Impact of QE3 on Indian Equity markets

Let's Pray my monetary works this time.... 3rd time lucky!!

The world has spent most part of the last 2-3 years gripped in fear of a meltdown in the Euro-zone and its eventual breakup and a sustained slowdown in economic growth in the US. This has had its impact on equities market and other risky asset classes over the past couple of years. But the world leaders have been making all efforts to ensure no such financial catastrophic events occur. Quantitative Easing (QE) and bond purchase has been their most powerful weapon in this effort. The most recent round of QE which has been coined as QE3 and the simultaneous Bond purchase announced by ECB last month, would have its impact on the risky asset classes in the near to medium term for sure. Below i have put down my thoughts in the form of a Q&A session to make it sound interesting. 

What would you advise investors and advisors in light of the recent QE3 and ECB action?

With the ECB determined to do whatever it takes to preserve the euro and the Fed promising to buy securities in the open market until the US economic recovery accelerates, a substantial amount of downside risk to markets has effectively been removed. Given this unusual degree of support from the major central banks, we recommend advisors and investors to take a more constructive position toward risk and equities.

With the global growth environment expected to stabilize in the next few months, sizeable forthcoming liquidity injections by central banks are likely to lift risky asset prices to new highs, and investors should take advantage of that by moving out along the risk curve. This move is not being driven by valuations, but rather by extraordinary monetary policy support. For the rally to sustain in the longer term, an improvement in global economic growth would be required in the next few quarters, and hence we would recommend investors to also time their exit from the risky assets at the right time when valuations look stretched and not get caught on the wrong foot incase global growth falters in the next several quarters. However, that is not the story for this year as a new cycle of monetary support is just beginning, cyclical sectors continue to operate at low levels, and valuations are not overly stretched in a number of risky asset classes.

How would QE3 impact the economies of emerging markets and India?

Though QE3 and its liquidity flows into emerging equity markets would be welcomed by all but it would have an inflationary impact on the asset prices in these countries. Inflation has already been giving sleepless nights to the central bank of India and other emerging economies. Rising commodity and property prices would lead to a bubble sort of situation in the longer term. Inflation in food prices would hurt the larger part of the Indian economy stakeholders. However this liquidity flows would also lead to appreciation in the currencies of the emerging economies which would benefit the import bill of these countries. We believe the investors should capitalize on the near to medium term buoyancy in the markets till the liquidity pumping continues.

What is the outlook for Indian markets keeping in mind the other factors that our economy is faced with?

The deterioration in the fiscal position of India has left the government with little space to mitigate the ongoing economic downturn. IIP and GDP data have been on a downhill trip since 2010 and is yet to pickup. Furthermore, the government has been weighed down by a political environment that has curtailed efforts towards reform. The central bank has also made it clear that, with elevated inflation, it remains reluctant to reduce policy rates.

However, there are signs that things are starting to open up on the policy front. The recent actions to increase diesel price, reduce withholding tax on foreign borrowing, and to allow FDI in retail, aviation and other sectors have been important steps forward and could potentially mark an end to the policy stalemate. However, this has precipitated a political backlash including the withdrawal of support for the government by the Trinamool Congress. Reform initiatives are thus at an important juncture. Although there are risks of some backtracking in the face of political opposition, if the government can withstand the political upheaval unscathed we could see a relatively better dynamic evolving in the coming months where policy crisis diminishes, some progress is made on fiscal adjustment, growth picks up, and the currency recovers ground.

After seeing the steady flows into Indian equities, how do you see the trend ahead?

Flows into emerging market equity funds soared to $4.3 billion in the week ended Sept 19, from a meager $447 million the previous week, according to fund tracker EPFR Global. That drove these funds' assets under management up 0.6%, marking the second largest weekly inflows for the year. Indian equities have seen FII inflows in 2012 of around $15.9 billion till the end of Sep’12. This is one of the highest inflows ever seen and I believe we would close the year better than that seen in calendar year 2007 when we had $17.5 billion of FII inflows in Indian equities.  Previous rounds of QE1 and QE2 are associated with a weaker dollar and gains for higher-yielding assets, such as global equities and emerging market bonds and currencies. Similar expectations will now drive more capital into emerging market assets in the near to medium term.

