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Stockmarkets: Testing times - Views on News from Equitymaster
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  • Apr 3, 2007

    Stockmarkets: Testing times

    The Indian stockmarkets, in the past few months, have struggled to grope for direction as they have been influenced by a host of factors both global and domestic. The latest 'culprit' jarring the markets has been on the domestic front (hike in the CRR and repo rate), which led to the Sensex losing around 600 points yesterday. In this article, we examine some of the factors that have tested the mettle of the Indian markets in recent times, the liquidity issues that the RBI faces and what investors need to do in these times.

    The liquidity angle: The Reserve Bank of India (RBI) on Friday (March 30) raised the cash reserve ratio (CRR) for the banking sector by 50 basis points to 6.5% (to be made effective in two tranche on April 14 and April 28, 2007) and the 'repo' rate from 7.5% to 7.75%. While it is obvious that the aim of the central bank is to curb the excess liquidity in the banking system to check inflation, the solution may not be as easy as it seems. With the US Fed keeping the Fed rates steady at 5.25% since June 2006 and the RBI increasing its rates, the country will keep attracting foreign capital. RBI already has foreign exchange reserves worth US$ 194 bn and if it buys more dollars (which the Foreign Institutional Investors (FIIs) bring in) more rupees will get released into the system adding to the liquidity, a trend, which the RBI does not want. Thus, there is a possibility that the intervention of the RBI in the forex markets is likely to be low. Having said that, if as a consequence, the rupee appreciates, this could likely hurt exports going forward posing a dilemma to the government.

    While there is no control to curb the foreign money into the country, the government needs to focus on increasing its capital expenditure on infrastructure and other productive uses to generate returns and thus reduce the problem of 'too much money chasing few goods' going forward.

    Catching the global fever: Given the fact that India is being increasingly integrated with the global economy, of late, developments abroad have had a rippling effect on the Indian stockmarkets as well. First, it was the Thailand effect, which saw the Thai markets take a hit of 15% on a single day (with the likely imposition of a 9.9% penalty tax), then it was China (where the indices fell by as much as 9% on a single day) and then the effect of unwinding of the yen carry trade. The prospect of a likely slowdown in the US economy has also played its part in hurting the 'sentiments' of investors. While this has led to a correction in the Indian indices, we believe that this pessimism is probably overdone given the fact that the Indian economy is likely to grow at a rate of 7% to 7.5% per annum on a long-term sustainable basis. Hence, investors should view these corrections as opportunities to invest in good quality stocks from a long-term perspective.

    Sectoral picture: The rise in interest rates is expected to impact the profitability of companies going forward, especially those having large amounts of debt on their books. We believe that certain sectors continued to remain in the 'overheated' mode. For instance, despite the sharp correction in real estate stocks, we still believe that valuation levels for most real estate companies are still not reasonable from a medium term perspective. On the other hand, sectors such as pharma are relatively better insulated from economic factors (in the sense that people have to purchase medicines when they are unwell even if the economy slows down!). While we are not advocating sectors that investors need to invest in, what we wish to emphasise is that earnings of India Inc. will grow at 15% per annum on a long-term sustainable basis. Hence, the trick is to identify good quality companies across sectors with strong earnings visibility, capable management and of course reasonable valuations despite these short term 'hiccups'.

    To sum up...
    Summing it all up, we believe that these times call for investors to be selective while investing in companies and thoroughly research the same before they make an investment decision. And more importantly, not get carried away by the 'rumour mongers', who make all the noise adding to the overall confusion. The idea is to identify one's risk appetite, stay disciplined and invest in equities for the long term.



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