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The Trend Is Your Friend
Whenever Asia is discussed among currency professionals, the dialog is usually narrowed to two economic giants. Mostly, there is talk of the booming economy in China, the macro concerns of its undervalued currency, and the huge trade deficit with the U.S. And, of course, there is the excessively long-term recovery of the powerful Japanese economy and its effect on the JPY. This week, I would like to discuss one of Asia's other darling economies — India.
In early 2007, the Indian rupee (INR) was trading near 45 INR per one U.S. dollar (USD). As of January 9, 2008, the INR traded near 39.24, the strongest level since February 26, 1998. That makes the INR one of the best performing currencies in Asia — rising over 13 percent, only behind the Philippine peso and the Thai baht (and much better than India's biggest competitor, China (CNY), which saw a 7.5 percent appreciation against the USD in the same time period). This all occurred despite the Reserve Bank of India playing an active role in the rupee market. Last year, the central bank spent over $75 billion in intervention in an attempt to slow the rupee's ascent. There are many reasons for the INR's strength against the USD. Overall, long-term USD weakness is certainly a factor. However, we cannot discount the obvious fundamental strengths of the Indian economy and the strongest argument: the supply of INR is mostly fixed and demand is extraordinary.
The reason for the INR demand is clear. India, Asia's third largest economy, grew an average of 8.7 percent over the past four years and is poised to grow at a similar pace in the 2007/08 fiscal year, which ends in March. The government's longer-term five-year plan to 2012 has a target of 9 percent average annual growth. Most Indian economists expect at least 8 percent growth over the next five years. Prime Minister Singh recently said, "It has been good years for the Indian economy, for our working people, and our entrepreneurs. The conditions are favorable to achieve and sustain 9 to 10 percent growth rates."
In addition, the Indian stock market continues to attract record amounts of capital from overseas investors. Last week, the Stock Exchange Sensitive Index (SENSEX) traded at an all-time high, closing near 21,000 (View Bloomberg graph). That is the sixth straight year in a row the stock market has gained. If you were lucky enough to invest in 2002, your portfolio would be up almost 700 percent. In 2007, foreigners pumped a net, record $17.2 billion in the local stock market. And there seems to be no end in sight to this stellar performance. The expected slowdown in the U.S. may make India's surging expansion and record-setting stock market a safe haven for global investors. Another test of India's capacity will start tomorrow when Reliance Power, a unit of India's Reliance Energy (India's second biggest electricity producer), plans to raise 120 billion INR (proximally $3 Billion). Potentially, this could be the nation's largest IPO.
In an attempt to contain growth and stabilize inflation, the Reserve Bank of India had to raise rates five times. They also tightened banks' reserve requirements, which has limited the funds available for loans. These tactics appear to have worked. Overall inflation has fallen to 3.5 percent, from 5.5 percent. Thus, 2008 will likely see interest rates stabilize as lending has also slowed to only 22 percent growth year-on-year, down from the 30 percent growth in early 2007. The central bank now believes the period of tight monetary policy is over, and interest rates are set to fall through 2008, as central bank officials will want to stimulate demand and increase funds available for investment and consumption.
Of course, there are always risks that could sidetrack this phenomenal growth. Inflation, if left unchecked, could lead to future economic and political problems. This past year, India's poor have been hardest hit. Let's not forget, almost 50 percent of India's population lives on only 100 INR — little more than $2 a day. With oil prices near record levels and consumer food prices rising at 5.5 percent per year, inflation represents real risk to India's current pro-growth administration. It also appears efforts to control inflation through higher interest rates have slowed demand for factory-made goods like automobiles and other durable consumer goods. The strong INR slowed demand for Indian exports.
All in all, the Indian economy and its currency should continue to shine. Growth should remain strong, although the momentum is likely to slow; but its growth should remain only second to China among major economies. The overseas investment community should remain willing to invest in to Indian's growing economy. Thus, one can expect the INR to remain in demand. The central bank will attempt to control any excessive currency appreciation through continued intervention in the currency market. But as the saying goes, "The trend is your friend." There is no reason to anticipate the INR to depreciate significantly. INR remains below 40 per 1 USD for 2008.