Why gold investment never runs out of fashion

One investment class which has found buyers across all generations and category of people is Gold. Often people ask me whether it’s a good time to buy gold now. There is no definition of “now” as whenever you want to buy gold, it’s a good time. You are buying into an appreciating asset and disregarding the short term price fluctuations in gold, you would never lose money in the metal.

There have been fables and dynasties built on this yellow metal. Gold has attracted the attention of man since the days of the Gold Rush when people risked their lives in the hope of making it big with the discovery of some gold mine. Over the generations, the yellow metal has found a place of eminence among the asset classes on account of its never ending demand. There are some facts which one should know about the metal before they commit there hard earned money on the shiny metal.

Gold is an inert chemical element and is one of the most malleable and ductile metal known. The metal retains its shine and colour even when exposed to air and water and that adds to its value as storehouse of wealth. The supply of gold is limited on earth and unlike fossil fuels, it does not get formed through the chemical reaction of the basic materials (carbon, oxygen, nitrogen and hydrogen). Moreover gold once mined remains above earth in some form or the other…. Jewellery, Gold bars, Coins, industrial machines, etc. Till date around 165,000 tonnes of gold has been mined.

Gold has been widely used throughout the world as a vehicle for monetary exchange, either by issuance and recognition of gold coins or other bare metal quantities, or through gold-convertible paper instruments by establishing gold standards in which the total value of issued money is represented in a store of gold reserves. Gold has been fascinating mankind since ages. Egyptian hieroglyphs from as early as 2600 BC describe gold, which king Tushratta of the Mitanni claimed was "more plentiful than dirt" in Egypt. Gold is mentioned frequently in the Old Testament, starting with Genesis 2:11 (at Havilah) and is included with the gifts of the magi in the first chapters of Matthew New Testament. The Book of Revelation 21:21 describes the city of New Jerusalem as having streets "made of pure gold, clear as crystal".

A recent report ranked the central governments of different countries according to their gold reserves. No wonder, US Govt. topped the list with close to 8900 tonnes of gold reserves. India was ranked 12^th on the list, but when it comes to gold consumption, no country can match up to India as far as the demand for gold is concerned. India consumes nearly 25% of the gold produced each year mainly in the form of jewellery. So if we consider both the government reserves and gold in the form of jewellery with the citizens, I am sure India would top the charts comfortably. It goes without saying how Indians have always realized the true value of gold which many countries are now realizing considering the weakness in the dollar which has been the measure of a government’s reserves.

Gold investment worldwide has grown dramatically in the last five years, but compared with the total stock of financial assets, gold bullion investment is still just a tiny proportion. Several factors are now stimulating gold investment by new pension fund money - as well as by private investors. Sales of gold jewelry across Asia are surging as the local economies boom and private investment grows. China's gold investment demand grew by 20% in 2009, while Indian consumers bought a record 900 tonnes – well over one-fifth of the total world market. Gold buyers in Asia tend to think of their jewelry as a form of gold investment. Prevented from owning gold bullion until very recently, they buy gold to protect their savings from inflation and currency shocks. That's why the most popular form of gold jewelry in Asia – heavy chains and bracelets – is known as "investment jewelry" in the gold industry.

Gold mining companies worldwide have failed to meet the growing demand from gold jewelry and gold investment buyers, pushing the gold price steadily higher. The world's No.1 gold mining nation, South Africa, has seen its annual gold output halve since 1998, and new operations in China and Russia - though growing - have failed to pick up the slack. According to consultants "Virtual Metals" total world mining output has fallen by 4% since 2003. Their gold investment analysts don't forecast an early return to growing output.

The surge in crude oil prices has closely matched the gains in gold prices since 2003, but many people now thinking about gold investment will also want to consider the surge in world food prices, the boom in base metals such as copper, and the current all-time highs in the cost of shipping. Rising demand for better housing and durable goods from Asian consumers is certainly a factor. But many gold investment analysts also point to the huge growth in credit and debt in the West. The money supply in the United States has doubled in the last seven years. In Europe, growth in the money supply hit a near-30 year record in late 2007, increasing the appeal of gold investment as the value of each Euro in circulation threatens to shrink under the weight of new notes and electronic account balances.

