July 1, 2012
I’m proud to announce that we published our first issue of the Value Investing India Report for our paid subscribers. The first issue contains both original research and analysis covering the global macro outlook, Indian economic outlook, a full asset allocation strategy and our first investment recommendation.
I’ve posted below a preview of the Indian Economic outlook contained in the first issue:
The Indian economy is clearly facing stagflation, which is a toxic combination of slow growth and high inflation. The US faced a similar bout of stagflation back in the 70’s and early 80’s, which was finally cured by the then Chairman of the Federal Reserve, Paul Volcker. The annualized inflation rate peaked at 13.5% in 1981 and was down to 3.2% by 1983. He achieved this feat by raising the federal funds rate to an astronomic level of 20%, which not only solved the inflation problem but drove the economy into a recession.
The farming sector was hit hard by the high interest rate environment and indebted farmers actually staged a protest outside the Marriner Eccles Building, which houses the main offices of the Board of Governors of the Federal Reserve System. Despite the near-term pain caused by the recession, Volcker laid the foundation for the massive bull market in US equities that began in 1982 and culminated in the dot-com bubble of 2000.
Indian central bank Governor Duvvuri Subbarao, has come under similar pressure due to his decision to leave interest rates unchanged on June 18th, despite weakening growth. India’s real GDP growth has declined to a nine year low of 5.3% for the fourth quarter of fiscal year 2011-2012. Decelerating growth combined with an inflation rate of 10%, as measured by the CPI, is enough evidence to make the case that India is facing serious case of stagflation. It remains to be seen whether Mr. Subbarao will be able to channel his inner Volcker following the clamor from the corporate sector. It’s clear that the continued rate of inflation leaves no room for a rate cut. At a minimum, I would be impressed if Subbarao is able to hold the line in terms of policy rates but I get the sense that the roar of opposition will only become more deafening.
Despite the recent weak GDP print, the economic data has not been universally horrible. The May composite PMI data reflected an improvement over April. The index rose to 55.3 in May from 53.8 in the prior month. The service sector showed surprising strength and despite the weak GDP data, it’s clear to me that the PMI data supports Subbarao’s decision not to lower interest rates. In my view, further aggressive monetary easing is unlikely for now.
However, based on the chart above we can see that the PMI level can decline rapidly as experienced in 2008. I think the downside risk for the Indian economy remains the issues in Europe and the US. In my view, India will not be able to avoid a further slowdown if the US enters into a recession this year. Furthermore, based on the US experience periods of stagflation are particularly negative for equity investors. Thus, it’s clear that preserving your capital is of primary importance in the current market environment. Although equity valuation levels have improved, the equity market as a whole is still not a bargain. The key to outperforming in the current market environment is to stay liquid and wait to buy great companies at a discount. Additionally, the current market environment is ideal for a special situations investment strategy. In the next section, I’ll be highlighting a unique special situation investment that has the potential to produce 32% annualized gains. Finally, in the asset allocation section, I’ll discuss how to position your entire portfolio across asset classes to best preserve capital.
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