The clock turns full circle: where do we go from here?

There are a lot of differences in the situation prevailing at the beginning of January 2008 and the end of June 2008.

In January the stock markets were in euphoria, breaking new records everday on the upside. Liquidity was driving the markets mad despite the unearthing of the US subprime crises. Analysts and Brokerages were predicting sensex levels of 25000 and above in the short term. Rupee was holding strong against the dollar and the predictions were af rupee appreciating to Rs36/ dollar by the end of 2008. Everyone was bullish on the growth prospects of Indian economy. The index of Market optimism was more than 90%, that means 90 out of 100 people beleived in pumping money into Indian equity. Even then there were 10% of the people who beleived that fundamentals of the markets were not supporting the overall optimism, so they were selling in the markets. They may have been branded as fools, because they may seem to have lost the oppotunity in the short term. These minority stakeholders must be a smiling lot today. Things changed dramatically within a span of a few days and the markets came crashing down by over 20%.

Today, in June 2008 the situation is reverse. Everybody is talking about the equity markets with a negative bias. The market continues to fall despite the growth prospects of Indian markets remain fairly optimistic. The market is flooded with negative news. The rupee is being predicted to depreciate to Rs45/dollar by the end of the year. The index of Market optimism is down to 10%, that is 90% of the stakeholders are running away from the markets, even at the cost of booking huge losses. It's again those 10% of the people who beleive that the valuations of the market have become exteremely attractive, and they are buying selectively inti 'Blue Chips'. In the short run the market may go down further, making them look foolish, but these will be the paople who will have the last laugh 6 months from now.

However, there is one similarity in the situation prevailing in the beginning of January 2008 and now. Both the situations point to a trend reversal. While January 2008 siganalled the end of the bull phase, June 2008 is likely pointing towards the end of the bear phase in Indian markets. Just one good news can change the fortunes of the markets. It could be the decline in oil prices to the level of US$ 100/barel. It may seem wishful thinking, but it is very likely to happen with the liquidity tightening measues initiated by Asian Central banks.

Its time to decide whether you belong to the 10% tribe, or will like to go with the majority opinion. Remember 'Fortune favours the Brave'.

How to survive in choppy markets

Anyone who has seen the one way movement in the markets for most part of calender 2007 is perplexed at the choppy behaviour of Indian stock market eversince the beginning of 2008. As most investors are governed by strong emotions, it is very diificult to survive the choppy markets. If we do not develop the survival instincts we will tend to loose huge money in this uncertain environment.

What went wrong with the 'India growth story'? Overseas fund managers have withdrawn more than US$3 billion during the first three months of 2008. The adverse turn of events on the global economic front are partially responsible for this turmoil. Emerging markets are grappling with higher inflation as the commodity prices have risen to new highs. Crude prices hitting new highs is a double whammy for net importers like India: High oil prices coupled with the falling rupee is putting pressure on the fiscal deficit of the govt. The falling rupee has also increased the risk aversion of FII's vis-a-vis India, because they find better opportunities elsewhere for the time being. There is a reasonable consensus among analysts for a slowdown in Indian GDP growth to between 7-7.5% this fiscal.

The individual investor is caught at the crossroads, baffled and bruised. For those who have invested for long term it is a time to forget looking at the indeces for a while and relax. Things will start to improve within the next 4-6 months. For the active investors it is time to do some portfolio churning. Everytime there is a change in the economic fundamentals, different sectors take the lead on the markets. The performing sectors of 2007 like infrastucture, power media and reality have become laggards, and the laggards of the last bull run like Pharma, FMCG and Technology have taken over the leadership mantle. The sensex has fallen about 25% in 2008 till date, but sectors like capital goods (infrastructure, power etc.) have declined over 40%, whereas media sector has declined by over 40%. On the other hand Pharma has given a growth of 14%, and returns on FMCG and IT sectors have been marginally negative.

So it can be seen from this data that we can survive bad patches in the markets by following the principle of portfolio churning.

