India Infrastructure and Random Thoughts

Good day today. I waded through data on 16 companies (See The Quant Report).

Bought some Bharti Airtel, sold some Cairn; nothing exciting really. I feel Cairn might face some challenges over crude quality; the potential buyers are overseas and with the baltic dry continuing upwards, transport cost will be an issue. They need local buyers. Also, the market is well supplied; I see no reason for buyers to go with Cairn crude unless its on pricing - which might not look great on Cairn's P/L. To offset this is the longer term prospects for Cairn which are positive; even very positive. Bharti Airtel on the other hand is trading at a small premium to fair value - does not sound great cause it is after all a premium to fair value; but it is a big deal when you look at the premium to fair value on several other stocks as well as the broad market. That is not to say I think the markets will fall very significantly; normal values are at significant premiums to fair values most of the time; in fact the opportunity to buy at fair and values rarely visits outside of recessions.

I think infrastructure is over hyped; eventually resource constraints (both capital, equipment & human) will constrain growth rates; I still expect 12% (6% real GDP + 6% inflation) will be achievable. But the market is pricing much more than that. Besides, decade forward growth rate expectations really do not translate into long term growth rates; nobody seems to look at sensible terminal growth rates and that can have a huge impact on valuations. I also think this sector will face serious cost control problems as a result of rising long term commodity prices. Now if you thought operating risk and economic risk was all there is to it; consider the financial risk. Other than BHEL and NTPC the extent of leverage employed by the infrastructure companies is awsome. Sure it might have got better since the year end but since Indian companies do not report balance sheets, I would not know, how much better. Okay, there has been a lot of capital raising this year; but (a) thats been dilutive, (b) it might have not even reduced leverage as funds to finance ongoing continuing activity were constrained too and I am not sure how strong operating cash flows have been during 2009. If you look at DLF and Unitech's history, it is amazing to see that those companies did not really create any operating cash flow leave alone free cash flow during the bull years. I looked at BHEL, Jindal Steel & Power, JP Associates, L&T, Tata Power and NTPC today; and while I would hold all (with a 6 year view) I would buy none. On Jindal Steel & Power and Tata Power, I would book profits and hold only capital. With a shorter horizon I would book profits on the lot except perhaps BHEL. The degree of financial leverage employed verges on bad governance!

Was pleased with the RBI actions. Good to see rising rates being adjusted into expectations; perhaps it is not good for the Real Estate space, but that is not a space which interests me at all. Still think that bubble needs to unwind further - read this to figure why. All in all I am happy that rates are now looking like they will rise cause that means the economy is on a firm upward trend. I will start getting worried once the 10 year GoI bond crosses above 9% together with narrowing on AAA corporate bond spreads.

Sensex closed at 16,283 which is getting close to my downside target of 16,046, though to be honest I thought 16,400 would hold. SP500 is still at 1051 which is over my downside target of 1038.

All told, I still see solid upside long term. However, value can be found in pockets; its not widely available compared with late 2008 and early 2009. Its time for cycle investors to start looking at sector valuations to make sure money moves with value. I also think Indian investors should consider value plays on the international markets. A lot of global players are beneficiaries of the BRIC growth story and today they are cheaper on valuation than Indian stocks simply because the Indian stocks have benefitted from broad market based enthusiasm.

Sensex Technicals & Fundamentals

Please visit The Quant Report and link through to the Sensex Quant Report.

Technicals

Sensex has approached a key Fibonacci resistance at 17,992. After reaching 17,457 as an intra day high, it has pulled back. At this stage, the markets are likely to retrace some of their gains. The 16,046 level has now become support. A drop in markets is highly unlikely to reach this level. In my view the market can be expected to pull back to 16,800-16,400-16,050-15750-15,300; I expect strong support at 16,050 and would be very surprised if that level breaks; realistically I would expect the market to resume upward momentum once it reaches 16,400. From this level, I would expect the Sensex to challenge and overcome the final Fibonacci level; the next challenge is the Sensex prior all time high.

