The dragon drags everybody down

It was sheer mayhem in Dalal Street on Monday (24^th August) morning. It was dismally colourful too. Even before the brokers could recover from the Monday morning blues, they began seeing red all over the place. It was one of those rare occasions when all 30 stocks in BSE S&P Sensex were in the red.

Dalal Street was not unique. Markets melted all over the world. These markets included commodity, currency and capital markets. Copper, nickel and oil found new lows. It was as if the pit was becoming bottomless. Chinese gravity was pulling everything down.

What was the origin, what is the course and what is the prognosis of this calamity? The epicenter is obviously China. China’s CSI 300 index spurted to 50% over 1^st January, 2015 by 30^th June, 2015. After that, it was all downhill. Now all the gains have been erased. Overemphasis on infrastructural development resulted in idle capacity of buildings, airports, bridges etc. (Moral: Economics in the long run does not brook any excess even in activities that are good in the short run.) Domestic demand started sliding. Exports slackened because many parts of the world are experiencing distressing fall in aggregate demand.

China is the largest or second largest economy in the world depending on whether you employ PPP (purchasing power parity) or not. Its GDP is about $18 trillion under PPP which is slightly in excess of America’s. It is obvious that any threat to such a massive economy will pose systemic hazard all over the world. This is exactly what is happening. China is a ‘too big to fail’ economy. Any misery in China is a body blow to rest of the world.

India is not de-coupled from China. Companies like Tata Motors and Tata Steel are devastated by the Chinese chaos. RBI Governor’s optimism that ‘the Indian economy is full of possibilities, even as much of the world is mired in pessimism’ is a bit of a stretch.

Are we in for a long term downturn? It is difficult to say. For every silver lining in the cloud, there are multiple forebodings. We were hoping that the US economy is well on its way to recovery. But the Yuan devaluation and its aftermath have thrown a spanner in the works or ,as the Americans say, thrown a (monkey) wrench in the works.

It may sound alarmist to fear that a currency war among various nations is in the offing leading to a Greater Depression than what was witnessed in the years 1929-33. However, let us not forget that uncertainty is the name of the economic game and nothing is ruled out in this age of the imponderables. To twist the Murphy’s Law a bit, even the unlikeliest event may yet happen.

Monday mayhem

Stock markets all over the world are going through an excruciating phase. On 24th August, global value of shares has shrunk by nearly US$ 10 trillion, almost the size of China's GDP. This loss on a single day is colossal, averaging around 6% in various stock exchanges.

China's market continues to sink despite the government permitting pension funds to invest 30% of their funds in stocks. This permission was given on 23rd August. It is ironic that communists in India are crying wolf over the Indian regulators permitting Employees Provident Fund Organisation to invest 5 to 15% of their incremental funds in equity. EPFO may have incurred substantial loss in their equity investments already. Bitten once, will it become twice shy? We can expect the communists to gloat over this development.

US $ is appreciating against all currencies save Yen and Euro. Japan and Europe will find their exports falling because of this. Federal Reserve Board of the US may postpone its intended increase of prime rates. Global uncertainty is escalating. RBI's moves will be worth watching.

Market's quirks

News number 1: "Bajaj Auto Ltd has announced the following Unaudited Standalone results for the quarter ended June 30, 2015 

The Company has posted a net profit after tax of Rs. 10148.00 million for the quarter ended June 30, 2015 as compared to Rs. 7399.80 million for the quarter ended June 30, 2014. Total Income has increased from Rs. 54716.80 million for the quarter ended June 30, 2014 to Rs. 60503.00 million for the quarter ended June 30, 2015."


News number 2:  "Bajaj Holdings & Investment Ltd has announced the following results for the quarter ended June 30, 2015 

The Unaudited Standalone results for the Quarter ended June 30, 2015:

The Company has posted a net profit of Rs. 1230.80 million for the quarter ended June 30, 2015 as compared to Rs. 1476.10 million for the quarter ended June 30, 2014. Total Income has decreased from Rs. 1693.00 million for the quarter ended June 30, 2014 to Rs. 1633.10 million for the quarter ended June 30, 2015."


These were released on 23rd July. People would have expected Bajaj Auto scrip to flare up in comparison to Bajaj Holdings. But what really happened was Bajaj Auto responded by crashing 5.02% to Rs.2487.75 and Bajaj Holdings shot up by 2.92% to Rs.1425.65.

Such are the odd ways of the stock market. Of course, there are always explanations flowing liberally. Bajaj Auto disappointed the market's expectations and the other company beat the expectations by a mile. Irrational expectations and unreasonable prices have become standard market behaviour.

