Stern warning by RBI: Markets must read the signals

RBI has finally decided to take on the inflation menace head on, and our markets must take cognisance of the essence of the stance taken by RBI. Despite the lip service by the Govt. in taming inflation in the past, inflation has moved from strength to strength in the past 18 months. The recent move by RBI should be seen as a very positive move to fight inflation, even at the cost of sacrificing a bit of growth in the short term. The hike of 50 basis points in Repo and Reverse repo rates announced today will be the main driver for the markets in the short run.

Bond yields have firmed up to 8.44% immediately after the announcement of rate hikes. Equity markets have also reacted sharply on the downside, shrugging the unwarranted euphoria of the past few weeks. The hardening of interest rates is bound to have a negative impact on the overall corporate earnings for FY 2011-12. The equity market valuations will be re-rated downwards in the weeks to come. The chances of an imminent crash in equity markets are fairly high given the overall global uncertainty. The major indices, which have been range bound for last 6 months, are likely to break the range on the downside in the coming 1-2 months. The correction could be in the range of 15-20% from the current levels. What should the investors do in this scenario?

• Long term investors can hold on to their stocks, if liquidity is not a concern.
• The market reaction to the monetary policy should be utilised to get rid of stocks that have come out with poor results. Stocks with high exposure to debt should be avoided.
• Investors who lack liquidity may sell at least 25% of their portfolio to generate cash, which can be utilised to buy the same stocks at lower levels, when the markets react.
• The focus should be on creating a buying list of stocks that have come out with good results, so that they can be bought on dips.
• The 'Risk-reward ratio' at the current market levels is not attractive for fresh equity investment. If one is looking at a one year growth of 20% or more in the portfolio, which an equity investor should look at, one should look for investment in the range of 4800-5000 levels on the Nifty, for a target of 6000 and above in one year.
• Interest rates on deposits for shorter tenures will see significant hikes in the near future, it may not be a bad idea to put some money in fixed deposits/ bonds for the next few months.
• Profit booking may be done at any bounce in the markets, in the range of 5600-5700 on the Nifty, which is the upper end of the current range.

The next few weeks are likely to see testing times for equity investors. Investors are expected to hold their nerves in the falling markets, and take a decision to invest in equity markets for long term when markets react on the downside. The Indian economy is likely to bounce back strongly in 6-9 months time when the inflation will be tamed and interest rate cycle peaks out. Remember, the 'Mother of all bull runs' is yet to unfold in the Indian equity markets, let us get ready for it.

Investors are Bulls at heart

Psychological studies reveal that investors are bulls at heart, and why not, the structure of our markets enables them to make more money on the upside rather than downside. Typically, bull phases last almost 2-3 times the bear phases. The last 2 bull phases would confirm this view: One of the longest bull phases on Indian bourses lasted 44 months from June 2004 (Nifty around 1500) to January 2008 (Nifty 6357). The ensuing bear phase was over in 10 months in October 2008 (when Nifty bottomed out at 2253). The next bull phase lasted around 25 months (Nifty topped at around 6300 in November 2010). Since then we have been witnessing a bear phase which is likely to get over by August-September 2011. Nifty which is currently trading at over 5700 is in the last phase of the ongoing bear market rally, which will give way to the impending bottoming out process which could take the indices down by 15-20% from the current levels.If we look at the brokerage recommendations the buy calls out number sell calls by 4:1. This also strengthens the view that long term investment in equities is always rewarding for the investors.

But It is always advisable for investors to keep on booking their profits from time to time to benefit from the wild swings in the markets. Indian stock markets are more volatile than markets in US and Europe, because of the shallow nature of our markets. Our markets are more prone to liquidity adjustments because they are by and large ruled by  Foreign Institutional Investors (FIIs) including short term hot money pumped by hedge funds. The current bout of bear rally has again been fuelled by this hot money, despite extreme dark clouds looming on the economic scenario in India and abroad.This makes the risk reward ratio in equity investment unattractive from a 9-12 month perspective. Investors who have made reasonable profits can consider partial profit booking at Nifty levels of 5700 and above, because the next fall could be severe. Despite this view the markets may show some strength till the middle of August, fuelled by better results declared by a few companies.