Fundamentals

Macro economic environment remains positive. Quarter on quarter GDP growth together with leading indicators are flashing signals indicative of an increase in the pace of growth. Interest rate expectations are now pointed towards rate rises and this causes people to become nervous; but one must keep in mind that rising interest rates, off historic lows means that the economy is growing again and does not need the kind of support from monetary policy as previously. In January 2009, the 10 year GoI bond was at 4.62% and it is encouraging to see it normalize and rise to 7.18% by October. The yield curve is still steep and supportive of credit expansion; at this stage some flattening of the yield curve must be expected.

Inflation expectations are creeping up; six month out projections now call for WP inflation to rise to 6% which is in line with median levels of inflation over the past few years. At the same time it is encouraging to see CPI expectations remain in control.

Earnings are above expectations and revenue growth and outlook improvements all point to a strengthening market. In my view we are now at a stage where earnings upgrades are likely to occur - further multiple expansion is likely to be muted, but rising earnings should support continued strength in the markets. In my view FY 2011 earnings will start rising rapidly towards Rs 1,100.

Factors to watch are (a) abnormal strength in Rs (indicative of excessive risk taking) - say below 42 is a good time to start getting concerned; (b) inflation levels rising at both CP & WP levels to levels over 7.5%; at over 10% hit panic buttons! (c) GoI bond 10 year yield rising over 9% (d) A falling corporate bond premium of 1% over the GoI bond can also be indicative of excess risk taking. At the same time a GoI bond at over 9% with a 2% premium for corporate bonds (i.e. effective rate of 11%) might not be healthy for a capital intensive growth period.(e) Oil prices over $100 - this is the maximum level I feel the economy can absorb with the Rs at 44/45 range.

In the meantime FY 2010 target for Sensex at 19,500 is very achievable. For 2011, 20,800 is likely and 23,000 is achievable.

US Market Influence

All in all we have some risks of a global double dip recession, but I feel that is a way off; the economy during 2010 will be firmly supported by stimulus (including accommodative {albeit less accomodative compared with present} monetary policy) and additional stimulus measures overseas; 2011 should be supported by growth stimulated by falling unemployment rates - employment growth should resume in Q2/Q3 2010. Mid to late 2012 is when I expect risks to start rising again.

The open risk to India is global; as foreign capital seeks risk, the Indian Rs has strengthened. At the same time the $ weakening has caused oil and commodity prices to strengthen considerably. Input costs remain somewhat stable as a result of the stronger Rs despite higher $ commodity and oil costs, but weakness in export markets can hurt. Frankly, it would be in India's interest to have a stable $; our growth requires massive investment in infrastructure and the pace of investment can slow as a consequence of rising input costs.

US earnings season so far has been encouraging on earnings growth. Top line growth has been mixed, which is an encouraging change from last quarter when top line growth was dismal. Outlook upgrades have generally been encouraging but cautious. Leading indicators provide strong support for robust upcoming growth; rising unemployment (at a slower rate of deterioration) is to be expected until mid 2010 after which it should decine. Like India, I expect the SP500 to see earnings upgrades - I expect 2009 will end with operating earnings of $55; for 2010 my expectation is to see robust recovery with operating earnings of $72. Technically SP500 is also facing a key Fibonacci resistance level at 1,121. A pullback is likely, however economic and earnings data should limit downside; in my view a worst case downside would take the SP500 to 1,038 - from this level it should be able to meet the challenge of its 1,121 Fibonacci target on the subsequent up move. The next Fibonacci challenge for SP500 is 1,228 and I expect this resistance to come into play mid 2010.

Sensex Not Over Valued

Please visit The Quant Report and link through to the Sensex Quant Report.

Focus on multiples without an understanding of the math of multiples can be a major investing error.

Consider this; during fiscal 2003 the market bottomed with a PE (Annual Average Price divided by 14.40. During fiscal 2004, the PE rallied up to 14.90 but the market was driven higher because of the rising E.

