Three biggest dangers to your stocks

Jan 31, 2011

In this issue:
» Egyptian crisis shakes up the oil market
» Opportunity in gold just got better
» Two big threats facing the Indian IT companies
» What worries foreigners most about India? It's not corruption!
» ...and more!!

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Indian markets have been on a correction phase lately. Stocks, even the blue-chips, have fallen considerably from the highs of October 2010. The BSE-Sensex has lost almost 11% in the first twenty trading days of 2011. The index has in fact lost around 76% of the gains that it had made in the whole of 2010. So, overall, there is a sense of despair amongst those who have remained invested over the past few months. There's also caution in the way investors are treading their way with respect to their investments.

We believe there are three core reasons that have caused this fear in the markets. The bad part is that these fears are for real and are set to impact stock prices in the near future as well.

The first of these reasons is high inflation in the country, which has been caused by rising prices of food, oil, and other industrial commodities. The second fear is that even the economic growth is showing some signs of stumbling. This was made clear by the industrial growth numbers that were released a couple of weeks earlier. And the third reason has been the stock markets' own high valuations, which have now come down a little bit.

We see the first two concerns - rising inflation and slowing economy - as big dangers for stock prices in the near term. As for the valuations, the good thing is that these are coming down thus making stocks cheaper than what they were in October.

What do you say? Which out of inflation, economy, and valuations do you consider the biggest threat to your stock portfolio? Share with us or post your view on our Facebook page.

 Chart of the day
Today's chart shows the amount of losses that some sectoral indices have seen in 2011, which have erased the gains made in the whole of 2010. The worst performer has been the BSE-Oil & Gas sector, which has lost 9.5 times the gains it had made in 2010. Then comes the BSE-Metals index that has lost 7.7 times the 2010 gains. The BSE-Sensex has lost 0.69 or 69% of its 2010 gains in just the first month of this year. And as we see now, the weakness for Indian stocks is not likely to go off anytime soon.

Data Source: CMIE Prowess; CG-Capital Goods

Anyways, the weakness in Indian stock markets continued this week as well. The BSE-Sensex was trading down by around 240 points (1.3%) at the time of writing this. Today's losses were led by stocks from the realty and IT sectors. Other key Asian markets also closed weak. While Hong Kong was down 0.7%, Japan closed weaker by 1.2%.

Egypt is in the midst of a political coup. Its President Hosni Mubarak has attempted to hold on to power by firing his cabinet, but not himself. This has led to widespread protests within the nation. Severe opposition to this coup has also come from across the world. The Egyptian crisis is bound to have a global consequence.

The first impact has already been seen on crude oil prices that have surged in response to this crisis that has shaken the entire Middle East, the leading region for oil production in the world. While the impact is likely to be near term, as protests in Egypt are likely to have a positive long-term impact on Middle Eastern politics and governance, if the situation were to get worse, it would have a tremendous negative impact on crude oil. And subsequently on oil guzzling countries, India included.

Gold had a dizzying outing in 2010. Prices surged 30% and caused many Indians to temporarily halt their gold purchases. Little wonder then that with gold prices having corrected a bit in January of this year, Indians are back to buying this precious metal. But the buying is being done in small quantities as many still expect prices to fall further. Given the way gold prices rose in 2010, a correction in the yellow metal was long overdue.

Hence, dips in gold prices should be looked upon as an opportunity to buy more of this metal. Indeed, the demand for gold is still buoyant on account of better farm incomes and more money in the hands of urban consumers. This means that further fall in prices will certainly act as an inducement to buy more!

Here's a double whammy for Indian IT! According to the head honchos of TCS and Infosys, inflation and the European crisis are the major threats for the Indian IT sector. The debt crisis and sovereign defaults in the Euro zone are still affecting clients. This will in turn lead to sluggish growth for these IT bigwigs. The only solution against this is for the companies to spread their wings further across the globe. They are also trying to aggressively push into new virtual areas like cloud computing. This will help mitigate any geographical risks as information can be accessed via the web or mobiles from remote data centers.

Another worrisome factor is inflation. For big IT firms, which each have over 100,000 employees, increased wage rates are likely to have a huge impact on operating costs. These companies have already increased employee pay packages. But, they also need to hire thousands of staff for their new initiatives. Rising prices also cause production costs to increase, further impacting margins.

If you were to be asked as to what bothered you more - corruption or inflation, what would be your answer? For most Indians, it would be inflation. Because when it hurts, it shows. Whereas corruption exists like a quiet thief, hurting in ways not very direct and assessable. And more so, corruption has taken the form of a cultural trait rather than an intolerable crime.

But this may surprise you. It surprised India's business leaders and political leaders too who attended the World Economic Forum recently. As it turned out, the global peers displayed more concerns about inflation than corruption and the so-called government deficit. This underlines the fact that the world views corruption as an inescapable part of doing business in the country. Just like the common man in India who takes the corruption punch on the chin and gets on with life.

But they did express their wariness towards the inflation issue. Several sessions saw speakers raise concerns about rising inflation, which is seen as one of the biggest threats to India's growth story.

