Making judicious use of SIP/STP

SIP (Systematic investment plan) & STP (systematic transfer plan) have been popular amongst investors as efficient modes of investment. When an investor chooses to invest via an SIP, he makes investments in smaller denominations at regular time intervals as opposed to making a single lump sum investment. The underlying intention is to benefit from the volatility in equity markets by lowering the average purchase cost. This method is popularly known as 'Rupee cost averaging'. While in SIP money is transferred from your bank account, in STP it is transferred from another short term liquid Mutual Fund scheme such as 'Money Market Mutual Fund'.

An SIP ensures that the investor stays on course for achieving his long term financial goals by investing in a disciplined manner. SIP makes irrelevant the concept of 'timing the market'.
However, an SIP may not be able to lower the average purchase cost if equity markets rise/fall in a secular manner. In such a scenario, the average purchase cost could actually rise. A report published in 'The Hindu Business Line' on 29th March 2009 says "SIP investors in MFs hit the most by equities drop". The data for the period February 2007 to February 2009 for tax saving MF schemes reveals that investors through SIP have suffered a negative return of between 34-40% over the period as compared to a negative return of 20-23% on an investment through a non SIP mode over the same period. Hit by the poor returns many investors are discontinuing their SIP mode at this juncture, which is a costly mistake.

How can an investor benefit through SIP/STP? Although most Financial advisers advocate the SIP/STP method to their clients for long term investment, they fail to educate the investor of the short term pitfalls of this mode of investment. However, even for SIP/STP investors unprecedented/secular rise or fall in the markets could be used for transferring funds from long term equity schemes to short term debt MF schemes and vice versa. Effective cash management is a skill that each investor must learn, without forgetting the judicious use of SIP/STP for wealth creation in the long run.

100th Post: A time to introspect

When I started writing my blog 15 months ago I had in mind the interest of the investors who, in the absence of adequate information on the investment products/environment, were prone to making unwise decisions at times. I have since written about stock markets, economic environment and issues related to Financial Planning. When I started writing the blog in December 2007 the markets were booming. Since then we have seen a lot of gloom and doom on the markets, investors' worth has been eroded rapidly and we have moved from a situation of 'Exuberant optimism' to 'Unwarranted pessimism'. Perhaps it is a time to introspect!

I would like to go back to my first post in which I had given a definition of 'INVESTOR'. If an investor wisely follows these eight tenets, life would be merrier for him in the 'Investment World':

1. INTELLIGENCE: Rely on your intellect and sagacity, acquire information from various sources, listen to views of experts, but be guided by your own conviction before taking an investment decision.
2. NOVELTY: Bulls and Bears on the market represent the two most forceful human emotions of 'Greed and Fear'. Novelty represents the investor's ability to do something different. This 'Contrarian strategy' helps overcome these emotions of greed and fear.
3. VERSATILITY: This represents the investor's adaptability to change. Market forces keep on changing constantly, sectors and stocks get re-rated, so one must be prudent to learn the 'Art of profit booking'.
4. ENDURANCE: It is the fortitude and forbearance of the investor. As an investor you need to keep your cool when things are not moving as per your plans, don't get carried away by the short term swings in the markets.
5. SMARTNESS: It is the ability of the investor to outscore the others with quickness of mind and cleverness. Smart investors look for opportunities in all kinds of markets. Let the principle of 'Margin of safety' guide your stock selection.
6. TENACITY: Patience is one of the greatest strengths of an investor. Focus on the underlying strength of the stock/ investment based on fundamentals, and forget about the daily price movement. Remember, investment is not a 20-20 cricket match.
7. OPPORTUNISM: An investor must always be prepared to seize a good investment opportunity. Market downturns should be viewed as buying opportunities, because the prices of good stocks also tend to get depressed due to 'fear psychosis'.
8. RATIONALITY: If markets were to behave rationally, there would not be any opportunity for making money. The power of reasoning is the discerning factor that differentiates an investor from a 'speculator'. Buying a good stock is like fostering a long term friendship.

As I write my 100th post, the clouds of pessimism seem to get thinner, and notwithstanding the sharp swings in the markets, we might see a strong global recovery 4-6 months down the line. Do send in your valuable feed back on my blog. Wishing you all 'Happy Investing'.

'Deflation' round the corner: Is it a time to rejoice?

Indian Economy is heading towards a serious 'Deflation' soon, and this is a matter of concern for the Economists and Policy makers. Inflation rate (measured by WPI in India) has fallen to its 30 year low of 0.44% as on 7th March 2009, as compared to 2.43% a week earlier. However, the paradox remains: Prices of food items included in WPI have risen 7.34%. The lower rate of WPI inflation is due to sharp reduction in price of industrial goods and fuel, and also the low base effect of WPI calculated this time of last year. Normally a fall in prices is welcomed by consumers, so is it a time to celebrate?