Now compare this to fiscal 2009. The markets bottomed with PE running at 16.14. During fiscal 2010 the PE rallied to 16.68 (year to date annual average price divided by EPS estimates).

At first glance it would appear that the market is very over-valued. But is that trully the case? It is not.

Consider this; the dividend payout ratio (Dividends divided by EPS) during fiscal 2003 and 2004 were 31.3% and 33.6% respectively. By fiscal 2009 payout ratio had fallen to 24.6% and by fiscal 2010 it is expected to down to 21.33%.

Falling payout ratios are consistent with growth economies; companies will retain a larger part of earnings to drive future growth. High growth expectations means that an investor can expect to pay a higher multiple. Investment gains arise from two sources, dividends and gains. When payout ratio's are low, the earnings retained for future growth are worth more; during such periods, investors can expect to earn a higher part of their investment gains from capital growth relative to dividends.

To compare multiples during periods when there is a significant difference in payout ratio's, adjusting the PE ratio's is important. Adjusting the multiple to compare like with like is easy; to understand the maths please read my prior post "The Math of Multiples". The adjustment is simple, you simply take the PE and divide it by (1-Payout Ratio) to arrive at the adjusted multiple.

During 2003 the PE was 14.4 and the payout ratio 31.3% and during 2004 it was 14.9 with 33.6%. Adjusting the PE to reflect a 0 dividend payment gives us an adjusted multiple of 20.96 for 2003 and 22.43 for 2004.

During 2009 16.14 with a payout of 24.6% and for 2010 it is expected to be 16.68 with a payout of 21.33%. This gives an adjusted multiple of 21.46 for 2009 and 21.2 for 2010. Assuming earnings of 874 for fiscal 2010, the market would need to close 2010 at an annual average price of 19,603 - at this level the adjusted PE will be 22.43 which is the same level as 2004 which was the first year of the prior cyclical bull.

For 2010 to close at an annual average price of 19,600, the market would have to trade at levels significantly higher than 19,600 for the second half of the fiscal year; recent annual average prices are in the 14,500 to 15,000 range and to drag this up to 19,600 means that the market needs to trade the third and final quarters of 2010 at about 24,000 levels. This is very unlikely to happen. All in all, I would consider the market inexpensive relative to 2004 until it reached 19,600; after that a higher degree of caution would be called for.

On an absolute basis, the market is expensive relative to estimated forward cycle fair value (16,200); however once growth has resumed there is no reason for valuation to revert to fair value until growth is threatened again. For this reason, my target for calender 2010 are 20,500 to 24,000 range.

Link through to the file "Sensex Fiscal Years Ended 31 March" valuation report on The Quant Report for a more comprehensive report on the methodology employed in valuing the Sensex.

For those of you who are not familiar with what Sensex is - the Sensex is an Index (compiled by the Bombay Stock Exchange) of thirty Indian listed entities. The companies are well regarded in India and come from across a variety of sectors. They include:

Company Name (Industry)
ACC (Cement - Major)
Bharti Airtel (Telecommunications - Service)
BHEL (Engineering - Heavy)
DLF (Construction & Contracting - Real Estate)
Grasim (Diversified)
HDFC Bank (Banks - Private Sector)
HDFC (Finance - Housing)
Hindalco (Aluminium)
HUL (Personal Care)
ICICI Bank (Banks - Private Sector)
Infosys (Computers - Software)
ITC (Cigarettes)
Jaiprakash Associates (Construction & Contracting - Civil)
Larsen & Toubro (Diversified)
Mahindra and Mahindra (Auto - Cars & Jeeps)
Maruti Suzuki (Auto - Cars & Jeeps)
NTPC (Power - Generation/Distribution)
ONGC (Oil Drilling And Exploration)
Ranbaxy Labs (Pharmaceuticals)
Reliance Communications (Telecommunications - Service)
Reliance Industries Limited (Diversified)
Reliance Infrastructure (Power - Generation/Distribution)
State Bank of India (Banks - Public Sector)
Sterlite Industries (Metals - Non Ferrous)
Sun Pharma (Pharmaceuticals)
Tata Motors (Auto - LCVs/HCVs)
Tata Power (Power - Generation/Distribution)
Tata Steel (Steel - Large)
TCS (Computers - Software)
Wipro (Computers - Software)

