July 2011 : Continuing headwinds

The Indian equity market continues to face headwinds – the Nifty is down 6% in the current financial year on the back of global economic concerns and the RBI’s strong anti-inflationary policy. Our portfolios continued to do well through this period, and despite the continuing market weakness, we closed the month on a positive note. For the current financial year, we continue to be significantly ahead of the market and satisfactorily positive.

The weakness in Indian equities is partly driven by the souring global macro-economic scenario. While Europe continues to struggle due to the high debt problems in the PIIGS countries, the focus has now shifted to the US where the government debt to GDP has hit 100% and thus the debt ceiling of $14.3 trillion is sparking a big debate in that country. The US government runs a serious risk of a credit down grade, a situation the world has not seen since World War I. The bond yields in Spain and Italy are also foretelling some serious debt issues in these countries. All these are partly reflective of expenses of these governments having gotten far ahead of actual tax revenues. In the final analysis, it is all about revenues versus expenses, be it individuals, businesses or the government.

The real issue facing the Indian markets for more than a year is the high rate of inflation. The RBI took baby steps in raising interest rates in the early part of the rate hike cycle in order to support growth. The result has been that inflationary expectations have set in firmly. Meanwhile, core inflation which was weak in the early part of last year, has climbed significantly in recent months. For a significant part of the last 18 months, a typical home loan has been available at about 2% below the prevailing inflation rate. Such a policy has led to a significant boom in demand, whereas supply has failed to catch up. You may have seen more cars being bought, but correspondingly roads are not being built. Significantly more air-conditioners and high end televisions are being bought, but not sufficient power plants are being set up. There is more demand than the ability of the infrastructure to accommodate the increased usage. A good part of the current inflationary situation is due to capacity lagging demand.

The RBI has started to take a serious view on this and has been taking steps to reign in the run-away demand environment. More importantly, the policy makers want capacity to catch up with demand, which takes time. We are likely to see a period of softening demand and a slowdown for a few pockets of the economy. This outlook has been affecting the equity market.

With a bit of cash in hand, we hope to take advantage of any further weakness in markets. Many of the stocks that we would like to buy have run ahead of themselves in terms of valuations, but are doing wonderfully well as businesses. We hope the current weakness will give us an opportunity to buy into some of these businesses at better prices than where they are trading now.