Year 2008 in retrospect

Year 2008 will go down as the most turbulent year in the history of Capital Markets across the globe. Anyone who took the risk of making a prediction about the markets at the beginning of 2008 has been proven wrong by the time the year comes to a close. Here is a summary of the major events that made 2008 as an extraordinary year in the lives of 'Investors':

• Stock Markets in India registered their largest annual decline in history. The sensex recorded a decline of 52.5% over calender year 2008 (Falling from 20287 to 9647). Amongst its peers it is one of the worst performing indices, next only to Shanghai Composite which declined by 65.4%. The valuations of BSE sensex companies (PE Multiple) declined from an average of 27.7 to 12.4 by the close of 2008. During the year the sensex declined to a low of 7697 intraday, and the valuations went down to a pathetic level of 9. Foreign institutional investors took away over $13 billion from the Indian markets.
• Commodity Markets played havoc with the fiscal deficit of the Govt. of India. Prices of base metals the Copper, Nickle, Aluminium and Iron ore went through the roof during mid year, causing a lot of distress to countries like India that are net importers of many of these commodities. Crude oil jumped to a high of $147/ barrel in July amidst excessive speculation, only to fall back to under $40/barrel by the end of the year.
• Inflation played havoc with the budgets of invidual investors. In india WPI inflation peaked out at 12.9% in July, and closed the year at a comfortable level of 6.6%. Due to demand softening, inflation is likely to come down further to the levels of under 4% by the end of this fiscal. This leaves enough room for the Monetrary and Fiscal authorities to increase liquidity and cut interest rates aggressively.
• Gold emerged as one of the best performing asset classes during 2008 giving a return of 4%, making it a eighth consecutive year of gains. Gold continues to glitter and is looking to extend its dream run in the next year as well.
• Political Climate: After a lot of uncertainty and bloodbath, 26/11 marked a turnaround in Indian political scenario. The countrymen and the political leadership rose from their slumber to unite as a nation. The elections conducted immediately after 26/11 gave a clear message that sincerity and hard work will be rewarded by the electorate. By the year end the prospect of a new govt. in J&K under a young CM augers well for return of democracy in the troubled state. In the aftermath of terror attacks, Pakistan was pushed into a corner through diplomatic initiatives, and the involvement of LeT as the perpetrators of terror across the world was established beyond doubt. India also emerged as a strong nation by getting access to nuclear fuel without signing CTBT. ISRO's mission moon 'Chandrayan' also raised the image of India in the world.

The year 2008 has come to a close, let us hope year 2009 will bring a lot of cheer and prosperity to the 'Investor Community'.

Significance of Volatility Index (VIX)

Volatility index is a tool aimed to help investors understand market risks better and take decisions accordingly. Volatility Index is a measure, of the amount by which an underlying Index is expected to fluctuate, in the near term, (calculated as annualised volatility, denoted in percentage terms) based on the order book of the underlying index options.

VIX, introduced in 1993, is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 index options. Often referred to as the fear index, it represents one measure of the market's expectation of volatility over the next 30 day period. Investors believe that a high value of VIX translates into a greater degree of market uncertainty, while a low value of VIX is consistent with greater stability. Since inception till October 2008, the average value of VIX was 19.04. It reached an intraday high of 89.53% on October 24, 2008.

The chairman of the Securities and Exchange Board of India, Shri C.B. Bhave, launched the index called India VIX in April 2008. It captures the implied volatility embedded in options prices, and is based on the Nifty 50 Index Option prices. India VIX is a barometer of investor consensus on market volatility expressed through option pricing. Whereas the Nifty 50 signifies the directional moves of the market, India VIX indicates the expected near term volatility. How to measure the fear or uncertainty in the market? Generally, if the VIX is going up it means the fear in the market is going up leading to a market decline, and if we see the VIX falling it means the fear in the market is reducing leading to markets rising. Higher the implied volatility, the markets tend to correct to appropriate levels and vice-versa. India VIX after hitting a range of over 70% during October-November 2008, has since come down significantly. It closed at a level of 45.16% on December 26, 2008. However, a level of more than 40% still indicates a lot of fear amongst the market participants. The markets may not be out of the woods yet.

