Saturday, August 6, 2011

The Currrent Global Crisis

The Sensex hit a 13 month low on Friday. This was along with the global panic in the equity markets due to the following:

1. Sovereign debt worries in Europe especially in Greece, Ireland, Portugal, Italy and Spain. The yield in 10 year treasuries in Italy and Spain suddenly spiked up in the last week. Large sums of Italian treasury mature next month and that increased market jitters. This increased fears over contagion over the entire regions as it has high exposure to Italian debt.
2. Slow down in the US economy. The ceiling on the debt will result in spending cuts and lowering of the stimulus of economic growth.
3. US debt rating has been cut from AAA to AA+ by S&P. We have yet to see the impact of that event on the equity markets.

Developed markets out performed Emerging Markets year-to-date as investors rotated positions. Hence Developed Markets saw net inflows and Emerging Market funds net outflows.


Our markets have been range bound for the last two years. The Sensex touched 17000 level on the way up in September 2007. After touching a Sensex high of 21200 in January 2008 and a low of 7700 in October 2008, it retouched 17000 again on the way up in September 2009. It is now been 2 years, and the Sensex level in still in the same range of 17000 to 20000. Due to global factors we are currently again at the bottom of the range.

We do have our own problems the major of which is inflation. Persistent inflation has caused the RBI to continuously raise interest rates. Higher commodity costs combined with higher interest costs has resulted in fall in profitability of our Corporates. Our fiscal deficit position too is not healthy. Constant scams, paralysis of the Government’s workings, lack of reform, also stunts India’s development.

Case for India.

1. There is nothing fundamentally wrong with the Indian economy.
2. The PE of our markets, when the Sensex first touched 17000 was 23.17 times. Although the market has gone no where, the PE is currently, at 18.03 times, due to the growth in earnings. The long term average for our markets from January 1991 is 19.76 times. The markets always look at one year forward PE, and 2012 PE is at 14 times. By December 2011, the market will start looking at 2013 earnings at that is at 12 times. 12 times one year forward PE represents crisis levels and we are definitely not in such a bad condition as the rest of the world.
3. With fears of a global slowdown, commodities, especially oil, has started falling. This is good for India as 70% of our import bill is oil.
4. We are likely to be near the top of the interest rate cycle. With commodities cooling off, inflation should also cool down. Further with a good monsoon food inflation too should show some softening. Stable interest rates will have a positive impact on our markets.
5. Past experience suggests that strong economies tend to out perform after dips caused by external factors
6. Weakness in developed markets will redirect flows back into emerging markets, such as India. This will result in a re-rating especially as valuations are now attractive.

Action to be taken:

1. For new equity investors, the risk / reward ratio is in favour of reward. Invest in the equity market, based on your asset allocation.
2. For investors already in the market, re-balance your portfolio and add to equity. If the market continues to fall, you can consider increasing your weightage to equities in your asset allocation.

Take advice of a Certified Financial Planner to build your portfolio based on your asset allocation.