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Friday, March 14, 2008

What should retail investors do..

What should retail investors do in this nerve-wrecking period?

The global turmoil has pushed Indian stock indices to levels unthinkable exactly two months ago
when market was trading at its all-time high and was roaring to scale new highs. The fall in last
two months has been so sharp and so sudden that it has un-nerved even the most seasoned fund
managers and investors. The fall has been so sharp that during these two months, BSE Sensex
dropped by 25 per cent, mid-caps dropped by 34 per cent and small caps dropped by 42 per cent.
And this fall in the market is associated with lack of volumes as well as buying support. There
are no buyers even after such sharp and drastic fall. This brings us to the core question – what
should an investor do in such a scenario?

Global Scenario

It is now well known that the current crisis in global market is due to sub-prime crisis in United
States resulting in drying of liquidity which was chasing momentum around the world for last
few years. While central banks around the world, led by US Fed, are cutting interest rates or
providing liquidity support to avert major credit crunch, it has not yielded desired impact till
now. Also nobody is in a position to react to the big macro issues such as where the dollar is
going, what is the likely GDP growth of US or China, what is happening to US and global
inflation, what will happen to commodity and oil prices and so on. For every smart person on
one side of question, there is another smart person on the other side.

However, like in any crisis, there is a silver lining. With crude oil at $ 100 a barrel, there is going
to be massive transfer of global financial wealth from oil consuming countries to oil exporters.
At the current pace of production and exports and at current prices, oil exporters are projected to
earn a total of US $ 2 trillion annually in oil export receipts evenly split among Gulf countries
and non-OPEC countries. While some of these (say 10 per cent) will be absorbed by economies
of the oil producers (with the size of the GDP of most of these oil exporters being relatively
modest) but a far larger amount will be saved and invested outside these economies. Indeed, a
petrodollar tsunami is coming, with significant consequences for global financial markets.
At the moment, much of this money is being invested in US Bonds. But with slowdown in the
US and a falling dollar on the one hand and sharp fall in the global equities on the other, it is
expected that most of these will be invested in the equities of emerging markets (read Asian
emerging markets including India). Indian markets should benefit from these petrodollar
investments just as Indian engineering firms are already profiting from the boom in West Asia.
Indian Valuations With the sharp fall in stock prices in last two months, a large part of froth generated in the
market is now out of the system. Markets are currently trading closer to their fair fundamental
value. Also, India's economic fundamentals are in place with GDP growth likely to be in the
region of 8 per cent and domestic savings and investment rate to be more than 35 per cent.
Interest rates are a bit higher and inflation (though bit of a concern), both are well managed by
RBI. Corporate profitability growth will however certainly slowdown in FY 09 but that too
mainly remain concentrated in financials, materials, telecom and utilities. Overall, India story
continues to remain strong but sentiment has taken beating due to unfavourable global
developments.

While BSE 30 Sensex may be presently trading at 16,000 level, large number of small and mid
cap stocks of well managed companies (including quite a few multi-national companies) are
trading at levels that corresponds to a Sensex of less than 10,000. The Index is only standing at
16,000 thanks to stocks like Reliance, SBI, Bharti, HDFC, ITC and HUL.
Investment Philosophy and Strategy Since 2003, there has been a globally benign environment for both the economy and equities
with low interest rates and low inflation. With the availability of high levels of cheap
borrowings, investors paid more attention to momentum than fundamentals (in the short run,
market is driven by perception rather than reality). And this continued good news led to a degree
of complacency and meant the market continued to take on risk. Today we are beginning to see a
reversal of these trends. There are indications that risk is being re-priced.

This indicates than not all stocks will do well in a slowing economy. So the environment now
favours selective fundamental stock-pickers who can seek out those who perform well despite
challenging macro market environment.

Opportunities are abound at the current market level. What is undeniable is India's appetite for
infrastructure development and increasing consumerism in the country. From a 3 years
perspective, the market should deliver high positive returns. As some one has rightly used
cricketing metaphor – "if you can see the first 10 overs through, when the ball is swinging, rest
can be managed".

We expect large number of open offers from small and mid cap multinational and well managed
Indian companies in next 12 to 18 months. In fact, a few such announcements have already
happened and lot of them should materialize in coming period.
Conclusion

In conclusion, current scenario presents an attractive opportunity to the patient and long term
investor to build a quality portfolio of stocks as prices of almost all well managed stocks have
come off by more than 40 per cent and hence returns from these levels over the next 3 years will
be significant for any investor. If you hold Equity Mutual Funds and/or ULIP's, being long term
investment, they keep their full attraction and remain an efficient solution in the medium term.
 
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