Mutual funds sahi hai... lekin

The problem of plenty
As they say in Economics, too many choices are always a problem. This complexity applies in the investment world. In the good old days of India, the common man did not have too much savings and too many investment options. Life was simple! Today, there are thousands of investment avenues and multiple risk-reward products that even a savvy investor would not know of!

Getting the basics right
A fundamental question that many investors do not ponder upon is, why do we have to invest? Financial planners call it GOALS. If you have inherited an abundance and do not really need to ever work for money, and you have enough to retire any day – then do you really have any financial goals to fulfill?

Of course a lot of us are not in that category. We earn regularly, save regularly but need lumpsums in the future for various goals & milestones. The time value school has taught us to start investing early and enjoy the fruits of COMPOUNDING.

Earning more by not risking more
What does an investor want? Very high returns with no risk! Well, I wish I would know where to get that from. The chase for extra rewards has made investors look for risky avenues like:

· Alternative Investment Funds

· Small Cap Stocks and Funds

· Credit Risk Funds

They all are inherently high capital drawdown products like the recent past has shown us.

Mutual fund investments are subject to market risks….
The recent past has not been good to investors. It does not take long for new investors to shun mutual funds and go back to fixed deposits.

The power of a common man!
Well, it would apply to a woman too. As an individual investor, one can do things that no mutual fund or AIF or PMS can do - Take the power of limits against their portfolio!

If planned well, a 1-crore investment in a safe Overnight Fund can get you benefits of almost double of your investment! Here’s how it works:

Invest 1 crore in a safe overnight fund - Returns of 6.5% (You can earn more in other categories)
Take trading limits against this holding – Brokers will provide you limits of Rs. 90 lakhs!
Generate additional returns using near risk-free strategies – Earn additional 7-8% p.a.
Voila!! A fairly safe 1 crore investment is able to generate 13-14% p.a.
Going back to a question I asked previously, why to take extra risk if 13-14% compounded over long periods of time can help you achieve your financial goals?

The power of Alpha – Reach goals faster or Retire with more money at your disposal

Imagine what an additional 6% can do to portfolio!

Product	Investment	Expected Returns	Value after 20 years		Returns + Alpha	Value after 20 years	Impact of Alpha	20-years goal gets achieved in
Equity MF	1,00,00,000	12%	9,64,62,930		18%	27,39,30,346	17,74,67,415	14 years
Debt MF	1,00,00,000	8%	4,66,09,571		14%	13,74,34,898	9,08,25,327	12 years
Fixed Deposit	1,00,00,000	7%	3,86,96,844		13%	11,52,30,877	7,65,34,033	11 years

To learn more about Alpha, feel free to reach out to us for a knowledge sharing discussion.

Happy investing and advising!

Mutual fund managers are not your advisers

When I'm conducting training sessions/talking to a group, it happens many a times that discussion comes to the talent/skills/experience of mutual fund managers. Many ask the same question - if the fund managers are so good, why cant they predict market falls and sell equity holdings? Well, that is a wrong place to go into. Here's why.

Mutual Funds are long-only. An equity fund cannot sell all equity and sit on cash. They have to follow the investment objective. SEBI rules state that an equity fund should have anywhere between minimum 65-80% equity depending on the category.

Fund managers are not your financial advisers. They cannot decide whether you should invest in equity or not. They have to manage the fund as per scheme's mandate. So even if he/she is really convinced that markets might correct, they still cannot shift out of equity. They cannot even hedge the entire portfolio. They have to sit LONG! Else, it will literally be like a fraud. Bcoz many investors might still be bullish and they invest in the scheme thinking money will be invested in equity. Fund managers cannot decide for the investors.

Please don't expect equity fund managers to sell equity or hedge. Their mandate is to try & generate better returns than the scheme benchmark. So if NIFTY falls by 10% during a period & an equity fund has fallen by 4%, they have still done their job! They are relative-return funds.