Benjamin Graham: Lessons in Value Investing

• Benjamin Graham has been called the father of 'Value Investing'. Several Investors, including the legendry Warren Buffet have benefitted immensly from his visionary investment techniques. Benjamin Graham believed that each security has an intrinsic worth that is recognised by the market in the long run. Here are famous qoutes from Benjamin Graham's 'Art of Value Investing':
  
  * The secret of sound investment can be summed up in three words: "Margin of safety"

* Investors should treat themselves as 'Owners of a business' rather than owners of a stock quotation, so focus should be on the underlying soundness of business.

* If you are sure that the markets are too high, it is better to keep your money in cash or Govt. Bonds rather than put it in 'Bargain stocks'.

* It is a great practical mistake to waste time on 'Forecasting the markets'.
Emotional decisions should not be allowed to overrule the market fundamentals. Market gives ample opportunities to buy good stocks at the right price.

* When beggers and shoeshine boys tell you how to get rich, don't be under the illusion that one can get something for nothing. This has been proven right several times in the past: during the US stock market crash of 1929, Harshad Mehta scam of the 1980's and again the recent stock market crash of January 2008. Yet public memory is too short, so we tend to repeat the same mistakes time and again.

Graham's investments mainly focussed on bargain stocks based on earnings potential or asset values. For this one needs to scan the balance sheets of the companies. Currently, with the markets in turmoil due to global oil crises and rising inflation, offer many such bargain buys. One just needs sometime to look at their balance sheets (most of the companies have already declared their annual results).

Behavioural Finance: its pitfalls for Investors

Behavioural Finance is the study of rational/ irrational behaviour of individuals which influences market prices, returns and allocation of resources. It attempts to understand how people forget fundamentals and make investments based on emotions.
The primary objective of all investments is to maximize returns and create wealth. Observing the behaviour of individuals leads us to believe that people are very often ruled by emotion (greed and fear) rather than by logic. They display imperfect rules of thumb (heuristics) to process the available data, thus bringing in individual biases in their beliefs, leading to commitment of fatal errors of judgement.

The important heuristics driven biases are:

• Representativeness – Forming an opinion of future action based on past performance. Investors may tend to rely on certain patterns in the past data that are random.
• Overconfidence – The human mind is trained to extract the maximum information from the available data, but it may not be adequate to arrive at an accurate forecast in uncertain market conditions. This phenomenon is described as ‘self-attribution bias’, where people tend to attribute their success to their investment skill and their failure to bad luck.
• Anchoring – Conservatism or the inability to change an opinion after subscribing to a fixed idea, often manifests in a failure to react to a new information which is relevant to one’s investment but does not match with his/her subscribed opinion.
• Innumeracy – This results from ‘mathematical illiteracy’ where people tend to misunderstand the statistical data. Generally, people tend to give more importance to big numbers and tend to overlook small figures.

Investors often fall prey to their own and sometimes others’ mistakes due to the use of extreme emotions in ‘Financial decision making’. If you compare the overall profits of traders, you will find that they make similar profits as long term investors. This is because they tend to pay huge fees such as brokerage, transaction charges, short term capital gains. You as a long term investor may be able to earn a higher return, in addition to the peace of mind.

So, the next time if one of your friend suggests a great investment opportunity, naming a ‘ten bagger’ or a ‘multi bagger’, just ignore it. When the market has crashed, the same set of people will create a panic by telling you to sell, just hold your emotions. Do not get carried away by extreme sentiments, because they bias your judgement and can only help you to make blunders. Have firm faith in yourself, and make your investments based on confirmed information and objective analysis of the same.
Remember: Money cannot buy happiness, but the lack of money can buy a lot of misery.

Inflation Effect: Is this the end of the India Growth story?

