks still have positive one year returns. So its a sector worth looking at and also considering some exposure to in these bad times.

The table below shows ten FMCG companies in India and their one year stock market performance along with their PE ratio and beta. The Indian FMCG sector stocks have a very low beta value which in itself indicates low volatility in these stocks. The study of these 10 stocks would also suggest how some have generate positive returns in this market meltdown. Please click on chart to see enlarged image.



Some stocks in the FMCG sector are trading at relatively high PE and can be avoided for now. They do need to come down somewhat to be in par with the overall market valuations. But downside might not be big as the FMCG stocks have been registering robust growth even in this enviornment.

Also while selecting a stock in the FMCG one need to look into several important factors such as:

• The kind of rural penetration the company products have. The higher the better.

• If most of the products of the company are high end face or bodycare products. These product companies can be avoided for now and companies with more basic day to day use products should be considered. Look at what is a necessity and avoid companies whose products might be more of a luxary.

• Comparison of the intersegment PE and also the PE of the company vs. its growth rate. So if a company has a PE of 20 but is growing at greater then 20% easily then its fine.

Another positive for most of these FMCG sector stocks is that they are debt free companies. This is always good and specially good in these times of volatile interest rate enviornment.

For investors eyeing the FMCG space, large domestic companies offer attractive growth prospects. These companies are outperforming their MNC peers and small Indian companies in the sector. But MNC's generally have a better profit margin then the local players.

Another stock which I have missed in the list of ten companies in the chart above is Nestle India Ltd. This is also a good company but trading at a relatively higher PE of 30. Tis stock is worth looking at if the stock prices do correct in the near future.


While there is no doubt that consumer spending in India will also be hit in the wake of this slowdown it will not be as high as the effect this slowdown will have on some other sectors. So if one really wants to invest in the stocks markets now he/she would be relatively better off investing in these FMCG companies then any other industry.

Best Stock Picks: stocks like ITC, Dabur and Gillette in the FMCG sector.

Caution: While the FMCG sector has not seen much correction in the stock market carnage it does not mean that it might not fall in the near future. A bear market can make good stocks fall to values which have no relation to their fundamentals or growth prospects. So even if one is investing small exposure is advised.

Check out the sectors unharmed by recession

Recession-proof

Look around and all you get to hear are never-ending discussions on recession, economies crashing down, markets going dry, freezing recruitments, wage cuts and of course the much dreaded word layoff.

But as they say, what goes up, comes down, there are industries that did not get that badly hit by this recession and are managing to sail through smoothly. They are unharmed by this turmoil and continue with their expansion and recruitment plans. Here's a look at some of these industries:

Pharmaceutical
"Even in negative situations like a crisis or recession, there is someone that profits. Wouldn't people still go to various doctor's or other pharmacies to get their prescriptions and medicine they're in need of ? I think they would," says Anil Kumar Kathuria Senior Manager HRM Administration , IOLCP.

According to Ajay Kumar, HR Director, BD India, "Pharmaceutical industry has been less affected by the global economic meltdown since consumption patterns in this industry is normally the last to get affected."

KPO/LPO
Within the domestic market, the demand for legal services has been equally strong because of the economic growth. This has resulted in the rising demand of legal professionals .

"The economic slowdown in the US has resulted in law departments of corporations revisiting their legal processes and budgets arising from the sub-prime fallout. As a result , getting legal work done efficiently and cost-effectively from quality offshore providers in India has become a compelling option," says Bhaskar Bagchi, CPA Global.

Vivek Menon, Director, Human Capital Management, Integreon adds, "One of the sectors in the outsourcing industry that has been relatively unaffected by the economic recession is the Knowledge Process Outsourcing / Legal Process Outsourcing (KPO/LPO) industry . This space is driven by investment banks, law firms and large corporations. To survive the recession, businesses will have to rethink their strategies with an emphasis on optimising costs and growing the business."