Many fund managers try to dissuade you from investing more in their equity funds through their commentaries. Go through fund's factsheet or website to see what view their equity team carries. If you still want to invest in equity, they cant stop you!

Many alternatives to mutual funds target absolute returns (AIFs, few PMS etc). Within mutual funds space, the dynamic asset allocation funds can also do this to some extent. But an equity fund will remain an equity fund! Don't expect them to save you from a market crash.

Thoughts on pricing & fair valuation

The fair value of any financial security is driven by 3 critical factors:

1. What are you going to get from it? Coupon for fixed income, interest for currencies, dividend/earnings for equities.
2. When are you going to get it? Coupon - half-yearly/annually, interest - monthly, dividend/earnings - annually but not certain to be received
3. What is your desired rate of return from the investment? Yield for fixed income, Cost of equity for equities.

A rational investor would evaluate & determine each of the above 3 factors before deciding to invest. And then there are many who gamble in the name of investments.

Also adds another aspect to pricing - how would you price commodities that do not really 'earn' anything except possible capital gains. That strategy is defined by many as the "Bigger Fool Theory" - you will necessarily need someone to buy it from you at a much higher price than what you bought at!

Banks & their mischief!

Past few years post 2008 have been arguably the toughest phase for global banks. Crumbling credit opportunities, tougher regulations, ailing financial markets and the inevitable drying up of liquidity have all impacted the bottom-lines of some of the largest banks. These reasons, though not justified, may have perhaps motivated some of these financial powerhouses to get scandalous! Not sure whether the management and shareholders turned away after seeing what was happening.

The following chart explains the regulatory fines levied on the top banks since 2009.

If you are wondering how is BankAm still surviving that hit, some of their retail banking acquisitions were really value adding deals for their profits. And Merrill Lynch added up numbers too.

Many are also surprised to see Goldman Sachs sitting much lower in that list. Well, now you know!

Economic history in a single pic

Interesting chart that I stumbled upon via Economist.

Fed stimulus

If anyone thinks that the concerns over tapering of Fed's QE stimulus are merely 'psychological', this data will erase all such doubts. Come 2Q2014, we will see some serious implications of tapering.

The changing phase (face) of IB

Why I Am Leaving Goldman Sachs

TODAY is my last day at Goldman Sachs. After almost 12 years at the firm - first as a summer intern while at Stanford, then in New York for 10 years, and now in London - I believe I have worked here long enough to understand the trajectory of its culture, its people and its identity. And I can honestly say that the environment now is as toxic and destructive as I have ever seen it.

To put the problem in the simplest terms, the interests of the client continue to be sidelined in the way the firm operates and thinks about making money. Goldman Sachs is one of the world's largest and most important investment banks and it is too integral to global finance to continue to act this way. The firm has veered so far from the place I joined right out of college that I can no longer in good conscience say that I identify with what it stands for.

It might sound surprising to a skeptical public, but culture was always a vital part of Goldman Sachs's success. It revolved around teamwork, integrity, a spirit of humility, and always doing right by our clients. The culture was the secret sauce that made this place great and allowed us to earn our clients' trust for 143 years. It wasn't just about making money; this alone will not sustain a firm for so long. It had something to do with pride and belief in the organization. I am sad to say that I look around today and see virtually no trace of the culture that made me love working for this firm for many years. I no longer have the pride, or the belief.

But this was not always the case. For more than a decade I recruited and mentored candidates through our grueling interview process. I was selected as one of 10 people (out of a firm of more than 30,000) to appear on our recruiting video, which is played on every college campus we visit around the world. In 2006 I managed the summer intern program in sales and trading in New York for the 80 college students who made the cut, out of the thousands who applied.

I knew it was time to leave when I realized I could no longer look students in the eye and tell them what a great place this was to work.

When the history books are written about Goldman Sachs, they may reflect that the current chief executive officer, Lloyd C. Blankfein, and the president, Gary D. Cohn, lost hold of the firm's culture on their watch. I truly believe that this decline in the firm's moral fiber represents the single most serious threat to its long-run survival.

