Contrarian Investment Strategy: It pays to be different!

Behavioural Finance tells us that markets swing between the extreme emotions of greed and fear. Market movements generally reflect the irrational behaviour exhibited by a group of investors working towards acheiving a common objective. Various theories/strategies have been propounded by experts on stock market investing. One such strategy is the 'Contrarian Investment Strategy'.

A contrarian strategy is one that relies on making profits by investing in a manner that differs from the conventional wisdom, hoping that the the consensus opinion will prove to be wrong. A contrarian believes that crowd behavior among investors can lead to exploitable price differentials (underpricing or overpricing) in securities markets. Practicing the contrarian investment strategy can lead to above average gains from the markets. A contrarian seeks opportunities to buy or sell specific stocks when the majority of investors appear to be doing the opposite. This approach has the tendency to misfire in the short term, as you are trying to swim against the tide. Patience is the key to succeed as a contrarian investor. Commonly used contrarian indicators for investor sentiment are Volatility Indexes (informally also referred to as "Fear indexes") like VIX, which track the prices of financial options.

Contrarian investment strategy has similarities with value investing strategy as the contrarian is also looking for mispriced investments and buying those that appear to be undervalued by the market. Warren Buffet is one of the legendary investors of our times who has used cotrarian strategy to make windfall profits on the markets. Some Mutual Fund houses in india have also floated specific 'Contra funds' that follow the principle of contrarian investing. Let us take an example: last year in January '08, at the peak of the bull phase there were a few takers for automobile companies in India. Most of these companies from the forward group like Maruti, Hero Honda have proved to be the best performers one year after. Similarly, at the current juncture, telecom sector has been given a thumbs down by the markets, and most analysts are negative on the sector for the next couple of quarters. A blue chip stock like Bharti Airtel is quoting at an all time low PE multiple of 12. If somebody invests in this stock today, using the contrarian strategy, I am fairly optimistic that he/ she would be able to make decent gains in the next 1-2 years.

RBI Quarterly Review: Exit from easy money policy!

The clock has turned full circle. After consecutively increasing the liquidity in the system over the 6 month period from October 2008 to April 2009, RBI has finally given a signal for reversal of the easy money policy. Although most key rates (CRR, Bank Rate, REPO and Reverse REPO) have been held constant, a signal for reversal comes by way of hiking the SLR (Statutory Liquidity Ratio) to 25%, a rise of 100 basis points. The immediate impact of the hike will not be much, as the average SLR maintained by sceduled commercial banks is 27.6%, well above the target of 25%.

The main concern voiced by the RBI Governor is on the inflation front, RBI's March '10 projection for headline inflation has been hiked upwards to 6.5%, keeping in view the pressures from tightening food prices. We would have to wait for the winter crop to hit the markets by the end of calender 2009, to see the actual impact on food prices. But, RBI's stance is loud and clear: It values inflation management as its first and foremost task, while keeping the economic growth intact. There are some indirect measures in the policy which would take out the ecxess liquidity from the system;

• Bank's borrowing from the Money market, not considered for CRR calculation till now be taken into account for CRR calculation
• There has been a hike in provisioning requirements for loans given to Commercial Real estate developers. Provisions on standard assets hiked from 0.4% to 1%. NPA coverage ratio for commercial loans hiked to 70%.
• Export credit financing reduced to 15% from 50% earlier.
• RBI has also signalled a reduced money supply growth rate for the fiscal 09-10, indicating that a CRR hike is due in the next quarter.

The recent stock market rally which was fuelled by excessive liquidity seems to have been punctured by the RBI policy. It is an excellent step by RBI to take care of bubbles that could create a lot of trouble later if allowed to grow. On the other hand, the stock prices decline offers investors an opportunity to buy sound stocks for long term at reasonable levels. The long term survival of bull markets always depends on lower inflation levels.

Samvat 2066: Return of the Bull Run!

We are in Samvat 2066 as per the Indian Calender. Diwali is an auspicious time for the investor community to  take stock of the past performance and analyse of the future of the markets. I am sure most of you must have made substantial gains during the past year, had you kept your cool during the turbulent times when the markets were down in the dumps. For me also it has been a very satisfying year as far as 'Wealth Creation' is concerned. If I go back to history, I recall the gloom of last Diwali when most investors felt that everything is lost. This Diwali has given most of them enough reasons to smile. Before I go on to a detailed prognosis of Samvat 2066, I would like to recall my perceptions about Samvat 2065, posted on my blog on 27th October 2008. I was pretty hopeful of a decent recovery at that time, but the stock markets have moved far ahead of my reasonable expectations.