It would be interesting to look at the factors that could influence the sharp fall in our markets:

• Lack of Governance: the Govt. may give indications of some reforms as well a cabinet reshuffle soon. But come August, the Parliament session will ensure that the governance will be relegated to the background. The govt. is likely to face renewed embarrassment on the issue of tackling corruption. In fact, we can expect the extreme eventuality of a change in Govt. in some form before the end of the year.
• Liquidity crises: The present upswing in our markets is fuelled by excess liquidity. The liquidity situation is likely to reverse soon with the worsening of the crises in Euro zone and the gradual withdrawal of QE2. The flow of hot money from safe heavens like Mauritius could slow down keeping in view the regulatory changes in the offing.
• Real estate crash: A crash in real estate market, specifically in the housing sector, is long overdue. Once this happens there will be a huge negative sentiment on the equity markets. The chances of defaults in this sector are fairly high, considering the huge debt accumulated by a large number of Realtors. Only those construction companies would be able to survive the crises that have diversified into commercial real estate and infrastructure creation.

However, all the above factors would be extremely positive for our economy in the long run. Considering this, the next downturn in the equity markets will be a precursor to the 'Mother of all Bull runs' which would give an opportunity for massive wealth creation for investors. Investors should be guided by the age old adage 'Make hay while the sun shines', book profits at current levels and create liquidity for buying at lower levels.

Don't Press the Panic Button: It's Time to Churn the Portfolio

Whatever happened on the Indian stock market on Monday 20th June was inevitable, however, the reasons chosen by market participants to hammer down the stocks was an aberration. But that's the way markets tend to behave if we try to understand it from the 'Behavioural Finance' perspective. The sharp knee jerk reaction to the news on Indo-Mauritius Tax Treaty can be explained through behavioural biases which market participants tend to follow. The reaction of Monday was a result of two commonly observed biases;

1. Availability Bias: Investors tend to heavily weigh their decisions more towards recent information which is widely available in the public domain. Availability is affected by various factors such as source of information, ease of remembrance, reaction time. Very often market participants overreact to new information leading to a dis-proportionate movement in market indices. The news on the review of Indo-Mauritian Tax treaty is as old as 3 months, and even if the changes are agreed to between the two countries the same will be implemented with a time lag of at least 6 months. The market reacted the way it did because of the reasons explained above.

2. Herd Mentality: It is the tendency of an individual to mimic the actions of a larger group, without bothering whether they are rational or irrational. The reasons for herd mentality are: i) a large number of people cannot be wrong, ii) social pressure of conformity. Investors influenced by the herd mentality constantly buy and sell their holdings based on the current investment trends. The initial reaction by a few FII's on Monday was to take advantage of the news on Indo-Mauritian Tax Treaty and press for stock sale, soon the herd mentality gripped the market and within seconds the stock indices started tumbling.

However, there is no need to press the panic button. I continue to hold a view that the markets are going to go down in the medium term, but that will not happen in a hurry. On the contrary, what has happened to the markets on Monday is extremely positive in the very short term. The markets in panic did touch their immediate support levels of around 5200, albeit briefly, on Monday. There is a very strong possibility of a strong rebound in the coming weeks which is likely to pull the market back to around 5450-5500 levels on the Nifty or even higher. But investors are advised to book profits on every rise in the momentum stocks, the likes of GTL group stocks which crashed by 40-60% in just one trading session. The list of such stocks is endless. The front line indices may go down to 4800-4900 levels on the Nifty, before the next bull run resumes. If that is going to happen, the probability of which is quite high, the Mid cap and Small cap indices may tank up to 15- 20%. But, as I said, this is not going to happen in a hurry. The events likely to trigger such a slide could be:

• Fall/ Major shake up in the Central Government: You cannot afford to overlook this scenario anymore with the kind of mess the Govt. finds itself at this juncture. If at all this Govt. has survived this long is through the generosity of the principal opposition party, which is in the middle of an even bigger mess.
• Real Estate Crash: A bubble seems to be forming in the real estate sector. When this bubble will burst is any body's guess. Real estate growth is sustained in an easy liquidity scenario, a real estate crises is waiting to happen once liquidity dries up. This could happen anytime when highly liquid FII's, Hedge funds take a flight out of India.