Week after week the inflation data is causing tremors in the markets. For week ending May 3, 2008, it has risen to 7.83%, a level not seen since 2004. How does it auger for the Indian economy? Inflation indeces comprise of 3 broad catagories: Agricultural output, Metals and Energy (Oil & Gas). Today analysts are pointing towards continuation of higher inflation, due to higher demand from the developing world, including India and China. The way things stand today, inflation is driven by high level of speculation in the 'commodity markets', a bubble which is waiting to burst. In the developed world, commodity prices have hit new highs recently as a lot of hot money has been diverted to the commodity markets, from other markets. Even pension funds have been investing higher proportion of their funds in commodities as a diversification tool. Let us analyse the movement of prices in India in the next 3-6 months:

• Agriculture: Foodgrain prices in India have started to ccol off with the bumper wheat harvest. World over foodgrain prices have softened recently. With the likelihood of normal monsoon prediction for the year in India, foodgrain prices are likely to remain soft over the next 2 quarters. The impact of this will be evident in the inflation indeces within the next 2 weeks.
• Metals: The slowdown in demand is starting to show its impact on prices of select metals. Gold is down almost 15% from its peak, and Nickle prices have cracked almost 50% from their peek. Iron ore prices are also showing signs of weakness. Cement prices in India historically have been low in the monsoon months, the impact of which will be seen after the onset of monsoon by the end of this month. Cement producres have been smart enough to reduce the prices of a bag of cement upto Rs.7 foreseeing a slump in demand.
• Energy: The only cause for concern remains the high crude oil prices. With the energy demand from the western world continiuing unabated, crude prices have continued their upward march. Speculation in the commodity futures is responsible for this trend. Indian economy is facing a double whammy: high crude prices accompanied by the slipping Rupee is causing a huge outflow of funds, putting pressure on the inflation indeces. Oil should peek out somewhere around the 130 $/ barrel mark soon.

Our stock markets have shown tremendous resilience, despite the negative inflation data, and flagging IIP numbers. In the short to medium term the markets have the potential to move upto 10 % from these levels, which will be an opportune time to book partial profits. The first quarter results for India Inc. may provide a slight negative bias, forcing the markets to react negatively. But a normal monsoon will help in easing the inflationary pressures by the second quarter of this fiscal.

Market Direction: Important triggers

Efficient Market theory advocates that human beings behave rationally and the markets always behave efficiently. But this is not true most of the times. Human beings rarely behave rationally as a group. The markets always look for market triggers: positive or negative to find their direction, in the short term. Let us find out what are the triggers for the market at this juncture:

• Results for FY 07-08: Currently the results are playing a major role in deciding the immediate course of the markets. As the results of majority of the companies have been better than expectations, markets have moved up about 20% from their March lows. This also is the time for portfolio churning based on the annual returns of the companies.
• Progress of Monsoon: Indian economy is very much dependent upon the monsoon. The markets will start discounting the progress of monsoon from the end of May. The predictions by the IMD are for a normal monsoon this year, if it holds good than the stock market will have a sustained rally in the months to come.
• Inflation: The government is doing everything to contain inflation, but the results have not been reflected in the inflation data so far, which continues to be a source of worry for the markets. Although the foodgrain prices have started to soften, the prices of crude oil and basic commodities like steel and cement continue to rise globally and the govt. can do very little in this regard. The artificial reduction in prices through force will only worsen the situation, unless supply concerns are met.
• Exchange Rate: The Rupee have depreciated against most currencies in the recent past and has recently breached the Rs41/ dollar mark recently. With crude oil ruling at all time highs of over 120$/ barrel mark, it does not auger well for the Indian economy as we are a large net importer of petroleum products. This will put a lot of pressure on our budgetary deficit and fuel inflation. But it augers well for certain sectors like oil exploration and refineries as their margins would improve. But public sector companies will continue to bleed because of faulty pricing mechanism followed by the govt.

Overall the markets have been resilient despite the negatives, and are currently consolidating above the 17000 level on BSE and 5000 on the NIFTY. In the absence of any major negative news, the medium term trend for the markets is up. But partial profit booking is advisable in the range 18200-18500 on the sensex and 5400-5450 on the NIFTY.