Sensex Poised for Major Upmove

The Sensex is poised for a major upmove. Infosys, Reliance, Bharti and Tata Steel are four Dow Jones Global members which excite funds flow like nothing else. The infection of greed flowing from these four infects the entire market with enthusiasm. It is time for panic buying by retail and fund managers who have missed the rally.

Reliance has considerable short term upside. Once the clouds over the dispute with ADAG dissolve, forward earnings expectations can carry the stock over Rs 2,700 and towards Rs 3,000 very rapidly.

Tata Steel had a trough earnings quarter immediately prior. In my view, confidence in forward growth will be expressed this quarter together with incrementally positive quarterly results. Short term upside to Rs 790 levels can be expected once confidence in a reversion to mean 6 year earnings of Rs 75 is strong.

Bharti is deeply under appreciated at present. After it gets over its oversold position; I expect the share to recover to Rs 550 in the short term.

Infosys, is the only one which I see as fully valued and with downside potential; and that too is benefitting from IT services positive outlook for strength post economic recovery.

These majors have big upside potential which can be expected to move the Index upwards. Equally, enthusiasm on these stocks will move broader markets too. In my view, expect a broad market upmove; with large cap quality leading and mid caps participating. Target for 19,500 before year end.

How Shareholder Value Gets Returned

Div Yld Payout Payout Med Adj Payout EPS Growth

XOM 2.3% 42% 36.5% 67.5% 12.75% (19.37%)

BP 7.6% 84% 42.8% 64.1% 7.62% (27.78%)

COP 4.4% 54% 18.0% 11.0% 12.5% (16.63%)

CVX 4% 66% 33.0% 45.0% 9.8% (19.27%)

Companies return and create shareholder value through dividends, buybacks and earnings growth.In this post,

a. the dividend yield is calculated as expected dividend for 2009 divided by the annual average price during 2009.

b. Payout is calculated as expected dividend for 2009 divided by expected earnings for 2009.

c. Payout Med is the median payout ratio over the years since the year end 31 December 2009

d. Adj Payout is the payout after considering buybacks net of dilutive events such as employee grants & share issuance on M&A activity.

e. EPS growth is the annualized growth in EPS using expected earnings for 2009 as the end date and earnings for the year end 31 December 1999 as the start date. The number in brackets are the median level of annual rate of change in EPS; this is a useful indicator during years when the start point or end point are a trough or peak earnings year because the annualized growth rates can be misleading during such times.

Detailed quantitative information can be viewed at The Quant Report.

Several investors have expressed dismay in XOM's low dividend. But the historic data indicates that XOM has the best return of shareholder value policy amongst XOM, BP, COP and CVX.

Dividends are nice because they create shareholder choice. The company pays cash, the shareholder pays tax and spends the rest of it. Dividends carry appeal to investors because they provide liquidity and income and the tax cost associated with a dividend is an acceptable cost. However, a institutional investors and investors who typically elect the dividend re-investment option, might not like a dividend because the tax cost makes it inefficient compared with earnings growth or share buybacks.

Buybacks are nice because they deliver exactly the same end result as a dividend paid with reinvestment, except that because no tax is paid on the number of shares acquired is higher. Thus this option carries appeal to a significant number of investors. The problem with buybacks is that most buybacks occur during periods when shares trade at a premium to fair or intrinsic value; if a buyback program was, like a dividend, designed to return shareholder value in a consistent and recurring fashion, it would work very well. The alternative would be to have a buyback program built on a market timing model where shares are only bought back when they are undervalued - very easy to say, but very difficult to implement since most companies really do not have inhouse expertise to either time markets or determine fair or intrinsic value; investment is not their business, running the company is.

