Ten Surprises for 2009

In a collaborative effort between Global Equity Strategy and Global Asset Allocation, and in keeping with their year-end tradition, UBS presented in their final publication of 2008 a list of ten possible ‘surprises’ for the coming year. Its aim is to identify plausible scenarios, representing risks—up or down—to investor consensus thinking, and in some cases, to its own views.

UBS' list of ‘surprises’ include:

1) Corporate default rates don’t rise significantly;

2) Oil prices fall below $20 per barrel;

3) The dollar falls to new lifetime lows;

4) Breakeven inflation rates remain near zero;

5) Global growth is negative for 2009;

6) The Fed purchases corporate credit;

7) Emerging markets regain parity valuations;

8) Equity ‘fallen angels’ soar;

9) Obama pushes for a ‘tax holiday’; and,

10) Gold goes to $300.

Perhaps next year the surprises will be somewhat more positive? Who knows! Now let us take a look at their last years' surprises (predictions) and compare their conjectures to actual outcomes.

1) Global growth surprises on the upside: Did it happen? No.

2) Oil prices: Is 50 the new 20? Did it happen? Yes.

3) The dollar appreciates: Did it happen? Yes.

4) World trade clouds: Did it happen? Sort of.

5) Developed deflation, developing inflation: Did it happen? No.

6) Financials outperform: Did it happen? No.

7) Emerging equity markets under-perform: Did it happen? Yes.

8) Japanese equities outperform: Did it happen? It depends.

9) Equity volatility settles at lower levels: Did it happen? No.

10) Chinese inflation falls sharply: Did it happen? Yes.

With a success ratio of 40% in their last year's predictions it attests that this exercise has merit. At least it can provide an avenue for 'out of the box' thinking which can aid risk management. Whether their predictions hold good or live upto its own benchmark is a question that only time can answer. Let's wait and watch!!

Market Failure and the Big Three

It was much debated on whether the Federal Reserve should bailout the U.S auto industry or not. Many were of the opinion (with a conservative view) that the Big Three could probably survive and be competitive if the U.S government would let them go into Chapter 11 bankruptcy instead of bailing them out with taxpayers’ money.

In a capitalist economy, government intervention is less likely and less welcome unless there is a market failure which has far reaching effects. The fall of the Big Three would have been an imminent danger to the U.S.A's national economy. President Bush's order for an emergency bailout of the U.S auto industry offering $17.4 billion have risen mixed feelings. The autoworkers union complained the deal was too harsh on its members, while Bush's fellow Republicans in Congress said it was simply bad business to bail out yet another big industry.

To my opinion the Fed's decision is perfect as it could not afford to allow the massive auto industry to collapse when the economy is already in the middle of an economic downturn. The Big Three's fall could send the U.S economy into a deeper and longer recession. But, it is also high time for the U.S auto companies to reform bad management practices and begin the long-term restructuring to safeguard the millions of jobs it provides.

Chiquita, Not Just Bananas!

The name Chiquita in the western world is synonymous to a banana. But there's a lot more to Chiquita than just bananas!

The company's website parade about its ethical business practices without shame or modesty which they hardly practise in reality:

"Chiquita is committed to conducting business ethically and in compliance with the letter and spirit of the law. This commitment is reflected in our Company’s Core Values – Integrity, Respect, Opportunity and Responsibility. These values embody who we are and what we do."

In March 2007, Chiquita was convicted of federal criminal charges for making more than 100 payments, totaling more than $1.7 million, to the United Self-Defense Committees of Colombia (Autodefensorias Unidas de Colombia or AUC), which has been designated as a Foreign Terrorist Organization by the U.S. government. Chiquita paid a $25 million fine.

In July, 2007 Colombian families represented by EarthRights International (ERI), together with the Colombian Institute of International Law (CIIL), Judith Brown Chomsky, and Schonbrun DeSimone Seplow Harris & Hoffman LLP (SDSHH), filed a federal class-action lawsuit charging Chiquita Brands International, Inc., the multi-national produce company, with funding and arming known terrorist organizations in Colombia in order to maintain its profitable control of Colombia’s banana growing regions starting in the mid-1990s.

