Monitoring the NaMo Bull Market in Stocks: Update as of end October 2014

Indian Stock Market Watch

Please refer to my blog of July 9, 2014 for the original note on using TMV/GNP ratio to gauge

whether market is cheap or expensive.  

Amazon’s performance critical for investors and the tech industry

Indian Stock Market Watch
S&P 500 Watch

I know of one company listed on the U.S. Stock market which has the following data points:

Forward Price/Earnings Ratio (FY 15) shown at Yahoo Finance is 250;

Reported recently the highest quarterly loss in in about ten years of $427 million;

$ 75 billion in revenues was generated by the company in 2013.

Any guesses on which company I am referring to? Yes, it is the truly amazing Amazon.

Why would investors continue to repose faith in such a company? One, Amazon has done a great job in the retailing space in serving customers. Two, since even today internet sales account for less than 10% of total retail sales in the US, investors have felt that Amazon, despite its unsteady record of profitability over twenty years, is a true long term profit story. Three, the larger than life figure of the founder, Jeff Bezos, has captivated analysts and investors.

Amazon has now reported two consecutive quarters of losses. The stock is down about 27% from its peak late last year. But is this enough?

Google is a somewhat similar sized as Amazon - Google’s revenues in 2013 were $60 billion – but far more profitable, and yet trades at a forward P/E of only 19 compared to Amazon’s 250. Assuming my maths is correct, if Google were valued on the same P/E as Amazon, its market capitalisation would be $4855 billion instead of $370 billion, or if Amazon were to be valued at the same P/E as Google its market cap. would be $10 billion instead of $134 billion!

From my perspective, far too much seem to ride on the confidence investors have in Amazon’s ability to generate profits in the long run. Jeff Bezos has repeatedly chosen to invest, not entirely successfully, rather than pursue profits on a quarter to quarter basis. This to me makes sense if this is accompanied by focus on a particular industry. But Bezos has Amazon investing in an amazing variety of industries apart from retailing: cloud computing, smart phones, e readers, drones, TV shows … At the same time, Amazon discloses very little about the details of these investments.

And will Amazon run out of cash?

If investors lose faith in Amazon, then it could lead to loss of faith in the tech market and perhaps even the first serious correction in the US bull market since 2008. Another scenario is that investors lose faith in the Bezos model of business: visionaries at companies such as Google, Facebook (Amazon is an extreme example) pursuing long term profits but doing so through highly speculative, or shall I say forward looking, investments in fairly diverse industries. One thing appears more certain, investors will lose faith in tech companies that do not make profit and even more so if they do not have any revenues – and today we have some high profile ones with sky-high valuations. 

China's governance: Martin Jacques' view

I recommend to readers an article titled "The myopic western view of China’s economic rise " by Martin Jacque that appeared in the FT yesterday.

Government and RBI should jointly agree on an inflation target

RBI should be given full autonomy to pursue the target rate

RBI Watch                                                                                    Monetary Policy 2014-15

A little over a week ago the Hindu on its front page carried a news item titled “Centre to set inflation targets for RBI”.  The report indicated that the Indian government felt that RBI could not be the one to decide what the inflation target for the country should be, but instead the government was in a better position to do so.

The background to this news item has its origin in Reserve Bank of India Governor Rajan’s appointment late last year of a committee to examine the goals and process of monetary policy formulation. The Urjit Patel Committee gave its recommendations early this year. It recommended, among other things, that RBI should adopt inflation targeting, target an inflation of 4% + or – 2%, and chose Consumer Price Inflation (CPI) as the benchmark for measuring inflation.

What is inflation targeting? Inflation targeting happens when the central bank makes public a specific target for inflation and then attempts to steer inflation to that target using monetary policy tools, such as the interest rate. What this means in practice is that achieving the inflation target becomes the predominant objective, perhaps even the sole objective, of monetary policy. It also means that the central bank becomes clearly accountable to government and the public in case it does not reach the inflation target.

Should RBI be given the responsibility to decide the appropriate rate of inflation? The Urjit Patel Committee made it clear that RBI should set the target rate, indicated the target rate as indicated above, and RBI has since been pursuing its interim targets– 8% by January 2015 and 6% by January 2016. Note, Rajan recently stated that RBI has not adopted inflation targeting.

Inflation is an economic and social phenomenon, and it is fair to say today that the Indian government, duly elected by the people, has a better pulse of what the inflation rate for India should be. The government controls huge swathes of the economy, both directly and indirectly. It has also in its power measures to reduce the frictions in the economy and thereby contribute significantly to controlling inflation. I therefore suggest that the target inflation rate for India should be set jointly by government and RBI. It should be reviewed every two years. RBI should be given full autonomy by government to pursue the inflation target, once set.

Second, should the RBI go in for inflation targeting?