Markets on the edge: Protect your portfolio

Equity markets after maintaining a tight range for about 3 months are finally giving signals of a breakdown from the range on the downside.  The recent weekly close indicates weakness in the markets as the market is in no mood to discount good news: Crude oil prices have retreated sharply during the week and the advance tax figures of India Inc. have shown a 77% increase y-o-y. On the contrary, market has given more credence to the negative news on the Greek crisis emanating from the international arena. Retail interest in the market has waned significantly in the recent months and FII's have also started to press the panic button. RBI has given ample signals to fight inflation at the cost of growth. The Govt. is grappling with the onslaught of pressure from the opposition as well as civil society activists which has led to a paralysis in the decision making process.

The slow and steady grind of the major stock indices downwards is leading to comparative inactivity on the volumes front. The volatility during the week (measured by the VIX) has also climbed to over 20 towards the weekend. All these factors are pointers towards a short term weakness in the Indian markets. Past experience tells us that the so called momentum stocks are the worst sufferers in a prolonged downturn. Investors holding on to such news driven stocks would be well advised to lighten their portfolio. Certain defensive stocks from front line indices will be good bets to protect the investor's portfolio. 

 

The next downturn in equity markets is more likely to be caused by a catastrophic fall in the real estate prices. The pressure on the Govt. to enact the Lokpal bill and the issue of black money stacked abroad is the primary reason for the impending realty prices crash. This issue can no longer be brushed aside, and the Govt. will be forced to take some corrective steps to redeem its credibility. The Competition commission is aggressively pursuing cases of complaints against some top real estate firms regarding malpractices in their affairs with buyers/ investors. Once this happens, there is fear of a severe liquidity crises in the markets leading to a further downfall in stock prices due to lack of buying support. Before this scenario unfolds, it would be wiser to have a closer look at your portfolio and take suitable remedial measures to protect it from a major downside risk.

 

India poised to become a major 'Manufacturing Hub'

India is poised to overtake China as a global manufacturing hub. Fortune 5000 global companies have shown their preference for India for outsourcing manufacturing over the next 3-4 years. With a host of these global firms setting up manufacturing facilities in India, the manufacturing sector may overtake the services sector as the major contributor to India's GDP in the next 5 years. India with its manufacturing, engineering and technological capabilities offers a conducive environment to qualify as a global manufacturing hub, provided it can overcome the political impasse and getting along with the economic reforms agenda. I am very sure this will start happening in the next 5-6 months.

Currently, India's GDP is dominated by the growth of the services sector, prominent among it being BFSI and IT sectors. But a change in trend is beginning to emerge. Historically it has been proven that a services led economic growth invariably leads to a collapse, as it has happened in the case of Iceland and Portugal. Even the Lehman brothers episode gave a big jolt to the US as a services led economy. Countries with a strong manufacturing base like China and India are likely candidates for a more sustainable economic growth.

What could be the impact of India transforming into a 'Global manufacturing hub' from a 'Services dominated economy'. Our markets will sooner than later accept this reality and re-rate the stocks from various sectors. The future belongs to the real economy rather than the virtual economy. In the emerging scenario investors are advised to focus on accumulating blue chip stocks from the manufacturing sector, and at the same time reducing exposure to service sector stocks like BFSI and IT. The next bull run which is likely to start unfolding in the second half of FY 2011-12, in all probability will be led by the real economy stocks - Domestic and foreign companies having a substantial presence in manufacturing sector. Most stocks from this sector including blue-chips like BHEL, L&T are languishing at their 52 week lows. As the markets are down and likely to remain in a subdued mode for another 3-4 months, investors with an eye on the future can start accumulating the manufacturing sector stocks which include steel, cement sector stocks which will be the indirect beneficiaries of the growth in manufacturing sector.