Chiquita’s payments to these paramilitary groups, including the AUC and its predecessors, were reviewed and approved by senior executives of the corporation, and resulted in the targeted killings of hundreds or thousands of individuals, including trade unionists, banana workers, and political organizers. It is also said that the company have been engaging women and child labourer in their plantations in El-Salvador, Colombia and other Central American nations, who were made to work under inhumanic working conditions.

It flaunts its 'Code of Conduct' (CoC) and holds it up as the representative of its ethics and compliance program. Apparently, going by the CoC of the company, it looks like the company is deep-rooted in strong fundamentals. But, the dark-side of the company's economic activities is scary.

DEEPENING WOES FOR JAPAN

In the face of the global financial meltdown it is now predicted that the recessionary situation in Japan may deepen further. The previous record was three quarters in a row, as in the last contraction seven years ago in the wake of the dot.com bust.

High oil prices were the primary cause for economic slowdown in Japan until the third quarter. But, what is currently being observed that Japanese companies are curtailing production at an unprecedented pace as demand plunges not just in the United States and Europe but also in emerging nations that had until recently weathered the global financial storm. The situation is aggravated further by the sharp appreciation in yen.

Economists have been expecting a 0.4 percent contraction in fiscal 2008/09 but that now needs to be revised down. It's hard to see at this point how the economy will return to a recovery. The sharp fall in oil price and other commodity prices should positively impact Japanese consumption but there is still time when the positive effects are felt.

Commodity, Debt and Currency

This is the most comprehensive comparison that can be drawn between the current trend in the prices of major commodities (like gold, crude, copper and aluminium), yield on 10 year Government Securities and, Indian rupee - US $ exchange rate.

The exchange rate just cleared the highest mark in the last eight months and is probably on a slight downward swing. Prices of gold, copper and aluminium has slashed down considerably; the volatality being the highest in gold price. The yield on 10-year government bond is also at the lowest point in the last eight months.

If we look at the gold price fluctuations then we see that in every four months during the last eight months it has progressively increased, peaked and then went down again; this was almost cyclical. If the same trend (or cyclicity) continues then it is the right time to invest in gold as it is expected to go up and peak in another four months' time. As the world demand for gold has absorbed quite large quantities of Central banks gold stocks over the past decade, with only a fairly small downward effect on prices, we believe that gold prices are more likely to increase over the next few years than to decrease. Certainly the upside potential must now be considerably stronger than the downside potential.

The decline in copper and aluminum price is expected to be reflected in lowering of prices of finished goods using these metals as inputs (such as auto-ancilliaries). The fall in crude oil prices would definitely be a sigh of relief for the oil refining and retailing companies like IOCL, HPCL, etc. The depreciation of Indian rupee against US$ would definitely benefit the exporters on one hand, but would have adverse effect on the importers.

A basic property of a bond is that its price varies inversely with yield. The reason is simple. As the required yield increases, the present value of the cash flow decreases; hence the price decreases. Conversely, when the required yield decreases, the present value of the cash flow increases; hence the price increases. In the current scenario a declining bond yield would result in rise in its price.

The Indian Satellite And Cable Space

Indian cable & satellite (C&S) space is valued at Rs. 167 bn, growing at a brisk pace of ~22% p.a. Despite being the largest segment in the Indian Media & Entertainment industry, almost all players within the space have been suffering losses due to lack of addressability in the analogue transmission mode and high level of fragmentation as a result of low entry barriers. However, the space is all set for a phase of sustained digitization and consolidation led by consumer demand for quality and technology making it affordable. It is believed that half of India's C&S homes will be converted to digital by 2015, creating one of the world's largest digital subscriber base.

The Indian cable and satellite space (C&S space) comprises of delivery of TV signals to consumers through cable, satellite or broadband. The industry is a decade and a half old, third largest in the world in terms of cable network reach, and highly fragmented and unorganized because of low entry barriers in the analogue mode. The C&S distribution segment is the last leg in the television industry's value chain which comprises of content producers, broadcasters, Multi System Operators (MSOs), Local Cable Operators (LCOs) and satellite players. Even though the sector comprises 28% of the total entertainment and media industry and is growing at 22% per annum, most of the value creation is being cornered by the LCOs due to lack of addressability in the value chain. However, we believe that the sector is all set to witness disruptive change brought through technology, which will shift the balance of power towards MSOs and DTH players, unlocking huge value for operators in this space.