Crystal Ball Gazing

Its an interesting time for any economist or investor.  We are faced with record breaking performances by the conventionally followed market indices with only bad news on all other socio-economic and political fronts of India. This column will focus mainly on investing abroad, but I will try and build thematic investment stories based on comparable themes with industries and countries, we in India can relate to. 

The last year has been eventful, to say the least, with more political skeletons coming out of the closet, an over zealous and unforgiving electronic media and an extremely ineffective and corrupt Executive making a mockery of the most important pillar of democracy, a Judiciary prioritizing social justice over India’s international reputation (rightly so) and Anarchists getting elected to state Executive office.

The goal of this series of articles will be to put in perspective, how specific sectors fared in India vs. the United States of America or other developing nations over a period of 5-10 years.  We will look at the sectoral returns as a whole and then pick a stock or 2 from each market and analyse the returns with the aim of identifying a pair trade.

This week we analyze Financial Services and compare returns across the FS sector in India vs. the United States from a macro perspective and subsequently from a micro stock based analysis.  We will look at 2 inflexion points in our analysis.  Both points are significant in terms of Economic Policy of the respective governments and their ability to adapt to crisis situations, also both points represent a growth spurt in the fortunes of the 2 countries.

2002-03

In 2002-2003, the world had just started recovering from 9/11 and the dotcom bust.  The financial engineers of Wall Street had started creating leverage and derivatives of leverage as instruments of growth.  Indian entrepreneurs were riding the Goldman Sachs BRICs story and the Y2K technology boom.  India had discovered the value of FDI, the BJP was shouting India Shining and subsequently easing policy reforms to help the entrepreneurs raise more money.

In the US, the Financial Sector started seeing incredible activity with 2nd 3rd and even 4th derivatives being created and sold across the world without any knowledge of the underlying asset, which eventually imploded.The media blames the housing sector but the problem was endemic. Bankers made money on both sides of the world.  The bubble had to burst.  As the graph shows, the US investors probably made more money from 2005-2007 but if they had stayed invested up to 2009-10 then they lost money compared to India which when the Congress led Government ‘stimulated’ inflation kicked in and the Rupee started its dramatic downturn.

2008-2009

We will take 2008-2009 as the second inflexion point to analyze returns in the Financial Services sector in India and the United States specific to 2 stocks pairs.

HDFC vs. Wells Fargo and ICICI Bank vs. Citibank.

HDFC and WF represent stable consumer oriented well-governed and controlled Financial Services businesses

HDFC Returns (ADR) over 5 years = 2008-2014 = 234.80% (ADR Automatically adjusts for the currency)

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Wells Fargo Returns  = 2008-2014 = 284.39% (over 5 years)

ICICI and Citibank represent faster growing but less stable consumer oriented businesses both of which had serious exposure to Investment products and both their prices had fallen dramatically

ICICI Bank (ADR) over 5 years = 2009-2014 = 185.55%

Citi Bank Returns  = 2009-2014 = 407.48% (over 5 years)

ICICI and HDFC both more look far more expensive on relevant valuation parameters and qualitatively more risky due to all factors mentioned in the next section.  US Financial Services Sector investors have also made significantly more money in the last 5-6 years.

A risk adjusted pair trade would be to short HDFC Bank and to go long Wells Fargo Bank, and similarly, short ICICI Bank and go long Citibank.

Historically speaking, even with of much higher growth rates in India, the US Financial Services stocks have returned far better returns than their Indian peers after adjusting for the currency.

Whats Could Happen Between 2014-2019.

This is the definitive year of Policy in India.  If 2014 sees a strong government at the Center then the investors will believe that its a sign of good things to come.  But if we look at the current scenario, it looks unlikely.

In highly regulated sectors like FS (in both countries), most investors would bet the free markets (US) would outperform the over regulated and controlled markets like India.  What’s worse is that India has embarked on a socialistic journey at a very precarious time of its economic history.  As investors we have to look at probability, and if history is any teacher about socialist governments then it is probable that India will be seeing poor returns across the board but more so in sectors like Financial Services and Banking because of existing high and unmanageable interest rates, and leverage in Corporate India.

The writer is the Managing Director of Saxo Bank (India) and the view represented are the writers alone. These views are not representative of DSIJ and Saxo Bank (A/s).