Wednesday, September 17, 2008




Stock markets have done it yet again. They have managed to spread panic in the minds of not only traders but also longer term investors. People are worried about their investments and whether a further erosion of capital is on the cards. Frankly I don't know and I suspect neither does anyone else. But the fact remains that we are structurally in one of our strongest economic cycles ever and a projected GDP growth rate of 7 % (even by the worst estimates) is nothing to be scoffed at. It would do us good to take a step back from the mayhem in the markets and take an objective look at some of the factors in our favour and some against us.

Since crude oil prices have already cooled down significantly and are expected to come off still further, India is likely to be one of the biggest beneficiaries of this scenario. Besides having a psychological impact on the markets, it is expected to push down inflation further along its downward trend. Even if retail prices of fuel are not revised, industry would benefit from lower cost of industrial products derived from crude, such as plastics and organic chemicals. Also a decreasing rate of inflation would cause a lowering of interest rates thereby lowering cost of funds for corporate borrowers.

Similarly, commodities like Non Ferrous Metals are taking it on the chin. Prices of Aluminium, Nickel, Zinc and Copper are at their year lows. This augurs well for manufacturers of all products. It was observed from the first quarter results that though there was a robust growth in top line, the net profit margins of companies took a hit. This signifies that companies faced a rise in input costs although the growth drivers are still intact. Taking this argument further, if most commodities have already corrected and are in the process of moving lower, this pressure on margins due to cost pressures would ease and translate into higher profits in coming quarters.

Again a lot of emerging markets like Brazil and Russia are dependent on commodities for a major chunk of their GDP. If commodity prices should remain at their current lows, a lot of funds belonging to FII's would desert these markets and a logical destination would be India. In fact Indian stocks offer an excellent natural hedge against a correction in prices of commodities.

Since there is a crisis in the American housing industry, it follows that a lot of consumers are affected in the US. However Indian companies dependent on a growing Indian middle class and a huge Government expenditure on infrastructure would be relatively insulated from the effects of a US slowdown. And when the US economy does show signs of recovering, these are the businesses which will be the first to take off. A contrarian view on the effects of the US recession is worth considering. A natural offshoot of a slowing business cycle would be the tendency to cut costs. Costs can be cut by off shoring some of the activities to less expensive locations. Indian companies are well poised to take advantage of this fact due to their lower costs and aided in no small measure by a rapidly declining Rupee.

One of the negatives that are being projected is that sentiment would be affected leading to a drying up of foreign fund flows. This may or may not be true in the short term, but for investors with a longer horizon the fact still remains that India is one of the fastest growing economies in the world with a democratic structure, a strong consuming class, positive demographics in a large segment of the population under 25 years of age and having strong institutions. We need to remember that FII's were not doing us a favour by investing in our markets. They invest in places where they are likely to get the greatest returns for their investments. If India happens to be one such destination, then eventually they are bound to return with their money.

Valuations are now more reasonable with the PE ratio at around 15 times historical earnings for the Sensex. Therefore, if companies can manage a 15 % growth rate in earnings for the near future, we are trading at below fair valuations. In my opinion Indian markets deserve a premium over other emerging markets because of their size, growth rates and the potential of our economy.

Therefore in conclusion I would argue that longer term investors should not panic because analysts are predicting doomsday scenarios. These were the same guys who were predicting $ 200 levels for crude, when it was at $ 145. If an investor has selected stable, large cap companies for his portfolio, I believe that he should ignore day to day volatility and stick with his investments with the conviction that he owns great businesses in one of the fastest growing economies in the world and that sooner or later their value will be rediscovered by the markets.


Subramanian said...

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Nobody ever made any money in a panic.