Over the course of my career I have had the privilege of advising two of the largest hedge funds on the planet, five of the largest asset managers in the United States, and three of the most prominent sovereign wealth funds in the Middle East and Asia. My clients have a total asset base of more than a trillion dollars. I have always taken a lot of pride in advising my clients to do what I believe is right for them, even if it means less money for the firm. This view is becoming increasingly unpopular at Goldman Sachs. Another sign that it was time to leave.

How did we get here? The firm changed the way it thought about leadership. Leadership used to be about ideas, setting an example and doing the right thing. Today, if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence.

What are three quick ways to become a leader? a) Execute on the firm's "axes," which is Goldman-speak for persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit. b) "Hunt Elephants." In English: get your clients - some of whom are sophisticated, and some of whom aren't - to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don't like selling my clients a product that is wrong for them. c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.

Today, many of these leaders display a Goldman Sachs culture quotient of exactly zero percent. I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients. It's purely about how we can make the most possible money off of them. If you were an alien from Mars and sat in on one of these meetings, you would believe that a client's success or progress was not part of the thought process at all.

It makes me ill how callously people talk about ripping their clients off. Over the last 12 months I have seen five different managing directors refer to their own clients as "muppets," sometimes over internal e-mail. Even after the S.E.C., Fabulous Fab, Abacus, God's work, Carl Levin, Vampire Squids? No humility? I mean, come on. Integrity? It is eroding. I don't know of any illegal behavior, but will people push the envelope and pitch lucrative and complicated products to clients even if they are not the simplest investments or the ones most directly aligned with the client's goals? Absolutely. Every day, in fact.

It astounds me how little senior management gets a basic truth: If clients don't trust you they will eventually stop doing business with you. It doesn't matter how smart you are.

These days, the most common question I get from junior analysts about derivatives is, "How much money did we make off the client?" It bothers me every time I hear it, because it is a clear reflection of what they are observing from their leaders about the way they should behave. Now project 10 years into the future: You don't have to be a rocket scientist to figure out that the junior analyst sitting quietly in the corner of the room hearing about "muppets," "ripping eyeballs out" and "getting paid" doesn't exactly turn into a model citizen.

When I was a first-year analyst I didn't know where the bathroom was, or how to tie my shoelaces. I was taught to be concerned with learning the ropes, finding out what a derivative was, understanding finance, getting to know our clients and what motivated them, learning how they defined success and what we could do to help them get there.

My proudest moments in life - getting a full scholarship to go from South Africa to Stanford University, being selected as a Rhodes Scholar national finalist, winning a bronze medal for table tennis at the Maccabiah Games in Israel, known as the Jewish Olympics - have all come through hard work, with no shortcuts. Goldman Sachs today has become too much about shortcuts and not enough about achievement. It just doesn't feel right to me anymore.

I hope this can be a wake-up call to the board of directors. Make the client the focal point of your business again. Without clients you will not make money. In fact, you will not exist. Weed out the morally bankrupt people, no matter how much money they make for the firm. And get the culture right again, so people want to work here for the right reasons. People who care only about making money will not sustain this firm - or the trust of its clients - for very much longer.

Greg Smith (the writer )is resigning today as a Goldman Sachs executive director and head of the firm's United States equity derivatives business in Europe, the Middle East and Africa.

Source: NY Times

The global credit crisis

I stumbled upon this primer on the credit crisis. I love the way the animated file explains the concept in a very lucid way.

Must see for beginners!

Insightful readings on the US downgrade

Here are some links to good readings on the recent downgrade of US Sovereign rating by Standard & Poor's.

Happy Reading!

The Basics

US Treasury's response to the downgrade

A good presentation on the situation

The big ERROR!

