Sunday, December 16, 2012

Trading the rally- Tiger by the tail

The government has managed to have its say in so far as the policy relating to FDI in retail is concerned. Our markets seem to think that this is a great thing and that this is perhaps a harbinger of things to come and that the ruling party will be able to push through everything required to make India a welcome destination for money from overseas. It is clear to all that our domestic finances are beyond repair (with expenditure constantly trailing revenues) and we need to attract enough of foreign capital flows in order to postpone our troubles. At some point, there will be a price to pay for sure, unless India structurally improves in a manner that export of goods and services will exceed the imports. The government is trying to focus on areas like restricting import of gold, which may plug some leak, but do not address any structural issues. So, the government is turning its attention to hang the ‘welcome’ signs to the foreigner to bring in his money. However, things are not so simple. If we look at the FDI in retail, the government approach is terrible. A new entrant will need to full fill a host of conditions and also seek each state government’s approval to open shop! General consensus is that at best this may bring in around ten billion dollars or so over three to five years. On the domestic front, the government is trying to bridge the fiscal gap by selling assets. This is a temporary solution. Once the government runs out of assets to sell, the problem re-surfaces. So, our problem of being financially ‘unviable’ (with revenues constantly falling short of expenditure) is an inherent one. The government is not investing in infrastructure that can help bridge this gap. Not that it is unwilling to, but is giving the impression that it cannot do. Roads, ports, power, logistics et all are the things required if India is to get a competitive edge in manufacturing or services. Simple labour arbitrage is not anything sustainable as wages will move towards each other (job losses in one country will move wages down, impose protectionism tariffs etc and job gains in the export nations will raise disproportionately). The world economies are also yet shaky. Europe is still troubled and it is possible that nations like Greece that were forced to accept moderation will go back to being profligate, causing yet another round of turmoil. The Euro zone is damp, US has to overcome its own fiscal cliff of moderating its finances and Japan is on the verge of contracting. So, domestic demand alone cannot keep us buoyant for long. We are going to feel the pain. The domestic politics of appeasement is also financially disastrous in the long run. There is a race to offer freebies to the populace by the Centre as well as the State governments. All of this fuel inflation. Supply side boosters are missing totally. Inflation is finally taking its toll on the consumer. We can see slowing demand in consumer durables, even whilst personal credit is growing. Interest rates could drop, but would not perhaps be significant enough to boost any demand. In this backdrop, our markets have turned bullish, on the back of record FII inflows in to the equities and debt segment. On top of that, the bulls point to the FDI victory in both houses of the Parliament as a sure indicator of the government pushing through reforms. As the government nears its last full year budget before elections, optimism is clearly visible. In this noise, it is important to keep a cool head. If you are a trader and want to trade this expected up move, do it with speed and caution. Speed because the market does not wait for you to complete your analyses etc., Caution because I do not see this move backed by fundamentals. The way to exercise caution is to have clear strategies for trading in terms of booking profits, having stop losses etc. Investment for the long terms can wait. Our markets are expensive at present levels and the run up in the last five to six weeks is clearly driven by liquidity and by very optimistic set of assumptions. It is very likely that the markets may be on tear for some more time, but given my conservative nature, I will keep aside. Quality stocks are expensive. The rally is driven by lesser quality names and at best, a trading opportunity.

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