2008 –A dismal year ahead?

(19th Jan 2008)

By

Vishnu.S.Jarugumilli

9845077374

http://crorepatihomes.net

This is an attempt to look at how various asset classes are likely to perform during 2008 from an investment perspective. The analysis is based on the conditions as they are today and events, particularly unforeseen ones, may shift the paradigms radically.

Macro economic situation –The running theme

• Indian GDP growth likely to slow down marginally to 7.5% to 8% compared to the 9% of 2007-8. This will further depend on the monsoons this year as industrial production is expected to slow down relatively more.
• Rupee appreciation likely to continue there by negatively impacting the export oriented sectors such as IT, textiles/apparels, leather and footwear etc
• Since the export sectors are the major job creating sectors, likely negative impact on job growth and salary increases in these sectors is envisaged.
• Fiscal situation at the national level likely to worsen and two factors will contribute to this. 1) Govt’s dilly-dallying on the retail price increase of the petro-products and 2) RBI’s attempts to artificially shore up the dollar against its global weakness.
• This is expected to strengthen inflationary trends and there by negates any proposed reduction of interest rates.

In view of the above scenario, this is how different asset classes are expected to perform.

STOCK MARKETS:

As we all know, stock markets are a function of three important factors. Let us see as to what is happening to each of them.

• LIQUIDITY: So far, in the history as we know it, major investment banks of the US have been the source of global capital market liquidity. For the first time in many years, they have been struggling to stay afloat on the back of mortgage and sub-prime write offs. Institutions like Bear Stearns, Merrill Lynch, Citigroup, Bank of America, JP Morgan Chase (the least affected) and a host of others are likely to write of more than 100 b USD, by the time the story unravels fully. This is a lot of money by any standards. Now these institutions are lining up behind Asian, Chinese and Arab investors to bail them out. The ramifications of this reversal of fortunes are still to be comprehended by any analyst. But the least that can be said confidently is that Indian secondary markets can prepare for muted or even negative flows. Sensex’s climb from 14000 levels has been primarily funded by FIIs. Hence the present scenario is definitely not good news. Moreover, many mega IPOs are lined up this year and that will also suck some secondary market liquidity.
• VALUATIONS: At the present level of 19000 on the sensex, India is currently trading some 23 times its 2008 earnings and some 19 times the projected 2009 earnings. In comparison, China is trading 16 times FY’08 and other Asian markets at approx 13 times FY08. Clearly, Indian markets are expensive. Analysts have justified them so far not just by the expected GDP growth but also by fancy theories like the EMBEDDED VALUE and REPLACEMENT VALUE theories. In the absence of strong liquidity flows these theories will evaporate in thin air and strong cash generation in P&Ls alone will matter.
• CORPORATE PERFORMANCE:  In general the Q3 results, which are out so far, have been in line with expectations. There is nothing, which is immediately in the air to suggest that this will reverse in a hurry. However, slower GDP growth, high interest regime and slackening of domestic demand will catch up over the course of the year. Expansions and acquisitions/mergers, which can only happen by leveraged funding, will find the going tough. Again income from operations will separate the wheat from chaff.

REAL ESTATE

Only builders with ongoing projects or hardened real estate agents will tell you that real estate prices will still go up. Transactions have been down by about 30-40% and prices have stagnated. Only some strategic micro markets in all cities where some important developments are kicking off (like Devanahalli in Bangalore) will buck the trend. That there may not be any significant downward revision of interest rates in the near future will act as a dampener. Real estate will pause to take a deep breath here and if there is any steam left further can be reassessed six months later.

GOLD

Basic economic knowledge states that prospects of gold are inversely proportional to the prospects of dollar. By that theory, Gold should go up. The general consensus is that gold will close this year at 15000 as against 11000 now. However there are risks in blindly endorsing this view. All commodity prices will have to backed up by consumption and gold at 15000 levels or even at present levels may see demand contraction. In my view, agricultural commodities will continue their onward march and gold will rise a little less, but still go up nevertheless.

In totality, 2008 is not expected to shower you with goodies, no matter which asset class you dabble with. Of course as I said earlier, developments during the course of the year may bring in new factors.

Nobody likes to be proved wrong and I am not an exception. However, in these exceptional circumstances I am only too eager to be proved dismally wrong so that, like countless others, I too stand to benefit in my own small way.