September 2011: Rupee weakness

After a steep fall in markets of over 10% in August, the Indian stock market consolidated in a range with the undertone remaining negative.  The Nifty was down 1.2% for the month and there does not seem to be any sign of recovery in the short run. Our portfolios continue to perform better than the market for the month and year to date.

One of the main events during the month has been a sharp fall in the Rupee viz the US Dollar. The Rupee fell close to 8% during the month, one of the sharpest falls in the past several years. There was some selling by FIIs, both in the equity markets and in debt markets, but nothing extraordinary which would impact the currency to this extent. The impact was seen in the currencies of several other emerging economies, partly due to the continuing crisis in Europe. Such a sharp fall in the currency has a positive impact on some of the exporting companies, but has a far higher impact on the already fragile inflationary situation and on companies which have borrowed in dollars.

With RBI policy continuing to address inflation, at the cost of growth, some pockets of the economy have started to see a slow down. Though policy makers have sufficient tools to give an impetus to the economy, we believe this may not be used in the shorter term, as inflation continues to run high. This can cause revenue growth and profits of many companies to be affected. More importantly, firms that are already loaded with a highly leveraged balance sheet and are facing business weakness may face some extremely difficult times. With interest rates going up sharply, several discretionary purchases are getting delayed. Further, we understand that several projects are facing delays due to a slowdown in decision making in government. Some of the infrastructure projects are facing delays due to longer decision cycles. As a result, one is likely to see some slowdown in economic growth. Though one is unlikely to see a recession, some slowdown could have a severe impact on several pockets of the economy. In this context, we believe it is wiser to stay focused on extremely sound companies that are not likely to see revenue growth getting affected too badly in the coming months. Stocks prices of these companies are likely to hold up better and more importantly, unlikely to spring any major negative surprises on shareholders.

In this cautious environment, it is important to note that markets are down close to 20% in 2011 and this severe fall has made several stocks trade at prices which makes them broadly look attractive. After almost about 2 years, valuations are trading closer to being called ‘cheap’. Many high quality stocks are starting to trade at favorable Risk-Reward and it seems like a good time to build a solid portfolio of stocks. One may not see immediate term results, but over a period one should see more than satisfactory returns.