If RBI adopts inflation targeting, as it is currently practiced, then its predominant objective becomes achieving the target rate of inflation. RBI has far less control over the underlying dynamics of inflation than in a developed country. Firstly, much of the economic transactions in the economy run in the informal sector – financed primarily outside the banking system. Even in the formal economy, RBI’s changes in its key interest rate – the repo rate – have a somewhat weak link with the cost of funds of banks, and its signalling role to markets is still evolving, given that much of corporate borrowing is through banks. Two, a large number of markets across industries lack transparency, some are dominated by black money, and some others are oligopolistic or monopolistic. Three, in many sectors wages, interest rates, and prices are not set by market forces. Four, government owned enterprises and departments still dominate many sectors of the economy.Finally, by the RBI’s own admission, food and fuel account for more than 57 per cent of the inflation rate (consumer price inflation) on which the direct influence of monetary policy is limited (page 20, Urjit Patel Committee Report). RBI does, however, have influence on the secondary effects of food and fuel inflation.

Under these circumstances, the bias of RBI to my mind will be to have a tighter monetary policy than necessary.  (I do not imply that is the case today. I am referring to monetary policy as it evolves on average over time. ) How else will RBI reach its target, for which it is publicly accountable?

I do believe in an independent central bank, which unrelentingly deals with a strong hand on inflation. The primary objective of monetary policy should be growth –actually employment - with price stability, especially so in a developing country like India. This should be backed by a formal target on inflation for the RBI. (Note the Federal Reserve of the U.S. and the European Central Bank, both very successful central banks in dealing with inflation, have an implicit inflation target.)

But this inflation target needs to be government’s target also. The Indian government has been obsessed with the growth mantra. Given that the government controls huge swathes of the economy, and a large percentage of the population lives below or just above the poverty line, the government must commit itself to an inflation target - an inflation mantra. Inflation is as much an evil as growth is a blessing. And in the long run, there is no trade-off between inflation and growth. RBI’s study shows that when inflation rises above 6%, it is harmful to the growth of the economy (page 18 Urjit Patel Committee).

What should be the process for deciding the course of monetary policy?

The Urjit Patel Committee suggested moving the responsibility from the Governor of the RBI to a Monetary Policy Committee (MPC). This makes sense.

The Committee suggested that the MPC should consist of the Governor, a Deputy Governor, an Executive Director of RBI, and two external members picked by the RBI. My view is that to start with we need a small MPC of four members, consisting equally of internal and external members. I suggest two external members, both persons of independent standing with experience in fields such as of banking, finance, industry (agriculture or manufacturing) and sociology. Government should pick these members in consultation with the Governor.  The two internal members will be the Governor and a Deputy Governor in charge of monetary policy at the RBI. In the event of a tie, the Governor should cast one additional vote.

Inflation in China at record near term low

Can steel be as cheap as cabbage?

RBI Watch                                                                                    Monetary Policy 2014-15

On October 6,  in my review of RBI’s monetary policy I drew attention to the exceptionally benign inflationary environment in the developed world. Actually, this applies to parts of the emerging market world also.

Among BRICs, we need to be particularly worried about the situation in China. The last reading for China’s CPI came in at 1.8% - the lowest since January 2010. PPI in China has been falling.

Please read this article in the Financial Times of October14 titled “China steel now cheap as cabbage”. 

Fourth, September 30, 2014, Bi-Monthly Monetary Policy Statement by Governor Rajan: RBI’s judgement prevails over its model

RBI Watch                                                                                    Monetary Policy 2014-15

Once again there were no surprises. Repo rate stays at 8%. No further reduction in SLR. Not a significant surprise; RBI could continue on the path of lowering SLR if there are signs of pick up in the economy.

Inflation in August trended lower to 7.8% and is below RBI’s target of 8% by January 2015. The Monetary Policy Report indicated that based on certain assumptions and current conditions, RBI’s model indicates inflation at about 7% by January 2016, well above RBI’s target of 6%. However, Rajan pointed out in the call with media that in the RBI’s judgement – so this is the subjective element – inflation is expected to reach the target of 6%, and therefore the current policy stance of the RBI is appropriate. So judgement has prevailed over RBI’s model, and rightly so, I believe. But to my mind Rajan needs to elaborate on what were the factors that influenced his judgement. This will raise the credibility of the RBI.

In this situation, RBI will resist from lowering the repo rate. This gives RBI the opportunity to attempt to keep real interest rates positive on a sustained basis.

Was the RBI’s judgement influenced by the exceptionally benign inflationary environment in the developed world? 

Following Japan, now the Eurozone is faced with the spectre of deflation – the last reading of inflation came in at about 0.5%, well below its target of 2%. So much so that one of ECB’s key rates, the deposit facility is a negative, yes negative, rate of -0.20%! This appears to have prompted the ECB to have on the front page of its website a link titled “Why has the ECB introduced a negative interest rate?” In the USA, inflation continues to be below the Fed’s comfort level also of 2%, despite strong gains in employment. Global commodity prices, including oil and gold – both critical to India’s current account deficit - are weak.

On the banking and financial structure front, Rajan announced that the final guidelines for RBI’s initiative at starting Small Banks and Payments Banks will be announced by end November, and that a new regulatory structure for Non Banking Finance Companies (NBFCs) will be introduced by end October, and this will lead to licensing of fresh NBFCs. Both are welcome and significant for the financial services sector.

To get the full context of this blog, please read the earlier one on August 21.

Monitoring the NaMo Bull Market in Stocks: Update as of end September 2014

Indian Stock Market Watch

Please refer to my blog of July 9, 2014 for the original note on using TMV/GNP ratio to gauge

whether market is cheap or expensive.