Insurance Update: Terror Cover

The recent terror attacks in Mumbai have raised an issue of 'Insurance against terror attacks'. As far as Life Insurance is concerned, there is no need for a separate terror policy if one is adequately insured. The thumb rule for adequate insurance is about 6-8 times your annual income. A typical life insurance policy covers death due to any reason other than suicide in the first year of the policy. Other options to cover the risk of terror attacks are: A personal accident insurance cover or a simple term insurance plan with a 'personal accident' rider. However, recently a unique exclusive terrorism insurance policy has been introduced jointly by a Delhi based insurer 'Optima Insurance Brokers' and 'Oriental Insurance Company'. The policy offers a 5 lakh cover at the annual premium of Rs 99 only, and can be availed through the online portal 'click2insure.com'. Policies like this are directed at middle class and lower middle class people who suffer from inadequate life insurance cover.

However, non-life insurance against terror is woefully inadequate in our country. Many companies are unaware of the level of terror risk faced by them. And, even after buying terror covers for their properties and possible business disruptions, companies do not clearly know how the personal and property claims from a terror attack could impact their balance sheets. Terrorism insurance is mostly offered as a rider or add-on cover to the main policies by domestic insurers. Internationally, it is available even as a standalone policy. Individuals can protect their property and valuables by opting for a terrorism cover under the householder's policy. This can be bought at an extra premium of 0.08%.

Terror claims are settled through a 'terror insurance pool' created by the non life insurers. The maximum rate of an add on terror cover is 0.22%, which is now proposed to be raised to 0.3% on the advise of the underwriting committee. There is also a suggestion to allow policy holders to opt for mid term purchase of terror cover.

Corporate Governance: Investor Concerns

The fiasco attempted by 'Satyam Computers Ltd' promoters for the benefit of family owned companies has brought the issue of 'Corporate Governance' to the fore. The backlash from shareholders to the move by the Satyam board was unprecedented, and the management had to backtrack on its decision within hours of its announcement. The promoters who hold less than 9% stake in the company have tarnished the image of the company, which may have negative global consequences on the future of the company.

What is Corporate Governance? It is as an internal system encompassing policies, processes and people, which serves the needs of shareholders and other stakeholders, by directing and controlling management activities with good business savvy, objectivity and integrity. Report of SEBI committee (India) on Corporate Governance defines corporate governance as the acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company.” The definition is drawn from the Gandhian principle of trusteeship and the Directive Principles of the Indian Constitution. Corporate Governance is viewed as ethics and a moral duty.

In India, Kumar Mangalam Birla committe was constituted in 1999, to promote and raise the standard of corporate governance amongst corporate entities in India. It is applicable to all listed companies with paid up capital of Rs. 3 crores and above. It is implemented through clause 49 of the listing agreement between the company and the stock exchanges. Provisions of clause 49 are:

• The Board will be comprised of 50% executive directors and 50% non executive directors, where there is a full time chairman
• Constitution of audit committee with 3 independent directors and chairman having sound financial background- responsible for review of financial performance on a yearly/ half yearly basis
• remuneration of non executive directors to be decided by board, disclosure of this information to shareholders
• Atleast 4 meetings by the board in a year, directors not to be members of more than 10 committees
• Management discussion and analysis report to include: outlook, risks and concerns, internal control systems, DISCLOSURE BY DIRECTORS ON MATERIAL FINANCIAL AND COMMERCIAL TRANSACTIONS WITH THE COMPANY.

Some more changes are in the offing as a part of the Company Law ammendment Bill.

Satyam promoters have violated the basic tenets of Corporate Governance, which has sent a wrong message to Foreign investors. The Govt. (Company Law Board) and the regulator SEBI have a responsibility to take requisite action against the defaulters to assuage the feelings of the shareholders of the company. This will send a strong signal to other promoters also, who may be thinking on the same lines.

What is 'Value Investing'?

Investors the world over have suffered huge losses in the current global financial crises, the impact of which has been catastrophic. Most of the countries in the developed world have slipped into a recession. Indian stock markets have also been negatively impacted by the global crises. Investors in India are a worried lot. To make money on the markets we need to understand the concept of 'Value Investing'.

