November 2010: Scams have diminished confidence

Equity markets showed the first signs of weakness in over 5 months, falling 3% for the month. Markets are also down over 8% from the recent all time highs reached earlier this month. FIIs, who have been active buyers over the past few months, started to show first signs of slowing down over the past few days. Market weakness was led by a combination of global events (China tightening, turbulence in Korea and Irish banking industry crisis) and more importantly a series of scams in India, which could potentially have an impact on the economy and the current political stability.

The Indian economy has been viewed as a stable and high growth market, and several investors had taken this for granted. With the recent spate of scams, this hypothesis is being questioned. Chances of a few hiccups in India’s economic growth journey have increased due to the events of the last few days. It is difficult to say if any of these scams will unravel into something dramatic and impact economic growth. On the other hand, what it has done is diminish the confidence of both the global investors and domestic investors. A positive investment climate is required to maintain high valuations, without which valuations are likely to drift back to historical averages. What we are seeing is a correction in the high prices seen over the past few weeks.

Some of the worst affected companies in this correction are companies that have either been directly involved in the scam, or those that have suspect balance sheets or managements. During the past few days, we have broadly seen all portfolio companies hold up well through the correction. The resilience of the stock prices of fundamentally sound companies, with a proven management track record is put to test only during such corrective periods.

The global economy continues to remain weak and concerns have started to build up again over the strength of the Euro zone countries. So far, only the Irish bond market has been seriously affected, but there are severe concerns over bond markets in Spain & Portugal. It is relatively easy to bail out a smaller economy like Ireland, but the task becomes more difficult if the problems spread to other larger countries. Though authorities have tried to solve the problem, it seems clear that what are being addressed are just the symptoms and not the problems itself. If such events do play out, equity markets can face more severe head winds in the coming days.

We believe companies that require low capital to enable growth and also manage their working capital well are companies that deliver great shareholder returns over time. There are several such companies that are listed in India. Some of these companies have also corrected in recent times and we hope to invest in these companies as and when we do see sensible prices.