|» INVESTING IN INDIA|
From the 20,873 peak of January 8, 2008 the BSE-30 Index collapsed by -12,652 points (-61%) to the low of 8,160 by March 9th, 2009. The 5 stocks that accounted for 49.4% of the losses in the BSE-30 Index were Reliance, ICICI Bank, L&T, Reliance Communications, and HDFC (Table 2).
And we have now witnessed the market surge +140% from the March 9, 2009 low of 8,160 to the September 17th 2010 level of 19,595. The 5 stocks that accounted for 46.3% of the recent gains in the BSE-30 Index are ICICI Bank, Infosys, L&T, Reliance, and State Bank of India (Table 3).
Is this a bubble?
No, not as yet.
For a bubble to emerge, you need to see the small caps and the mid caps surge.
Just as they did towards the end of CY 2007. That has not yet happened (Table 4). While the BSE-30 Index is 6.1% below its all-time high, the BSE Mid Cap Index is 19.9% below its previous peak and the BSE Small Cap Index is 26.7% below its all-time high.
But it does not take long for small caps and mid caps to "get hot" and fire away. The BSE Small Cap Index doubled in 3 months from October 2007 to January 2008.
Is history about to repeat itself?
Stock prices are determined by two key variables:
Share price = (Earnings and trust in management) X (what investors are willing to pay)The first part of the equation ("earnings and trust in management") is, in my opinion, not that difficult if you have a long term time horizon for many companies in India. My optimism is intact - there are some pretty good managements and businesses out there which are still worth investing in.
If you watch companies and managements for a long time, over decades, there is a certain predictability of the "likely outcome".
--------------------- Do you like the "Quantum way"? ---------------------
If you've been reading the Honest Truth and like what Ajit has to say, we are sure you would be pleased to make our acquaintance.
We are, Quantum Mutual Fund, a fund house that works on a set philosophy - the same philosophy reflected in the Honest Truth - Non-commissions, Transparent Costs, Basic Products, Long Term Investing!
Give us a chance to know you better. We're just a click away!
Some management teams will remain disciplined and focused on their business - and treat their shareholders fairly.
Some management teams will always find a way to take a "little extra" from what rightly belongs to all shareholders - in the hope that no one is looking. Or even if they get caught with their hand in the till, our greed as investors will ensure that our memory is short and all will be forgiven. Investors will come rushing back into their stock as soon as the "bull" market returns. After all, how can you not afford to invest in a stock that is rising?
Some management teams rely on the ignorance of even the smartest investors. "Haven't you become rich owning our stocks", they ask, "why are you worried about the details?" And so we get lulled into a trap that could be sprung on us anytime. Sometimes it may come in the form of a fax to the stock exchange as it did in the case of a Satyam.
As I said, determining the "direction" of the earnings and which managements to trust is, in my opinion, not the difficult part of the two-part equation of determining share prices.
Watch the flows - and control your greed
The big unknown is the second part of the above equation: "what investors are willing to pay".
I am a strong believer that the Indian economy is not that strongly linked to the fortunes of the global economy. Yes, there is a linkage - don't get me wrong - but India will not plunge into poverty and darkness if everyone in Europe and USA stopped buying goods today. In such an extreme scenario, China would have a real problem with its export factories shut down and India would head to a 5% to 6% rate of growth in GDP.
India's problem and linkage to the global economy is the money flows we rely on. While the underlying value of most Indian companies is not linked to the global economy, the price of these companies on the stock exchanges is set by the foreign investors. While most of the Indian mutual fund industry is still busy fighting for the rights of many distributors to earn opaque commissions - rather than focusing on winning investors - the foreign investors are busy investing in India (see Table 5) and have purchased USD 12.9 billion worth of Indian stocks since the start of the year. Many distributors - focused on earning commissions on the next ULIP product since SEBI has clamped down on their commissions from mutual funds - are busy advising their clients to sell their mutual funds. That accounts for the sale of USD 3.4 billion by mutual funds - this means that many investors have probably been wrongly advised! There will be some flow back of the money sold by mutual funds which will now come in via the ULIP route - minus the commissions that investors (unknowingly?) paid when being advised on this switch.
But the point is that the money flows of the Foreign Institutional Investor (FII) will determine where share prices head in the near term. The Indian money is on the sidelines.
And that is the problem.
We have no idea what the foreign investor is likely to do - or when and why!
Will the FII invest more in India because they are scared of the economic situation back home in Europe, Japan, UK, and USA? The FIIs did that in September 2007 - just after the now-failed Bear Stearns allowed one of their hedge funds to go bust. FIIs pumped in USD 6 billion in 4 weeks then, this caused the market to surge - and led to the peak of January 2008 and then the slide before the crash in October 2008 as the FIIs changed their views on India and other emerging markets.
If interest rates were to increase in the USA to 5% (not likely in the very near term, but that is a guess) will FIIs decide that they would rather keep their capital in US government bonds and earn a safe and steady rate of interest? If they wanted safety and a 5% return, they could sell out of India - and cause the market here to decline sharply.
What if the pensions and long term investors in Europe, Japan, UK, and USA are not allowed to invest outside their home countries? Far-fetched? Guess what President Obama is doing now - making "Made in America" a requirement on the label for products and for companies to get tax breaks. In 1972, the UK government imposed capital controls when the UK had an economic crisis. Government could impose a higher rate of taxation on capital gains on "foreign investment" that subtly discourages foreigners from owning stocks in India and other emerging markets.
Yes, it is far easier to predict the earnings of companies than it is to predict what the share price - or Index - will be at any given point in time.
So should I buy shares now - or sell?
I don't know your individual situation or your individual finances.
But use this as a base case and then change the allocations to suit your needs and your willingness and ability to take risks.
As the Table 6 at the end of the article indicates, individuals should have exposure to different asset classes. It is advisable to calculate the money you need to spend every month for your family and the keep aside 12 months to 24 months of these monthly expenditures in a safe place like a PSU Bank. Then the rest of the money should be invested in stock markets, in gold, and in liquid funds or fixed deposits.
If you have invested in shares and the surge in price has seen your allocation to stock markets heads to, say, above 90% (against your target of 60%), it would make sense to sell some of your shares and re-deploy the money in gold or liquid funds. This "re-balancing" will allow you to ensure that you are selling your winners and putting money into the laggard asset classes.
If you don't have any equity shares at all, I would suggest buying into the stock markets over the next 12 to 24 months using a Systematic Investment Plan.
And the same goes for gold - if you have missed the run up in gold over the past 10 years, don't worry. Start buying some on a regular basis over the next two years. Gold, like land, is something you buy for a generation - not for one year.
No one has a clue how share prices move, but many may have a view on the direction of earnings over the next few years. And you should take advantage of that and buy shares for their future growth in earnings - not because the foreigners wish to buy or sell. Or because some of the distributors have convinced their clients to redeem mutual funds and buy ULIPs instead!
Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)