Money Lessons of a Lost Decade

Read this interesting piece written by Brett Arends and I believe its a must read for all....

What are the biggest investing lessons of the past decade? It's been a tough and turbulent ten years, but if we begin the next decade wiser as well as older then maybe it won't all have passed in vain.

For me, these are some of the main takeaways, lessons and reminders of the past few years.

The price something used to be is irrelevant. Just because a stock traded for $100 six months ago doesn't mean it's cheap at $50, or $20, or even $1.50 today. Think of technology stocks from 2000-02, bank stocks from 2007-09, and so on. The same is true, with some extra zeroes, for Miami real estate. Psychologists call this "anchoring" -- we let previous prices influence our views of current value. It's a menace, possibly the biggest peril facing private investors. (The corollary is that market bubbles give you plenty of time to get out when they start to deflate, but too many people hang around because they believe that things can't get any cheaper.)

Have a portfolio that doesn't keep you awake at night. For real people with real lives, investments that let you sleep at night are far more valuable than exciting speculations that offer "pin action" and "momentum". We've just seen why. If we really understand and trust an investment, we're more likely to hang on to it or even buy more, in a crash. This is a much-overlooked advantage to investing in companies like, say, Diageo (Guinness beer, Smirnoff vodka) or Kraft Foods (Kool-Aid, Jell-O) or ExxonMobil. If you owned them in 2000 and 2006, you were less likely to dump them when things got tough down the line. That's one reason I'm still wary of buying financial stocks in any environment, even if they are cheap.

Beware the phrase "relative value." It's the financial equivalent of "half pregnant"—pure nonsense. Value is value: It's absolute. An investment is inexpensive in relation to its future cashflows, or it isn't. But in every boom, many people are suckered into paying way too much for an asset on the basis that it's cheap relative to other (even more overpriced) assets.

Have the courage of your convictions. Today's investing geniuses started the decade looking like idiots, because they held old-fashioned value stocks, emerging markets, gold and commodities. These investments slumped for years while the likes of Cisco and AOL made countless paper millionaires. You can look wrong for a long time before you look right. It was ten years ago this winter that some of those value stocks hit rock bottom: solid blue chip companies were boasting 10% dividend yields, but hardly anyone wanted them. The brave made a fortune.

There is no substitute for saving. Sounds obvious, yet for most of this decade the U.S. savings rate has been on the floor. Hard to believe today, but earlier this decade some commentators argued that Americans didn't really need to save more because they were making so much money on their stocks and homes. Saving money is like losing weight. There are no reliable shortcuts. Whatever you make, spend less.

Never confuse a trade with an investment. If you want to speculate on the next bubble, it's up to you. Although risky, bubbles yield the easiest and biggest profits. Just remember it's a trade, a short-term holding, not an investment, which you should expect to hold for years. Just be sure to get out in time. Earlier this decade, too many people decided to call their tech stocks long-term investments once they started tanking, in effect turning a short-term loss into a long-term disaster. (Oh, and a corollary: Never be afraid to take a loss on your trades. The willingness to take a 20% loss may save you a 100% loss).

Daily headlines are less important than long-term trends. The investors I know who made a lot of money this dismal decade usually did so by understanding long-term trends--the effect of Chinese economic growth, supply and demand in the gold market, or burgeoning U.S. debt. Yet most private investors aren't interested in these long-term stories. They want to hear about short-term news -- quarterly earnings, takeover talk, market "action" and so on. What do you think investors paid more attention to back in 2001 -- Cisco's latest update on industry conditions, or the gold price? In retrospect, which turned out to be more interesting?

You can't time the market perfectly, but you can usually value it accurately. Investing more when assets are cheap, and less when they are expensive, is both doable and profitable. If you are patient and use dollar-cost averaging to smooth your way in, you will generally make good money over time. The finance industry repeats the self-serving mantra "you can't time the market" to keep you fully invested all the time. That's true in the narrowest sense that you usually can't pick the perfect moment when things will turn. But you don't have to.

