Warren Buffett & co. Abandons ‘Buy India’ Theme

Former value investor and now Obama crony Warren Buffett cut losses from his investments in India along with other major investors.

From the Bloomberg: (bold mine)

Little more than two years after Warren Buffett labeled India a “dream market,” the economy is expanding at the slowest pace in a decade and the nation’s debt ratings are at risk of being cut to junk.

In the last three months, ArcelorMittal (MT) and Posco scrapped plans for $12 billion of investments, while global funds pulled $12.6 billion from Indian stocks and bonds. The exodus drove the rupee to a record low and caused short-term borrowing costs to soar, sending the government’s two-year bond yield to the biggest premium to the 10-year rate in Bloomberg data going back to 2001. Even Buffett packed up and left, with Berkshire Hathaway Inc. (BRK/A) exiting an insurance distribution venture.

Earlier the legendary investor Jim Rogers said that he has shorted India, while Greed and Fear author CLSA’s Chris Wood sees India as highly vulnerable to a sovereign debt crisis.

Despite the sharp rebound of India’s markets, India’s problems has been structural, has been intensifying and has been highly dependent on a risk ON environment

From the same Bloomberg article: (bold mine)

Investors see little prospect of India tackling budget and current-account deficits that drove the rupee down 20 percent in two years as Prime Minister Manmohan Singh boosts food subsidies to woo voters before a May 2014 election. Standard & Poor’s said this month there is more than a one-in-three chance the nation will lose its investment-grade rating within two years, while Pacific Investment Management Co. sees a “large” chance of a cut in as little as 12 months. Last year’s economic growth of 5 percent compares with an average 7.6 percent in the previous decade…

Weakened by corruption scandals and the loss of allies, Singh’s government has passed the fewest bills ever by an administration sitting a five-year term. That is allowing imbalances to build in Asia’s third-largest economy.

The current-account deficit widened to a record 4.8 percent of gross domestic product in the fiscal year ended March 31, while the 4.9 percent shortfall in public finances was the highest among the four largest developing nations. The World Bank estimates more than 800 million people live on less than $2 per day in India, where consumer-price inflation has held close to 10 percent for more than a year.

Data this month showed gains in wholesale prices unexpectedly accelerated to a six-month high of 6.1 percent in August. Every 10 percent decline in the rupee adds as much as 80 basis points, or 0.80 percentage point, to wholesale-price inflation, Nomura Holdings Inc. estimates show.

The emergence of bond vigilantes has only exposed on the structural defects of highly politicized economies as India. 

India’s war on gold for instance is a symptom of shrinking real markets due to expansive political controls.

Yet fickle foreign funds stampede in and out of Indian markets

Raghuram Rajan outlined a plan to give concessional swaps for banks’ foreign-currency deposits when he took charge as the 23rd governor of the Reserve Bank of India on Sept. 4. That, along with the U.S. Federal Reserve’s decision this month to continue monetary stimulus that has buoyed emerging-market assets, has helped the rupee pare some losses. Foreign funds have bought a net $2.04 billion worth of Indian shares in September and outflows from debt have slowed to $594.6 million.

The rupee has rallied 5.8 percent in September, after a 14 percent slide in the previous three months that was the worst performance among 24 emerging-market currencies tracked by Bloomberg. The S&P BSE Sensex (SENSEX) of local shares has climbed 6.8 percent this month as Rajan’s measures and the Fed’s policy boosted inflows. It fell 5.8 percent in the June-August period.

Those ‘financial tourist dollars’ flowing into India of late represents the throng of frantic yield chasing players, in the words of CLSA’s Chris Wood "crowded into quality, albeit expensive stocks that have outperformed".

And proof of this has been the wide divergence between blue chips and small companies, again from Bloomberg:

India’s smallest companies are trailing its biggest corporations by the most since 2006 in the stock market. The S&P BSE Small-Cap Index, a gauge of 431 companies with a median market value of $91 million, has tumbled 26 percent this year, compared with a 2.4 percent advance in the Sensex, where the median value of 30 firms is $16.9 billion, data compiled by Bloomberg show.

The most important development has been in India’s bond markets, which appears to be signaling a forthcoming recession or even a crisis via an inverted yield curve, again from the Bloomberg (bold mine)

A cash crunch created by the RBI to shore up the exchange rate caused short-term interest rates to exceed long-term ones, inverting the yield curve that gauges the length of investment against returns. Three-month government debt costs jumped to as high as 12 percent at the end of August, from 7.31 percent three months earlier. Two-year bond yields exceeded 10-year rates by as much as 272 basis points on July 31. Notes due in a decade pay 8.72 percent, compared with 2.63 percent in the U.S., 0.69 percent in Japan and 3.98 percent in China. 

Inverted yield curves typically reflect investors’ lack of confidence in an economy and presaged bailouts in Europe in the past three years. Greece’s two-year debt started paying more than 10-year securities a month before the government sought financial aid for the first time in 2010, while Portugal’s curve inverted a week before it sought a rescue.

Inverted yield curves are manifestations of the transition from policy induced inflationary boom to a deflationary bust.

As Austrian economist Gary North explains (bold original)

This monetary inflation has misallocated capital: business expansion that was not justified by the actual supply of loanable capital (savings), but which businessmen thought was justified because of the artificially low rate of interest (central bank money). Now the truth becomes apparent in the debt markets. Businesses will have to cut back on their expansion because of rising short-term rates: a liquidity shortage. They will begin to sustain losses. The yield curve therefore inverts in advance.

On the demand side, borrowers now become so desperate for a loan that they are willing to pay more for a 90-day loan than a 30-year, locked in-loan.

On the supply side, lenders become so fearful about the short-term state of the economy -- a recession, which lowers interest rates as the economy sinks -- that they are willing to forego the inflation premium that they normally demand from borrowers. They lock in today's long-term rates by buying bonds, which in turn lowers the rate even further.

An inverted yield curve is therefore produced by fear: business borrowers' fears of not being able to finish their on-line capital construction projects and lenders' fears of a recession, with its falling interest rates and a falling stock market.

An inverted yield curve normally signals a recession, which begins about six months later. The stock market usually begins to fall six months prior to any recession. So, the appearance of an inverted yield curve normally is followed very shortly by a falling stock market. Fact: The inverted yield curve is an anomaly, happens rarely,and is almost always followed by a recession.

So while the yield chasing manic crowd may drive India’s frothy markets to even higher levels, the emergence of the inverted yield curve implies of a escalating risk of a market shock.

India epitomizes what has been going on globally; manic yield chasing punts pushing up markets, even as unsustainable imbalances have become more evident and more prone to violent adjustments.