Aug 2013 : Crisis typically precipitates action

To say that financial markets are going through stormy weather is an understatement. In the current financial year, since April 2013, the Rupee is down 21.1% and the 10-year government bond is down 7.0%. Currency and bond markets rarely see such violent volatility. The Nifty is down 3.7% for the year, but the Nifty performance to a large extent, masks the performance of the broader market, where one has seen carnage. The uncertain economic environment is causing investors a lot of heart burn, especially the foreign investors, who own nearly 18% of Indian stocks, and who have experienced a double whammy due to the depreciating rupee.
We believe the lack of confidence and poor sentiment are affecting markets a lot more than just the fundamentals are. Even on the currency side, the underlying fundamentals are not so bad to justify such a severe fall. To quote Mr Adity Puri, ‘The fundamentals of the economy are not half as bad as the vicious fall in the financial markets would suggest’. The problems can be fixed, but markets are looking towards the government to make decisive pro-business and pro-reform oriented steps. As a friend put it – the government should manage the economy rather than try to manage the rupee. Crisis typically precipitates action, and we do hope to see decisive steps soon.
As value investors, our main objective is to buy into buy high quality stocks at a reasonable discount to intrinsic value. With the sharp deterioration in the economic environment, severely leveraged balance sheet and cash flow bottlenecks, our ability to ascertain intrinsic values for many stocks has become very difficult. There are several companies which are carrying far too much debt and are facing an uncertain business environment. In such cases, it is nearly impossible to evaluate the intrinsic values of these businesses, and even though stocks prices are down well over 70% from their peak levels, we have not been able to gain sufficient confidence to buy into these companies. Frankly, we don’t understand the balance sheets of these companies. Many of these companies are likely to disappear into oblivion in the coming years.
On the other hand, we do follow quite a few extraordinary companies with sound management. These companies have been doing quite well through the past few years, despite the tight economy. With competitive conditions turning in their favour, as competitors weaken, they not only benefit but are also better prepared for a positive turn in the economy. Even with the markets correcting, valuations have not really collapsed for this basket of companies. We believe the integrity of markets are being maintained, with valuation well within historic range. We do find a few great opportunities to invest.
The Indian economy going through rough weather, and like many such storms, this too shall pass. We do believe we are sailing in a sturdy ship – companies run by management who have a stable head on their shoulders – which will definitely weather the current storm. In the final analysis, every crisis presents an opportunity because it is in times of uncertainty that valuations get crunched.