Closing Stock Worries

According to the study, for a representative sample, closing stocks were almost double what they were as at end-June last year.

This ties in neatly with what bankers have been saying about the rapid pick-up in non-food credit this year. Their contention is that the rise has been across the board and is the consequence of the need for increased working capital. The study corroborates their stand.

Can we draw any conclusions from this trend? Well, there could be two reasons for the build up in stocks -- either a slowdown in demand or stockpiling for future demand. The chances are that it is the former which is more likely, given the slowdown in industrial growth witnessed during the past few months, and the effect of the drought in the early part of the year on agricultural demand.

In either case, the expected pick-up in demand at the end of the monsoon will be crucial. Once that happens, and so far there are no reasons to believe that it won't, profitability will most likely go up steeply in the third quarter.

That's because profits reported as a result of higher closing stocks are lower than profits reported on sales, due to the mark-up on the latter.

That's one reason why the profitability (not just profits) of companies rise when emerging from a recession as inventories are sold.

Credit is a lagging indicator for a recovery, because the stocks built up during a slowdown are sold initially and inventory restored to more normal levels.

Bank credit is therefore used only at a later stage when credit is again needed to build up inventory. By this reckoning, the recovery has been underway for quite some time now which again corresponds to all other indicators as well as squaring with the upturn in interest rates.

Post-monsoon, we should see higher demand, better bottomlines and faster growth, but as of now, that's still a bit of a shot in the dark.

US 64 NAV

The Unit Trust of India chairman has made two significant announcements pertaining to its flagship schemes US-64. First, US-64 will be converted into a net asset value-driven product within the end of this fiscal (June 2001) and secondly, the allocation to debt will be increased to 55 per cent from 32 per cent currently. Both these measures are well overdue and are good for the fund's future.

However, what is worrying is the way in which the trust is planning to transform US-64 into a NAV-driven product. The conversion will be done in three stages wherein the NAV will be declared monthly first, then weekly and finally daily.

Apparently, the chairman has sited technology constraint as the reason for not moving to daily NAV declaration from day one. That the trust would not be ready with the 'technology' to declare daily NAV even after two years of planning only reaffirms the sad state of affairs at the country's largest mutual fund manager.

That apart, the monthly or weekly NAV will mean a resumption of historic pricing system which the trust abandoned under all its other scheme some time back after bitter experience.

Historic pricing means that the investor knows the NAV at which he is purchasing the units. For instance, in a monthly historic pricing system, NAV is declared for a particular date, say, the last day of the month and the same NAV is used as the sale and repurchase price for the following month.

In volatile times, historic pricing can ruin a fund and negatively effect returns to long term investors.

Consider this: the NAV as on August 31, 2000, is say Rs 14 and this is pegged as the sales and repurchase price for the month of September.

Assuming that the market moves up 400 points during the month which is about 10 per cent at an index level of 4000, the investor can gain from this market movement without assuming any risk. Given that the fund has an aggressive equity component which would have appreciated significantly during the market upswing, the investor can make a neat profit by buying at the August NAV (applicable in September) and sell at September NAV (applicable in October).

Evidently, the punter already knows that the fund has gained and takes a position based on this. The peril is that historic pricing allows punters to make money at the cost of long term investors.

UTI will be better off to put aside its plans to declare the NAV till it is fully geared to declare it on a daily basis rather that switching to historic pricing mode which will only be detrimental to investors who stay with the fund.

Tech stocks

The case for tech stocks gets stronger and stronger. First it was their immunity to a interest rate rise that made them attractive, then the rupee depreciation added to their appeal. Now, the rise in oil prices poses a new threat to the economy, a threat from which the tech stocks are insulated.

What that means is that all other things remaining equal, there should be a reallocation in the portfolio to tech stocks. Sure, the Nasdaq risk continues, but that's been there for months now, and the market has already corrected for it.

EMCEE (with contribution from N Mahalakshmi)