January 2010: Unbridled greed to extreme regulation

Equity markets witnessed a sharp 6% correction this month. The steep fall corresponded with similar weakness seen across all global markets. Our portfolios were broadly protected against this fall due partly to the large component of cash in the portfolio and partly due to our portfolio stocks performing well relative to the market. We would like to reiterate the importance of protecting capital during severe downturns in this context.

The correction in global equity markets seems to be due to increasing concerns that governments globally could withdraw the economic stimulus delivered at the height of the crisis as also a global investors return to risk aversion. The Chinese government recently clamped down on incremental bank lending, after the ballooning of bank lending over the last 12 months. In the US, following the loss of a key election by the Democrats, the government has started talking about stern bank regulation going forward. It appears that the pendulum of capitalism has started to swing from the extremes of unbridled greed towards excessive government regulation. The recent moves by President Obama indicate the US government’s move towards a regime of stricter government regulations on banks and it is possible that other governments in the West may follow suit. This could have far reaching impact on the conduct of banks in the future. Another big fear in the coming months is sovereign risk, with the risks over the Greek government solvency starting to gain press coverage. All these factors have been leading to foreign investors selling off Indian equities over the past few days.

In India, there has been a sense of caution due to the continuing tightening measures by the RBI and expected actions on taxation in the coming budget. Though the RBI does not want to disturb the economic growth trajectory, and is fairly confident of GDP growth in excess of 7-8%, RBI is deeply concerned over rising inflation. What is of concern to us is while inflation is 8.5%, fixed deposits yielding only 6%. The post-tax 4% that the Cash Funds are yielding is giving us sleepless nights. With its recent credit policy, the RBI has clearly started its journey towards tightening liquidity and addressing inflation on a serious note. We need to watch out for what the Finance Minister would do next month in the budget, but there is consensus building up on the need to increase some of the indirect tax rates to reign in the fiscal deficit.

The key question to address now is whether after this market fall, equity markets have become attractive enough to warrant incremental investments. It is our belief that though markets have corrected, most stocks are still trading at moderate to expensive valuations. There are a few pockets where stock prices are beginning to look cheap, but that situation is not wide spread. Having said that, if the current trend continues, we should start seeing some attractive prices soon. Since we have been building the cash position in the portfolio gradually over the past few months, we are looking forward to a market where stocks prices become more attractive. A falling trend in prices, if it continues, should be to our advantage. The broad India economic growth story is still intact and it would be great if one can buy into the long term growth story at sensible prices.