And then there is growth. When a company can be trusted to use the surplus money better than the investor, reinvestment in growth is the best option for growth generates future capital gains which delivers shareholder value. The problem is that in the long term, very few companies can deliver growth at levels which justify retention of surplus capital; too much will be paid on M&A activity, overconfidence will cause overspends on organic growth, competition will eat away benefits of growth. In the early life of a company this option makes best sense; but as it matures a mix of methods to return shareholder value is worth considering.

A company needs to select the best method of returning value to its shareholders after considering the needs of different types of shareholders. Some succeed, as I believe XOM has, some like DELL do not. DELL does not pay a dividend; their share is thus unattractive to income investors; without investor interest from a significant investor group, the share price is severely punished during periods of distress. DELL's buyback program has not been the smartest, it lacks consistency and shares are not purchased when valuation is deeply distressed. And growth is something they delivered beautifully in their early years, but in since 1999, their annualized growth has been a spectacular 0.29%. Now I have long positions in Dell for many reasons including because their median level of annual rate of change in EPS is in excess of 20%; I believe the management can turn it around compared with where it is. I am investing on the basis that value will be delivered through growth ultimately; it is a risk a long term investor is willing to take, notwithstanding the lack of price stability caused by no dividend and a poorly executed buyback program. An good company need not be a financially smart company!

Personally, I like shareholder value returned via a mix of all three methods. Sometimes I will mix it up and use a higher dividend yield on one stock together with another stock which in my view might deliver better earnings growth through a turnaround.

Disclosure: Long BP, DELL.

Stocks: XOM, COP, CVX, BP, DELL

India Real Estate

Affordable housing became a big buzzword amongst the real estate industry in India. It is not going to go anywhere. With per capita GDP where it is, the buying power is low; even with wide disparity in income, it is a matter of decades before housing can become affordable. At present affordable housing will end up meaning big compromises on space and quality; that is not something the few buyers that exist will be interested in.

Residential real estate in India needs to have the nexus between brokers and builders broken; at present it is mainly a ponzy scheme driving up prices and leaving the few genuine buyers over paying by far. This can work for a short while, but it will be a disaster in the long term.

There is a better model. But it is probably a bit too clean for this dirty business. Housing is not affordable to the public at large. However, income disparity means that there is a significant pool of investable money which could be attracted to real estate. There are others who might no be able to afford a house; but might be interested in owning part of a house. People lack capital to pay down; the interest rate risk coupled with employment risk is high too. But where there are people who do not own property, there are renters.

What builders need, is long term money for investment in residential real estate; a simple REIT format should work. Look at it this way; for $60 million, I could probably buy a self contained residential development of 300 homes in Gurgaon. I could rent these units at an average of $6,000 per year; that is $1.8 million for the complex. About 25% would go towards mainting the units in immaculate condition. The rest is investor yield; a 2.25% yield is not bad considering the capital appreciation potential.

If we assume rentals rising at 6% per year and assume real estate prices will rise in line with GDP and inflation for a total of 12% per year, an unleveraged investor could look for an annualized return of near 13.5% over 20 years. An investor with leverage of 30% initial property value, borrowed at 10%, could expect near 14% in annualized returns over 20 years; however, the rental yield would go towards pay down of debt. An investor with leverage of 30% initial property value, borrowed at 10%, could expect near 17% in annualized returns over 20 years; but again rental yield would go towards paydown of debt not for investor returns. A 12% annualized capital appreciation is very reasonable; chances are it will be higher if the location is chosen with care.

The key is to have availability of capital committed on a long term basis; where is the long term money when investors of today run for the hills at the first hint of trouble! Today's world has a major problem in that the quality of capital is weak, very weak. People lack commitment; people lack confidence and people lack character; frankly it disgusts me.

