Should we welcome this investor?

In this issue:
» Foreign institutional investors love emerging markets
» Food price inflation touches 20%
» Goldman Sachs stops cash bonuses, opts for long term stock
» Chinese stimulus could endanger the world economy
» ...and more!!

Everyone loves attention. So we can't blame the emerging economies if they are flattered by all the attention they have been receiving of late from institutional investors from the developed world. They are attracted by the growing middle class in the emerging nations. This middle class has the habit of saving and taking on very little debt. That's in sharp contrast to their counterparts in the developed nations. Small wonder then that the institutional investors believe they should park their funds in emerging markets. Despite the steep recovery from their lows earlier this year. In fact, as per Reuters, emerging market equity funds have attracted a net inflow of US$ 60 bn in 2009, much higher than earlier record of US$ 54.3 bn in 2007.

But not all attention is good. Foreign institutional investors are notoriously fickle. They were the same set of investors who dumped assets in the emerging markets in 2008 to move into US Treasuries. Some emerging economies realise this fact. Brazil has recently slapped a 2% tax on foreign equity and fixed-income purchases. The question is - does India realise the same? Seems not. The RBI believes the recent inflows cannot be compared to those of 2006 to 2008. They are not creating any asset bubble.

We are not so sure. Net foreign institutional investment is estimated at US$ 18 bn this year. When we look around for the great businesses in India, we find they are now trading at rich valuations. Many of them are at their all time highs. We tend to not get very happy with steep valuations. Especially when we know the large but fickle foreign investor has the power to pull the carpet under our feet. When that happens, those with the stomach to look for a bargain have a field day. But the vast majority of retail investors get severely burnt.


Today Indians are admired for their technological prowess. Academicians believe we have the potential to create trend setting products. But we have not lived up to the expectation. To use the cliché, India has not really moved up the value chain. Today's chart of the day shows how Indian citizens and firms have fallen way behind their Chinese counterparts in the recent years when it comes to obtaining patents for inventions in the US. The reason is the lack of funding for ideas. Government and corporate research & development expenditure lags behind other nations. Venture capital finance is also hard to come by. It also has to do with a culture that promotes rote learning and frowns on unconventional career choices. While there are historical reasons - colonial rule and central planning thereafter - for this culture, we believe it is high time we moved on.


Did you ever imagine that the price of the humble potato would have an effect on the monetary policy of the country? Very soon it could. Food price index has risen by nearly 20% YoY this week. But the Reserve Bank of India (RBI) is finding it hard to implement measures to control it. This is because the RBI is seeking to strike a balance between supporting a nascent economic recovery and controlling inflation. RBI governor, Mr. Subbarao has indicated that tightening the monetary policy may not be very effective in controlling food inflation. However, it may be used for preventing a spillover from high food prices. For this purpose, Mr. Subbarao started withdrawing the economic stimulus in October. He did this by directing the lenders to deposit more money in government bonds while maintaining the reverse repurchase rate. We believe that RBI will soon have to raise interest rates to control inflation. However, it will have to be cautious so as not to disturb the fledging economic recovery.


'How can you mend a broken heart' is a song that was released by the Bee Gees in early 70s and went on to become an instant hit. But guess who's taking it very seriously these days? It is the investment bankers. Goldman Sachs to be more specific. The world's most powerful investment bank seems to have had a sudden change of heart as it has announced that its most senior executives would forgo cash bonuses this year and would instead be paid in the form of long-term stock, which are shares that cannot be sold for five years and can be retracted if the executive does something that hurts the firm.

Although it looks like better sense has finally prevailed this time around, we don't know for sure how much of a help the current measure is going to be. Goldman's tendency in recent times to make some outrageous, arrogant remarks and then to retract it is already well known. All this makes one wonder are these people really apologetic of their mistakes. If the answer is in the negative as we believe, then the game of excessive risk taking may continue to play on in the future as well and the financial system will continue to remain vulnerable.


We had recently warned you that the 'Next Dubai' could be closer than you think. Ironically there are a few others who share this opinion. The European Union Chamber of Commerce in China is one of them. It believes that the country's overcapacity situation could finally lead the dragon nation to its doom. Besides, many are willing to bet on the possibility of China throwing up a Dubai-like shock. Of course, of a much bigger proportion. Much of China's 'overcapacity' has been driven by excessive capital spending and the artificial peg of the Chinese currency to the US dollar. These measures protect China's export-led manufacturing industry.

But that is not the end of the story. China's famous saving and investment history also has many critics. It seems China's investment to GDP ratio of 50% has broken all records. That of Germany's 27% in 1964, Japan's 36% in 1973, and South Korea's 39% in 1991. Also, the longest any country has sustained an investment to GDP ratio of over 33% was nine years. They were Thailand and Singapore. China is well into its 12th year of heavy investments. In fact a business daily has cited an interesting quote of a Chinese economist. "China's mega-stimulus programme is like drinking poison to quench a thirst'." Do we need to say more?


If there is one asset class that holds the potential to earn really strong returns in the future then that is commodities. That is what legendary investor Jim Rogers firmly believes. In fact, Rogers is of the opinion that agricultural commodities are the place to be in because the prices are still depressed. This is despite the fact that prices have risen at a fast pace of late. His rationale is that there is an imminent prospect of food shortage. Be it rice, sugar or wheat, inventories of food as a whole are the lowest in decades and he expects a food crisis to loom large in the next 5 to 6 years. And while the speculators will be blamed for prices soaring, the fact is that no farmer will be ready to cultivate crops unless he gets a higher price for it. So all in all, while Rogers is bullish on commodities as a whole, agricultural commodities is that one class on which he seems to be the most positive.


Meanwhile, Indian markets witnessed a relatively choppy trading session today after a positive start and the BSE Sensex was down nearly 26 points at the time of writing. Stocks from the banking and telecom sectors were among the ones that failed to garner investors' interest. Asian markets are trading a mixed bag, while Europe is in the green currently.


Today's investing mantra
"Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return." - Warren Buffett