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Happy investing!

May 20, 2006

The fact that the Indian stock markets, and for that matter even the global markets, have had a very volatile week is not a news to anyone. From our perspective, falling stock markets offer significant buying opportunities for long-term investors. It is time to take a long-term call and invest. Instead of focusing on the gainers and the losers in the last one week, in this weekly round up, we have focused on macro issues and how they will impact the stock market performance over the next two to three years. We have consciously stayed away from sounding 'we said so'.

Net investments...
(Rs bn) Mutual Funds FIIs Total
11th May 2006 (0.7) (12.0) (12.7)
12th May 2006 3.6 0.2 3.7
15th May 2006 7.9 (7.3) 0.7
16th May 2006 3.3 (5.3) (2.0)
17th May 2006 1.9 (4.2) (2.3)
Total 16.1 (28.7) (12.6)

Random thoughts on the current trends...
On Thursday, the benchmark BSE-Sensex fell by over 826 points. Investors attribute the same to largely three factors.

  1. The recent inflation report in the US and the Federal Reserve's stand on interest rates did raise concerns among the global investing community with respect to whether there is a possibility of interest rates rising much faster. Commodities, including crude oil and gold, witnessed significant correction.

  2. Secondly, domestic investors were 'concerned' about the prospects of new tax being imposed on select Foreign Institutional Investors (FIIs) trades, which the Finance Minister later denied.

  3. Significant unwinding of open interest position in the futures and options market.

If the proposal to tax FIIs was the reason for the Thursday fall, even after the FM clarification on the issue on the same day, what triggered the fall yesterday? We do not have answers to that and neither do the market participants. But one thing is for sure. It is time investors in India recognize the fact that global factors can have a dramatic impact on the Indian stock market performance. Till now, the increase in interest rates, including US, was sidelined with a view that the 'India story' was on a strong footing. Indeed, we subscribe to the India story. But we also acknowledge the fact that the investment decision of FIIs depends on their evaluation of 'India' and its valuation in relation to other emerging markets.

Valuation conundrum...
As our subscribers are well aware, we have recommended a Sell on stocks from sectors including engineering, power and cement purely based on fundamentals. Why should a 'X' cement company (and that too, a regional one) trade at a EV/tonne (enterprise value per tonne) of US$ 200 when the best of cement companies in the global markets are trading between US$ 125 to US$ 150 per tonne.

Similarly, why should an engineering company trade at a price to earnings multiple of over 40 times trailing twelve months earnings when the best of the engineering companies globally are trading at less than 15 times trailing basis. Yes, growth is robust, but we do not wish to upgrade our valuation multiple just to make sure that we have a 'BUY' rating on a stock. But yes, we have reviewed our valuation metric and wherever it was necessary, we have upgraded/downgraded our valuation multiple to reflect the fundamental change in the sector.

We continue to believe that certain stocks from sectors are trading at rich valuations and we see downside risk outweighing the upside potential. That said, even at these levels, we do recommend our subscribers to invest in stocks from a long-term perspective, provided the valuations are justified.

Where to from here?
As we mentioned in our view on the market after the Thursday fall, this decline should be taken as an opportunity to invest and build a long-term equity portfolio. Needless to say that the equity component of the overall asset allocation should be in line with one's risk-return profile. We would also like to remind investors that with the rise in interest rates (and prospects of further increases), debt is becoming attractive.

Therefore, we suggest investors to invest in short-term fixed deposits or floating rate funds that further invest in shorter duration government securities. Overall, you, as a retail investor, should not shy away from equities given the recent decline in the stock market. Invest in good companies with a sound business models (i.e. ability to ride through cycles) from a two to three year perspective and one need not worry about the day-to-day market movements. Happy investing!


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