Wednesday, April 22, 2009

Lords of Finance

"Lords of Finance - The Bankers who Broke the World" by Liaquat Ahamed is the best book on the 1920's-1930's financial markets that I have read so far. Now I haven't read a lot about this time period, so it doesnt say much. But it is definitely better than "1929" by Galbraith in giving a context to the whole episode. Highly recommended. 

It was the gold standard which caused the recession to become a depression, as countries couldn't expand credit fast enough to fill the gap left by private sector deleveraging. As soon as US went off the gold standard, dollar depreciated against gold and other commodities (Jim Rogers is right when he says commodities went up in the 1930's, but that was after a huge plunge happened in early 1930's. And it was linked to dollar devaluation). As soon as prices started going up, industrial production went back up - including in mining. And that led to new discoveries of gold itself. 

Michael Milken has written a very good article in Tuesday's WSJ on the importance of capital structure. This is a very good line: "History isn't a sine wave of endlessly repeated patterns. It's more like a helix that brings similar events around in a different orbit"

Monday, April 20, 2009

Deflation continued

Continuing the deflation post from yesterday, there is a big difference between consumer price inflation and wholesale price inflation right now in India. CPI is running in high single digits, while WPI is close to 0. This implies firms are increasing margins - which is what FMCG analysts are factoring in their EPS growth projections. I don't think this can last long. In each FMCG category, there will be an upstart who will try to use price cuts to expand market share, which will force the biggies to react. Lets see.

Sunday, April 19, 2009

The key is oil prices

I have been looking at various consensus S&P EPS projections for 2010. Depending on which analyst it is, EPS is going up from $45-55 in CY09 to $60-$70 in CY10. Almost everyone assumes oil prices will be $70-$80 next year, up from $50 this year.

The bull argument for oil is - credit crunch has made new supplies difficult. So when global growth resumes - coupled with the natural field decline each year - the excess oil inventory and supply will be taken care of soon. And, it is a good inflation hedge. 

What was unusual between 2003-2007 was that not only did global growth happen, but it lasted for a long time. For the oil bulls to be correct, not only should global growth occur, but it should continue for some period of time. If growth were instead turn out to be erratic - which is what I think is more likely - productivity improvements and climate change pressures might ensure that the time taken to work off the excess inventory and supplies is more than just a couple of years.  Oil companies and national governments are still doing capex - it is down but not to 0. 

Deflation and Indian FMCG stocks

Buying stocks with pricing power in a deflationary environment - especially when they are priced on deflationary EPS - might be the best hedge against an eventual return of inflation.  

Like a lot of people, I have been trying to figure out the inflation-deflation conundrum. On the one hand, the output gap (capacity utilization in US less than 70%) will suggest producers will find it hard to stick any price increases. On the other hand, if Fed and other central banks keep using this logic to print money ad infinitum, then at some point of time inflation will become a monetary phenomenon. 

Now what I am pretty sure of is that inflation will go up in India and other emerging markets before it goes up in US. Last year, Indian rupee depreciated by 25% and inflation is a staggering 0%. That would have been a very startling outcome for anyone before 2007. In 2008, rupee appreciated by 15%, and inflation was 10%. Now it is the reverse. That tells us how powerful the inflationary surge was in 2007-08, and how powerful a deflationary environment exists today. 

In the next 4 months, we are going to pass through probably the highest deflationary numbers in India. It was from March-April 2008 onwards that the big spikes in oil and other commodities came, so yoy inflation numbers are going to trend negative. A lot of FMCG companies increased prices early last year to take care of the increase in commodity costs. Some of these companies have already reduced prices on some products (paints, soap etc) and others might follow suit in the coming months.

What I have found quite strange in analyst projections is - volume growth and margin expansion is supposed to offset the impact of reduced prices, so that EPS growth in CY09 is same as CY08. That is very unlikely. FMCG, tobacco etc have price elasticity less than one. Companies are better off in a moderately high inflation environment than in a 0% inflation environment. 

Also, last year stockists and dealers were keeping increasingly higher inventories as they expected prices to go up - so last year's volume growth was a bit inflated. That dynamic has likely reversed and will remain so at least for the next few months. 

Indian FMCG stocks trade at very high multiples (Nestle is 30x, HLL is 25x etc). So, a reduction in EPS estimates might hit both on bottomline and multiples. 

So (a) Indian FMCG stocks might see a leg down as EPS growth expectations are revised downwards due to deflation, (b) Indian economy will again see 5% type inflation - probably in the next 12 months itself, (c) FMCG companies have pricing power (d) As inflation comes back, EPS growth expectations will go up, and (e) If Coke USA with 7% long-term EPS growth can command a 13x-14x multiple, then Nestle India with 12%-15% EPS growth can deserve a 20x multiple. 

Now it is possible that companies really deliever on the EPS growth expectaion due to margin expansion. Or that even if they miss, stocks don't fall at all. But if they do, then it might be a very good time to buy some of the FMCG stocks. 

I am assuming that India can grow at 3%-5%.

Tuesday, April 14, 2009

GS employees to make 25% more this year

Compensation benefits up 18% to $4.7bn, while employee strength down by 7%. Enjoy the benefits of a steeper yield curve and the largesse from AIG. 

Is the company paying dividends on its prefs? Preferred dividends are down qoq - total prefs outstanding are $16.5 bn and dividend paid is only $155 million. In 1 month in Dec 2008, pref dividend payout was $248mn - now that was probably too much.  

Thursday, April 09, 2009

A Surreal April

It is playing out like April 2008. From middle March onwards, we get a huge rally. Wells Fargo comes out with huge numbers. Are we going to get a repeat of "Sell in May and Go Away?"

Bottom or Top

Who cares - there are ample opportunities to make money whichever way indices move from here.
I think inflation is going to be an issue much faster than what anyone expects. See what the IMF is doing. Politicians are convinced now that printing money is not going to have any side effects. Everyone missed the credit crunch, and everyone is going to miss inflation when it happens.