This concept has been developed by ‘Benjamin Graham’ and ‘David Dodd’ in the 1930’s, and has been put to practice by many of their students, notable amongst them being the legendary billionaire Warren Buffet, Chairman and founder of Berkshire Hathaway.Value investing generally involves buying securities that appear underpriced by some yardstick of ‘Fundamental Analysis’. These securities may be stocks in public companies that trade at discounts to book value, have high dividend yields, have low price to earning multiple (PE ratio) or have low price to book ratio. According to Buffet value investing is buying stocks at less than their ‘Intrinsic value’. However, finding the ‘Intrinsic value’ of a stock is not an easy task. There is an element of subjectivity in arriving at the true intrinsic value of a stock. To overtcome this drawback, another important concept in value investing is that of ‘margin of safety’. The discount of the market price to the intrinsic value is called the ‘margin of safety’. Fundamental analysis is an attempt to study everything that can affect the security's value. It includes macroeconomic factors affecting the overall economy and industry such as inflation and intertest rates, and individual specific factors effecting the financial condition and management of companies.

Warren Buffet has identified four filters to succesful value investing:
· Invest in businesses that you understand
· Invest in companies that have favourable long term prospects
· Invest in conpanies with able and trusted management
· Invest in stocks that carry a reasonable price tag

The current market turmoil offers a great opportunity to identify 'Value stocks' and hold them for a reasonably longer period to see your investments grow. Buy on market declines to improve your 'Margin of Safety'.

Indian Economy is not in 'Recession'

The worst fears have come true: India's IIP numbers for October '08 have turned out to be a negative 0.4%. IIP numbers are likely to stagnate for the month of November '08 also, putting pressure on the earnings growth of Indian corporate sector for quarter ending December '08. These may seem like dark clouds on the horizon. Does this mean that Indian economy is moving towards recession? The answer is an emphatic 'NO'.

Let us try to focus on the silver lining amidst the dark clouds to find an answer:

• Inflation has moderated to reasonable levels, and is likely to decline further to below RBI's benchmark level of 5% in a few weeks time. The prices of food articles have also seen a decline in the past week. Crude oil prices, which accounted for a major portion of India's woes, have corrected substantially, and despite OPEC's call to cut production are not threatening to cut loose any time soon.
• Interest rate cycle has peaked and we can hope to see drastic cuts in interest rates by the banks in the next few weeks. A further rate cut on REPO front by RBI may be expected towards the end of December. Demand will see a revival after the excise cuts announced by the govt. All this augers well for Corporate India, as the much needed money will be available at reasonable price to sustain growth projects.
• FII outflow from Indian markets may be coming to an end. The signs are evident with the Rupee stabilising against the dolllar. India may benefit when overseas fund allocations are made for emerging markets at the beginning of 2009. As liquidity position eases in world markets, India will emerge as one of the preferred destinations for 2009, because the Indian economy continues to be one of the fastest growing economies amidst the global turmoil.
• The mood of the people is quite upbeat, and more importantly the country stands more united to fight external threats. However, the political instability ahead of general elections may have a subdued effect on the markets in the short term. The slowdown in earnings also threatens towards one more leg of downward move on our stock market, but the base building exercise thereafter will lay the foundations of a strong upmove post May-June 2009, that is after the new Govt. takes charge at the centre.

The negative growth in IIP numbers may have been caused by the severe liquidity crunch faced by the industry in October '08. The situation has improved since then, and the positive factors discussed above should lead to a rebound in the last quarter of this fiscal. An economy growing at 6-6.5% in the worst case scenario, cannot be classified as an economy in recession.

Global Recession: How to cope with it

Economic recession is defined as: "a significant decline in the economic activity across the economy, lasting more than a few months, resulting in negative real GDP growth, fall in personal income, employment, industrial production, and wholesale-retail sales." In macroeconomics, a recession is a decline in a country's gross domestic product (GDP), or negative real economic growth, for two or more successive quarters of a year. IMF regards periods when global growth is less than 3% to be global recessions. The latest World Bank report has estimated that Global economy will grow by 2.5% in 2008, and the growth is likely to fall to a mere 0.9% in 2009. Going by this definition global economy is in the grip of a serious recession led by the largest economy USA which accounts for around 25% of World's GDP.

