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Let prudence prevail! - Views on News from Equitymaster
 
 
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  • Nov 10, 2003

    Let prudence prevail!

    The Indian markets have been on a 'dream-run' since the beginning of 2003 and the optimism behind this run is not showing any signs of fading off. While the BSE-Sensex has gained over 47% since the beginning of this calender year, the rise since the April lows has been more significant at around 66%!

    The graph above shows the strong correlation that exists between net foreign Institutional Investors (FIIs) inflows into the Indian markets and the rise of the same. Just as a matter of fact, FIIs have pumped in a net of Rs 221 bn into the Indian markets, which is more than five times the net amount that flowed in the whole of 2002. While this massive flow of foreign funds seems a vindication of the optimism regarding the Indian growth story, one fails to understand what has happened in the last 6-7 months that has increased this optimism to heights unprecedented till the beginning of this period. Has something really changed so dramatically, or is it just the 'feel good factor' ('irrational exuberance' sounds better, right?).

    While optimism regarding improved prospects of emerging nations (including India) has definitely attracted the FIIs to pump in money into these markets, there is one more factor that is given little importance - the relatively high levels of interest rates in the emerging markets. If one were to look at the graph below which shows the Federal funds rate over the past three decades, one can easily come to the conclusion that these rates are at a bottom at present.

    Especially, since the period starting January 2001, the Federal Reserve has adopted a strategy of softer interest rates to prop up declining output levels in the US economy. This strategy seems to have succeeded to an extent and the US economy now seems to be on an upward move. The chances of the Fed raising interest rates going forward are becoming more certain. The Australians have already raised their interest rates and the Britons have indicated raising rates, as their economies are showing signs of improvement. So, big deal? Yes, it might be a big deal, on a more concerning note, for the Indian markets.

    As said earlier, one factor that has helped markets in the emerging nations (including India) witness increasing inflows has been relatively higher interest rates here. And what would happen when developed markets (including the US) take cue from the improving prospects of their respective economies and start increasing interest rates. Then there is a possibility of much of these foreign funds to revert back to these developed markets, thus depriving emerging markets from much anticipated gains. And that could impact the Indian markets as well.

    So, the lesson for investors is to stay away from temptations that rising markets like these bring with them. Investing just because markets are 'expected' to touch new highs would not be prudent. Rather, taking a long-term perspective, investors need to gauge their risk-return profile, zero-in on quality companies with sound business models and visionary management and then make their investment decisions. That would not only be a prudent way of making investment decisions, it would also bring with it adequate returns on these investments.

     

     

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