It is back to Fundamentals

The Indian Stock market is now reacting to fundamentals, therefore, money making is going to be selective. The Year 2008 will see to it that money is not made on tips or hearsay. This is not the year of 'Momentum Stocks', so one should focus on 'Value stocks'. The current uptrend/relief rally or whatever you may like to call it, is based on the fundamentals of the companies on the basis of quarterly/ annual results for FY 07-08. The market will reward those who do their homework well. There are three levels of analysis to take stock of the market moves. It is known as EIC analysis (Economy, Industry and Company).

• Let us first analyse the Economic situation. The ngative factors are a high inflation rate and high commodity prices. Although, with the prospects of a good crop foodgrain prices are likely to cool off soon, but high crude prices are here to stay, and this may hurt the Indian economy very badly in the long run. But the positiove side is, that Indian economy is still growing, and even a slower growth rate of 7.5-8% will not hurt the sentiment badly. The CRR hike is already behind us. The credit policy on 29th may announce a Repo rate hike of 25 basis points, which has been factored by the markets. If the hike is higher it might effect the sentiment negatively. It is unlikely that the RBI Governor will resort to a steep hike, which might kill the India growth story. If no surprises are there in the credit policy the markets are likely to maintain their uptrend in the near future. Valuations of the overall markets at 17000 level BSE/ 5100 on Nifty are in line with the historical trends (PE of 20 trailing basis, and 17 for one year forward basis). The markets are not likely to move past the earlier tops in the next 6-9 months, because of the uncertain economic/ political environment. The range for the markets could be 15% on either side of the fair market value i.e. 14500-19500 for the sensex. Broadly this range may be utilised by long term investors: Buying at the levels of 14500-15500 and booking partial profits above 18500 levels.

• The next level of analysis is the Industry Analysis: Although the benchmark indeces give us a direction, all stocks within the index do not move in the same direction. The sunrise sectors of last year which have given super normal returns will no longer lead the uptrend. We need to divide sectors into three catagories: First the ones which have long term value at current levels and are less likely to be affected by an economic slowdown: Pharma & Healthcare, FMCG, Retail, Media & Entertainment. These sectors are more or less insulated from the economic slowdown. Selective purchases can be considered in stocks from these sectors. The next are the sectors that get negatively impacted by the slowdown: Capital goods, Auto, Banking & Finance, Realty & construction. Auto & Banking (especially PSU banks) are still quoting at reasonable PE multiples and can be bought on declines. But refrain from investments in Capital goods and Realty as most of the stocks from this sectors are quoting at ridiculously high PE's. Case in point are the stocks like ABB and Siemens. I would consider even L&T and BHEL expensive at current levels. The sectors falling in the third catagory are those which get affected by Govt. policies. These sectors are Oil & Gas, Telecom, Basic Metals. PSU Oil/Gas companies like ONGC, Gail, IGL, IOC, HPCL, BPCL are all quoting at reasonable PE multiples, but the Govt. policy is responsible for keeping them at subdued performance levels. Telecom sector is highly dependent on spectrum allocation. Diversified companies like Bharti still hold good value from this sector. Basic metals like Steel and Aluminium, and even commodities like Cement are currently under the scanner of the Govt. in its bid to control inflation. So, a prudent investor should stick to the first catagory of stocks for buying. Partial profit booking is advisable in the second catagory, whereas a wait and watch approach is advisable for third catagory of stocks.

• The last level of analysis is the Company Analysis: Generally the markets tends to give a thumbs down to certain sectors, and even individual 'Gems' from the sector get punished alongwith the market sentiment. Intelligent investors are those who are able to identify these gems from the beaten down sectors, these stocks ultimately turn out to be multi-baggers. One such beaten down sector in the current scenario is the IT sector, where lot of good growth stocks are languishing at ridiculuosly low valuations.

Year 2008 will prove that there are no short cuts to make money on the stock markets. Do your EIC analysis properly before taking an investment decision. Otherwise it will be better to park a large chunk of your money in fixed income instruments for atleast one year.