— Joe O'Leary, Senior Advisor, SVB Silicon Valley Bank's Global Financial Services
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Tech Goes Green
Technology firms are taking the green movement seriously, moving to clean up their act with products such as biodegradable PCs and solar-powered cellphone speakers. In addition to the electricity that electronic gadgets use, tech hardware is filling up landfills, with U.S. consumers junking 14 million to 20 million PC every year. Forrester Research Inc. found that 12 percent of the 5,000 U.S. adults it surveyed indicated they would pay more for consumer electronics that use less energy or come from a company considered green. (Wall Street Journal)
Fast Chips, Faster Software
The potential speed of chips is still climbing, but now software is having trouble keeping up. Newer chips with multiple processors require complex software that breaks up computing chores into chunks that can be processed at the same time. Microsoft is mounting a major effort to improve these parallel computing capabilities in its software, anticipating that "manycore" chips (processors with more than eight cores) will transform the world of personal computing in roughly three years. The new software could increase computing speed as much as a hundredfold, an advance would enable a class of programs that could end the keyboard-and-mouse computing era by allowing even hand-held devices to make complex real-world decisions.(New York Times)
Protecting Biotech Preeminence
BayBio, northern California's life sciences trade association, released a study detailing the drug research contributions of the region, which houses one-third of the U.S. life sciences industry. Despite extraordinary growth, the life sciences industry faces a host of policy challenges that threaten its viability nationwide. BayBio calls for policymakers to act immediately to protect the industry's ability to create life-saving therapies, including: 1) increasing the National Institutes of Health and National Science Foundation budgets by 5 percent per year; 2) enacting patent reform legislation that maintains and protects American leadership in the life sciences;3) investing in more people and technology at the U.S. Food and Drug Administration and U.S. Patent and Trademark Office (Bay Bio)
Biofuel's Future
The biofuel industry is experiencing hard times as prices for the feedstock used to make the fuels have risen and margins have declined, although companies that focus on the next generation of biofuel technology should fare well in 2008, analysts say.
BCC Research predicts the world biorefinery market will reach annual sales of $155.9 billion in 2012, from an estimated $84.7 billion in 2007. IPOs in the sector in 2008 will likely come from firms focused on research and development of proprietary technology, such as projects making the next generation of feedstock (algae or jatropha) viable. (Red Herring)
Personalized Meds Must Prove Themselves
Several Bay Area personalized medicine biotechs hope to ramp up in 2008 with products aimed at fashioning individualized treatments. Yet companies must build evidence and set up rigorous reviews for their products to show regulators, insurers, physicians, and investors that personalized tests and therapies will help patients. The sector ". . . needs to provide evidence that biomarkers make drug development more predictable," said Susan Desmond-Hellmann of Genentech. (San Francisco Business Times)
Teva's India Push
Israel's Teva Pharmaceutical Industries, the world's largest manufacturer of generics, plans to invest over $1 billion in India in the next 24 months. Around $250 to $300 million will be used to set up manufacturing facilities and the rest to acquire Indian drug companies. A few weeks ago, Teva had acquired over 100 acres of land near Gwalior, Madhya Pradesh, to set up active pharmaceutical ingredient (API) manufacturing facilities. India has become an attractive alternative for several global drug companies, which are attracted by the huge talent pool, scientific skills, and cheap labor that has enabled Indian companies make drugs at about a third of the cost in the West. (The Business Standard)
Record Year for U.S. Private Equity
U.S. private-equity firms raised a record $302 billion in 2007 across 415 funds, up 19 percent from the $254.7 billion raised by 404 funds in 2006, according to Private Equity Analyst. The $228 billion raised by 182 LBO firms accounted for 75 percent of all the capital raised by private equity firms last year. Overall, the fundraising outlook is uncertain for 2008, as the firms that have raised the majority of the capital face hard questions from LPs about how they are going to put money to work with the dearth of large deals. Still, a few industry participants predict another record-setting fundraising year for 2008, driven by interest from new limited partners like government investment funds and investment in emerging markets. (Wall Street Journal)
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January 14, 2008
Buddy, Can You Spare a Dime?
