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Excerpts from “The Commodity Boom & Bust Journal” Ashu is widely respected as a financial markets guru who has often called market cycles across asset classes way ahead of the market pundits. Here are excerpts from Ashu Dutt’s “The Boom & Bust Journal”: Severe compression of prices in all asset classes is a reality. Its not just stocks but commodities (including oil) and real estate that will bear the pain given that all investors are linked by investors and price compression in one asset class will bring around a price compression in other asset classes “The Boom & Bust Journal”, November 1, 2008 However, I believe markets tilt in one way or the other. When they tilt the way they are doing now, nothing revives them for some time. Not cheaper crude, not lower inflation and not a cheaper rupee. When we were in a boom, I did not see any fall in consumption patterns in crude oil even when we went to US$ 140 and above “The Boom & Bust Journal”, November 1, 2008 “Stimulation” by lowering interest rates usually works when your consumers have money in their pockets or your businesses have a reason to borrow because their businesses are booming. Neither seems to be the case currently. So that begs the question. Even if you bring interest rates to zero, how do you get businesses (who have less or no new business to borrow for) or consumers (who are cutting down on spending or just trying to pay off old loans) to spend (let alone borrow and spend)? “The Boom & Bust Journal”, November 1, 2008 Oil, I believe is ripe to move back to US$30-40 in the next 12 months. If Obama makes it to the White house, we could see Iraq come back into mainstream oil supply and with their massive development needs, we are talking a very large oversupply of oil. Combine that with Libya and Iran’s oil supply (not to speak of the upgrading of the refineries in all these 3 countries that are over 3 decades old), and we can see why there is almost nothing stopping a steep decline in oil “The Boom & Bust Journal”, November 1, 2008 While the temptation is high to buy the rupee and invest at high interest rates (over 10%), emerging markets have a hard time controlling their currencies in periods of financial crisis. I don’t know where the rupee will eventually head but the short term seems dicey and whether it ends up at 54 or 60 is a matter of how significant is the flight of capital As I have said before the nature of India’s foreign exchange reserves are such that short term flows (caused by investments in stocks etc) can impact the rupee in a larger measure than lets say china where the flows are largely FDI in nature “The Boom & Bust Journal”, November 1, 2008 October 9, 2008 So when will this ease? While equities markets may stabilize, the real economy has already taken a hit. Liquidity has been wiped out as farmers are not getting buyers for their land, real estate sales have all but stopped, IT companies have hit a wall (though they are still in denial) and banks have gone into a huddle. With brakes like this, it is unlikely that sectors that drove India’s GDP i.e. hotel, travel, financial services etc can drive growth. We should realistically expect growth to slow down to 5-6% in the next 4 quarters “The Boom & Bust Journal”, October 9, 2008 Bubbles are nobody’s babies and hurt only the rich and the greedy. A liquidity squeeze or freeze (as we are experiencing now) have many godfathers as they hurt main street. Central bankers and governments can ill afford not to intervene with increasing the cash supply to banks and lowering interest rates so that people consume more. And as the problem becomes bigger, the interventions will become extreme till the time the damage stops. And it will stop. Once it does, we will wonder why we were not buying earlier A “Liquidity” squeeze usually leads to gross underpricing or mispricing of assets and asset classes like equities, real estate etc because of a mismatch of sellers and buyers. Too less money chasing too many assets. There are usually no buyers at any price. Consequently, such markets throw up unbelievable opportunities to buy stock at prices which are way off from their real value In liquidity squeeze situations, you also find the “owners” of stock getting “decoupled” from the “sellers” of stock. From promoters to investors, many use stock as collateral to borrow. Once we end up in the situation we are in, the guys selling the stock is the collateral holder and not the owner of the shares and the collateral holder does not care if the price he is selling at is right or wrong. His sole aim is to get the money he lent back. Consequently he sells at prices which no owner in his right mind would. This is what is compounding the fall in the markets In a bubble, we see an extreme correction of overvaluation. Bubbles (as we saw in the dot com boom) are caused by pure greed and delusion and neither central banks nor governments care if they go under. That’s way they are usually long drawn and more painful “The Boom & Bust Journal”, October 9, 2008 THE BIG PICTURE In markets like this, the chances that shares will be mispriced (downwards) is great. Liquidity forces institutions and investors to sell things in their portfolio that make perfect sense except they need the money and this kind of selling throws up unbelieveable opportunities as it is doing now. However, it is important that the portfolio be limited to 10-15 