Our pronounced caution over the past two months (in the midst of a rising index) has severely backfired after the Lok Sabha election results. Safe Wealth’s 77% exposure in cash stands out like a sore thumb. It has risen only 10.75% against the Sensex, which has gained 60% since the lows of early March. Wealth Zoom has done even worse, courtesy the small shorts that your fund manager had attempted. It has risen less than 2% in a fortnight that saw the mid-cap and small-cap stocks rise sharply even as the Sensex set a record for the biggest single-day rise both in absolute and percentage terms.
While it is clear that we have severely underperformed in relation to the broader market, we must also recognise that there was very little by way of rational evidence over the past few months that could have prompted us to go long.
Except for one big development, which was, and continues to be, the collective enthusiasm of central banks and governments around the world to engage in quantitative easing, that is, increasing money supply and restoring confidence in the credit markets. In the face of this liquidity surge, all other factors take a backseat. So as the tide comes in, all boats will rise. Many of them have risen already—just look at the smart gains in some of the stocks in our Safe Wealth portfolio.
I’d remain cautious about the sustainability of this 60% rise in under three months, and would actually bet on a blowout, should we cross a threshold. Now, this threshold may not be defined by a clear Sensex PE because currently the Sensex is trading for over 15 times one-year forward earnings. Even if the earnings estimates are upgraded a little from here (in keeping with the considerably better mood), we would get about 7% earnings yield from the Sensex, which is only marginally higher than the price of a 10-year government paper today. So where is the margin of safety?
On the other hand, government borrowing is now set to increase if it has to fulfil the sky-high expectations on social and hard infrastructure creation in the next five years (not that I am against such spending). This will surely push up interest rates, crowd out private borrowing, and push down not only profit margin but risk appetite for equities. If, instead of raising borrowings, the government chooses to monetise a large part of its shortfall, then inflation could rise, causing immense hardship to most Indians. Catch-22!
To understand what’s going on, let’s rewind a bit. Earlier in the year, as the aftershocks of the first wave of economic recession set in, commodities continued to crack from their early and mid-2008 highs, business volumes across industries contracted due to severe cutbacks in sales and pipeline destocking. With the credit crunch setting in full time, the over-leveraged US consumer drastically cut back on consumption, sending the Chinese, and much of the global, manufacturing into a tailspin.
Naturally, equity markets across the world contracted severely. In India, financial services (banks) and industrial (infrastructure, real estate, construction, capital goods and engineering) stocks were the worst hit, leveraged as they were to the interest-rate cycle. This hurt even more considering the relative over-ownership, and consequently, stronger selling of such stocks by institutional investors in keeping with the ‘India’ theme.
Now, as investors’ hopes are rekindled by this strong and artificially induced pull-back, fund managers at mutual funds and foreign institutional investors are rushing to buy. They feel severely left out of the recent run-up, which they were dismissing as a bear market rally. So let’s face it, there are some more positive feedback loops to be completed before this rally peters out. As a citizen of this country, I will obviously hope that economic growth comes back with a vengeance. But the rest of the world does not seem to share my enthusiasm.
So, 15 times one-year forward is not exactly a level I will rush to buy at. If it means that I am at the receiving end of readers’ comments for a few more weeks or even months, so be it. There is still far too much that is structurally wrong with the financial world, no matter how strong a story of Indian growth the optimists might proffer.
The high levels of cash in the two portfolios might seem like an opportunity lost. But, having missed this strong pull-back rally, there is no way we can risk our money for the sake of some more short-term pyrotechnics in the stock market. So we have neither covered the shorts initiated, nor added any stock to the two portfolios. A patient wait will yield rewards, and if they don’t accrue right away, so be it.
One stock that is missing in your Wealth Zoom portfolio this time is Bartronics. Why? Also, why haven’t you considered stocks such as KS Oil and 3i Infotech, which have a good CAGR? I think you should start another category called ‘multibagger’ for investors who have a high-risk appetite.
- Saurabh Sharma
My key position remains what it was in January 2008. Stock markets will hit the bottom between March and August 2009 and then immediately take the path to recovery. The worst news on the economic front, globally and from India, is yet to come and will do so between April and September 2009. The initial stages of economic recovery will happen between October 2009 and March 2010. However, the recovery will move along very slowly in 2010.
- Amar Harolikar
The IT firms are headed for the worse—difficult macro-economic conditions, reducing margins, lower utilisation of employees, tougher competition for the same pie and business models that are no longer unique. No IT company should find a place in either portfolio, at least till the end of the October or December quarters.
- Pramod T. Palathinkal
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