November 2011: Life finds a way

The Indian equity market has given up all the gains made in the previous month and is now trading at close to the low point over the last 2 years. The market is now down 17% for the current financial year – the weakness is driven by several factors, some relating to the domestic economic slowdown and some relating to the on-going European crisis. Since the problems relating to the domestic economy are driven more by RBI monetary tightening which has the potential to get reversed, it is the worries surrounding the situation in Europe which seems to be a bigger concern. Though our portfolios have held up well in this market, one can’t deny that the short term outlook is murky.

We are often asked whether this is a good time to invest in equities, given the somewhat uncertain economic outlook. No one really knows how Europe will solve its problems, or when the political log-jam in India will get resolved, or when the economy will get back on its tracks. But what we do know is that equities as an asset class have performed extraordinarily well over long periods of time. The Sensex has a base of 100 in 1978-79 and has delivered a 16% compounded return over long periods of time. The global economy has gone through several crises over the past 100 years such as the Great Depression, World War II, the Oil Crisis of the 70s and many such. Though we are not absolutely certain as to how the problem in Europe will get eventually resolved, we do know that when man comes up with a seemingly insurmountable problem, he does find a way – as the late Michael Crichton wrote : Life Finds a Way. One has to respect the capital market system for its ability to find a way out of a difficult problem.

In the current slowdown, some companies are facing significant trouble. One has started to hear of companies approaching bankruptcy and it is possible that more of these highly indebted companies will face problems in this economic turbulence. However, there are several companies which are doing very well and are unlikely to get majorly affected by the economic slowdown. We don’t see anyone in India changing their decision to buy a soap or biscuit if Italy defaults on its bonds. We are tracking several companies which are performing well ahead of the economy and are highly profitable. These companies are beginning to trade at prices which are reasonably attractive.

One observes that the period of maximum uncertainty often produces very attractive opportunities for the patient long term investor. To give an example, the day the planes crashed into the World Trade Centre was perhaps among the best buying opportunities in the stock market. We have been patiently sitting on cash for quite some time because the valuations then were not attractive – now we are seeing a lot of opportunities among the set of high quality companies that we track and we hope to use the current uncertainty in the market to build a solid portfolio of such stocks at attractive prices.