stocks, otherwise, diversification takes returns closer to the index “The Boom & Bust Journal”, October 9, 2008 As equities and real estate collapse everywhere, but specially in oil rich regions of the Middle East and Russia we will see a quick and extreme rewinding of crude oil futures as investors and owners sell crude and crude futures to finance or meet their margins in other asset classes I expect a deep and severe fall in crude oil prices and a US$ 40-60/barrel is a reality in 12 months “The Boom & Bust Journal”, October 9, 2008 Get rid of the IT companies from your portfolio. Their comments sound delusional. I just noticed one of the largest IT companies lowering forecasts on earnings by a pittance. That’s ridiculous but not surprising. The next phase of any structural shift in business conditions is denial. And IT companies are in denial. The reality is that they will not just see almost zero growth in new clients or orders, their current clients might not be paying up. Infosys, Wipro, Satyam, HCL (not to speak of the smaller guys) are grossly overvalued. I won’t be surprised if they go down another 50% from where they are now “The Boom & Bust Journal”, October 9, 2008 IT cities like Bangalore, Pune and Hyderabad are going to bear the brunt of job losses. And I expect job losses across Financial Services and IT to be severe in the next 3-6 months. However, these job losses are not enough to write off India’s real estate potential or its consumption potential “The Boom & Bust Journal”, October 9, 2008 Bottomline is, stay out for the next 6-12 months. It is getting worse before getting better. You will get markets at 10000 Sensex levels to buy “The Boom & Bust Journal”, October 1, 2008 Real Estate companies are in a severe liquidity crunch. They have overbuilt (and have lots of projects in the process of building but the money purses have vanished). No one needs the new IT parks. IT towns like Bangalore and Pune can go back to their old cantonement days and chill. I still believe cities like Mumbai and New Delhi are very good bets and real estate companies that operate in these cities will come out of this even stronger “The Boom & Bust Journal”, October 1, 2008 2 good things come out of from this churn. Oil prices will drop as I had said previously to the 40-60 us dollar range. Inflation will fall back and interest rates will rationalize The question is, will it be too late? Will we again have a confluence of abundant jobs, new industries like insurance etc coming up in combination with a low inflation, low interest rate environment or will a slide in commodities, stocks and real estate send us back a few years “The Boom & Bust Journal”, October 1, 2008 Two phenomenon are playing out right now. There is a genuine slowdown hitting home, car and retail sales (among other things). That has a domino effect on the entire economy. Combine that with a sudden squeeze on cash flow (You may be wealthy but not have the cash flows). So while many people own physical assets, they don’t have extra cash or need to get out of something to get into something. Add to that jittery investors (like my friend) who suddenly don’t feel so sure of where they are headed Lower earnings, single digit growth (read stocks may be expensive even after the fall) and queasiness towards stocks (read you cannot have bull markets without cocky sure investors and other suckers up the pyramid scheme) and we know why the market may be heading no where. I do believe there is enough insurance and pension money with funds in India to invest but I also believe the number of stocks that are waiting to list is a deluge (with all these private equity investors looking to make an exit and promoters waiting for the first chance to grab more money and announce more grandiose plans) “The Boom & Bust Journal” - August 1, 2008 India’s story is based on “valuation” and “paper wealth” (unlike China’s which is largely based on generating operating income from businesses). And if this valuation bubble bursts, inefficient businesses run on monopoly mechanisms like retail and real estate will go right down the disposal shoot “The Boom & Bust Journal” - August 1, 2008 There are 3 emerging themes that the market should bear in mind: The “Agricultural Land” theme – For the past 4 years, farmers and owners of agricultural land in India have run riot in terms of the money they have made selling out their lands to dream merchants. That has brought unheard of money to the rural economy. Whats different about the money in this real estate rally is that it is enough to finance a boom in real estate and automobiles/two wheelers among other things. This trend has not just stopped but reversed in the past few months with severe repercussions. Most real estate deals are signed on part payment. All those deals are stuck. Farmers(and specially their indulgent sons) have gotten used to the good life (what with driving white scorpios and building tiled houses, not to speak of the number of liquor shops that dot the rural landscape of states like Maharashtra). I believe this has severe repercussions on car sales, two wheeler sales and materials like cement and we should see the impact in the next 2-3 months “Consumption” job generating industries are done with their ramp up. Insurance, IT, Financial Services, Hospitality were key drivers of bringing millions of Indians into the “big ticket” consumption cycle (i.e homes and cars) in the past 4-5 years. I am