20 years of Economic Liberalization

All through my learning days, I have kept hearing and taking about the economic liberalization measures taken in 1991 by the then Finance Minister Dr. Manmohan Singh. I came across this piece, written by C Rangarajan (who was the Deputy Governor of RBI during 1991) that was published in The Financial Express in 2001, to mark the 10 years anniversary of "opening up" the economy. It is a fascinating article! Happy Reading.

As an aside, came across this paragraph from the budget speech of 1991 read out by Manmohan Singh:
Ever since my appointment as Finance Minister, I have had to spend long hours in office. This has quite naturally made my wife very unhappy. The House will agree that it is not good for the health of our economy if the Finance Minister of the country has strained relations with his own finance minister at home. I propose that the total exemption from payment of excise duty currently available to utensils made of aluminium, copper and stainless steel be extended to certain other household items particularly tiffin boxes.

The Indian version of yield-curve conundrum

Alan Greenspan coined a term called ‘yield curve conundrum’ to describe what he thought was an anomaly in the US treasury market then. As the Federal Reserve with Greenspan at the helm of affairs kept raising the Fed rate, long term rates ironically kept low resulting in a flat to inverted yield curve. The impending slowdown in US was one key fundamental reason for the long term rates to remain relatively low. Yet, the generic long term demand for US treasuries by global central banks and long term liability managers kept the long term rates subdued despite the increasing inflationary pressures in the economy. For a period too long, the long term rates seemed to react to anything but events and policies mushrooming in US.

A similar conundrum, albeit differently, is what we are experiencing in the Indian bond market for some time now. Reacting to a domestic slowdown resulting in contraction of output and falling prices, the Reserve Bank of India has rightly been easing its monetary clutches in the economy by cutting all rates it could – CRR, Repo, Reverse Repo and SLR. Though the central bank embarked on the easing during mid-2008, it intensified the rate cuts towards the end of CY2008. After an initial logical fall in the long term yields, we have experienced a reversal in the trend during the last few weeks starting mid-January 2009. The key reason for this conundrum is the supply of long term bonds to fund the accumulating fiscal deficit. An already fragile bond market has depicted its non-willingness to keep absorbing higher supply without paying lesser price for them. Yield, henceforth, have been moving northwards. With the supply calendar looking to increase with coming months, where are we headed in terms of interest rates in the system?

For one, RBI will continue to ease benchmark policy rates against a very comfortable backdrop of near-zero WPI based inflation and contracting industrial output. Considering the most likely scenario of WPI inflation remaining at an average of -1% from now to the end of FY2010 (conservative estimate), and a real interest rate of not more than 2%-3% to tackle an extremely subdued growth outlook, the nominal benchmark rates will have to be cut to levels of 2% or less quite soon. With liquidity conditions expected to keep positive on a consistent basis through CRR cuts/OMO by RBI, the effective benchmark policy rate would continue to be the Reverse Repo rate. Thus one could expect at least 150bps of easing over the next few months.

Secondly, yields would be supported by comfortable liquidity in the money market. Fiscal spending, OMO and possible cuts in CRR will help the liquidity remain the positive regime over the next many months. It seems very unlikely that bonds would be sold to create liquidity for meeting credit demands in the economy.

Thirdly, generic demand from insurance companies, banks, mutual funds, and importantly FIIs will help absorb the incremental demand in FY2010. With rupee trading at 50-plus levels against US Dollar in the exchange market, a comfortable stance by the RBI to help currency appreciation will favour the foreign investors chasing risk free yields in the uncertain global investment regime. It seems highly likely that RBI will intervene more aggressively starting April to push USD/INR rates lower after FII buying into bonds. Weakening USD globally (backed by huge monetization of deficit by US government) and revival in investment flows will help the rupee appreciation cause too in favour of investing FIIs.

Fourthly, RBI’s holdings in outstanding government bonds have been steadily rising over the last 12 months. This trend will most likely continue and rather intensify as we move ahead. RBI’s holdings as a percentage of total outstanding has steadily increased from 4.3% as at December 2007 to 5.8% as at the end of September 2008.