It is time to analyse what lies ahead during SAMVAT 2066:

• Technical Factors: The water shed event for sustained market uptrend was the installation of a stable Govt. in India during May 2009. Markets which were in a bottoming out situation at that time, got the trigger to move into a new orbit by the declaration of election results. The gap created in May 2009 between 12500-14000 on the Sensex and correspondingly 3800-4200 on the Nifty will technically act as a strong base going forward. Technically, the markets are ripe for a strong correction before the end of calender year 2009, considering the sharp upswing witnessed since July 2009. Whenever markets move closer to the upper end of the range suggested, investors must buy strongly for the long term. Thereafter, markets are poised to retest the earlier top of 21000 on the Sensex by Diwali next year. We have to keep our fingers crossed to see whether it happens or not.
• Fundamental Analysis: The factors that favour the 'Return of the Bull Run' are a stable economic scenario, low interest rates with moderate inflation, a strong currency. So far the Govt. has given enough indications of a fast track reform process coupled with strategic dis-investment. Interest rate scenario is favourable for higher economic activity, but inflation is a bit of concern. The way India has tackled global recession has been appreciated by international community. The strength of the Ruppe is an indication the FII's are positive on the Indian economy. Although the valuations of most of the frontline companies look stretched at the moment, the growth in profits during 2010-11 will ensure that valuations become attractive in the second half of FY 2010-11. Indian economy's massive push towards sustainable growth will be trigerred by the hosting of Common Wealth games in Delhi during October 2010.
• Astro Analysis: Based on the views of renouned astrologers, markets are poised to regain their glory after a brief period of correction during Oct-Nov 2009 and January 2010. Bejan Daruwalla has forcasted a market range of 13200-18500 for the Sensex for Samvat 2066.

Considering all the above factors I feel that investors are in for some good times during Samvat 2066. But making money this year may not be easy, because the frontline stocks are looking a bit stretched on valuations. Rather it would be a year of the Midcap stocks, provided you are able to identify the right stocks after careful analysis of their underlying strength. Specific sectors that are likely to outshine are those which focus on the domestic growth story: Retail, Pharma & Healthcare, FMCG, Media, PSU Banks, Hotels & Tourism. There is no doubt in my mind that the 'Mother of all Bull Runs' has arrived. Stay invested, add on declines to profit from the India growth story for the next 3-5 years.

Equity Research in India

Every morning when you scan the pages of a financial newspaper you would come across some Buy/ Sell recommendations. The 24 hour business channels dish out these recommendations throughout the day. How reliable are these equity research reports for the common investor? Presently, most of the research is carried out by brokerages, and their efficacy can be questioned because of the direct conflict of interest as the brokerage recommending a particular scrip may be having positions in that particular scrip. As the system of disclosures in India is inadequate, it is difficult for the retail investor to rely on these reports. Further, less than 6% of the companies listed on Indian bourses are covered by the analysts.

There has been a long impending need for independent equity research in india. Ideally the research agency should be independent of the marketing function in independent research. Globally, there are three models for independent research:

• Sponsorship of ratings by the company as followed in Hong Kong
• Paid research by Stock Exchanges, as practiced in Singapore
• Research reports commissioned by investors.

One of the frontline rating agency CRISIL (A subsidiary of Standards & Poor),  has recently stepped into the field of independent equity research. It remains to be seen which of the above models will be used by CRISIL for its equity research. However, this will be the first serious attempt at independent equity research in India. CRISIL plans to cover not only the frontline stocks but also mid cap and small cap stocks through its research. Grades will be awarded to the stocks on a scale of 1-5, and the rating agency will abstain from giving a Buy or Sell recommendation. CRISIL has come out with first set of research ratings on 13 companies in its first report. This appears to be a good opportunity for retail investors to get an access to unbiased research reports. It is sincerely hoped that this trend will gather momentum in the future.

Economic Outlook: Mixed signals

If one is to be guided by the stock market movement of recent weeks, it points to a strong economic revival in Indian as well as World economy. But the ground data suggests that all is not well to get that euphoric about economic revival. First, the major positives for Indian economy are:

• GDP growth for June '09 quarter has bounced back to 6.1%, after languishing for 2 quarters.
• The IIP (Index of Industrial production) numbers at 6.8% for July '09 (although slightly lower than June '09) look quite promising.
• There has been a squential improvement in exports & imports, despite negative growth as compared to corresponding period of last year.

However, there are certain threats which still loom large over a speedy economic revival:

• The overall growth in Bank deposits & Bank credit have steadily declined to a growth of around 20% and 14% respectively
• WPI inflation has climbed to a positive territory (0.83%), after remaining in negative zone for over 3 months. The inflation measured as per CPI for industrial workers has grown at over 11% in August '09. WPI inflation is expected to touch 7% by march '09
• The monsoon season has just eneded with a deficit of 23% over the long term average, its worse performance in 30 years. This will put additional pressure on food grain prices.