Sensex Valuation

Between the year ended 31 March 2000 and 31 March 2009, the Sensex has delivered annualized earnings growth of just under 14% and a dividend growth of a similar amount. The six year median earnings growth has run at an astonishing 28.91%. Using 31 March 2010 estimates annualized growth rates have been solid at 14.77%, 13.19% and 26.35% for earnings, dividends and six year median earnings respectively.

If you had invested Rs 100,000 in the Sensex at average prices which prevailed during 2000, and re-invested dividends at average prices during the year of dividend receipt, today your portfolio would have been worth Rs 428,906; in addition you would have had a dividend income stream of Rs 4,666 per year. Rs 4,666 is more than you would earn of a fixed deposit of Rs 100,000 post tax today and your initial investment would have multiplied 4.29X; that is a rock solid performance.

Earnings expectations indicate that the year ended 31 March 2009 was a trough earnings year. During the year ended 31 March 2010 earnings are expected to rise to Rs 874 which is up from the prior years earnings of Rs 765. With long term GDP growth of 6% and inflation running at similar level, corporate earnings can be expected to grow at a long term rate of 12% per annum.

The financial crisis caused by the bursting housing and debt bubble in US led to massive risk aversion and drying up of liquidity. The risk aversion is now abating and liquidity is starting to return to markets. A crisis of the size and intensity will leave a nasty hangover; in all probability the multiples seen at bullish extreames during the past decade will not recurr.

During the year ended 31 March 2000 and 31 March 2009, average PE's ran at 17.5X earnings, while median PE's ran at 16.5X. During the the year ended 31 March 2000 and 31 March 2010, PE 6 (annual average price divided by 6 year median EPS) ran at median levels of 28.83X. So despite calls of over-valuation, there is considerable money on the table. Earnings estimates for 2010 are average in the context of the forward cycle expectation so the earnings risk on a cycle basis are at normal levels. Performance in line with the past decades is indicative of a normal valuation of 34,754 by 2014 with rises to 40,551 on bullish extreames. More conservative valuation measures are indicative of targets of between 20,252 and 27,002. In my view a 2014 target of 27,000 to 34,500 is very likely. On a 12 month basis there is a strong case for significant upside from where we are; I would look for at least 19,354 by end March 2010 and for 22,212 sometime during the following 12 months. Of course none of this will occur if risk aversion returns; what needs watching is liquidity flows and the US economic recovery. Other risks include drought impact of rural India, which is in my view unlikely to cause huge downside risks as of now; the risk of early interest rate rises looms, in my view moderate (not aggressive) rising interest rates are a long term plus as it is indicative of a return to economic health.

The bad boy to watch out for, is India losing competitveness as a global market, as a result of loss of investor post tax returns - there are good changes in the new tax code which seek to eliminate tax abuse; but coupled with bad tax policy of taxing foreign gains in India, may result in drying up of liquidity flows into India. I expect to see first signs of nervousness in Q1 2010 because it is likely that the budget will drop securities transaction tax, which will lead to long and short term capital gains coming within the tax net. In Q1 2011 (or earlier - depending on when the final version of the new tax code is enacted), the response could be more severe. It is sheer foolishness to assess capital gains tax on passive foreign investment in India - no developed market does it - not the US, not the UK or other West European countris, not Australia, not anyone with an ounce of sense. Foreign pension funds & investors who enjoy tax exempt or tax defered status in their home jurisdictions, are not going to be amused about losing money to taxation in India. Other emerging markets including China, Brazil, Russia will gain in relative attractiveness versus India and the impact on funds flow will be high; this slowdown in liquidity can have an adverse impact on valuations. Keep in mind that valuation can have a significant impact on the real economy - strong valuations allow corporates access to cheap capital. What I find really disappointing is that the statement that India has grown not because but inspite of the government remains true. Why, why must we cut our legs at the knees just as we stand up?

