Sunday, September 16, 2012

Reforms and QE3 - What you need to know

I haven't seen so much of economic decisions being taken in 2 days as I saw last Friday (14 Sept, 2012). In fact it took me a day or two to just digest all the facts. QE3 from the US Feds and the biggest surprise of all, the UPA government in India after years of policy paralysis, finally pushed through some reforms! The government increased the price of diesel (diesel is a subsidized fuel in India), allowed liberal FDI in multi-brand retail, aviation and broadcasting and allowed divestment in four public sector companies. Just as a columnist mentioned in today's paper - Friday's announcements have all the key words that usually have foreign investors reaching for their wallets - fiscal reform, FDI, multi-brand retail and divestment. Together with QE3, the markets are in a jubilant mood! I expect the sensex to surge in the coming weeks but it is in times like this that an investor needs to take the highest degree of care.

For the benefit of my readers, first of all what is QE3? QE3 stands for the third round of quantitative easing from the US Federal Reserve. Under the programme the Fed will purchase $40 billion (£25 billion) of mortgage debt, known as mortgage-backed securities (MBS), every month. Ben Bernanke, head of the Federal Reserve, said the purchasing plan is open-ended and will be run until the job market improves ‘substantially’. And what does this mean? This means that the US Fed has effectively opened up the cash spigot and would inject billions of dollar bills into its economy over the next few months. Needless to say, some of this money would find its way into India, thus boosting its stocks. 

Second are the reforms by the UPA government path breaking and game changing? Hardly so and here is why. FDI in multi brand retail has a million clauses and sub clauses attached to it. For eg. the retail stores can only be setup in big towns and cities, 30% of the goods have to sourced locally form small and medium enterprises and the biggest deal killer - the State Government has to grant permission to allow a foreign chain to open their store in that state! And about FDI in airlines - sadly barring one or two, most airlines hardly make a good case for anyone wanting to invest their money. For example, why would someone want to invest money into Kingfisher airlines? Anyhow the stocks of all airline companies have risen substantially and would keep rising in the next few days! 

What should an investor do?

Just as a rising tide lifts all boats so will a flush of liquidity try to lift stocks of all kinds. In other words, chances are that not just the fundamentally good stocks will go up. But even companies with bad business models and leveraged balance sheets will tend to find a lot of takers. This is not all. There will be a tendency for even good quality stocks to run way ahead of its fundamentals. Thus, now more than any time before, utmost caution has to be exercised while investing in stocks. The virtues of a strong track record, existence of some form of competitive advantage and good quality management, need to be present in every stock that you are considering for an investment. And not just that, one will have to ensure that the stock is available at attractive enough valuations. 

With QE3 now out in the open, gold is also likely to go higher in the medium term as it is the only safe currency round and unlike paper currencies, cannot be printed at will. Thus, the more printing is done, the higher the value of gold goes. Along with gold several commodities will also start start going up.

Conclusion: The markets are going to rise without doubt. But with a sudden flush of good news, there is always irrational exuberance. If you had lagging stocks that you wanted to get exit from, this is the time to exit. If you were unsure about the prospects of a certain sector (like retail), this maybe a time to invest if you are comfortable with the valuations. But don't get carried away by all the activity in the market. I, for instance, am going to use this time to sell some poorly performing stocks that I have & then just wait and watch to see as to what happens.


  1. Hi Rahul,

    That's a good analysis of the recent Big Bang announcements by the Fed and the Indian government. Regarding the QE3 effects on different asset classes, this is a good article which gives the relation between the previous QE operations and movement of different asset classes:

    The only thing to be cautious about is that at this time, the markets seem to have already priced in the QE3 announcement, and the upside may be limited as the fundamentals do not seem to have changed a lot for the US economy.

    For the Indian markets, there may be a few announcements like the expected RBI rate cut and the IMG report on Coalgate that may act as triggers for the market. Perhaps the next two weeks may decide the next course for the Indian markets.


    1. Thanks for your comments ankur. It is true that the markets may have already factored in some effects of QE3. But QE3 is bigger and coupled with the announcements by the government on key reforms, would ensure that FIIs could turn bullish on the Indian markets!

  2. Interesting article. How do you think the price of crude react to QE3?

    1. Hi John, typically when there is a lot of liquidity suddenly made availability, the money end up chasing commodities with crude oil being one of them. QE3 would see an increase in the price of crude but I do not expect crude prices to stay at a high level for too long.