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Sunday, September 14, 2008

The Fate of Irrefutable Presumptions

If I look back at the end of last year or start of this year, there were a many 'cannot go wrong' assumptions about how things will unfold through the course of the year.
  • Foreigners would continue buying Indian stocks - theydon't have any options in a slowing global growth environment (Oh the middle east guys are sitting on over trillion dollars of petro-dollar liquidity - where will it go?)
  • India is immune to slowdown globally - we will continue to grow around 8-9%
  • Interest rates in India are headed lower due to lower inflation and widening interest rate differential to global interest rates
  • If commodity prices correct, India would be a natural beneficiary from an equity market standpoint)
  • Valuations do not matter when you are swimming in sea of liquidity
  • Rupee is in a secular uptrend - reflecting robust capital flows, structural improvement in trade balance once gas discoveries come on stream etc...
One by one, all these assumptions have come crashing...
  • Foreigners have actually on a net basis sold over US$7bn of stock. Overall capital flows would likely be down 50% in FY09 over FY08
  • India's growth is slowing - and part of the reason for slowdown is higher commodity price led inflation leading to RBI tightening
  • India's interest rates have actually increased - and increased significantly. It was naive to argue that on one hand our growth is uncorrelated to global growth but our monetary policy is...
  • Commodity prices have corrected - Oil is down 30% from peak and from a market perspective we are less than 10% away from the lows of this year
  • Valuations do matter - the worst performing stocks are amongst the most expensive - valuations may not becorrelated to fundamentals on a day to day basis - but theydo cross paths every now and then...
  • Rupee is amongst the second worst performing currency amongst the major emerging markets and it has depreciated in the recent past even as oil has come off sharply - anyone who argues that in the short or even medium term currencies behave in accordance with trade flows needs to wake up...
What next? What are the current 'cannot go wrong' assumptions in the market? In my view, the following:
  • FII's have sold US$7bn in the first eight months of the year - rest of the year is unlikely to see selling anything close to that magnitude
All I would say is after pausing for July and august when FII'scumulatively sold under US$1bn of equities, in the first two weeks of September they have sold almost US$1bn. Even after the selling and market crash FII's own over US$150bn of Indian stock!
  • FY09 is a aberration - commodity prices will come down and so will interest rates and so in FY10 we will resume growth momentum with growth back in 8-9% range
In FY10 there is a real chance of growth slipping below 7% in my view - financial community is in denial mode over growth slowdown. If growth does not slowdown, you will get even higher interest rates to curb inflation. Growth has to slowdown.
  • Interest rates will come down; inflation is already showing signs of moderating as commodity prices moderate
It is absurd to expect RBI to even signal softer monetary policy when inflation (as measured by WPI) is running above 12% and growth still around 8%. Four weeks of inflation hovering around 12-12.5% does not imply inflation has moderated. Only caveat I would add would be a major overseas event which forces RBI to backoff purely due to 'liquidity' reasons.

In my view, as the rest of the year unfolds, even these three 'cannot go wrong' assumptions would come in question and fall apart like many others have done so far this year...

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