To answer this question we need to understand the concept of "Deflation'. Deflation is defined as a sustained fall in prices that occurs when the inflation rate falls below zero percent. As the prices of goods start falling, consumers have an incentive to delay purchases and consumption until prices fall further, which in turn reduces overall economic activity contributing to the 'deflationary spiral', which is detrimental to the growth of the economy. This is a more worrisome situation than tackling inflation. The ill effects of deflation can be summarised as:

• Companies are forced to sell products at distress prices reducing their profitability, leading to production cuts and cost cutting.
• The above step leads to large scale lay offs or pay cuts, leading to defaults in debt/ loan repayments.
• Equity markets tend to move down as the performance of companies gets effected. Investment in high debt ridden companies can be highly detrimental in deflationary conditions.
• If deflation is allowed to persist it can create a severe 'Liquidity trap'. This is what most central banks have been trying to avoid by pumping more liquidity into the system.

What are the implications of Deflationary trends on Indian economy? The silver lining is that although the demand has softened, domestic consumption is fairly robust. The fall in global commodity prices is good for the Indian economy in the long run. The Govt. can help tackle the deflation by providing demand stimulus by further lowering interest rates. It is high time that we lowered administered interest rates (It may not be a bad idea to lower small savings rates and Bank savings deposit rates marginally).

Reduced Volatility points to an 'Intermediate Uptrend'

The volatility on the Indian bourses has been consistently low during 2009 so far, as compared to the volatility prevailing at the same time in 2008. Volatility can be measured in two ways:

• Historical volatility capturing the price changes over past trading sessions (intraday), measured by standard deviation for January 2009 was at 1.5% as compared to 3.2% in January 2008.
• Implied volatility measures the expected volatility using option prices, measured by the VIX index of NSE has come down to 35 (it closed at 35.57 on 13th March 2009), after touching a peak of around 90 in November 2008.

The Chicago Board of Options Exchange 'CBOE VIX' is currently around 40, after recording a peak level of 89 in October 2008. High volatility results in wide swings in the markets as investors lose the ability to think and act in a rational manner. Higher volatility also leads to increased selling by FII's. Low volatility currently means low fear levels amongst investors, which is pointing towards an uptrend in the markets in the near short term.

The short term uptrend (or bear market rally) which may last till the current expiry of F&O contracts i.e. 26th March 2009, holds a lot of promise as the indices can move up by another 10-15% in this period. This trend may be utilised to book profits/losses towards the upper end (9500-9800 on the Sensex). However long term investors who have entered at lower levels can continue to hold their stocks. Investors are advised to watch the VIX levels, as VIX movement above 45 will give a signal for a further downside.

Banking on the elusive 'Economic Recovery'

Asian Development Bank (ADB) has painted a not so rosy picture of the emerging economies in its recent study titled "Major contagion and a shocking loss of wealth?" Here are some excerpts from the report:

• The complex and the wide ranging interaction between the financial world and the real economy has already begun to have serious consequences on the emerging economies, and prospects of a fast recovery are remote.
• Economic growth may decline by half in developing economies, emerging Asia may grow at a lower 5% in 2009 (Growth projections for China & India are 6.7% & 5.1% respectively).
• Genesis of the crisis were the growing imbalances - The US embarked upon a consumption binge with low rates of saving and a high fiscal deficit, financed by surpluses of oil producing countries, China & Japan and to a lesser extent by Europe, leading to a weakness in US Dollar.
• The loss of capital valuation of financial assets worldwide may have reached over US$ 50 trillion, equivalent of one year of World GDP (includes erosion in market cap of stocks, loss in value of bonds, depreciation in currencies).
• Net private flows to emerging economies declined from $930 bn. in 2007 to $470 bn. in 2008, and are projected to decline to around $165 bn. in 2009.
• Emerging markets are no longer decoupled - trade in goods and services & remittances and capital flows to emerging markets have risen manifolds in the past five years, the slowdown in global economy has reversed the trend. It may take 2-3 years for a meaningful recovery to occur.

Close on the heels of the ADB report, IMF chief has also issued a grim warning: “The IMF expects global growth to slow below zero this year, the worst performance in most of our lifetimes,” IMF managing director Dominique Strauss-Kahn told African political and financial leaders in the Tanzania.

Given this depressing scenario, stock markets can only go south in the near future (say the next 3-6 months). It may not be a bad idea to sit on cash or even book some profit/ loss in the intermittent rallies.

Turbulent times ahead for Equity Markets

Equity markets do not like uncertainty, but unfortunately India has entered an uncertain economic/political phase with the announcement of General elections. Global situation is already in a downturn to offer any succour. The US and many European indices have already broken their support levels and are headed much lower. And this does not offer much hope to Indian equity markets for at least the next 3 months. This is the reason why positive developments like falling inflation and reduction in interest rates is not lending support to the markets.

The market will be focusing on the news emanating from the political front, and any negative use, the chances of which are fairly high, could cause panic sell off in the markets. The ballooning fiscal deficit is putting immense pressure on the Rupee leading to a massive sell off by the FII's. Domestic institutions and Mutual funds are happy sitting on a pile of cash. That is precisely what retail investors ought to do, and wait for the panic to set in. There is every likelihood that the markets will make new panic lows between March to May 2009, and that will be the time for long term investors to enter the markets.

The uncertain environment is likely to end with the installation of the new Govt. at Delhi. Falling inflation and reduced interest rates will definitely show in the profitability of corporates from Q2 of the next fiscal. Thus, any downturn in the markets will give an attractive opportunity for investment, as the risk reward ratio will turn extremely attractive at lower levels.