January 31, 2009

That's what is a meltdown!

The picture says it all. One of the biggest lessons of the subprime fiasco is that all big boys with their extra-ordinarily smart people can ALL go wrong AT THE SAME TIME. The next time when you hear of the NEXT BIG THING that everyone's gung-ho about, beware. The majority need not be always right!

Click on the image for a larger view.

January 22, 2009

Inflation rise, bonds fall - looking ahead to the policy

YoY WPI based inflation has risen to 5.60%, thanks to truckers' strike during the week under review. Primary articles and food component of manufactured products have contributed to the price rise.

Yet, I do noe see any real deviation from the underlying trend. It is a matter of weeks before we see inflation figures in the sub-4% territory.

Bond prices have corrected this week, being the last before the key policy announcement next Tuesday. Lesser section of the market is nor expecting any rate cuts by RBI this time in the policy. I am still a part of this minority. From the Q3FY09 results that have already been announced by corporates, the slowdown is clearly evident in India Inc. Sans a few names, most have spelled out disappointing numbers. I would expect RBI to remain pre-emptive in estimating the impact of slowdown and trend in falling inflation. A 50bps cut in both the Reverse Repo and Repo Rate will be apt given the current juncture. Credit needs to flow at a faster pace to the real sector and fairly quickly. The global factors are not showing any signs of a revival any time soon and it is upto the domestic think-tank to moderate the pace of de-growth in economy.

Apart from rate related measures, expect easing in risk weightages and provisioning norms. With liquidity at almost 56K crores surplus, a CRR cute looks improbable.

Disclosure: I am invested in gilts through a mutual fund scheme.

January 13, 2009

An entry point for getting into bonds

Last few months have been extremely conducive for traders, including day traders and jobbers. Not just in equities, but even in currencies and commodities. With the introduction of currency futures in September 2008, punting in that space have become fairly convenient too. However as a retail trader, bonds are still inaccesible to me for direct trading. Ironically, my best trading views and most of my high conviction ideas are in that space. Anyways, trading in equity derivatives and currencies have been fun and excitingly profitable. I am not a commodities person. As of now!

Whilst I am incapable of trading in bonds directly due to logistical issues including big lot sizes, I can translate my views into money through open-ended gilt schemes. I have been bullish on bonds since September 2008. We have already seen a super-rally in bonds. The benchmark 10-year yield has eased from 9.50%+ levels to sub-5.25% levels over the last 3-4 months. Despite that, there is still some juice left in bonds, more so on a relative basis vis-a-vis equities. The 10-year yield is currently trading close to 5.70% level. The market witnessed a huge bout of correction and profit-booking during the first few trading sessions of 2009 till yesterday. The primary trigger for the sell-off was the Rs.50,000 crores fresh borrowing announced by the government for the last three months of the current fiscal. That, and the fact that we had rallied a lot (and pre-maturely perhaps), resulted in a correction of a good 90bps over the last one week. 1% change in yield of 10-year government bond is equivalent to approximately 7.10% change in the bond price.

Where do we stand now? Let us look at the negatives first. Firstly, higher supply is pain for bonds. Secondly, the generic demand in the form of SLR might be moderating with lower deposit growth. Bank deposits are growing at 21% for few fortnights now, lower than the 25%+ that we have seen last year.

Among the positives:

The biggest driver will be falling inflation. With fuel prices expected to be cut again in a couple of weeks, we could see inflation falling more starkly. At a time when the policy makers are trying to revive growth, real interest rates cannot be higher than 2%-3%. Year-on-year price change will soon be negative. So, we will see the overnight Reverse Repo rates and CRR cut by at least 75bps-100bps pretty soon. Liquidity remaning in the positive regime and call rates at sub-4%, 10-year yield cannot stay at these levels for very long. The 10-year over call rate spread should be at a high of 50bps-75bps at the peak of the markets. So if call rates do trade at 3.5%, 10-year yield can surely see the sub-4.50% levels.

Corporate results and industrial/manufacturing growth has few more quarters before showing signs of strength.

Net net, there exists not many reasons to keep yields high. At current levels, one could buy bonds and expect atleast 10% returns in a time-frame of 4-6 months, conservatively. That's 20% per annum! Not bad at all.

About my portfolio: I have invested in the ICICI Pru Gilt Fund - Investment Plan. With an average maturity of 16.66 years, modified duration of 9.15 years and backed by a decent corpus of 716crs (as on 31st Dec. 2008 - sourced from their fact sheet), it is perhaps the best bet for the above-mentioned view.

Happy investing!

January 02, 2009

Stimulus package: Version 2

Barely a couple of days after I wrote that I see more rate cuts coming from the RBI, we get 100bps cut each in Reverse Repo and Repo rate, coupled with a 50bps cut in Cash Reserve Ratio. These rates stand at 4%, 5.5% and 5% respectively.

The government, from its side, has announced a number of measures as a part of its second and more importantly, last package for this fiscal. You can read the details here. With national elections expected to be held during May/June 2009, I do not expect any more fiscal measures effectively before the end of June 2009. Plus, if there is a change in government, the new team will take few more months to take any concrete actions. My fear is, by that time the damage in the economy would have been done.

Barring few specific measures like cuts in excise duties, nothing else in the fiscal package looks likely to impact the economy positively enough. With the demand side of the equation almost in a standstill in key sectors, a lot of these measures merely gives the producer class some breathing space before the inevitable happens. And that is cut in production and prices leading to cut in shops and reduction in worforce. We have already seen this in few sectors. More will come our way this year.

The fiscal package includes some shockers. Increasing the FII limit for investments in corporate bonds! Are we kidding? Considering what the spreads have been for Indian corporate papers in Euro markets, I find it improbable that they will absorb similar issuances in Indian soil. Similarly, raising the ECB interest ceiling for select integrated township developers also seems a blunt measure.

Am I, as a consumer, going to spend more based on this fiscal package? No. And that is the problem.

I am glad that the monetary measures have come again. The rate cuts I expected have come a little earlier than my sense of timing. That leads me to believe that we have to see more. At least 50bps more on all the three key rates before the end of this fiscal. Of course, considering what already has been seen, further 50bps is just nominal. But it makes a lot of difference for bond yields. 10-year yield falling below 5% on Monday is a given. 4.50% is the next level I would be watching, but not quite soon. Higher spending means higher borrowing. The supply side for bonds will temper the rally to some extent. Yet, do not expect anything to prevent 4.50% to be traded over the next few weeks.

What next? Expect a series of rate cuts by banks. Deposit rates first, followed by lending rates. They would hope that the consumers will return to borrow soon. I have my doubts. When your job is in danger, you don't think of adding a liability (for an asset) to your personal balance sheet, do you?. Sentiment is the key here too, like in markets. It takes a lot to convince a terror victim that the world is a very safe place!