not even counting the millions of ancillary jobs these sectors created. All these industries are now in “replacement only” mode or marginal growth mode. The days of sudden ramp ups are over. Infact, in case of IT, it has largely gone unnoticed that job creation (I mean overall and not just at Infosys and few such flag bearers) has gone negative. India is no more the world’s BPO/Call center destination. Places like the Philippines are getting most of the new additions to such jobs The Central bank’s surprise increase in interest rates is going to hit harder than we think. You see, this is like the “last straw” on the camels’ back. Most home and auto borrowers have been salaries employees in the past 5 years. Either they are facing no increase in salaries or will start losing jobs in the next 3-6 months “The Boom & Bust Journal” - August 1, 2008 If the US, India and China are slowing down (even relatively), then oil consumption is bound to fall. That should freak out speculators enough to slam oil down. Combined with abundant supply and even more coming up if Mr Obama becomes the US President (we can expect Iraq to be on its own and a more constructive dialogue with the Iranians and both need to pump a whole lot more oil to get back to the real world), I don’t see anything that can keep oil from heading back to US$ 60 levels in the next 1-2 years “The Boom & Bust Journal” - August 1, 2008 It is time to quit automobile, auto ancillary, retail and finance company stocks. With the rural land selling bonanza over and Mr Reddy making it very difficult for middle class Indians to find sources of paying their mortgages and their car loans a squeeze is on its way. Expect banks to start reporting bad loans (not to speak of the asset liability mismatches that they are sitting with) in the next few months “The Boom & Bust Journal” - August 1, 2008 The ‘Big Mo” is gone (i.e. the Big Swing). That’s the swing trading legends wait for once in a lifetime to make their fortunes which they can then harp about for a number of years. We are not going to get that big swing once more for quite some time now. Short covering, insurance companies etc will from time to time create a trough but that’s about it I still believe the markets have not clean themselves out and we will see one final move (perhaps a slow drift now) to that 10,000-12,000 level “The Boom & Bust Journal” - April 1, 2008 Sell Big Indian IT. While the world around them collapses including their biggest clients i.e. Global Banks and Financial Services firms, they sit smug as if nothing is going to happen to them I don’t like the pricing of stocks like Infosys, Satyam, Wipro and Iflex. All of these companies are overvalued and their prices are not factoring in what can happen to their financials, once their contracts get cancelled or they don’t get paid. Even more damning is that their future order flows cannot be extrapolated anymore (i.e the client moved up from US$ 50 million to US$100 million). Now it will be more like a client moved from US$ 100 million to US$ 10 million (or just evaporated) “The Boom & Bust Journal” - August 1, 2008 There are serious questions in India about the ability of companies to scale up in sectors like real estate or retail. Or for that matter serious questions on the pace of rollout of infrastructure projects. While the optimism may be well placed, the timelines set by investors are ridiculous. I am convinced that India will frustrate even the most patient investor in terms of delivering what they expect in any time framework in these areas What does that mean? It means bad days for private equity funds, domestic investors and traders. It means great value for middle eastern investors, leaders in the industry/sector (they can now buy cheap and consolidate their position) and for investors who don’t let financial media gibberish bother them “The Boom & Bust Journal” – July 1, 2008 Bull markets create a number of companies whose only claim to fame is the availability of excess capital that feeds their inefficient growth and ill conceived plans Be aware of these creations of the Bull market. Absolutely avoid companies with no real competency or delivery record (in certain areas) and don’t construe wanton expansion as business acumen As the Asian Financial crisis of 1997 showed, easy capital created business monsters that were sent back to the Ice ages in though times “The Boom & Bust Journal” – July 1, 2008 THE GOOD - INFLATION MAY HAVE PEAKED OUT As India and other countries stop subsidizing oil prices for the Middle East, demand will recede as the “indifference curve” moves higher. We need an end to the “big swing”(in terms of speculators) along with a total disappearance of “shorts” in the crude market and then we will begin to settle to realistic levels I do believe we will head below 10% on inflation rates within the next 3-6 months. Perhaps even 6-12 months “The Boom & Bust Journal” – July 1, 2008 Just take a look at your portfolio. If you find companies (specially automobile, retail and real estate and perhaps financial services) that have gotten into sectors because they believe easy capital gives them god’s right to expand and enter new areas, then sell them Now starts the real test. When money is tight, forget visions of great growth. Think survival. No investor needs to be charitable. Such stocks will continue to get worse so its best to bite the bullet and move on “The Boom & Bust Journal” – July 1, 2008