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Ask yourself - Views on News from Equitymaster
 
 
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  • Nov 24, 2003

    Ask yourself

    In view of the volatility that is being witnessed on bourses over the past few days, investors seem to be a confused lot trying to fathom which stocks to invest in and which stocks to come out of. In this article we make an attempt to answer four basic questions that will go a long way in solving the average investors' dilemma.

    Does a bull market really alter the risk profile of stocks in general? Do equities become 'less risky' in a bull market as compared to a bear market?

    On account of high returns that the equity investments provide, the risk profile of stocks is always higher as compared to other avenues and it remains unchanged regardless of the bullish or bearish trends witnessed on the indices. Investors have a tendency to think that during a bull market, equities become less risky and hence they start putting in more money in stocks hoping for good returns. We believe that this is a wrong strategy and are of the view that the investors should not give in to the lure of high returns in the short-term as this is extremely risky and can erode his equity investments in no time, once the market does a U-turn.

    Since there is an upward movement in interest rates in select global markets, will fund flows continue to remain robust as the way they are currently? Can India lose its 'attractiveness' on a relative basis? It has to be remembered that India just accounts for an estimated 0.5% of world market capitalization.

    Its true that FIIs have pumped in close to US$ 5 bn in the Indian equity markets and they have been responsible for the rally to a certain extent. But attributing the surge in stock markets completely to the FII investments would be doing injustice to India's potential to emerge as an economic force to reckon with. The FIIs are making huge investments in the country because they've realised that the huge elephant (in economic terms) that India is, is finally beginning to come out of its deep slumber and is well on its way to realizing its full potential. One look at the per capita growth in consumption of commodities such as cement, power, steel, cars and the like gives us an idea of the huge unmet demand just waiting to be tapped. Together with the potential for internal growth, the country is also emerging as a cost competitive base for many global companies, which will further add to the growth. Thus, on account of the growth potential across various sectors, the Indian companies are likely to be the radar of global investors and despite the upward pressure on interest rates, Indian stocks will continue to give attractive returns to FIIs. However, this is going to happen gradually and hence investors should not worry about the short-term blips, as the long-term future of India Inc indeed looks bright.

    What if out performers in the past under perform benchmark indices in the future, as growth in earnings for the next one to two years seem to have been already reflected in current valuations?

    The bull markets have a tendency to go overboard on certain stocks and make it rise so much that it becomes an unviable investment for the next one or two years on account of the fact the current price already reflect the valuations. Therefore, our advice to the investors would be that if the company is good and has a consistent record of outperforming its peers, then one should buy it for a longer-term period despite the fact that it under performs the indices in the short term. Such companies remain largely insulated from the market vagaries and therefore during bearish trends when weaker companies show a substantial decline, the good companies have a far greater chance of giving positive returns on account of their fundamental strengths. However, one should have a long-term horizon in mind when selecting such companies.

    What if there is an upward pressure on interest rates given the ever-rising fiscal deficit of the central government? If corporate investments were to gain momentum as they are, can liquidity continue to remain high?

    History says that interest rates never stay constant for long periods of time and move in either direction depending upon the various factors that are at play. India is going through a stage where interest rates are at an all time low and people are splurging on houses, consumer durables and cars like never before. This in turn is aiding the growth of various industries, which is impacting the stock markets positively. But can the interest rates continue to remain at these levels. Unfortunately the answer is no. Once the high liquidity that is prevalent in the money markets today, shows decline on account of spending by the government and also corporate sector investments, the demand will exceed supply and this will put upward pressure on the interest rates. Therefore, a rise in interest rates will hurt the stock markets as not only will the cost of borrowing of corporates increase thus causing bottomline to decline, it will also hurt the topline on account of lower off take of goods, unless income levels rise proportionately. Thus while investing in stock markets one also needs to be wary of the interest rate scenario.

    Thus, in this article we have repeatedly stressed on two important terms viz. long term and fundamental strengths. It is important that the investor keeps these two terms in mind while investing in stocks as these terms can help him avoid the vagaries of markets and come out with minimum possible damage and maximum returns.

     

     

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