"Say, don't you remember, they called me Al; it was Al all the time.
Why don't you remember, I'm your pal? Buddy, can you spare a dime?"
— Lyrics by Yip Harburg (1931)*
There is was — staring at me in bold black and orange: "U.S.'s Triple-A Credit Rating 'Under Threat.'" We immediately ran down to the bond desk to see if they had put Treasuries on our watch list. Last week, the Financial Times reported that Moody's thinks the U.S. is headed for the poorhouse and a downgrade in 10 years, unless we get our act together. Hearing Moody's talk about credit ratings 10 years out is a little like listening to the local weatherman talking about climate change in the year 2050. We'd be happy if they could correctly rate asset-backed securities six months from now. The rating, which hasn't change since 1917, is at risk, according to Moody's analyst Steven Hess, because we have a management problem and a cash flow problem. Mr. Hess ignored the fact that we can actually manufacture the cash needed at a very low cost with some high-tech paper and ink. But as the Weimar Republic and Brazil proved long ago, that's a short-term fix with catastrophic long-term consequences. Other than that aside, we find Mr. Hess correct on both counts.
Source: Congressional Budget Office, The
Long Term Budget Outlook Dec 2005
The cash flow problem is depicted in this chart from the Congressional Budget Office. It shows that current commitments for health care and social security will rise to 18 percent of GDP only 23 years from today. That 18 percent of GDP is equal to 100 percent of the taxes we currently collect. So, if we want to keep all these benefits, we need to zero out the military, the space program, welfare, the State Department, support for education — everything else. Or, I suppose, we could raise taxes to 30 percent of GDP, which would squelch growth and put us on a track to becoming France. (We already have better wine; we just need to enhance the cheese sector, we suppose.)
Hess was much more circumspect in talking about the management problem. As a firm that has recently been trotted out for some congressional "show trials," that is understandable. We can't think of any of the current presidential candidates that have shown any familiarity with this chart. They are certainly not talking about it. I've watch some of the commercials, and I think there are not enough charts on display. (Too bad Ross Perot won't step back into the fray.) In fact, a fair portion of the debate is around how to make the health care numbers grow even faster.
Does anyone really care? One cynic told us that an Aaa rating isn't worth much anymore. Part of that has to do with the failure of the rating agencies to protect the quality of their branding system. In truth, the performance of some triple-A rated tranches of the structured investment vehicles have performed abysmally. And we all recall when Michael Milken promoted his junk-bond investment strategy with the phrase, "If you own a triple-A rated asset, there is only one way it can go."
Since there is no solution to the management problem, the key question becomes what to do about a firm that would issue an unpatriotic report questioning Uncle Sam's credit rating. Maybe we should add them to the "Axis of Evil" and send in a Navy SEAL team to disrupt their ability to issue more negative reports in the future.
Bernanke Speaks
In remarks last week, Fed Chairman Ben Bernanke said they were ready with "substantive additional action" giving the distinct impression that they will ease an additional 50 bps at the end of January. The market euphoria was brief as traders balanced the prospect of a freshly spiked party punchbowl with the depressing data the central bankers must be seeing to prompt their chairman to make such a statement. The slipping market was pushed further by the final holiday shopping numbers, which were up only 2.3 percent for the last two months of the year. This was compounded by negative reports from credit card issuer American Express and luxury retailer Tiffany & Co. Now it seems even the rich are struggling. The DJIA dropped another 1.5 percent for the week and is now down 5 percent for the year, which marks the worst start since 1930.
Talk of recession amongst Wall Street economists is becoming so commonplace that it is beginning to reverberate in the halls of Congress. Specifically, members of both parties are calling for a fiscal stimulus package. We think the probability of this dysfunctional Congress reaching a consensus on a tax relief package is not a number much different than zero.