Mani Shankar Aiyar's false argument

Writing in The Economic Times dated 28th August, M.S.Aiyar argues, "I don't quite know what Anna Hazare is doing at the Ramlila ground when he ought to be laying siege to Dalal Street and the CII headquarters. For, while some of the corruption can be traced to the venality of politicians, all of it leads straight to business houses."

Well, this is a convenient argument to deflect popular anger away from the government. But is this a valid argument? If crimes go unchecked in a particular town, we do not hold demonstration against the criminals. We only question the police / state why they are not taking any effective action. There is an implicit contract between the citizens and the elected representatives who form the government that the latter would keep criminals at bay. There is no agreement between the corporate sector and the citizens that the former would stay away from venal ways. Therefore even if Aiyar's assumption that corporates are the fountainhead of corruption is correct, his conclusion that we should question only the corporates and not the government is absurd.

However if Aiyar is sincere in his expression, we expect him to organise a dharna in front of Dalal Street. We may know how many people support him.

Are Indore Bank shareholders short-changed?

State Bank of India has proposed to acquire its hitherto subsidiary, State Bank of Indore popularly known as the Indore Bank. The proposal envisages allotment of 34 shares of SBI (State Bank of India) for every 100 shares of the Indore Bank. Is the proposal equitable?

Public shareholding in the Indore Bank is only about 1.95% The shares are not being traded and therefore there is no market price as such. Hence the theoretical value of the share needs to be calculated. Typically share value is calculated based on Earnings per share, Dividend per share and Book value of share. Let us see how these work out for the Indore Bank vis a vis SBI.

EPS for the Indore Bank is Rs.159.40 and for SBI Rs.143.77, both for the year ended 31.03.2009. Dividend per share for the year is Rs.15 and Rs.29 respectively. Book value of share is Rs.893.75 and Rs.912.73. Of these values, dividend per share is the least favourable for the Indore Bank shareholder. If we consider this as the basis for share exchange we are taking the most disadvantageous basis for the Indore Bank shareholders. Even by this unfavourable yardstick, the exchange ratio must be 51.72 shares of SBI for every 100 shares of the Indore Bank. (15/29 of 100).

Let us now consider another ratio that is important for banks. Return on Average Assets is 0.88% for the Indore Bank and 1.04% for SBI. This can be taken as a proxy for Brand value. It is expected that funds will be cheaper for a better branded bank and therefore its return on average assets will be better. Discounting the exchange ratio of 51.72 for 100 keeping in view this factor, we arrive at 43.76 shares for 100. (51.72*0.88/1.04)
Thus even by the most pessimistic estimate, 43.76 shares of SBI for every 100 shares of Indore Bank is what the shareholder of the Indore Bank must get. Offering only 34 shares of SBI means there is a further unfair discount of 22.30% (100*9.76/43.76)

I am not a shareholder in State Bank of Indore; therefore, I do not have a vested interest in the calculations.

The seven rules of Wall Street

"The Seven Rules of Wall Street : Crash-tested investment strategies that beat the Market" is a readable thin book written by Sam Stovall and published in January 2009. The author is the Chief Investment Strategist at Standard and Poor's Equity Research. The stated rules are:
1) Let your winners ride, cut your losers short.
2) As goes January, so goes the year.
3) Sell in May, and then walk away.
4) Buy Straw Hats in winter and Overcoats in summer.
5) Don't fight the Fed.
6) Don't get mad--get even.
7) There is always a bull market someplace.

There are many one-liners about Wall Street. Most of them are words of wisdom, but not always true. The following are some more crisp statements:

Don't fight the tape.
If you are going to panic, panic early.
A stock and a company are not always the same thing. (A stock sometimes represents the company and sometimes represents what the company is not; wisdom lies in knowing what is when.)
A bull market is born amid pessimism, grows up under scepticism, matures with optimism and crashes with euphoria.

Sensex 25,000?

Rakesh Jhunjhunwala,the irrepressible bull in Mumbai,keeps saying that the Sensex will touch 25,000.Of course,he does n't say when.People generally dismiss him as a pathological optimist.Sensex at 7,000 was unthinkable a few months back.Many erstwhile unthinkables are becoming real these days.Who would have thought,scarcely a month back,that a Chinese company would outbid Chevron for Unocal?Who would have known that Jap funds would flow to India to nudge the Sensex past 7K?Is it unthinkable that a part of Chinese wealth now going to US treasury,may find its way to Mumbai stock market?With Globalisation apace,the locus of the unthinkable keeps shrinking.Chinese funds will soon drive Sensex if only because it is unthinkable now.Market capitalisation of Indian companies,presently around $400 billion,can easily be swayed by funds from our neighbour.But why should the Chinese be interested in Indian stocks?That is a million yuan question,as of now.