P-Notes or participatory notes were once known as the visa for unscrupulous FII investments into Indian stock markets. However the market regulator SEBI clamped down on them in late 2007. This tightened the issue of these instruments. So much so that both SEBI and the RBI count the considerable fall in P-Note investments among their achievements. As per SEBI, P-Notes as a percentage of FII AUM now comprise just 16% as against a peak of 51% in 2007. Important to note that the drop in P-Notes' popularity came in primarily after the SEBI issued stricter KYC guidelines for them. Therefore it is easy to conclude that the so called FII investors wished to keep their identity unknown. However, this does not mean that foreign interest in Indian stocks has waned.

Despite the absence of such opaque instruments, FII inflows into the secondary markets were to the tune of US$ 29 bn last year. Number of FIIs registered with SEBI is also up 53% since 2007. Thus P-Notes or no P-Notes, the lure of returns from Indian stocks will continue to attract overseas money to Indian shores.

 Today's investing mantra
"It's not always easy to do what's not popular, but that's where you make your money. Buy stocks that look bad to less careful investors and hang on until their real value is recognized." - John Neff

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21 Responses to "Three biggest dangers to your stocks"

Manoj Kumar

Feb 9, 2011

All three are in fact! badly intertwined. All these 3 factors i.e. inflation, economy and valuations are inter-related. If inflation is high, economy stumbles and if economy stumbles the valuation of stocks goes down. However, the trigger seems to be inflation.


Piyush U Singh

Feb 3, 2011

In a long term, inflation concerns are definitely the most detrimental for the economy . Although, all the three cited reasons are components of a synergy. As one can say: a robust economy would fetch more revenues to the system - thus help improving businesses. Consequent increase in earning will propagate positive sentiments for India Inc. (& improve valuation in terms of P/E or P/BV etc.) & draw more money from institutions (FIIs & DIs). Coherently, inflation - that results in high prices of raw materials & commodities, put pressure on profit margins of the companies. It is very apparent that the domino starts at high inflation rates -- which has already done some damage.



Feb 1, 2011

We feel valuations are a major danger followed by inflation and economy.


Bhoomi Patel

Jan 31, 2011

Slow economic growth would hit the most of all the three factors. As far as inflation is concerned it can be controlled by economic growth. and it is economic growth and development which is ultimately desired



Jan 31, 2011



DC Sekhar

Jan 31, 2011

This is just a game of FIIs to book profits on ivestments in 2009 and distribute the same in US and other countries. It is no surprise that they can tank the markets at their will, until the common investor participation raises. But it is very low at 3% of total savings in this country. We are at the mercy of FIIs. The swing is 10 times than what it deserves. The negative points are conveniently highlighted to set the course and direction of the market. Alas it continues.


JS Pandher

Jan 31, 2011

Dear Sir,
Its surely the inflation which would affect everything else.


Anupam Garg

Jan 31, 2011

Inflation is the biggest problem in my personal opinion. I don't even count the remaining 2 as threats. IIP figures are biased coz of base effect. growth is undoubtedly gonna stay, albeit not at the level which was predicted. Not all stocks r overvalued & thr can b good pickings

Inflation is bringing down the value of money every passing day. Spending power and therefore proportion of income of middle class families will get severely affected. The hike in interest rates will undoubtedly slow down industrial activity, eventually leading to decline in stocks. The fear of high cost definitely exists.


C K Vaidya

Jan 31, 2011

Of the 3 threats enumerated by you, I feel that 'valuation' is the biggest threat. While the quarterly results have been by and large good, thus giving no grounds to downgrade Indian equities, 'valuation' in developed markets such as US may be more compelling. If FIIs start pulling out money due to better returns expected in other markets, our markets may tank.


Ap Sunderram

Jan 31, 2011

In my opinion INFLATION is the real danger. THE WAY THE GOVERNMENT IS HANDLING IT BY RATE HIKES IS AN EVEN GREATER DANGER. The rising cost of food/ comodities/ oil etc is due to increased consumption as a result of the India Growth Story - More people are buying. However the Government has for long ignored or payed less attention to the supply side for all of this. It is a fact that the acreage under cultivation has decreased resulting in a mismatch between supply and demand. The rising costs and the resulting inflation increases all the input costs of the manufacturing/ business sectors since even the wages are indexed. Consequently there is going to be a slow down in growth and capex and other spending would have to be put on hold. Furthermore the rate hike and monetary squeeze, supposedly to contain the rising prices and inflation is also not helping. The government should move at great speed to increase the supply side by giving a boost to the agriculture side - steps to double the acreage under cultivation and hugely subsidized long term loans to the farm sector to modernize, sops to corporates willing to foray into the farm sector, write off of previous loans, better waste management and alternative sources of energy such as Solar/ Wind/ Bio Gas etc should be developed. All of these steps would take time to bear fruit and deliver, however if the government takes firm and committed steps the sentiments would cool and the situation would stabilize. JUST RATE HIKES IS NOT GOING TO HELP - IT WOULD ONLY WORSEN THE SITUATION. CORRUPTION IS NOT A WORRY. THESE WOULD DEFINITELY GET EXPOSED DUE TO THE HEIGHTENED AWARENESS AND THE ACTIVE MEDIA. VALUATIONS ARE BOUND TO GET HIGHER WITH GROWTH - THE QUESTION IS "IS IT WORTH IT?" WE HAVE TO MAKE IT WORTH IT. TO DO THIS THE IGNORED SECTORS SHOULD BE GIVEN THE BOOST THEY DESERVE. ONLY THEN WOULD THE GROWTH BE INCLUSIVE AND SUSTAINABLE

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