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How to make good use of the market fall!

Dec 16, 2014

In this issue:
» WPI at zero! Will the RBI cut rates?
» IIP is not a worry for India alone
» Jim Rogers thinks currency wars have already begun!
» ....and more!


00:00
 
The Indian markets have retreated from their life highs recently. As we write this, the BSE Sensex is down 350 points today. This correction has brought with it the usual market noise. Is the rally over? Will the Sensex fall below 25,000? Is it only due to global factors or is the Modi magic wearing off? Our long time readers will be aware that we have heard these types of questions many times before. And they do not make us lose our sleep. We had warned that the rally was driven largely due to FII sentiment and not a big change in fundamentals. So this correction has not come as a surprise.

While the reason for the fall does not concern us too much; we are interested in making good use of it! True to Warren Buffett's investing style, we believe in being greedy when others are fearful. After all, the best time to buy high quality stocks is when they are marked down. But what should we buy in this market? If markets were truly pessimistic, we should expect to find many stocks trading cheap, especially mid and small caps. However, this is not the case today.

A good way of gauging market sentiment is to compare the valuations of midcap and largecap stocks. Normally, the price/earnings (P/E) ratio of midcaps should be lower than that of largecaps but a study by the Economic Times found the opposite to be true. A sample of 300 midcaps was found to have a P/E of 37.3 while the top 100 largecaps had a P/E of 19.4. This gap in valuations is the largest in the last few years.

This tells us two things about midcap stocks. First, the earnings (E) are under a lot of pressure. Over the last few years, very few midcaps have managed to come through the economic downturn in fine shape. Sluggish topline growth, high interest costs, low capacity utillisation and poor pricing power resulted in a lot of stress on profits. This situation has not changed too much.

Second, the price (P) still remains high, despite the recent correction. This is because the markets are factoring in a sharp economic recovery. Many so called 'experts' believe that the worst affected mid and small caps will provide the best returns when the economy booms. Needless to say, we do not subscribe to this view.

We believe the best way you can make use of this correction, is to buy high quality stocks across market capitalization, ensuring that that they are available at reasonable valuations. Companies with strong moats, riding the Megatrends driving the economy, will create huge wealth in this decade and beyond. As the economic recovery kicks in, it will be these firms that will benefit the most. The rest of them will be unable to deliver the earnings growth needed to justify their lofty valuations.

So do not blindly overpay for growth or be in a haste to invest in this correction. Instead, follow the timeless advice of keeping your focus on the fundamentals and a hawk-eye on the valuations. Let the Megatrends do the rest.

How do you plan to make the most of the correction in the stock markets? Which factors will you keep eyes on? Let us know your comments or share your views in the Equitymaster Club.

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02:50
 Chart of the day
 
The last 4 months have seen inflation come down whether one looks at the wholesale price index (WPI) or the consumer price index (CPI). Indeed, the latest data for November 2014 shows that while CPI stood at 4.38% that of WPI was zero! Not surprisingly, lower international crude prices certainly played a part in bringing down these numbers. But that was not all. Food prices, which has been the major culprits behind firm inflation, had cooled off as well.

As a result of these numbers, the clamour for a cut in interest rates is bound to get louder. The RBI so far has chosen to keep rates status quo. The rationale has been to ensure that the trend we have been seeing so far is not short lived and is sustainable going forward. To make matters worse, the latest industrial production data has been weak. So the pressure has just piled on the central bank to cut rates and spur growth now that inflation has also come down to acceptable levels. Whether the RBI governor takes the bait remains to be seen. But to reiterate what we have previously stated that loose monetary policies cannot be the only factor that will drive growth. For that, a long term solution in the form of reforms implementation is needed. In that regard, the Modi government still has a long way to go.

Will the pressure increase on RBI to cut rates?

