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Riding the cycle - Views on News from Equitymaster
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  • May 15, 1999

    Riding the cycle

    So the markets are running. And how. From a level of 3,000 to 3,800 after the Sinha budget. Then a fall to 3,200 after the BJP government fell and then back again to 3,900 as foreigners go on a buying spree.

    And guess what? The foreigners are not buying the software stocks. They are buying the cements and the steels. It seemed like yesterday that the foreigners were telling us how cement and steel did not matter anymore but the internet and software stuff did. So, what happened to all the FIIs overnight? Did the US Air Force bomb their homes by mistake forcing them to re-build their makaans? Or did somebody wake up and do some number-crunching on PE ratios and replacement costs? The answer lies somewhere in between.

    Many fund managers in the US have been a bit concerned about the valuation of the technology stocks. They still like the business but they are a little more skeptical about the prices of the shares. And then they began to look around and see what else was trading in the US market and discovered that there is such a thing as non-technology stocks.

    And while these US fund managers were debating whether to take the plunge into these low-priced cyclical stocks, two things happened. Firstly, producers of some commodities like oil and aluminium, cut back production and helped increase prices. Secondly, expectations of better demand from Asia have accelerated as those economies are seen to be recovering.

    It is against this global backdrop that the FIIs are buying these orphaned Indian stocks. It is not that the FIIs know for sure that there will be a majority government post October, 1999 let alone which party will be in a position to stake their claim in Parliament. It is just that their colleagues in their global headquarters are buying any stock linked to a commodity cycle. And UTI is reportedly selling.

    For every dollar the FII is willing to bring in to the market, UTI is willing to surrender Rs 42.8 worth of shares. UTI is doing the right thing. It needs to get its own portfolio in shape by moving away from equity to a little more of debt. Also, although global cycles are important in valuing commodity stocks, so is domestic politics. Commodities, by definition, are the most easily transportable products. A new government can have policies that influence the import and export of commodities.

    Additionally, when commodity prices begin to rise for any sustained period of time, factories that have been mothballed may be brought back into production. This resultant increase in supply can cause commodity prices to collapse again. There is also a fear that central banks around the world will raise interest rates, stalling Asia's economic recovery and killing the commodity price rise. The US central bank has fought a long and hard battle against inflation. They are not going to give up those inflation-beating gains in a hurry.

    In the long run, the commodity related stocks are good to own. But there is a price and time to be in them. Just as there was in software. Maybe the time to be in commodity stocks, in light of the Indian elections, is pretty much over. Ride the cycle, if you wish, but be prepared to bail out at short notice.



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