Will Mr Bernanke affect your investments? - Views on News from Equitymaster

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Will Mr Bernanke affect your investments?

Jun 20, 2013

The Fed Chairman, Mr Ben Bernanke has announced that he plans to taper off the huge bond buying program. In essence this means that he plans to shut down the money printing presses that he had opened with the quantitative easing (QE) programs. This is subject to the condition that US economy continues to show signs of improvement.

The global stock markets have reacted quite badly to this news. Nearly all the Asian stock markets including our very own BSE-Sensex have opened deep in the red. The obvious question in everyone's mind should be 'what will happen to my investments'?

To answer this question let us first step back in history to see how the money printing affected our investments. The QE programs resulted in a flood of cheap money and in essence helped US keep its interest rates at near zero levels. With no incentive to invest in US (due to the low interest rates), this flood of money found its way into emerging markets where interest rates and returns were much higher. As the flood gates were kept open for a pretty long time, the money continued to pour into these markets resulting in an increase in prices of nearly every asset class. India was no exception to this rule. The stock markets surged as FII money kept coming in. Commodity prices soared. Since the Finance Minister opened up the debt markets, the bond markets did well too.

So now that the flood gates are going to be closed, it is natural for foreign institutional investors (FIIs) to think about pulling out their money. Why? Well if US ends its QE program, then interest rates in US would start trending upwards. Once that happens then it is expected that the FIIs would prefer to invest within US rather than taking the additional risk of investing in a country like India.

For India, the problems will be deeper. The thing is that India has a huge current account deficit. This means that the money going out of India is much more than the money coming into India. If foreign investors start to pull out their money or if the flow into India is reduced then the current account deficit would widen. This would add more pressure on the Indian currency. If that happens then the overall attractiveness of India as an investment comes down. This in turn would further fuel outflows from the country. This would put the Rupee in a vicious circle which can and will spiral downwards unless the government intervenes.

From an investment perspective the depreciation in the rupee a general as well as a specific impact. The general impact is the linkage between stock markets and the performance of Rupee. As seen in the chart below, the stock markets have a knee jerk reaction whenever there is a sudden decline in the value of the rupee.

Source: Trent, BSE Sensex

This reaction is very short term in nature and should not really affect your long term investments.

But the bigger problem is for companies that get impacted directly by the decline in rupee value. These would be those that are net earners or net spenders of foreign exchange. For those that are net earners like export oriented companies, the fall in the rupee value bodes well. This would include companies in sectors like Information Technology, pharma, etc. However, the news is bad for those that are net spenders of foreign exchange. This would include companies in the space of oil refining, engineering and capital goods, etc.

The decline in the value of rupee is also bad news for those companies that had piled on forex debt. In the past few years there are quite a few companies which have taken on foreign currency denominated debt to take advantage of the lower interest rates in the global markets. With the decline in rupee's value the interest burden as well as the debt burden for these companies would shoot up. This includes some of the big names in the telecom sector.

Again the thing to remember is that these problems are more short to medium term in nature.

So what should the investors do?

We have always recommended investors to be cautious when it comes to investing. This need has become all the more pronounced.

In the short term the impact on the stocks would be two-fold. The first would obviously be the impact related to the movement in the rupee. To avoid this investors need to study the financials of the company. If it is a net forex spender and has not hedged its exposure to rupee, then it could spell short to medium term troubles for the company. Another area to check in the financials is the exposure to forex debt. If forex debt levels are high, then its best to give the company a pass rather than see its debt burden increasing due to the rupee. In any case we have always suggested that investors invest only in those stocks where debt to equity levels are low.

Another thing to remember during such times is to be cautious of stocks that have a higher FII holding. If FIIs turn net sellers then the prices of such stocks would correct. But this is not really a scare for companies that have strong fundamentals. Because eventually the valuations of these stocks would adjust to reflect their underlying fundamental strength.

The need of the hour is to exercise caution and prudence. Doing your own homework on the stocks has become even more crucial. Invest only in stocks that have strong fundamentals and robust managements. And use the current volatile times as an opportunity to pick up great stocks at cheaper valuations. If you cannot find a stock that qualifies on these parameters then its best to stay away from the stock markets rather than burning your fingers in it.

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