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News and views (28 Aug 2007)

U.S. housing data isn’t encouraging
The US markets are down on bad housing data. With house sales reducing every month (y-o-y) for the last five months, things look ominously bad. How does it affect us? Well, no home sales means defaults in loans. Loans are given by banks, packaged as mortgage based securities, and in turn sold to hedge funds. Hedge funds have fingers in every pie, including India. They may sell their profitable positions like India to make up for the housing losses.

This situation isn’t improving anytime soon, even if the Fed cuts rates. There is simply too much silly lending that has happened to let it not affect us.

Dollar moves
The dollar’s up to 41. Time to buy exporters? Not quite. In the face of the falling dollar, hedges were shored up to one quarters revenues in July, and as you might realise, the quarter still has a month to go. We’ll have to see if the rupee slide is for real or temporary, but the going up indicates that FIIs are moving out (or at least, aren’t coming in with gusto). But would you buy Infy and IGate? Not unless you read:

IGate and Infy hurt by subprime

So Infy and IGate fell prey to the subprime situation by losing a customer – Greenpoint. Not a very big deal for Infy, but could be for IGate. The P/Es of these companies are still 25 or so – fully valued for the near term if the dollar stays at this level.

The dollar upmove has another implication:

Forex gains of ECB holders to reverse
Tata Steel, Bharti Airtel, Reliance Communications etc. showed large forex gains (500 cr. types) in their Q1 results. With a fall in the rupee, the gains will reverse to a certain extent – and perhaps make their results less attractive in comparison. Airtel, without its forex gains, would have made just a 33% gain in profit over last year – high, but not as much as the 100% it did show. Again, for a company with a P/E of 40, even 33% growth isn’t all that much.

There are other factors that may affect the market very soon: At the end of this month, hedge fund data will show us what kind of redemption pressure is around in the US. While all of this may sound bad, here’s a few positive notes:

On a bullish front, US S&P 500 Puts are being bought by the dozen – a move that is bound to cause the market to rise because when a lot of people bet on the market falling, it usually rises.

In India, judging from just the sentiment on the TV channels, there seems to be an extremely high rate of caution. When people are cautious, the market rarely falls very much – as has been proved in the last month. Perhaps it’s time to figure out what to buy; some candidates are in the small and mid cap spaces which have been battered much more than the top guys.

  • Venkat Muthukrishnan says:

    >Hi Deepak,
    Can you pls look into the below line and explain?

    “Well, no home sales means defaults in loans.”

    I dont understand this. How no home sales would mean defaults in loans?

  • hari says:

    >Agreed.The MD of infy says that these clients that belong to the subprime category is less than 0.5%.Also I feel that market falls when only there is extreme optimism.When people are cautious they do not fall.But I would like to say one thing regarding this.There has been a lot of support for the markets bcoz the MF and ULIP money has flown in like crazy. Money that was garnered through a lot of NFO were deployed in the market.Also many funds that were in cash have deployed that in market in the recent weeks.Else the cut in the markets would have been deeper and uglier. Atleast its comforting to see that our Markets are less dependent on the FII.

    Regards
    hari

  • Guruprasad says:

    >Dear Venkat:

    No home sales mean more default.

    Less home sales clearly mean that ” home buying party” is not good, which could probably have happened due to too more defaults. This could have resisted lenders to cut their exposure for lending loans to home buyers which in turns reduce sales of homes. I think you’d understand now.

  • Deepak Shenoy says:

    >Venkat: Adding to what Guruprasad said, there’s also an effect phenomenon. When less homes are sold, prices drop. When prices drop to considerably below the value that the owners originally paid, the owners realise it’s cheaper to default and rent or even buy the neighbouring house than to pay back the loan.

    In the latter case (where they decide to buy a neighbouring house) the effect of the deal can take a while because a default would typically not allow them easy access to credit.

    Add to this the fact that a large number of loans given were “interest-only” meaning no loss in equity of the homeowner in case of a default.

    Lower home sales can result FROM a higher default rate, or result IN it. Either ways it would mean loan impact.