Healthcare
"I would say that healthcare is one of the key sectors that have largely remained unaffected because it is a necessity like food and shelter and not a luxury. People tend to delay expenditure on all other things, but when it comes to necessities like food, home rent, education of kids and healthcare of the family, one makes sure that he gets the best that he can afford," explains Dr Balbir Singh, Senior Cardiologist, Apollo Hospital.

Narender Kumar, Business Head-VLCC Institutes adds, "Sectors like beauty and wellness, healthcare, education and pharma are now termed as necessities of life and a person generally does not like to cut down them."

Education
Education sector is also exhibiting resilience towards the impact of recession, as people prefer spending more on education to counter job crunch in times of economic meltdown.

"It will be an exaggeration , if we say that these sectors have remained insulated from the impact of the recession. But, on a comparative basis, the impact has been on the lower side. This can be attributed to the principle of 'Zero Sum Game' , where the loss of one sector can be termed as a gain for the other.

This is particularly true in case of education sector, where people go for higher education to gain an edge over others in job market ," expresses Ashok Mittal, Chancellor, Lovely Professional University.

FMCG
"The unit value of the product in the FMCG sector is too small to be affected by recession. These are daily utility items and will move at the counter irrespective," avers Amal Purandare , Head India Operations , Arzoo.com.

For example, a person might cut expenses by not buying an expensive soap, but she buys a soap nevertheless and doesn't settle for just a water bath, due to recession ," he says.

Interactive Media
The reasons for Web Solutions /Interactive Media businesses to not only sustain themselves but actually grow during the recession are simple. When most companies are looking to cut costs on expensive traditional media , the natural alternative takes them to the new communication and customer interaction medium of the Internet ," says Vineet Bajpai, Founder and CEO, Magnon Solutions Pvt. Ltd. and Magnon Interactive Pvt. Ltd.

Purandare further states that though the travel industry did get hit by the recession, the growth in the 'online travel' industry is so encouraging that a relatively small blip in the graph due to recession can be easily compensated by the industry's awakening of the benefits of booking online.

"Sectors where spending is largely non discretionary are primarily the sectors which remained unaffected and sectors which offer direct savings in cost or increase in productivity, saw growth," adds Harish Bahl, Founder & CEO, SITG(Smile Interactive Technology Group.

Telecommunications
Aditya Maheshwari, Director -HR , Delta Electronics India says, "Government is driving huge investments to improve and expand tele-density in India's huge rural market which accounts for 70% of total Indian population. Several international players are also setting up base in India to target this huge market."

"Telecom sector has also shown a recession proof character as a mobile phone today has evolved into more of a necessity , just like food, shelter, clothing, healthcare, etc., " asserts Sumesh Arora, Head Finance & Administration, FUJIFILM India, adding, "India has immense potential for growth and this recession will not be able to put a noticeable dent on it for long."

Power
"In case of power, it's a basic infrastructure requirement and there is still a long way to go in achieving self sufficiency in this sector.

More players are required to join hands with the public sector to improve the requirement levels," avers Maheshwari.

Consumer Goods
Maheshwari states, "Millions of Indians under the age of 30 are slowly receiving better access to healthcare and education , which enables younger Indians to drive the economy by virtue of middle class growth. They will become consumers , spend discretionary income, and enjoy the associated status. This growing middle class will continue to create large levels of domestic customer demand for goods and services."

"The economy of India is the 12th largest in the world by market exchange rates and 4th largest in terms of GDP. Projections of sustained strong growth in India depend importantly on the utilisation of the huge increase in India's working-age population projected over the next two decades. I foresee more employment as economy will bounce back and move upwards ," Suman Anjoy, Head, HR & Professional Services, Himalaya Optical states.

These industries go on to prove that though things are looking glum, there is still a silver lining in the cloud. They have managed to sail through these troubled waters smoothly and the future is certainly looking bright.

http://economictimes.indiatimes.com/quickiearticleshow/4587567.cms