Dull phase in Equity Markets: Testing times for Investors

A dull phase in life can be quite a challenge. Human beings by nature love and enjoy action: We admire the gushing waves of the sea, we also get pleasure in admiring the snow capped mountain peaks, but we seldom derive the same satisfaction by watching the barren land. Equity market investors also strive for action, because the swings in the market enable them to make money. Dull phases in equity market can be quite nerve wrecking for the investors. The markets are currently passing through a dull phase and investors must learn to cope with this phase. Market analysts call such phases as 'range bound movement' or 'consolidation phase'. What should one do in a dull phase:

• Take a break from the market: It is better to take a few days break from the markets rather than watch your portfolio move in a narrow range. This would help you to keep boredom at bay, because the more we think about the listless market, the more frustrated we get.
• Reshuffle your portfolio: The dull phase should be used to get rid of the dud stocks in the portfolio with blue chips. The blue chips have a better chance of outperforming the markets when markets resume their trend.
• Increase the cash levels: Dull or flat markets do not deliver a return on your capital, hence trimming the portfolio and increasing the cash levels/ debt exposure can see your capital earn reasonable returns. The surplus cash can be redeployed in equity markets once a trend reversal is evident.

Our equity markets are likely to follow range bound movement for a few months from now (say the next 4-5 months). The broad range being 5200-5700 on the Nifty. The range can be broken decisively on either side with the global news flow. The positive triggers would be: Normal monsoon, cooling of inflation, return to governance by the Govt. The negative triggers bothering the markets are: Withdrawal of stimulus leading to liquidity crises, political instability in the country, defaults in global markets etc. Let us bide these testing times without getting ruffled too much, because good times are likely to return to the equity market in about 6 months time. We need to be patient to reap the fruits of equity investment.

The ‘Exit option’: Use it judiciously to make money

The very essence of ‘Investment’ is to make money or create wealth. In this context, it is equally important to use the exit option (sell decision) judiciously as it is important to make an investment decision. Be it investment in stocks or mutual funds it does make sense to make a sell decision at the opportune time. The sell decision may result in a ‘profit’ or at times could result in a ‘capital loss’. The decision should always be influenced by the long term health of the portfolio. It is comparatively easier to book profits as one is taking money off the table. But, it is a painful decision to exit at a loss because nobody wants to destroy capital. But then, sometimes this painful decision needs to be taken if one is to protect the portfolio from higher risk in the future.

It is unfortunate that most advice is available to buy into a stock or a mutual fund, but seldom do we find advice to sell your holdings. Perhaps, it is not in the interest of the mutual fund company to give a sell call at the cost of running down its AUM (assets under management). Similarly, brokerages also focus more on buy calls and sell calls, if any, are put up for the short term traders only. Investors also tend to spend a lot of time on reading research reports, searching websites before taking a decision to invest. But seldom do we keep track of our investments to look for the appropriate time to exit or dis-invest. Does it mean that an investor should stay invested for a lifetime! Learning to use the exit option for ‘profit booking’ and at times for ‘loss booking’ is an art which every investor must learn.

Here are some key factors an investor must analyse in order to exit his/her holdings (individual stocks or mutual fund schemes):

• Relative performance: If the stock/ MF is under performing vis-a-vis its peers it is a time to take an exit call. The YOY (Year to year) and QOQ (quarter on quarter) performance based on declared results helps an investor to take this decision.

• Unrelated diversification: The announcement of an unrelated diversification, deviation from stated objectives in case of MF, puts pressures on the performance of the company. It should be analysed in terms of future profitability to arrive at the exit option. On the other hand backward/ forward integration of businesses helps in consolidation.

• Achievement of target: Most investors take an investment decision based on a specific target for the particular investment. If your favourite scrip has achieved its price target, it is advisable to book at least partial profits in the scrip.

• Negative news on the company/ MF scheme: Any negative news on the company/ MF should be viewed with suspicion. For example, detection of a fraudulent practice by the company, change in Fund manager of the MF scheme, should be analysed for the future impact, and an exit call taken after due analysis. In this case even ‘loss booking’ would be advisable’.

• Long term trends: Although, it is said that investors should not time the market, it is worthwhile to study the long term trends for the markets. Disturbing macro factors, uneasy economic situations invariably have a negative impact on risk assets (equity markets in particular). Such a situation should be used to press for the exit option. This gives an opportunity to sell now to buy cheap later.

Remember, equity investment is undertaken for ‘wealth creation’, one must take necessary steps to avoid ‘wealth destruction’. Exit option is a means towards achieving this objective.