Despite a heave supply side pressure on yields, it still looks likely that the long term yields would ease in the coming months responding to a temporary statistics-induced deflation and easing benchmark rates.

As a probable move in the near term, RBI could consider introducing a ceiling on the Reverse Repo absorptions under LAF to effectively bring in a zero interest rate policy without officially cutting interest rates. Subdued money market rates will help the yields ease helping the cause of broader interest rate regime in the economy.

We will have to wait for the April policy to see if RBI might want to embark on a dynamic path like this to manage the monetary objectives.

Can we read something here?

An interesting chart that I happened to stumble upon. Just as a background, equity market price corrections (reversal from a bull phase to a bear phase) must technically clear two parameters - the test of time and the test of price erosion. Now look at the chart below (for larger size, click on the image):


We seem to have fulfilled at least the price correction parameter. And time corrections could be evaded by incremental positive events and data flows. Looking at the latest set of data in US (I will elaborate on this part separately in a post later), we might well have seen the worst in US.

Ofcourse the chart reflects Dow. But then, hasn't the recent crash educated us already that India and US never de-coupled in a strict sense?

More bond supply to chew

Governments all across the world, including US and India, are all out to do everything they can (and more) to save growth. Between US and India, the difference just being that the US Fed Reserve Chairman and their Finance Secretary has to officially justify and testify what they are upto. Back home in India, we get to know about what has already been done. No questions asked. More like, no one to ask.

If we are unhappy about what is being done, we sell stocks and bonds. Quite simple. And so bonds have been bearing the brunt of these growth-saving-efforts. Government wants market to fund it another Rs.46,000crores over the next 6-8 weeks. Phew.. So much to absorb, literally. With this, the total amount of auctions has reached Rs.231,000crs (gross) for the current fiscal. Out of these, banks alone have bought Rs.164,000crs. Add the demand from insurance companies, primary dealers and mutual funds, fact is the supply might be short of the requirement!

Last few weeks, the yields have been surging, prices dropping. Does it hit my stop-loss as a bond buyer? Not really. I would look to add more. Underlying bullish trend still remains firm, the rally just being postponed for the time being.

Let's see why. Excessive supply of bonds is negative for the market in two ways. Firstly, the liquidity angle. Supply of bonds equals absorption of system liquidity. But only temporarily. Government is borrowing BECAUSE it wants to spend. So money has to flow back sooner rather than later. Also, if there is even a short term liquidity mismatch, RBI will step in swiftly to infuse money by buying more MSS bonds or cutting CRR or if need be, both.

Coming to the second impact, that of higher supply of bonds due to auctions. That is, demand being equal higher supply can be absorbed only by reducing prices. If you look beyond the obvious, the long and short of it is that MSS bonds are being replaced by Non-MSS bonds in the investors' portfolio. There is no NET increase in the stock of bonds available really. That is why buyers won't really feel the weight of auctions in these times.

To put numbers into this statement, the total amount of MSS bonds bought back during Oct. 2008 till date is Rs.65,040 crs. Total auctions during the same period was Rs.86,230 crores. Redemptions during the period was Rs.11,450crs. The net increase in outstanding bonds in the market, hence, is only Rs.9,740crs. During the same period, the net accretion to banking system's deposits was Rs.187,940crs. Incremental SLR demand on this comes to Rs.45,105crs. Now, compare 45,105 with 9,740 and you will know why the yields are so lower than what they were in October 2008. The demand side from other generic buyers apart from banks have not been considered in my calculations. (For basic readers of this blog, hope the math is not very confusing)

Point is, me thinks this situation will continue. Meaning, the pain of incremental supply is not really a lot. Look at the armory with the RBI. CRR is at 5%, can be cut to 3% without any hitch. That's about Rs.72,000crs of liquidity. Outstanding MSS is Rs.108,764crs. Add both, and there's a lot of money to be released if need be. Don't forget, we are already sitting on a surplus liquidity of Rs.43,000crs approx.