Global economic indicators pose a much greater threat to an early economic revival:

• US unemployment rate for Sept. '09 at 9.8% is the highest since 1983.
• IMF has warned of further write downs from banks in Europe for atleast a few more quarters.
• The continuing weakness of US $ is a matter of concern for many countries, who have put money in US treasury.

These indicators suggest that although the worst may be over for world economy, revival at best will be slow. Investors shuold not hope for miracles like a V-shape recovery any time soon.

Market Moves: It's time to exercise caution

It was around this time 2 years ago that our markets embarked upon the frenzied climb to Mount 21000 on the Sensex. And the end result was a steep fall to sub 8000 levels within 11 months from the highs created in January 2008. A majority of the analysts were talking of levels above 25000 at that time. Eversince the market touched 17000 on the Sensex (5000 on the Nifty) recently, these analysts are back to their old games. Investors are being advised to buy stocks at high prices, as if there is no tomorrow. Generally, the feeling of being 'Left out' lures retail investors to make the same mistakes repeatedly. Even Mutual Funds which were sitting on huge piles of cash when the markets were down in dumps, have invested heavily in the markets and their cash levels are down to between 5-10%. Agreed, that the economy is on a recovery path, but the process will be very slow and steady, and one should not expect the profits of the companies to rebound so soon to command such rich valuations. Foreign Institutional Investors have turned cautious at higher levels, and we may witness rounds of FII selling in the days to come. For retail investors, it is time to be patient. Generally, small investors who are worried about the safety of their principal investment should keep away from the markets at this juncture. Investment through SIP/STP may be continued, but do not get disturbed if the NAV of your fund temporarily dips below your average purchase price.

But this does not mean that there are no good opportunities to buy at this juncture. History tells us that every new bull run is made up of new market leaders, whereas the old winners fall by the wayside. At the current valuations most of the leaders of the last bull run like Reliance, L&T, BHEL, etc. look either fully priced or overpriced. On the other hand Auto and Realty sectors have had a fairly good run in the recent past, so they are also richly priced at current levels. If selective buying has to be considered, sectors like Retail (Pantaloon, Videocon, Geetanjali), Pharma & Healthcare (Ranbaxy, Fortis) etc. can be considered on dips.

But to reap  good returns from this market one must  have a minimum  investment horizon of 1-2 years, because that would be the time when corporate earnings catch up with the valuations. Yet, the market may surprise us on the upside because of the excess liquidity available in the system.

IPO Pricing & Listing Gains

Initial Public Offering (IPO) is as an exercise when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public. For example, the recent Oil India IPO had both the above components. Subsequent issue of securities by an already listed company is referred to as Follow-on Public Offering (FPO). The IPO can be in the form of a fixed price option or in the form of a book building method. In India, currently the 'Book Building' pricing method is in vogue. This method provides an opportunity to the investors to decide a fair valuation of the issue through the 'Price Discovery mechanism'. In a book built issue allocation to Retail Individual Investors (RIIs), Non Institutional Investors (NIIs) and Qualified Institutional Buyers (QIBs) is in the ratio of 35: 15: 50 respectively.

There was a time when investors made a beeline for new issues for the sake of reaping decent 'listing gains'. After a lull in the IPO market due to the crash in secondary markets, the primary market is again buzzing with activity, with a large number of companies getting ready to tap the primary market through IPO's. But the poor post listing performance of a few prized IPO's (Adani Power & NHPC) has made the retail investors lose interest in the primary market. A retail investor refers to an investor who applies or bids for securities for a value up to Rs.1,00,000. For this reason the Oil India IPO received a less enthusiastic response from retail investors. However, qualified institutional buyers (QIBs), who invest with a long term perspective are quite bullish about the new issues hitting the markets. It seems there is ample liquidity to take care of the future IPO's getting a decent response from QIBs.

Small retail investors will have to be careful in choosing an IPO for investment, and not be guided by vested interests promoting the issues through media. Since most of the new issues are being priced aggressively, including the new issues by Public Sector companies, the chances for making listing gains are few. If one has to invest in a good IPO one should invest with a long term perspective and not merely for listing gains. SEBI has made rating of new issues an optional exercise, but a majority of the companies get their IPO's rated by rating agencies (CRISIL, ICRA, FITCH etc.). The grades assigned to companies are avilable on NSE's website. The highest rating is a 5-star rating. Amongst the recent IPO's, the issues of OIL India Ltd. and Mahindra Holidays and Resorts Limited have been awarded a 4-star rating by CRISIL & FITCH respectively. Before investing in any IPO, retail investors are advised to go through the Red herring prospestus (RHP) carefully, or seek the opinion of their Financial Advisor.