03:20
 
India is not the only country having to deal with weak industrial production. China has been facing pressure on this front well. As reported in the Mint, Activity in China's factory sector contracted in December for the first time in seven months as new orders declined. The purchasing managers' index (PMI) fell to 49.5 in December. A reading below 50 indicates contraction, while one above 50 points to expansion on a monthly basis. This only further reinforces the fact that the Chinese economy is slowing down. And there is a possibility that the Chinese government will ape its Western counterparts in tackling this problem. Indeed, the Chinese central bank had cut interest rates recently. And there are expectations that further stimulus measures could be unveiled.

The other BRIC country, Russia, has taken a different route. The Russian economy is not doing well either. As reported on Bloomberg, as much as a quarter of GDP is linked to the energy industry. Thus, a combination of falling oil prices as well as sanctions imposed by the US has hurt the Russian economy considerably. Despite this, the Russian central bank has not cut rates like the West or China. It has in fact raised interest rates to 17% from 10.5%. The Russian currency rubble has been sliding and the central bank is worried of this escalating into a full blown currency crisis. Hence, the hike in rates even though this will dampen the economy further. Both the China and Russia examples highlight how the central banks are taking centre stage by tackling economic problems through monetary policies. Unless the government steps in and focuses on growth and development, these monetary policies will only be short term fixes at best.

04:05
 
While we are on the topic of the global slowdown how can we not mention the views of renowned investor Jim Rogers? We are always keen to hear his views and he recently spoke about a topic that we regard as important: currency wars. He believes, as do we, that currency wars have already begun. While it may not be deliberate, it is certainly happening.

In a bid to boost their respective economies, central banks of the EU and Japan have begun major easing programs. Their goal is to devalue their currencies to boost exports as well as stimulate domestic consumption via inflation. According to Rogers, central banks don't seem to realise that these policies will cause serious volatility in currency markets. While the short term beneficiary has been the US dollar we believe that in the long run, having a bit of Gold in your portfolio will be a good insurance in these uncertain times.

04:45
 
In the meanwhile, the Indian markets were under pressure with the BSE-Sensex trading lower by about 363 points or 1.3% at the time of writing. Stocks across the board were trading weak with those from the metal and FMCG spaces leading the losses. Mid and smallcap stocks were under pressure as well with their representative indices trading lower by about 2% and 3% respectively. As for markets in Asia, they ended the day on a weak note; while European indices were trading mixed at the time of writing.

04:55
 Today's investing mantra
"In the short run, the market is a voting machine but in the long run it is a weighing machine." - Benjamin Graham

Today's Premium Edition.

Is banking really where the money is?

With banking being in the spotlight for their stressed loan books during the slowdown, we step back to have a look at the long term profitability of the banking industry.
Read On...Get Access

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3 Responses to "How to make good use of the market fall!"

pc chacko

Dec 17, 2014

The bullish trend from Last April 2014 onwards is due to the expectation of the change in government .UPA was getting unpopular due to Multiple scams and silence of the PM and other Ministers and low profile publicity of the UPA.People were expecting Modi will come and he will make milk and honey flowing in this country .When election results came and on taking of the government by Modi the business community particularly the share brokers and and financial advisers expected that Modi is a Magician and he can bring immediate and drastic changes. Modi is a Political Magician but not an Economic Magician .The fast increase in Sen-sex and Nifty was based on the MODI HYPE and not due to Fundamentals of the Companies .Hype cannot last for long time .The Hype was created by big brokers and Financial advisers ,Forecasters ,FIIs and not by the real investors.When a balloon is inflated by air it cannot remain so, for long time One day it will burst.Now that has started and Sensex will go back to 20000 to 22000 which is the real level of the market .

Like (1)

Savio

Dec 17, 2014

These industry analyses are really good.

Banking is the latest one to go through the ROE microscope and it just shows that there are inherently good businesses and inherently bad businesses.

When you invest in a bad business (or one that doesn't have good economics), the odds are already stacked up against you.

Thanks.

Like (1)

arun jain

Dec 16, 2014

i am investes in sail how long this or i exit in lose

Like (1)
  
Equitymaster requests your view! Post a comment on "How to make good use of the market fall!". Click here!


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