Honest, I Was Just Kidding
In a recent note about ideas to fix the environment, I complained about having a bunch of government-mandated CFLs in my kitchen that I never used, noting: "So far the city of San Francisco hasn't figured out a way to monitor my actual activity in the kitchen, but it is not hard to imagine RFID bulbs linked via the Internet to a central monitoring station downtown." Well, apparently big brother in Sacramento was paying attention. According to the International Herald Tribune, the California Energy Commission, which sets state energy efficiency standards, has endorsed a proposal to require the installation of radio controlled thermostats in homes that would allow a central office to turn off your heat or turn down your air conditioning at a whim. We look forward to the day when we will be calling the local assemblyman to intercede with the government to turn up the heat in order to comfort a sickly child.
— Jim Anderson, Editor
*"Brother, Can You Spare a Dime"; lyrics by Yip Harburg; music by Jay Gorney (1931)
Investment Strategy Outlook is published each week to highlight issues we hope you find relevant and topical. The views expressed in this newsletter are solely those of its authors and do not reflect the views of SVB Asset Management, Silicon Valley Bank, or any of its affiliates.
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Recession Signal? Americans Cut Back Sharply on Spending
Strong evidence is emerging that consumer spending, a major bulwark against recession over the last year even as energy prices surged and the housing market sputtered, has begun to slow sharply at every level of the American economy, from the working class to the wealthy. The abrupt pullback raises the possibility that the country may be experiencing a rare decline in personal consumption, not just a slower rate of growth. Such a decline would be the first since 1991, and it would almost certainly push the entire economy into a recession in the middle of an election year. (New York Times)
Costly Oil Imports Widen Trade Gap
A record increase in imported oil prices in November sent the U.S. trade deficit to its highest level in over a year, the Commerce Dept. reported last week. The seasonally adjusted trade gap widened 9.3 percent to $63.1 billion in November, the largest deficit since September 2006. Most of the increase was simply a matter of higher prices, however. In inflation-adjusted terms, the real trade gap widened by 4.2 percent. The unexpected increase in the real trade gap will likely lead economists to lower their projections for fourth-quarter GDP. (MarketWatch)
Wall Street's $35 Billion Write-down Puts Squeeze on '08 Profits
Citigroup Inc., Bank of America Corp. and Merrill Lynch & Co. may report their worst-ever quarter, beset by $35 billion of write-downs that threaten to crimp profit through 2008. The losses have depleted the banks' capital, forcing New York-based Citigroup and Merrill to seek more than $13 billion from foreign investors, and have hobbled their ability to make new loans. Other sources of fees, including credit cards, are also in jeopardy as the U.S. economy slows, said CreditSights Inc. analyst David Hendler, who estimates Citigroup, Bank of America, and Merrill won't earn more this year than they did in 2006. (Bloomberg)
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Fed Raises the Stakes
Fed officials and Chairman Ben Bernanke are signaling a more aggressive response to the increasing risk of recession. Bernanke testifies to Congress this Thursday, two days after a government report that economists predict will show that retail sales stalled last month after a gain of 1.2 percent in November. The Fed chief and Governor Frederic Mishkin unveiled the new strategy last week, when they said in separate speeches that they favor greater "insurance" against the prospect of an economic downturn. That's a break from basing policy on central bank forecasts, which still anticipate a continued expansion. (Bloomberg)
Fed Governor: Stop Obsessing about Size of Rate Cut
Markets are too preoccupied about how much the Federal Reserve will cut interest rates, a top Fed official said last week. "It's the journey, not the stopping-off points along the way, that merit attention," said Fed Governor Frederic Mishkin in a speech in New York. "What is important for pricing most financial assets is the path of monetary policy, not the particular action taken at a single meeting," Mishkin said, adding that he hopes the Fed's more transparent communication policy can shift attention away from the medium term. (MarketWatch)
Oil and Gold Show Inflation, TIPS Don't
Just because oil trades above $100 a barrel, gold costs more than $900 an ounce, and consumer prices climb at the fastest rate in two years, many say now is not the time to buy treasuries protected from inflation. Treasury inflation protected securities (TIPS), which produced the best returns for government debt last year, will prove disappointing in 2008, as the economy struggles with myriad signs of its first recession in six years, many managers say. TIPS returned 11.6 percent last year, beating the 9.1 percent for all treasuries and marking the best year since 2002, when they gained 17 percent. (Bloomberg)
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