January 2011: Cautious view on the market

After being the best performing among major world markets in 2009 and 2010, the Indian market is now showing a lot of weakness. The Nifty fell 10.3% in January, largely on account of FII selling. FIIs have been large buyers in India over the last many months and this is the first month of outflow from FIIs since May 2010. We have been taking a cautious view on the market, reflected in our high cash position, due to our previously stated position that the valuations in India were at a high level. As a result, our portfolios did much better than the overall market. It is in such market conditions that the importance of capital protection gains importance. At this stage, it is difficult to say whether the current negative momentum will continue, but there are reasonable indications that negative sentiment may persist.

Despite the correction in equity markets, the Indian economic growth story broadly seems intact. Opportunity for companies to grow significantly in the coming years seems good. We follow several companies, which have a proven track record of good performance through both good and bad economic conditions, and these companies continue to deliver exceptional performance. There are some companies that have seen some margin pressure due to raw material price inflation, but the issues should be temporary in nature. Underlying strength of these businesses continues to be strong.  The recent correction in stock markets is more to do with moderation in valuations of these companies, rather than dramatic worries over their performance in the coming years.

The high inflation in recent times and a dramatic rise in interest rates over the past few months have led to some concerns over the economic growth momentum. The sharp increase in interest rates will definitely affect some pockets of the economy in the immediate term. The government has also changed its stand and made inflation control a higher priority over economic growth. This change in stance may be prompted by the upcoming elections in several states – it is certainly welcome because once the inflationary expectations set in, they are very difficult to fight. Whether this changed focus will actually impact inflation in the short term is difficult to say because a lot of the inflation is due to structural issues with respect to food grains and higher international commodity prices.

The other issue which is receiving a lot of attention of late is what some people have called the governance deficit. This has been an issue dogging India for a fair period of time but it seems to have come to the fore because of the large number of scams which have been unearthed recently. Apart from inflation, this is the other issue which seems to be impacting the Indian stock market in the short term.

With the correction in stock prices, several of the companies that we follow closely are now closer to our ideal buy prices and we are beginning to take small bites there. If the current trend persists, we should start seeing some very compelling prices soon and we are beginning to get excited with the prospect of buying into good quality companies at great prices.