October 2010: Easy capital availability

After the very strong performance last month, October was expected to be a month of consolidation for equity markets. Equity markets traded in a narrow range during the month and finished marginally negative for the month. Continuing strong FII inflows were offset by the massive Coal India IPO during the month, which witnessed record subscriptions. Global events continue to dictate the course of Indian markets.

Over the past few months, there has been a struggle between the US government wanting to weaken its currency, in order to give a boost to its exports, and the Chinese government intent on pegging its currency to the USD, in order to protect its export industry. Combined with the low rates of interest in US and a weakening currency, there has been a record flow of funds towards emerging markets. Several countries like Brazil, Thailand and others have started to take precautionary measures by imposing additional tax on foreign inflows. Despite such moves, global allocations towards emerging markets are at record highs. If we thought the Coal India IPO of $ 4 billion was a record, Brazil had a $ 60 billion IPO recently. Such numbers are staggering. The conflicting problem faced by the RBI is that money is flowing towards countries where inflation is high, and therefore interest rates are high. The increased flow of funds is creating a further inflationary environment. This is likely to lead to an asset bubble environment, which will face severe whiplash as and when the fund flow towards emerging markets reverses. It is difficult to predict when this flow of events may turn the corner, as this is dictated by events way beyond anyone’s control.

We have been looking back over the past 3 years on the performance of individual companies and corresponding stock price performance. There are several companies that are about 30% lower than peak, and several companies that are well over a 50% above the peak levels reached in 2008. One of the factors that stand out among the good performing companies over this period is the ability of these companies to grow at reasonable rates without requiring too much capital to grow. These companies get a special advantage in recessionary periods, as competitors struggle to raise capital for growth. These are the companies defying traditional logic of wanting resources in order to grow, and the stock prices of these companies tend to do well over time.

The current environment, where capital availability is easy, is conducive for companies to raise capital. As and when the capital flow slows down, we believe the Free Cash generating companies will stand apart. We hope to pack more of these companies in the portfolio.