Take expert forecasts with a grain of salt. In February 2008, fewer than half the economists surveyed by the National Association of Business Economics said they expected a U.S. recession that year; those who did expect a downturn predicted its effects would be "relatively muted." What is remarkable is not merely that the actual recession proved the worst since World War II, but that by the time of this survey the economy was already in recession (according to later reports). The opinions of stock analysts can be similarly fallible, especially when most analysts seem to agree. A case in point: At the peak of the housing bubble, when home-building stocks were at crazy valuations, most construction industry analysts were bullish.

You have to stay in the game. One danger from the last ten years is that people will walk away from investing altogether and instead keep their money in the bank. It's a terrible idea. Cash is a very poor long-term home for your money. After taxes and inflation you'll be lucky to come out ahead. Inflation remains the quiet menace that investors too often underestimate. This has been a "low inflation" decade, when the consumer price index has only risen by a pretty modest 2.6 percent a year. But even at that rate, the purchasing power of a dollar has still fallen by about a quarter since 1999.

Never confuse the unlikely with the impossible. Ten years ago it seemed unlikely that Enron and WorldCom (and Bernie Madoff) were giant frauds, or that oil, recently $10 a barrel, would rise to $140, or that gold would skyrocket above $1,000 an ounce, or that stocks in boring "old" Europe would outperform Wall Street. Even five years ago few imagined real estate would crash nationwide, or that Bear Stearns and Lehman Brothers would collapse, or Fannie Mae, Bank of America and AIG would all need a rescue. Yet all came to pass. It's a fair bet that some of the things that happen over the next ten years seem just as implausible today.

Insurance and investment awareness

Insurance has different connotations for different people. For a financial sales person it means insurance premium targets to be met, for a family man, its a sense of security for his family and for some others it might be one of the options of saving on tax without much consideration for the real purpose of insurance as they do not see the need for it.

However it think it is important for everyone to understand that the real purpose of insurance is to provide for uncertainties and unexpected negative outcomes. The risk appetite differs from individual to individual and accordingly financial consultants recommend different classes of assets with different riskiness. Ones investment in insurance should also reflect one's risk appetite. At the forefront i would like to highlight that there should be a clear cut distinction between investment and insurance. ULIP is one product which was the baby of the financial industry and offered the investors a mix of both worlds - investment and insurance. Infact many ad taglines highlighted this issue - "investment bhi, insurance bhi, dono saat saat".

What a layman fails to understand is that he is falling short on both fronts, investment and insurance. The ULIP offers very low insurance coverage and also a significant proportion of the money put in goes as expenses in the first three years of the coverage, thus reducing the investment value as well. Infact the ineffectiveness of ULIPs can be felt in bearish markets when you realise that the insurance coverage on the ULIP is very low and would not be sufficient to meet the needs of your family in your absence and the NAV has also fallen sharply so your portfolio investment value has also eroded. I would say ULIPs are more suited for bullish markets but that too are better investment vehicles rather than insurance.

Always buy one pure term plan for your insurance needs and have investments in mutual funds if you cannot manage your equity portfolio yourself. Infact i would say ETFs (Exchange Traded Funds) clearly stand out as a better option to mutual funds also. It has been observed over a large sample size over 15-20 years time period that very few mutual funds could actually outperform the benchmark indices. ETFs provide you returns which are in line with index return and have very low margin of error. There is no entry and exit load and you only pay the brokerage like any other equity transaction, which is minimal. Doing an SIP into ETFs is a wise idea and you do not need fund managers to manage your money.

Now coming back to insurance, realise that have an insurance for every liability and every asset. Insure your assets like home, car, life, etc. Also insure your liabilities like home loans and other loans. But then also avoid over-insurance as then you might just end up paying premiums which could be avoided. Understand your risk taking capacity and your assets and liabilities and act accordingly. If in doubt contact your financial advisors, but don't take any product they push without understanding its implications....