Nonetheless, India remains an attractive market; reduced liquidity may cause low valuations short term; this would be a buying opportunity. Long term valuations might not rise to bullish extreames seen in the past; but is that a bad thing - even using normal value levels as bull targets for the next cycle allows for significant capital appreciation. Growth might slow due to lowered access to equity capital, but the impact is unlikely to be more than 0.5% of GDP; and it might even lead to better managed growth and less volatility. In consideration of this risk, I would reduce overweight positions back to equal weight at 18k levels, using significant pullbacks to increase overweights; keep in mind that pullbacks caused by what is viewed as bad policy can be severe in the short term; but once the disinterested liquidity is gone, markets will return towards normalcy fairly rapidly.

In my view global economic risks to the downside remain; but these risks will likely be 15 months to 18 months away - so far the crisis has been managed well - we need to watch for the first crisis management error to start worrying.

Have a look at The Quant Report (Sensex) for historic data and the various valuation methodologies applied in arriving at indicative out values.

Thoughts on Inflation & Saving Rates

Inflation:

Capacity utilization is at multi year lows. This is indicative of low levels of inflation in future years. Offsetting this is the sheer size of liquidity which is indicative of rising future inflation levels.

One factor to keep in mind is that core CPI has been an area of focus for monetary authorities for several years. There is a high chance that CPI will remain elevated because of high and rising food and energy prices while core CPI remains subdued.

Ultimately, monetary authorities will need to respond to CPI and not core CPI. US discretionary spending is down; savings are rising. The part of house hold budgets dedicated to necessities (food) and energy has risen; the energy intensity of the US economy is no longer as low as it was. A low food and energy intensity economy can absort rising CPI provided core CPI remains low; but as food and energy intensity rises this is not the case.

To tackle rising CPI, a strong $ policy will be required ($ and commodities have a fairly inverse relationship). A strong $ will remain with elevated risk aversion and as the risk aversion fades, higher interest rates will likely be necessary.

All in all, I expect rising CPI with stable core CPI, coupled with interest rates rising earlier than most believe. Rising interest rates are good as long as the economy is growing at a healthy rate and can be expected to continue in that vein. What I hope for is that rising rates will elevate risk aversion; this elevation will strengthen the $, reducing the need for a Volker style rising rate cycle. And this will allow the economy to continue to grow; albeit at a slower rate compared with long term trends (i.e. below 3.5% real) - I would look for 2.5% to 3% over the next few years. At the same time, inflation can be expected to be moderately higher than long term trend (2.5%); I would look for 3.5% to 4.5% on CPI (not core CPI). So growth in nominal terms can be expected to continue at 6% to 7.5%, which is broadly in line with long term trends.

Saving Rates

Several observations have been noted about how US savings rates need to rise. In my view, US savings rates do need to rise and a rate of 7% to 10% will be healthy for the economy; to maintain savings rates once the economy resumes growth, unemployment starts falling and disposable incomes start rising will be the challenge.

There have also been comments on how savings rates in emerging nations such as India and China need to fall. This too makes sense. But expectations for falling saving rates needs to be kept low. Keep in mind that during 2009 the nominal GDP per capita in India is $1,018 per year; China is $3,185. Compare this to United States where GDP per capita is 44,721. India and China are rapid growth economies; but true prosperity at per capita level lies several decades away. As of now, staples carry a very significant proportion of household budgets - what gets left over is not spent on discretionary items, simply because what is not consumed today needs to be saved for "bare survival" in retirement. For savings rates to fall, it will first be necessary for GDP per capita to rise. I would look for per capita GDP levels of over $6,500 before a meaningful decline in savings rates can commence.

Even when looking at the so called purchasing power parity per capital GDP (which in my view are pretty useless), India and China have per capital GDP's of $2,780 and $5,970, compared with the global average of $10,415 - there is a long way to go before savings rates in poor emerging countries can rise; these economies remain poor no matter how influential their economies might appear because of the sheer size of their population.