Now, if interest rates still have to come down by 150-200bps over the next few months (my views expressed in earlier posts still hold good), yields can only go one way - DOWN. And so, I'll look to buy more gilts through my favorite ICICI Pru Gilt Fund.

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.

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.

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!

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!

What's in store for 2009?

2008 was a disastrous year for all asset classes, except bonds for the last few months of the year. Gold managed to do well too. Most of us in the market saw a different face of the markets relative to the last few years. Even the seasoned players have learnt a lesson or two from the events in the global markets. Risks got re-defined and 10% per annum seemed astronomical returns. The rate at which entities went belly-up was shocking. 50%-90% fall in stock prices were still digestable, but banks and financial powerhouses turning into hollow structures was the most shocking event of the year for me. Short-term US bills trading with negative yields was a revelation too!

One of the key drivers behind the mega-bull rally that the Indian markets witnessed during the period 2004 to 2007 was global liquidity. With global interest rates at significantly low levels, a glut of liquidity found its way into attractive avenues, including Indian equity markets owing to extremely robust economic shape of the country and sustained corporate earnings growth.

As we entered 2008, global interest rates had almost peaked with commodity and oil driven inflation being the primary reason pushing up rates. Also, the sub-prime crisis dried up otherwise liquid corporate bonds and MBS/ABS markets. Liquidity starved and risk averse investors resorted to 'flight to safety' by shifting their investors from equities to gold and US treasuries. The music had stopped! The selling pressure intensified with each episode of bankruptcy in the financial industry in US, UK and other major economies.

Within the domestic economy too, growth momentum clearly had started to slow down significantly. Indicators like IIP, GDP and credit growth had peaked in 2007 and investors started pricing in a slowdown in corporate earnings also. Resultantly, equity markets, with PEs at historically high levels, started to contract taking down the prices. Sentiment related factors also played its part as investors went from an extreme of greed to fear between the beginning and end of the year.

So what should we expect heading into 2009? Here are my thoughts:

1. Barring the first few months (till April/May 2009), volatility will die down significantly. One of the most important features that marked 2008 was high vols. 2009 will be a stark difference to 2008, at least in this respect.
2. Corporate earnings will shock us on the negative side. A large section of the market believes that most of the bad news is already in the price. I beg to differ. With interest rate cuts not yet passed on to the real system, the light at the end of the tunnel is still far-off. Q4CY08 to Q3CY09 will throw up results that will make Sensex at 9000-levels look rich.
3. Globally too, data releases and sentiment has a reasonably long way to keep falling before it picks up for the better. I do not expect the global investor community to consider India very seriously again before mid-2009. Fresh selling might halt soon, but buying might not resume soon.
4. Expect RBI to continue dropping interest rates even lower. From the current level of 5% for the benchmark Reverse Repo rate, I see room for atleast 100bps easing. With industrial production and exports looking to fall in the negative territory soon and inflation to fall into the sub-5% zone, RBI can focus completely on supporting the ailing growth. The interest rate differential between India and US in the growth cycle has been about 3%. I see no reason why it cannot be at similar levels in the slowdown phase. Growth in both the economies look to correct by about 4%-5%, which is not starkly different. So with US officially adopting Zero Interest Rate Policy (ZIRP), India's benchmark rate will possible settle at 3.5%-4% levels and that should happen before April 2009.

What are the implications from an investment perpective, if the above holds true? Firstly, one can afford to stay away from equities for few more months. By that I mean you might not miss a mega rally by not investing now and investing after April 2009. I would want to put money into gilts. Gilts, not corporate bonds-linked income funds, mind you. I do not see any major value in corporate bonds irrespective of what the AAA and AA spread indicates. Gilts looks good to deliver an absolute 5%-8% returns over the next few months. Post that, money can move into equities. An aggressive investor could look to allocate 75% to gilts and 25% to equities. Within equities, banking, FMCG, pharma and capital goods segments are the sectors that looks good to me for the next couple of years.

Wish you and your loved ones a rocking New Year.

Happy investing.