Economists and Central Banks across the world are grappling with the situation by cutting rates across the board, cutting taxes to spur investment and consumption. Although Indian economy is not in the grip of a recession, but a severe economic slowdown is feared due to the world economic crises. Recessionary conditions are often preceeded by stock market meltdowns and fall in real estate prices. India is also witnessing these depressing signals. But given its strong growth during the past 3 years and the fact that Indian economy is not an export driven economy, it is likely to bounce back to the normal growth trajectory ahead of the developed world and even China. But this may take atleast 6 months if not more.

Investors, who have seen their net worth/ investment erode rapidly in the recent past, are a worried lot. How can we cope up with this turbulent phase in the stock market? The volatility in the market has gone up substantially, and the daily movements are sometimes baffling the investors. The current uptrend in the markets has come as a pleasant surprise to many, especially after the Mumbai terror attacks. The Indian indeces are probably trying to catch up with the global indeces: India has been one of the worst performing global markets since November 21, 2008. There is still some steam left in the current upmove. It would be prudent to book partial profits/ losses if the market goes up by another 8-10% in the next few days. This cash may be kept safe to be re-invested in the next downturn. Negative news from the US could catch up with the markets soon. The slowdown in IIP numbers back home may also spell doom for the markets in India. If the markets are able to stay above the previous lows (2250 on the Nifty and 7600 on the Sensex), then we could see the end of this long Bear phase. Till then keep your fingers crossed.

Fluctuating Crude Oil Prices: A crises brewing!

Crude oil for January delivery ended down $2.85, or 6.5%, at $40.81 a barrel on the New York Mercantile Exchange this Friday, the lowest closing level since December 2004. Oil lost 25% during the week, the largest drop since the week ended Jan. 18, 1991. Having fallen over $100 from the July 2008 peak of $147 a barrel, questions are being asked about the 'Fair Value' of Crude Oil.

Saudi Arabia’s King Abdullah has said $75 is a “fair price". Saudi Arabia has the world’s largest oil reserves and is OPEC’s biggest producer. When the king talks about a “fair price”, perhaps what he is referring to is a price which keeps afloat the Saudi treasury, not the state oil company. Citigroup Inc. estimates that Saudi Arabia, the world’s largest holder of crude reserves, must sell oil for an average of about $70 a barrel next year to finance its imports and domestic projects. The United Arab Emirates also requires $70 next year to balance its current account and fiscal spending, while Kuwait and Qatar both need $55 a barrel to break even.

How do we determine the Fair Price for oil? A fair price is one that gives producers an incentive to continue investing but does not compromise consuming countries’ economic growth. Global demand for oil is expected to climb from its present level of 82 million barrels a day, to 120 million barrel a day in 2025. For a matching increase in supply to occur, oil prices have to go up to encourage further investment. Europe and newly industrialized Asia (Including China and India ) import as much as 30 to 60% of their Oil needs. Japan is worst placed, where almost all of its Oil is imported. Let us turn to a bit of history: In 1971, an agreement between OPEC and oil companies recommended a gradual rise in oil prices of 2.5 per cent to keep up with inflation. The price of a barrel of oil then was only about $2, but the idea of adjusting prices to inflation was a reasonable. At present, a fair price for oil, after correction for inflation, is anywhere between $40 and $50 a barrel. And this price needs to be adjusted annually to compensate for inflation and to stimulate investment in the industry.

Let us find out what speculators have to say about Crude prices. "Crude oil prices could fall to as low as $20 a barrel in 2009 as falling U.S. demand outstrips Chinese growth", Hedge fund manager Jacques Mechelany told Reuters this week. Having already profited handsomely from the steep decline in crude prices, Mechelany intends to continue to take short positions in crude oil futures and selected oil-related stocks. "When oil prices begin falling leveraged investors have to unwind positions, further depressing prices," he said.

It is uncertain times ahead. In the short run it may benefit net oil importers like India, but falling oil prices leave little incentive for new oil exploration and it also reduces the political will to push through costly renewable energy initiatives. This may be detrimental for the global economy in the long run. All we require is stable crude oil prices, for which global steps need to be taken like curbing excessive speculation in commodity markets. The last round of global crises (market turmoil) was triggered by ballooning oil prices, the next round will perhaps be triggered by the falling oil prices.